With no demand for oil due to Covid-19 stay-at-home orders and few places left to store it, producers holding contracts to deliver oil in May were forced to pay buyers roughly $40 a barrel just to take it off their hands.
But the president must be careful. Any protective measures or a bailout for the US oil industry would not only be politically dicey, it could also undermine the free market forces needed to reshape and strengthen the sector in the longer term.
The unfortunate truth is that the US oil industry must endure this brutal period, the worst crisis in its history, without much help from Washington if it wants to be able to compete with lower-cost rivals like Saudi Arabia and Russia in the future. Because that future likely involves operating in a lower price environment than before the pandemic arrived.
Recent negative prices for oil should accelerate the decision to shut-in wells for many companies rather than lose money on barrels that nobody wants. We’re also seeing an uptick in bankruptcies across the oil industry. Both are necessary to begin the process of rebalancing the oil market and building a stronger domestic energy sector for tomorrow.
There will be no other choice when storage tanks fill and demand remains historically depressed. The IEA estimates the oil supply surplus will be 26 million barrels a day for May.
There is no managing your way out of that kind of market.
That’s why implementing protectionist measures like tariffs or anti-dumping laws, or whipping up a massive industry bailout, doesn’t make sense. The US oil industry is not too big to fail. In fact, underperforming swaths of it should be allowed to fail.
Government intervention in the market risks delaying the rebalancing that needs to happen, particularly in the US sector where many companies are burdened by heavy debt loads.
The truth is that the US shale sector was rife with underperformers that relied too heavily on debt to fund operations. Many companies faced a reckoning this year even before the double black swans of the coronavirus and the Saudi-Russian price war emerged.
In the long run the oil industry will be better off it it’s led by fewer, stronger, well-managed companies, because it will be imperative for the sector to drive down its break-even costs to sub-$30 WTI levels.
At minimum, it will take at least a couple years to use up the massive oil inventories that have built up. And it sure looks like we’ve entered an “even lower for even longer” price environment, especially with the low-carbon energy transition and climate policy applying more pressure.
Government protection or bailouts won’t ready the industry for this tough new era. Yes, we should take steps to help the workers laid off by this crisis. But if the Trump administration really wants to help the industry, it will let free market forces drive the restructuring that is necessary.