Another Coronavirus Casualty: Western Energy

“We’re at war with the virus,” says President Trump.

True enough…

In keeping with the martial analogy, one early attack vector by the coronavirus has been energy demand. It’s been hit hard across the globe and across all markets. Airline travel is down by as much as 96%. Driving is down by about 70%. Refined products are barely moving.

From prospect to pipeline, refinery to gasoline pump, the oil sector has rapidly tumbled into a deep, demand-driven (or “lack-of-demand”-driven) slump. And it’s been compounded by the oil price war that Saudi Arabia triggered, as I discussed on April 21.

We’re setting the stage for the next crisis… A crisis in energy, which will hit like a ton of bricks when the medical issues begin to resolve.

To understand why, let’s start by looking at some really big, expensive things that are currently sitting idle…

Less than two months into the fight against coronavirus, the entire energy sector is retreating from the front lines to the aid stations. It’s carnage out there. Rigs by the hundreds are laid up, and crews by the tens of thousands are being laid off.

Here’s a striking, but eerie, photo from the U.K. Financial Times. It’s a long string of offshore drilling rigs, idled and anchored in a Scottish inlet that connects with the North Sea.

idle rigs

Sixteen idle rigs in the Port of Cromarty Firth, Scotland.

“The whole of the North Sea has gone into meltdown,” according to Bob Buskie, chief executive of the Port of Cromarty Firth.

Offshore rigs like these are major capital assets. Brand new, they run from $200 million to over a billion dollars. So that photo shows about $10 billion in capital, just sitting idle. Under current conditions, more than a few of these offshore rigs — and many more across the world — are headed to the scrap yard, barely worth the price of their steel.

Meanwhile, drilling crews are valuable teams of human talent. It takes years to learn the skill set required to work on a rig. But as oil companies slash budgets, even the best of crews have been pulled back off drill sites.

Of course, the energy industry has long been cyclical. There have been good years and bad ones since the days of Colonel Drake at Titusville in 1859. People who’ve been around the oil patch know how it works.

Indeed, when I worked at the former Gulf Oil Company, now part of Chevron, people used to say, “An optimist is a geologist who brings his lunch to work.” As in… you may not be around by noon to eat it.

When times are good in the oil biz, they’re good. But when times get tough, it’s brutal. Out on the rig, the radio crackles or the phone buzzes. You learn that management has pulled funding for further work. “Shut it down and secure operations,” comes the word…

Then, as we see in Cromarty Firth, Scotland, above, rigs and crews make their way to a sheltering lee, to await their fate while riding the tides of time.

Of course, these dramas aren’t just occurring offshore. Onshore it’s just as bad — if not worse.

“Drilling rigs sit idle as OPEC declares war on American oil and gas producers,” is the headline of a recent note in Roughneck City News, a web site for energy industry workers.

From drill decks to pipe yards, everybody knows what’s happening. There’s no beating around the bush. OPEC – and Saudi Arabia, specifically – wants to rip the heart out of the U.S. energy industry. Canada too, it’s worth noting. Saudis have little but disdain for North America’s “high cost” oil. Especially since that oil has displaced Saudi barrels from the market.

Here’s a photo of “stacked” rigs that accompanies the Roughneck note. (When rigs are laid away for storage, it’s called “stacking.”)

Idle rigs

The future is now. Idle rigs in Texas.

To add numbers to the imagery, here’s a graph of the Baker Hughes rig count over the past year. As you can see, things were tightening a bit at the beginning of 2020, but still going alright.

And then came March…

rig count

Baker Hughes rig count.

The graph indicates over 200 rigs shut down in about a month. More are on the way, too, based on public announcements by oil companies.

While you dwell on that, let’s put some human faces on these shutdowns.

Directly or indirectly, a typical onshore rig might employ well over 100 people. That’s three shifts of workers, support personnel, service crews, office personnel and various others from truck drivers to bulldozer operators.

Doing the math, 200 rigs times 100 employees per rig makes for 20,000 job losses in the U.S. oil patch alone. And that’s good-paying work — often about $100,000 per year. All told, unemployed rig workers are losing s $2 billion in payroll.

Now factor in everything that a drilling rig uses to make a well. There are drill bits, pipe, chemicals, tools, diesel fuel and more. Plus, there’s down hole logging, and everything that goes into an oil well for completion, from pipe and cement to measuring equipment, pumps, wiring. And then all the topside equipment.

Add it up and we’re looking at multibillions of dollars of capital and supporting services that are not being invested in the U.S. energy business. All lost to the economy in a month or so.

It’s big bucks lost to steel mills that don’t sell steel. Big bucks lost to cement plants that don’t sell cement. Big bucks lost to companies like Schlumberger and Halliburton that don’t sell oilfield services. And big bucks lost to a long supply chain of equipment makers who produce everything from exotic electronic circuit boards to welding rods, nuts and bolts.

And you thought China took U.S. factories? Now, courtesy of Saudi and its oil war, we’re looking at a major U.S. industry — with global reach — being economically strangled. It’s over 150 years of industrial heritage dying right in front of us.

This is definitely not just an oil patch tale, either… The effects of all this will soon hit the broad U.S. economy.

