The Price of Recovery for U.S. Oil

COVID-19 was brutal for the U.S. oil business. With the lockdowns of the economy, demand for oil and its products crashed. This writer calculated that in the first year of the pandemic, the U.S. consumed 2.4 million barrels of oil per day fewer than the year before. One of the analysts below claims it was “the largest short-term decline ever recorded,” but was actually 3 million BPD fewer. Whatever its exact size, the 2020 demand drop created a supply glut, and the price of oil crashed.

In May of 2020, during about the fourth month of the pandemic in America, McKinsey & Company, the world’s largest consulting firm, ran “Oil and gas after COVID-19: The day of reckoning or a new age of opportunity?” The paper is authored by no fewer than five contributors, and if one makes a pdf of it, it’ll take up 20 pages. Here’s a bit of it (italics added):

The oil and gas industry is experiencing its third price collapse in 12 years. After the first two shocks, the industry rebounded, and business as usual continued. This time is different. The current context combines a supply shock with an unprecedented demand drop and a global humanitarian crisis. Additionally, the sector’s financial and structural health is worse than in previous crises. The advent of shale, excessive supply, and generous financial markets that overlooked the limited capital discipline have all contributed to poor returns. Today, with prices touching 30-year lows, and accelerating societal pressure, executives sense that change is inevitable. The COVID-19 crisis accelerates what was already shaping up to be one of the industry’s most transformative moments.

Oil’s price collapse made it impossible for America’s shale oil business, which had made up more than half of our domestic oil production, to generate profits. But what were oil analysts saying a year and a half after the McKinsey report?

In November of 2021, Forbes ran “Sorry, President Biden, This Is Not OPEC’s Fault” by Robert Rapier, who reported that Pres. Biden had blamed OPEC and Russia for high oil prices due to their refusal “to pump more oil.” Rapier then relates the real reason “oil prices have surged over the last year”:

U.S. oil production declined by 3 million barrels per day (BPD) during the pandemic. That decline was exacerbated by a price war between Russia and Saudi Arabia just ahead of the pandemic, but then the pandemic crushed demand (and oil prices). […]

Demand started to come back in summer, and by fall demand was recovering faster than supply in the U.S. Our crude oil imports began to climb, and along with that so did the price of crude oil and oil products.

One could make the alternative argument that rising gas prices are from the refusal of U.S. producers to increase production. However, it’s more complex than that. During the pandemic, some producers went out of business.

Also in November of 2021, National Review ran “With Gas Prices Soaring, Biden Searches for a Scapegoat” (italics added):

For the past decade, U.S. fossil-fuel companies have essentially subsidized consumers, making massive investments in domestic production that brought down energy prices but returned little in profit. […]

But it is also true that the rise of so-called Environment, Social & Governance (ESG) investing, which the White House has included in public-pension plans, has pushed up the cost of capital for U.S. energy companies. If Biden’s early moves are any indication, capital costs will only continue to increase in the years to come.

In October of 2021, Barron’s ran “Why Are Natural Gas Prices High? Because Fracking Isn’t Really Profitable,” by guest commentator Bianca Taylor. Tourmaline Group, which Taylor founded, has a focus on ESG concerns, like climate, and her article does address concerns like methane leaks, but it also touches on profits in U.S. shale oil (italics added):

But the truth is actually less complex: even before the pandemic, shale oil and fracking had not been profitable.

According to data from Credit Suisse’s HOLT database, North American energy companies had a return on investment below their cost of capital for 21 out of the last 30 years. In other words, 70% of the time, returns were disappointing. […]

Shale oil fields have what industry calls a “high depletion rate,” meaning that the fracking process itself impedes the capturing of the full amount of oil and gas in the fields.

In order to turn a profit, the drilling and extraction needs to be done slowly, but energy executives were being paid to show high revenue growth. As a result, many, including the industry darling Chesapeake Energy, went bankrupt. 

North American “energy has been a wealth destructive business in recent history,” a Credit Suisse analyst wrote in an August 2021 report.

In October of 2021, Financial Times ran “Inflation drives up drillers’ costs in US shale oil patch”:

The supply bottlenecks and labour shortages felt across the US economy are driving up the cost of shale oil production, a trend that is helping to underpin the price of crude.

Expenses including steel, wages and contracts to hire drilling rigs are on the increase. Cost inflation in the oil patch is likely to run at 10 to 15 per cent next year, much faster than the broader US price indices. […]

But as the industry has tried to expand again it is running into the kinds of supply chain and labour problems bedevilling consumer brands such as McDonald’s, Ford and Walmart, raising costs and lifting the oil price at which a producer can breakeven.

In November of 2021, ran “Breakeven Price For New Oil Projects Drops In 2021” (link added):

Back in 2014, Rystad Energy estimated the average breakeven price for tight oil [i.e. shale oil] to be $82 per barrel and the potential supply in 2025 to be 12 million bpd. Since then, the breakeven price has come down while the potential supply has increased. In 2018, we estimated an average breakeven price for tight oil of $47 per barrel and potential supply of 22 million bpd. The breakeven price for tight oil has continued to fall, reaching a current average of $37 per barrel.

Since 2008, when the bottom fell out of the economy, the price of oil has bounced around from $145 to less than zero. To get a better feel about how the oil business has been faring, go to this interactive chart for West Texas Intermediate from the St. Louis Fed. Notice the price for WTI crude on April 20, 2020, when it sold for negative 36.98. One wonders if they were giving the stuff away. (I’ve preset the Fed chart HERE so you wouldn’t need to; notice the pop-out in the lower right-hand corner.)

In October, WTI crude was selling for more than $84 a barrel. So, if the breakeven price really is $37, it would seem that recovery is at hand for the U.S. shale oil business. However, for shale oil to be a viable business, the going price of oil must be neither too low, nor too high. Too low and the oil business can’t turn a profit; too high and the broader economy has a major drag on it and can’t hum along as we would like.

Some might say the price of oil is already too high. But the U.S. oil business exists at the pleasure of not only consumers, but also of financiers, investors, and creditors. American consumers need to understand that for the last decade or so the U.S. oil business has “essentially subsidized consumers.”

So what’s the “right” price for a barrel of oil? Ask the market.

Jon N. Hall of ULTRACON OPINION is a programmer from Kansas City.

Image: Furfur

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