On April 20, U.S. oil prices turned negative with Western Texas Intermediate (WTI) plunging below zero. One aspect of this scenario is supply and demand but it’s not the sum total. There’s also a massive geopolitical game at play between the US, Russia and Saudi Arabia. A re-ordering of oil geopolitics, along with causalities, will occur but it’s unclear as to who will come out on top. This is not a cycle. There will be no return to normal – this is a defining moment of ‘restructure’ that will completely reorder the supply chain and create new opportunities.
For the US, the fallout for shale production could likely fall between a 30% to 40% reduction. We can also expect many unconventional oil companies to go bankrupt, as well as private equity firms rushing in to recapitalize and buy them for cents on the dollar. This means that as the demand curve recovers, even at $20 to $30 per barrel, PE firms will make acceptable returns on capital because they can move in on this production for almost no capital. This, combined with another wave of innovation, reduces operating costs. Shale’s inherent flexibility to turn production on and off at relatively low cost provides the flexibility to respond to these shocks.
The backdrop is that we have no idea if demand will ever get back to the levels that we once experienced. There’s too much uncertainty, too many things in flux. What we will see is the breaking of another norm. In the last 10 years, we’ve seen several industry norms become broken. For instance, U.S. shale production broke the connection between natural gas and oil prices. Now, this drop in WTI has snapped the connection between current and future price. There’s never been a spread so significant between yesterday’s price and the future: a 60-point spread across WTI.
Mark Carney, former governor of the Bank of England, shared this insight about the world after COVID-19 in The Economist: “Even after this, local resilience will be prized over global efficiency.” To put it plainly, energy independence, in order to drive resilience in an economy, will be even more important after this crisis than before.
This article originally appeared on LinkedIn.