The Houston Chronicle forecasts that U.S. oil output will fall by over 2 million barrels per day by the third quarter of this year (aka “July”). That’s not quite 20% of current U.S. daily output from wells. It’ll be replaced by imports from the likes of Saudi Arabia or Venezuela.

The point is… We’re looking at a vast expanse of the U.S. economy going up in smoke. Other oil producing areas like the North Sea are in deep trouble as well.

So the next question is, how long will it take to recover?

Obviously, there’s “too much” oil in world markets. Demand has nosedived. Oil prices have declined globally and utterly crashed in the U.S. and Canada. It’s no accident. This is a “hit” on the U.S. and Western energy industry and energy security.

That is, Saudi Arabia has flooded the world with oil in a “crude” attempt (see what I just did?) to smack down prices and wipe out U.S. “shale oil” — meaning oil from fracking. Courtesy of Saudi, oil prices have tumbled across the world, but nowhere more than in the U.S., particularly West Texas and the U.S. mid-continent. (Again, I discussed the Saudi angle on April 21.)

In fact, oil contracts for West Texas Intermediate (WTI) oil went “negative” recently. Some traders had to pay over $37 to a counterparty to unload their delivery contracts. (This is a “paper oil” trading issue — due to lack of storage for all the excess oil looking for space inside the U.S. market.)

Thing is, though, thanks to the Saudi gambit, there’s a heck of a lot of surplus oil not just in the U.S. but across the globe. Oil storage tanks are filled to nearly the top from Edmonton to Oklahoma, from Rotterdam to China. Pipelines are full. Refineries have no storage left. By some accounts, over 200 million barrels of oil are stored in tankers floating around the world’s oceans.

Here’s the forecast… It will take much longer for the world oil business to recover than many people think.

For example, one big name leading the overoptimistic charge is Goldman Sachs.

Goldman anticipates a “V-shaped” rebound to the U.S. and global economy. That is, as people eventually return to work, we’ll see more driving, more airline traffic, more energy use in general. Here’s Goldman’s chart…

covid chart

Goldman believes that global demand for energy will all be back at relatively “normal” levels by this summer.

I doubt that… It’s more like Goldman is “talking their book,” to use an old phrase. Goldman doesn’t want people to throw in the towel. Goldman wants people to go out and buy some stocks!

Of course, we “hope” that people go back to work, make money, spend it and burn oil.

But recovery from the widespread lockdowns will be a slow process across the U.S., subject to all manner of domestic politics. Plus, kicking up the fuel-burn in other nations is no sure thing either, from the U.K. to Argentina. Even China, with its alleged “recovery” from the virus impact, is still firing on less than all cylinders.

So no, don’t count on a flood of pent-up, post-lockdown demand to bring things even close to what it used to be, all of two months ago.

The follow-on implication is that we won’t see a V-shaped recovery. And the current glut of oil in tanks, pipelines, tankers and more will be around for quite some time as the world burns it down. Think in terms of 2021, and possibly into 2022.

What’s the forecast for the U.S. oil industry? Grim, for as much as I hate to say it.

The big picture is first, lack of demand, which will abate slowly. Then there’s the fundamental oversupply of oil. Along with low prices. And no relief in the short term. It’s a bad setup.

At the business level, we’ll soon see an explosion of bankruptcies across the oil patch. Operating companies, support service companies, “body shops” that supply labor, construction companies, suppliers…  And then there are the banks and hedge funds with deep exposure to energy loans. It’s going to be a total mess.

Some commentators look at this and see the proverbial “glass half full.” They rationalize that while businesses may go bankrupt, “the assets remain.” That is, the wells, rigs, supplies in warehouses and even many of the people involved will still be there, awaiting reorganization by new owners and management teams.

Yes, but… Whatever happens in bankruptcy court, the next version of the U.S. energy industry – the one that comes out of all this – will be much smaller. We’ll see far fewer people involved, with less equipment available and overall fewer capabilities. Then, over the next year or 18 months, the “new” firms will emerge into a miserable environment of surplus oil, low prices and slow demand.

Another more strategic risk to the U.S. is that foreign money might swoop into bankruptcy court and buy up critical assets or technology. Then, just sit on it. And the U.S. will really lose control of its energy destiny.

Looking ahead, there’s no doubt that the U.S. will produce less oil. It’s a new version of North American “peak oil.”

In the future, the U.S. will import more raw petroleum, and even import some refined products. Just what we need… More reliance on imports. That worked so well from the 1970s to the 2000s (just kidding).

This is what happens when you destroy capital in record amounts and at record rates. Or more precisely, when a Saudi-initiated oil war destroys pricing and kills the U.S. energy industry. We’re going to come out of this virus and oil war situation a poorer nation in many respects, but particularly in terms of energy security.

We’re in a “war,” say the politicians? Well, this is what happens when you lose.

On that note, I rest my case.

That’s all for now… Thank you for subscribing and reading.

Best wishes,

Byron King

Byron King
Managing Editor, Whiskey & Gunpowder
WhiskeyAndGunpowderFeedback@StPaulResearch.com

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Byron King

A Harvard-trained geologist and former aide to the United States Chief of Naval Operations, Byron King is our resident gold and mining expert, and we are proud to have him on board as the managing editor of Whiskey & Gunpowder.

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