The State Hit Hardest By The Oil Crash

By Nick Cunningham

The Texas economy has suffered a double blow from COVID-19 crisis and the collapse of the oil industry.  U.S. shale drillers had already planned on cutting capex this year by 10 to 15 percent, even before the pandemic. “Coming into 2020, many exploration and production firms faced an inability to produce attractive returns amid heavy debt burdens and an oversupplied oil market. Investors had grown skeptical of the sector,” the Dallas Federal Reserve said in a report.

But drilling has gone from merely a “slowdown” to a more extreme sudden stop. The rig count has plunged by more than half. All told, the sector could spend 40 percent less this year compared to 2019, with much of the contraction concentrated in the second quarter.

“While U.S. oil production growth was already on the verge of leveling off due in part to the steep output-decline rate of existing wells, the drilling slowdown makes it likely that U.S. output will struggle to reach its previous highs in coming years,” the Dallas Fed said.

At the same time, market sentiment is improving. Global supply fell by 12 million barrels per day (mb/d) in May, according to the International Energy Agency. Oil prices are trending up as a growing number of analysts envision a supply deficit in just a few months.

If OPEC+ sticks to its supply cuts, the oil market “would be undersupplied to the tune of 5.5 million barrels per day on average in the second half of the year,” Commerzbank wrote in a note on Friday.

But even if the oil market heads towards some sort of “rebalancing,” it will stabilize at a substantially lower level. The market could be undersupplied because supply will be somewhere between 90-95 mb/d, for example, rather than 100 mb/d.

More importantly, oil prices are widely expected to remain stuck below $50 per barrel for at least the next year. The U.S. shale industry was never profitable even when prices were much higher. There is little reason to think that the energy industry will be an economic engine with WTI trading well below $50 per barrel for the foreseeable future.

“We probably have to let go of energy as being the No. 1 industry in the long run,” Peter Rodriguez, dean of the Jesse H. Jones Graduate School of Business at Rice University, told the Texas Tribune in a recent interview. “That primacy is no longer in the cards for Texas.”

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The oil and gas sector spent $1.2 trillion on drilling wells between 2010 and 2019, according to data from the Dallas Fed. The industry – and Wall Street – won’t be spending anywhere close to that rate going forward. Investors had already begun to sour on oil and gas, as evidence by collapsing share prices for shale companies in 2019.

That means that unlike the 2014-2016 downturn, it will be vastly more difficult for indebted shale drillers to convince big investors and banks to dole out another wave of financing. As a result, a rebound in drilling close to pre-pandemic levels is out of the cards.

The economic fallout from the decline in investment in the energy sector is already enormous. For the week ending on May 7, Texas saw 32,800 unemployment claims from workers in the “mining” sector, which is mostly made up of oil and gas. In other words, roughly 137 out of every 1,000 unemployment claims filed in Texas came from oil and gas workers. Over the past week, Texas shed another 1,000 jobs in oil and gas. Lower spending will translate into a 6.1 percentage point decline in total U.S. fixed investment in the second quarter.

More broadly, the energy sector will remain at the mercy of the pandemic. Much of the popular press has framed the dire economic situation as one of reopening the economy versus maintaining a draconian shut down. But that framing sets up a misleading straw man argument. Many U.S. states have already begun to reopen parts of their economies, and did so weeks ago. Others are in the process of lifting restrictions.

The problem is that many people are staying home anyways, even in states that are “open,” in an effort to minimize risk of infection. That doesn’t bode well for the prospect of a swift return of oil demand. It is also an ominous sign for the economy. Even Senate Majority Leader Mitch McConnell (R-KY) opened the door to more trillion-dollar stimulus, after previously stating that he saw “no urgency” to act.

By Nick Cunningham of Oilprice.com