The COVID-19 pandemic has seized center stage as people “shelter in place” and companies shut down until a safe path emerges. And as should be expected, the demand for oil has plummeted, bringing the price of a barrel of crude into the mid-20’s range near the end of March, 2020. There are many interrelated factors. The purpose of this article is to untangle them and then explain why Allied Resource Partners is positioned to make the most for ourselves and our partners.
Make no mistake; at the global level, oil and gas suppliers are an oligopoly. OPEC has survived for over 40 years, which is a testament to the importance of oil for both consumers and producers. But remember: oligopolies eventually unravel as members fight over market share.
Russia, essentially a resource-based kleptocratic country, has muscled its way to challenge Saudi Arabia as the oil supply side leader. All other national oil companies and countries are feckless (think Venezuela); the international oil companies (think Exxon) lost control of the heights (think wellhead) fifty years ago and were left to manage the plains (think distribution and downstream refining and marketing). Only one challenger to Saudi Arabia, Russia, or what’s left of OPEC remains: America’s domestic oil producers. They form a competitive market that can make good money living underneath an umbrella that set prices on the international market.
Strange as it may seem, Russia and the Saudis often pretend that “someone” controls America’s domestic oil and gas industry, that they can pick up the phone and tell someone to throttle back production. That’s not true. Domestic production is comprised of many public and privately held oil and gas companies (like Allied Resource Partners), whose collective BOPD production tops the list. And it has managed to rise to the top because of American oil and gas service companies’ technical expertise that has unlocked shale oil and gas.
The Russian Gambit
Until COVID-19 tanked the demand for gasoline and liquid fuels, Russia and Saudi Arabia could live with their current BOPD production and market price in the mid-$60s. But both countries need sustained production at a price that yields a cash flow that can fund their economies. Russia acted first when demand plummeted: it would increase production, expecting to garner a larger share of the market to offset (only partially!) falling prices. Saudi Arabia struck back, leading to the current battle for market share. Who will win or what will be the outcome is unknown: oil is both a political and an economic game.
Both countries will suffer economically until they reach some sort of agreement. The press reports only their posturing. What’s going on behind closed doors is private, but each might think they can “shut down” our domestic production, especially what comes from shale, whose production costs are higher than from conventional wells.
History says otherwise. Domestic producers are resilient, quick to act, and able to drive down production costs when oil prices go down. News articles warn that over-leveraged domestic producers may go bankrupt, but it they do, smarter entrepreneurial types will pick up pieces of acreage and leases at bargain prices.
The Public’s Position
Drivers and travelers are getting a reprieve that comes at a perfect time. Lower gasoline costs cushion reduced work hours or furloughs. Prices will eventually go up when the pandemic “dies down” and oil inventories fall to more normal levels. A case can be made that our domestic oil and gas producers need government help during the pandemic, but never forget: the public doesn’t trust oil companies, even though the facts show they are price takers, not price makers. It won’t support much financial assistance to over-leveraged oil and gas producers.
The Government’s Position
Washington must consider both the public and the oil and gas producers. It must reach a middle position: expect gasoline prices eventually to return to a pre-COVID-19 level, but until then let drivers benefit from low oil prices while keeping the 1.5 million domestic oil and gas workers employed. Whether or not domestic oil and gas companies will be included in the Administration’s COVID-19 Relief Package is to-be-determined, but here is one suggestion:
- Put a floor on domestic oil prices (the price domestic suppliers get). Buy from foreign suppliers AT A LOWER PRICE what is needed to meet domestic demand. Alternatively, slap a tariff on foreign supply that brings price to a level our domestic oil and gas producers can live with.
The devil’s in the details, but at least we’ve offered a workaround.
The Bottom Line for Allied Resource Partners
We have no crystal ball, just some rational common sense. What does it say?
- Our commercial wells will make money even at mid-$20’s prices. And if prices fall below breakeven, we’ll shut in production until prices go up.
- Our current drilling and completion activities continue as planned. This demonstrates to our partners and vendors that we are long-term players who know how to operate no matter where in the business cycle prices may be. And contractors will like us for keeping them working, possibly giving us a discount on drilling and completion costs.
- Our search for new leases and acreage may benefit as other companies cut back or sell. We can “buy low” and offer attractive units to new or existing partners.
Finally, this fact needs no crystal ball: Allied Resource Partners is debt-free and privately held. We know how to live within our cash flow.
Please google for additional relevant information if you want even more facts and conjectures, but we think the above is enough for us and our partners. And no matter the ultimate COVID-19 trajectory, our nation and our oil and gas industry will do fine; Allied Resource Partners will say the same.