Week Ending May 15, 2020

Industry Eyeing Signs for Recovery as Policymakers Debate Aid, Resources

This Article Appears as Published in Foster Report No 3299
Industry Eyeing Signs for Recovery as Policymakers Debate Aid, Resources

As Congress considers the next round of financial relief to address the effects of the COVID-19 pandemic, producers and service companies in the upstream sector hope to receive assistance while gauging when the global oil market will provide signs of a recovery on the way.

Some of the market signals being watched include gasoline and jet fuel demand as travel restrictions are eased, oil storage levels, refining activity, broader economic trends and, of course, oil prices. Gasoline demand changes may be lumpy and hard to assess, as more people resume driving instead of taking mass transit in major cities, said Bob Fryklund, vice president and chief strategist for the upstream energy group at IHS Markit.

Storage is filling at a rapid rate, Fryklund and others noted during a May 13 webcast held by the Independent Petroleum Association of America (IPAA). “We’re not selling a barrel of oil in May,” as any production that has not been halted is being put in storage, said Jim Wilkes, president and part owner of producer Texland Petroleum LP. “Storage should be hitting a wall here by the end of the month,” Fryklund said.

Global production cuts have kicked in among the OPEC+ nations and stay-at-home measures are starting to be lifted in some states and countries. Those factors were among the reasons for prices stabilizing and climbing slightly, the International Energy Agency (IEA) said in its latest oil market report. IEA adjusted its demand projection to show less of an effect from the pandemic compared with its April report, but cautioned that “a resurgence of COVID-19 is a major risk factor for demand” in the coming months.

Global demand in the second quarter is expected to be 19.9 million barrels/day lower than the same period in 2019, and the full-year 2020 demand forecast is expected to be 8.6 million b/d lower than in 2019, IEA said.

Those numbers marked a slight change from April to account for a gradual easing of lockdown measures. IEA estimated that from a peak of 4 billion people living under some type of stay-at-home orders, about 2.8 billion will be in that category at the end of May. Mobility still will be limited, “but businesses are starting to reopen gradually and people are returning to work, which will provide a boost to oil demand, albeit a modest one at first,” the agency said.

On the supply side of the market, global oil supplies are set to drop to a nine-year low of 88 million b/d, with the 12 million b/d drop in May attributed to the OPEC+ agreement and production declines elsewhere in response to market conditions. It is in the upstream sector where the power of market forces has been demonstrated, with the pain of lower prices affecting all producers and refinery storage bottlenecks multiplying in early May, IEA said. Saudi Arabia on May 11 announced a further voluntary reduction of 1 million b/d in addition to the cuts agreed to in the OPEC+ alliance, meaning Saudi production in June will be 4.4 million b/d below what it was in April.

By the end of 2020, however, IEA expects the U.S. will be the biggest contributor to supply reductions compared with 2019. U.S. production could be 2.8 million b/d lower than at the end of 2019, while Saudi Arabia would be down nearly 1 million b/d if compliance with the OPEC+ deal is 100%. Saudi Arabia’s added voluntary reduction cut only applies to June, IEA pointed out.

“Major uncertainties remain,” and the biggest one may be whether governments can ease lockdown measures without prompting a resurgence of COVID-19 outbreaks, IEA said. Another is whether compliance with the OPEC+ agreement will be maintained by all parties, with the next meeting among the nations scheduled for June 10.

The pain among U.S. producers includes bankruptcies, abandoned wells, and assessing where and how to limit production without damaging equipment, speakers noted during the IPAA webcast. About 20 producers have declared bankruptcy since the beginning of the year, and the amount of production shut in, along with refinery output reductions, is amazing, Fryklund said. The dramatic reductions allow analysts to look at when the market has hit bottom and when the recovery will start, he said.

Mergers and consolidation are expected in the service sector, said W. Byron Dunn, founder and CEO of Tubular Synergy Group. “I hope there’s consolidation,” to keep people employed and service companies operating, he said. There are more than 500 companies with less than 5% market share in the service sector, which is not good when markets collapse as they have, Dunn said. The bigger firms with strong balance sheets, such as Schlumberger and Haliburton, may be acquiring some companies in a buying and selling spree among the fragmented service sector, Dunn said.

That might not be good for producers like Texland, because it will mean less competition among service companies, but it would assure producers that services will be available, Dunn said. “The question is can we swim or tread water until we get to the other side” when a market recovery kicks in, he said.

That recovery will be a slow and gradual one, Fryklund and Wilkes maintained. The demand recovery will take time and depend on how states handle reopening their economies, perhaps with regional differences. Wilkes does not expect demand to be back to normal by the end of 2020 and Fryklund said it could take up to 18 months to work off the oil storage glut.

Producers that shut in wells usually inject them with corrosion inhibitors to prevent rods and tubes from being damaged once production stops, Wilkes said. Dewatering wells for an extended period of time means it can take a long time to bring them back into production, with a lot more water handling needed during the restart process. “Some wells take a year or more to recover from a shut-in period,” which is why Texland and other producers keep certain wells operating at a loss when prices are so low, Wilkes explained. The technical and economic factors inform producers which wells to bring back on, he said.

While producers are struggling to stay afloat, policymakers are debating the best way to help the economy recover from COVID-19, and a vote in the House of Representatives is expected soon on the latest relief package. That package (H.R. 6800) is a $3 trillion HEROES Act that contains many provisions not supported by Senate Republicans, and leaves out several elements supported by GOP members, such as liability protection for businesses.

Lawmakers from producing states have lobbied the Trump administration to include oil and natural gas companies in lending plans and other measures providing COVID-19 relief. A group of senators asked President Donald Trump and others in the administration to ensure that financial firms receiving government aid are not discriminating against fossil fuel companies, which was brought up in a recent White House event.

The House measure includes provisions to protect utility customers from being disconnected when they are not able to pay their bills, with Democrats pointing to disconnection notices as states begin the recovery process.

At FERC, the agency is providing guidance to electric utilities and others as customers unable to pay utility bills are protected from service disconnections during the emergency conditions. FERC’s division of audits and accounting on May 7 issues an accounting guidance letter addressing uncollectible accounts receivable and an update from the Financial Accounting Standards Board (FASB).

The FASB update requires companies to change the method of measuring credit losses and FERC’s guidance letter finds the methodology acceptable for Commission financial accounting and reporting purposes. If a jurisdictional entity determines that an adjustment to its beginning retained earnings account is needed to implement the FASB update, it is authorized to do so without seeking FERC approval, the Commission said.

FERC also partnered with the North American Transmission Forum, the North American Electric Reliability Corp., and Department of Energy on a pandemic response plan resource to be used by companies as they address emergency conditions and recovery activities. The resource guide provides examples and information related to COVID-19, including aspects of operations returning to normal. It will be updated over the coming months as the situation evolves, according to a May 14 statement.

By Tom Tiernan ttiernan@fosterreport.com

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