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As mentioned on the podcast and on LinkedIn posts, David was asked to provide members of the Executive Branch a whitepaper on Governmental Responses to the Domestic Production Crisis.

In short, the white paper discusses what steps to take, with the keys being:

A) it rebalances the market in this crazy time and protects companies from a full unstructured collapse and chapter 11

B) if adopted would immediately retaliate (ban) flaring which would be environmentally better and aid in rebalancing the market

C) lower capital activity in the US to a sustainable level and aid the transition of energy policy

D) support workers who are currently and will be displaced out of the industry until the economy stabilized post COVID-19

E) uses tariffs on imported oil to finance and back the plan, supporting America’s energy independence go forward.

White Paper follows:

White Paper

Stabilization of the United States Oil & Gas Industry

March 16, 2020

Purpose

The purpose of this paper is to propose necessary federal action to stabilize the United States oil and gas industry, protect domestic energy independence, and avoid widespread economic hardship which will result from the collapse of one of America’s most prominent industries.

Executive Summary of Key Actions Proposed:

1. Shut in production on all federal onshore and offshore leases, impacting an estimated 2.8 million barrels per day of supply.
2. Provide covenant guarantees to those companies affected for 180 days for the COVID-19 crisis to pass
3. Implement a $30/bbl tariff on all imported crude, excluding Canada.  Part of this tariff would be used to support hourly, field, oilfield service and midstream staff impacted by the reduction in activity.
4. Cut U.S. crude exports to 0 until the US SPR is refilled.

Background:

The importance of the oil and gas industry to America cannot be understated. The sector contributes significantly to the American economy through employment, tax revenue, and support of consumer economy. For example, according to the 2019 U.S. Energy and Employment report, the fuels sector, which includes oil and gas exploration and extraction, employed 1,127,600 workers[1] and under President Trump’s energy agenda, total energy production across various sources reached a record high in 2018[2]. Increased domestic production and exports of crude oil made significant contribution to the flourishing economy under President Donald Trump. 

As a result of vulnerable balance sheets, perilous declines in demand due to the COVID-19 pandemic, and international price instability the industry is now in a state of emergent decline. Reduced production by OPEC and Russia enabled the U.S. to grow production to a record of 12.863 million barrels per day in 2019[3] at a $50-$55/bbl price environment. Recently, Russia rejected the OPEC recommended continuation of production cuts from member countries. Saudia Arabia responded with a threat to increase production and signaled the initiation of a price war. The threat of a price war and increased global crude supply tumbled Brent crude 24.7% to $34.10/bbl the following day, since which markets have continued to fall.

Coupled with the threat of a global price war, prices have been crippled by the threat of COVID-19 and a sharp decrease in global demand. Globally, 63.7% of oil consumption[4] is from transportation of people and goods. If we estimated that instantaneously in early February, Chinese demand for oil was down 22%[5], and that was before all the international flight restrictions and lock downs, it is fair to estimate global demand for transportation will be down 30%, which equates to 20 million barrels per day.  With global supplies at 100 million barrels per day (mmbo/d), excluding any actual increase in production by Saudi Arabia and Russia, there is a probable minimum of 20% over-supply of crude oil globally.  With no consumption, all surplus must go into storage until there is no capacity left, at which point, prices will tumble further. 

Finally, the state of industry balance sheets will make wide-spread bankruptcy unavoidable. After the oil price crash of 2014, with equity unavailable for growth, producers funded much of the recent production growth with debt. Over $200 billion of debt will mature over the next four years.[6] With global crude prices at $30/bbl oil and gas companies will be unable to repay maturing debts. At present, oil and gas companies in the United States don’t have sufficient cash flow to service interest, general and administrative expenses and capital and therefore continue to produce, further exacerbating their balance sheet risk by depleting resources and exposing regional banks.

