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Are Mandatory Output Cuts The Only Way To Save U.S. Oil - OilPrice.com

Irina Slav

Irina Slav

Irina is a writer for Oilprice.com with over a decade of experience writing on the oil and gas industry.

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The United States has been on the opposite side of the OPEC oil cartel for decades in a great battle between the free market and supervised production levels.  All that may be about to change, with the free market in the United States giving way to unprecedented action that could direct production levels of its private oil companies, playing OPEC’s game to survive the current crisis.

The U.S. oil industry is very sick and getting sicker by the day.

The negative prices we saw last week, finite oil storage space and the decimation of demand caused by the coronavirus have signaled a radical change in the American shale patch.

The change has been quick and brutal. Just last year, buoyed by sharp increases in natural gas and crude oil output, the United States actually produced more energy than it consumed for the first time since the late 1950s, according to new data from the Energy Information Administration (EIA). 

Fast forward four months from December 2019, and we have shale drillers shutting in wells, suspending deliveries to clients, and filing for bankruptcy. Demand for oil has fallen by close to 30% globally and is unlikely to recover anytime soon. Production is also falling—but not fast enough: The OPEC+ cuts won’t take effect until May, and it takes a while to shut-in a well, so the first effects of the cuts are still months away.

Meanwhile, storage is filling up with unsellable oil, both onshore and offshore. Around the world, at least one in every 10 very large crude carriers (VLCCs)—each capable of holding 2 million barrels of oil—is currently acting as floating storage, according to Saudi energy officials. Demand for VLCCs is rising, according to data from Signal Group, but the bookings are not for crude oil deliveries, just for storage.

The United States federal government has leased 23 million barrels of storage space in the Strategic Petroleum Reserve to struggling oil companies. 

Related: How Trump Convinced Saudi Arabia To End The Oil Price War
A pipeline operator, Enterprise Products Partner, has offered companies to open up the unused capacity of its Seaway pipeline to send oil to the Cushing hub. 

Energy Transfer has gone a step further and has asked the Texas Railroad Commission to allow the use of pipelines as storage space.

All these things paint the picture of an industry in a state of panic, and with good reason: It’s running out of options. 

In addition to the voluntary shut-ins of wells, the only meaningful move that U.S. oil has is to cut production. Since most U.S. oil companies do not want to cut production except as a drastic last resort, regulators need to step in.

The idea of mandatory oil production cuts like the ones affected by OPEC+ but also by Canada’s Alberta was first floated by Texas Railroad Commissioner Ryan Sitton as a way to mitigate the effect of the Saudi-Russia price war and the looming coronavirus crisis on oil prices. Now, with the war over but the subsequent crisis still in full swing, the idea probably sounds, if not more appealing, then at least more probable.

The Texas Railroad Commission was scheduled to vote on mandatory production cuts this month. Instead, it delayed the vote until May 5, likely in hopes that the situation would somehow resolve itself. 

Although some companies such as Pioneer and Parsley Energy are vocal supporters of mandatory cuts, most are against it, notably the supermajors, who are also the most resilient to the crisis.

Of course, there is also negative sentiment to government-instituted production limits. It’s just not the American way to dictate to companies how much oil they should pump—the United States likes to leave that to the oil cartels. But when push comes to shove, some have realized that these glaringly un-American measures might be the industry’s only hope.

And despite the blowback on legal grounds, there is no legal obstacle, either, according to a Reuters round-up of lawyer opinion. It is illegal for companies to agree on production limits amongst themselves, as this would constitute a cartel under U.S. antitrust law. It does not, however, prohibit state or federal regulators from imposing a production limit.

Related: Russia’s Grand Plan For Arctic Oil Is Under Threat

“Trump himself, other federal officials, and Congress cannot violate antitrust (law) by any official actions they take. It doesn’t apply to them,” one antitrust law professor said.

One may ask why the industry would need mandatory cuts if it’s already cutting by default due to market pressure? After all, President Trump himself said U.S. oil production would decline organically, thanks to low oil prices. However, prices have fallen way too low and too fast, and an organic decline will not be fast enough to respond to the situation, which would justify mandatory cuts.

And while Texas and its oddly named Railroad Commission have stolen the limelight in this respect, it is not the only state considering mandatory cuts. In a recent notice, the North Dakota Department of Mineral Resources is also set to discuss whether producing low at current prices is not a waste of resources, suggesting that they may be preparing for mandatory cuts, too.

So, the chances of state regulators imposing production limits on oil companies are growing increasingly more likely. The question of whether they would work fast enough to revive the U.S. oil industry, however, remains. Some, such as the government in Washington, are optimistic. Others, such as Art Berman, not so much

One thing is for sure, though. The effect of this crisis on the U.S. oil will be even more transformative than the shale revolution.

By Irina Slav for Oilprice.com

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