Doubling Down on the US Oil Industry Amidst the Coronavirus Outbreak
Collapsing oil prices have sent global stocks plunging as the market enters a more threatening stage of coronavirus-induced downturn. Investor uncertainty, manifested in a flight to lower-risk options, has left overleveraged, independent US oil producers at risk of default and increased merger and acquisitions. An escalating oil war between Russia and Saudi Arabia further threatens their predicament. Buried beneath the chaos is a message for investors and industry leaders: to the extent that the present moment validates concerns about the vulnerability of American oil producers, it also reaffirms the importance of, and potential for, US oil and gas industry expansion.
The future of smaller US energy companies will be decided, in part, by the lens through which current setbacks are understood. Investors will need reassurance that the coronavirus represents an anomalous interruption to expansion, and that recent performance is not indicative of complex, unresolvable issues inherent to the industry’s geopolitical status. Fortunately for American oil producers, the root cause here is largely singular: decreased worldwide productivity amid fears of a deteriorating global health situation has created a negative demand shock. The immediacy of this problem is tempered by its likely short-term nature. The current glut does not reflect a longer systemic problem such as an unfriendly regulatory environment or any other more permanent obstacle to success.
Skeptics would be correct to point out that OPEC and Russia’s decision to engage in a price war in the midst of this viral crisis is largely responsible for the magnitude of the price drop. However, they would be wrong to interpret that choice as a sign of unassailable market dominance. If anything, it exposes weakness. Rosneft and other Russian parties have openly stated that the reason they did not align with Saudi Arabia to reduce supply was to prevent American shale-oil producers from increasing their market share. The opportunity to retaliate against recent sanctions on the Nord Stream 2 pipeline undoubtedly influenced their decision. Saudi Arabia, in turn, initiated the conflict by promising steep discounts and raising production to squeeze Russian companies.
Beyond the compelling political motives of both parties, the underlying logic of their gamesmanship has limitations. Cutting oil prices is a tactical move that stunts the growth of the US energy industry in the short term. However, it isn’t a credible strategic threat in the long term because the success of the American economy is far less dependent on oil prices than its antagonists. The most recently available World Bank data indicates that Saudi Arabian and Russian oil rents as a percentage of Gross Domestic Product (GDP) are 130 times and 36 times higher respectively than those of the US. Although that gap has likely shrunk in recent years, the significantly more diversified US economy has greater resilience to oil price manipulation, and punishment exerted against American producers may quickly be outweighed by Saudi-Russia self-inflicted damage.
While US oil producers might lose in a sprint to cut prices, they can win on endurance. That endurance translates to strength. Russia’s recalcitrance to cut supply, even at the cost of alienating an ally, is proof of the threat posed by the growing US energy industry. Their gambit only succeeds if American oil producers are forced to cease operations. For domestic investors, hanging tough has a higher payoff in the long term, and achieving a greater market share will help make American oil companies more resistant to price manipulation. Depending on its longevity and intensity, the OPEC-Russia infighting may even give the industry time to further consolidate and expand.
The coronavirus will pass, and if artificially low prices fail to significantly diminish production and deter American investors from providing the capital necessary for sustained expansion, the US oil industry will be positioned for a strong rebound in the aftermath of the outbreak. Smaller producers in particular will have to cut operating expenses and exercise financial discipline to ride out the crisis, but if successful, they will have an opportunity to capitalize on price increases when the Saudi Arabian and Russian economies are inevitably exhausted by their oil war. For American investors and producers, a steady hand in the face of uncertainty may be rewarded with a more robust domestic oil industry, greater energy security, and enhanced negotiating power. Yielding now would amount to a missed opportunity to subvert the strategies of vulnerable energy adversaries.
Guy F. Caruso is a former Administrator, US Energy Information Administration.