The federal government took action to increase purchases for the Strategic Petroleum Reserve (SPR) but this is not sufficient to rebalance the market and provide the necessary cash flow to service upcoming debt. For these reasons it is imperative that we acknowledge  that a crippled domestic oil and gas industry will have significant negative impacts on domestic employment and economy, increase imports of crude oil, threaten America’s energy independence, and increase the geopolitical influence that Saudi Arabia and Russia have on domestic energy policy. In order to mitigate the threat of wide-spread economic and social harm, the U.S. government must suspend operations and production on federal lands to correct short term supply-demand imbalance, and, utilize tariffs on imported barrels to support short term market price, increase cash flow, maintain industry employment rates, and facilitate corporate restructuring.

Analysis

1. Current Federal Action is Insufficient

While the decision to purchase crude for storage is great for consumers, it will do little, if not nothing, to stabilize the domestic energy industry or world commodity prices.  At the least, exports should be reduced to 0 until the SPR is full.  First, we lack capacity in existing storage to accommodate oversupply. Second, storage cannot account for our reliance on export demand. And finally, purchasing for storage fails to provide the necessary cash flow to prevent widespread bankruptcy imminent across the industry.

Since 1982, the maximum storage in the U.S. including the SPR is 1.227 billion barrels[7]. Today, in total, we are 140.9 mmbbls away from maximum storage. For the SPR, the historical maximum is 726.6 million bbls, and we are 91.7 mmbo/d away from that. President Trump wants 77 million barrels purchased for storage. If the world is over supplied by 20 mmbo/d, we will fill storage in 7 days. Capacity of storage is thus clearly questionable. Additionally, storage does not account for our reliance on exports. Despite domestic production growth of light sweet barrels 7.9 mmbo/d (from 5.0 mmbo/d in 2008 to 12.9 mmbo/d in November 2019), the U.S. has maintained imports of sour barrels 6.5 mmbo/d over the same time period. Clearly, an increase in domestic production does not reduce our reliance on foreign producers. Similarly, in 2020 exports have averaged 3.5 mmbo/d.  Like it or not, domestic production is wholly dependent on world demand. Finally, because storage does nothing to increase market prices and increase cash flow benefit to producers, it will not mitigate the inability of companies to repay the $200 billion of debt we expect to mature over the next four year. 

Certainly, the purchase of crude for storage is an indicator of support by President Trump for the oil and gas industry. Similarly, the policy will provide many future benefits to consumers. However, because storage lacks the capacity to be a long term solution to curb oversupply, fails to account for reliance on world demand, and cannot stabilize market pricing sufficient to overcome balance sheets in crisis, the measure will fail to prevent the imminent crisis associated with a collapse of the domestic oil and gas production industry.

1. Federal Government Must Immediately Cease Operations and Productions on all Federal Lands

As discussed above, one can estimate that the world is over-supplied by 20 mmbo/d of crude.  Because the United States has consistently contributed to the oversupply of crude, the federal government must take immediate action to reduce domestic production and evidence good faith participation in the stabilization of global oil and gas prices. Production from federal onshore and offshore lands accounts for roughly 23% of domestic oil production.

The federal government must take action to curb domestic production and authorize an immediate temporary cessation of operations and production across all active offshore and onshore federal leases. Negative impacts on domestic producers should be mitigated by automatic extension of existing authorized federal leases and permits as well as guaranteed relief for lender covenant compliance for producers with significant federal assets.  The immediate cessation of operations and production on all federal onshore and offshore lands would remove 2.8 mmbo/d, which reflects a reduction in global oversupply of approximately 14% (being one and the same as our proportionate global market share). Such action taken by the federal government would be well received in the global community as good faith participation in the stabilization of global supply and demand.

A cessation of operations and production on all federal lands would necessarily include the shut in of many currently flaring wells.  In shale wells, first year declines are 70+%.  However, if you shut in a well that is less than a year old, it has the ability to “flush volumes” (over produce volume relative to where it was when it was shut in) as a result of the repressuring. My work in the Bakken, Eagleford, and Permian over my career has shown that if a well is down for 30 days, after 45 days back on (1.5x the time down) you will be at the exact same cumulative volume.  Having lost nothing but gained the benefit of selling at increased prices due to stabilized demand. Additionally, by promoting the immediate shutting in of all flaring wells, policymakers will be able to tout commodity preservation and environmental safeguarding. Surely a message that will resound well with upcoming elections.

1. Federal Government Must Initiate Financial Measures to Stabilize International Competition and Demand

To fund remedial measures for domestic production companies and prevent widespread financial distress, the federal government should implement tariffs on imported barrels of crude.  The incremental revenue collected on imported oil should be used to backstop unemployment benefits for industry hourly, oilfield services and midstream employees in financial distress as a result of halted activity, provide loan guarantees to prevent Chapter 11 filings, and promote corporate restructuring. 

Tarriff revenue used to prevent Chapter 11 filings should provide 1000-day loans by the government to those companies that take it at 8% (the Buffet pref).  Limitations should be imposed on use, for example, funds will be applied only to meet interest payments on first lien debt and provide liquidity sufficient to keep companies out of Chapter 11 until the crisis has passed and prices are restored. A similarly useful stipulation may be that any company who accepts funds must agree to austerity G&A across all positions including a standardized adjustment to executive compensation based on market cap average of the first 60 days of 2020 and all wells flaring gas must be shut in. Finally, it should be stipulated that tariff revenues will be allocated to provide a 3-6 month cushion in support of cash compensation reduction across industry.  As companies cut salaries, without eliminating benefits, they would be eligible for allocations from these funds.  Reduction of G&A is the only way to preserve cash, and a reduction in salary for everyone prevents layoffs, unemployment, and permanent loss of industry talent.

1. Conclusion

It is obvious that the U.S. must shut in at least 2.8 mmbo/d to accelerate the restoration of supply and demand globally. Domestic use of debt and subsidies from OPEC+ to grow U.S. production to 12.8 mmbo/d was not sustainable at the best of times, and remains downright irresponsible today. US industry needs $50-$55/bbl to drill economic wells, allowing natural declines to rebalance the global market and without dramatic intervention the market will not be restored to these prices before the majority of domestic producers are critically vulnerable to bankruptcy.  

In the present environment, with coronavirus restrictions limiting travel and the movement of goods, global oil demand is down 20 mmbo/d.  In 30 days, the world will have enough oil stored to replicate that SPR.  This oil will be owned by international countries and financiers who will be able to dump it on the market once demand returns at levels that could surpress the price of oil for years and never allow U.S. producers to repay debts, drill economic wells or support the domestic economy. Immediate temporary action by the federal government to curb all operations and production on federal onshore and offshore land would be a significant step toward rebalance of global supply and demand. Additionally, doing so while protecting domestic producers from economic insecurity through the allocation of tariff funds protects an industry most vital to our thriving economy.

About the author:  David Ramsden-Wood is a 20 year industry professional with a degree in Chemical Engineering with Petroleum minor from the University of Calgary, and MBAs from Cornell University and Queen’s University.  He has worked for Anadarko, Enerplus, Sundance and most recently co-founded OneEnergy Partners, a Delaware focused private equity back company which was sold in 2018.  His roles have covered all disciplines of engineering and operations, strategic planning and management.

[1] https://www.energyindepth.org/new-report-energy-sector-outperforming-the-economy-on-job-creation/

[2] https://www.whitehouse.gov/briefings-statements/president-donald-j-trump-unleashing-american-energy-dominance/

[3] https://www.eia.gov/petroleum/production/

[4] https://www.globalpetrolprices.com/articles/39/

[5] https://www.bloomberg.com/news/articles/2020-02-02/china-oil-demand-is-said-to-have-plunged-20-on-virus-lockdown

[6] https://www.wsj.com/articles/energy-industry-faces-reckoning-as-oil-prices-crash-11583806884

[7] https://www.eia.gov/petroleum/supply/weekly/