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Oil industry stabilizing, but painful recovery ahead

Copyright © 2020 Albuquerque Journal

Four new oil wells in the Delaware Basin south of Carlsbad in September 2019. (Eddie Moore/Albuquerque Journal)

The global pandemic knocked the wind out of New Mexico’s oil and gas industry last spring, but as the economy gradually reopens, stability is slowly returning.

Most local producers closed the spigots on existing wells and largely ceased drilling on new ones during the height of the crisis in May, when many people stopped driving or flying and the crash in fuel demand pushed oil prices to their lowest levels in two decades. But over the summer, prices rebounded significantly as oil producers worldwide slashed production to reduce global oversupply – and as coronavirus lockdowns faded, allowing people to start traveling again.

Higher prices have, in turn, encouraged most producers in the Permian Basin in southeastern New Mexico and West Texas to reopen existing wells for crude to start flowing again. And, while the state’s active rig count fell from a record high of 117 last March to just 47 now, those remaining rigs are at least doing some work on new wells.

But recovery is still a long way off. Oil prices remain well below pre-pandemic levels, because consumer demand has not yet returned to normal, and the world remains awash in excess oil.

Until those supply and demand issues are resolved, the bust in New Mexico’s oil patch will continue, even if the rapid decline in activity has abated, said state Rep. Larry Scott, R-Hobbs.

“The best way to put it – we’re holding steady at a significantly reduced level of activity,” said Scott, a longtime oilman and owner of Lynx Petroleum in Hobbs. “We’re not at 117 rigs like we were in March, but at least people are out there working. … There’s been an uptick in production since the spring, but we still have a long way to go.”

Slow rebound

Oil prices will remain depressed until ground and air travel fully rebound from the pandemic, something few industry veterans expect to happen until a coronavirus vaccine is widely available and people feel comfortable returning to life as usual, said New Mexico Oil and Gas Association executive director Ryan Flynn.

“Like other industries, we remain challenged because of demand destruction from the pandemic,” Flynn said. “People are still working at home and not commuting. And there’s almost no leisure travel, especially by plane.”

Although estimates vary, global consumer and industry demand for oil plunged by between 20% and 30% during the March-May peak of the lockdowns – from about 100 million barrels per day to between 70 million and 80 million.

Over the summer, consumption rebounded as economies began to reopen. But demand isn’t expected to return to pre-pandemic levels until at least 2022.

The International Energy Agency projects global demand for petroleum and liquid fuels to remain about 8% below 2019 levels through December, and then narrow to about 2% by year-end 2021.

U.S. gasoline consumption in August remained, on average, 18.2% below last year’s levels, according to global consultant IHS Markit’s Oil Price Information Service. And jet fuel consumption is still down by more than 70%, said Raoul LeBlanc, IHS Markit’s vice president for nonconventional oil and gas.

“Jet fuel demand in particular is terrible, but all fuel consumption remains depressed,” LeBlanc told the Journal. “Discretionary travel for things like running errands or shopping is back close to normal, but daily commuting is still way down. A lot of people are still not going to work.”

Background

The virtual overnight plunge in demand at the start of the pandemic, combined with increasing oil production in the U.S. and elsewhere, led to record market gluts in early spring, causing an unprecedented crash in prices, which briefly dove into negative territory in mid-April for the first time in industry history. By early May, prices hovered in the mid-teens, down from about $60 per barrel at the beginning of 2020.

Prices began to rise in mid-May, thanks to an agreement by the Organization of Petroleum Exporting Countries and other major producers like Russia to collectively cut output by about 9.7 million barrels per day to drive prices back up.

Two drilling rigs installing oil wells in the Permian Basin southeast of Carlsbad, Tuesday November 5, 2019. (Eddie Moore/ Albuquerque Journal)

U.S. production as well plummeted as operators shut in active wells and virtually halted all drilling on new wells to await better prices. Domestic output fell to about 10.7 million barrels per day by midsummer, down from a record 13.1 million last March, according to the U.S. Energy Information Administration.

In addition, as coronavirus lockdowns in the U.S. and other countries receded in June, demand began to recover across the globe, driving prices back up. For most of the summer, the price for U.S. benchmark West Texas Intermediate has hovered between about $40 and $43 per barrel, more than twice the levels recorded in May, but still well below the $60-per-barrel range last January.

“Prices bounced back pretty well over the summer,” LeBlanc told the Journal. “The industry is in a better place now compared to the spring, with most wells that were shut in back online. But things are still not good, and the industry is definitely not yet back on a growth path.”

Operators cautious

To grow production, operators need to start drilling new wells again. But that’s unlikely to happen on any large scale until prices climb back to pre-pandemic levels, said Raye Miller, president of oil company Regeneration Energy Corp. in Artesia.

“The outlook is better, but producers are still very cautious in southeast New Mexico,” Miller said. “The rig count has flattened out at less than half of what it was in March. To add rigs back with active development on new wells, we need better prices and a clearer picture of what the industry faces, because everyone is concerned about demand going forward.”

Most New Mexico producers shut in their active wells for at least two months, although some of the large, deep-pocketed operators like Exxon or Chevron kept wells open and even continued work on new ones, albeit at a much slower pace, Miller said.

Local oil production declined in May for the first time in years, falling almost 11% from a monthly tally of 27.6 million barrels in May 2019 to 24.7 million last May, according to the state Oil Conservation Division. Output remained flat in June at 26.6 million barrels, compared with 26.5 million in June 2019.

OCD statistics for July and beyond are not yet available. With shut-in wells reopening, production going forward could decline at a slower pace or remain flat, but it’s unlikely to grow significantly until higher prices drive more rig activity.

Regeneration Energy, for example, has fully reopened the 60-plus active wells it shut in May. But it won’t drill any new ones until the price climbs back to the $55 to $60 per barrel range, Miller said.

That’s because local producers lose about $13 per barrel after royalties and taxes, pushing net income down to about $42 per barrel when the price is at $55, Miller said. And it costs up to $7 million to drill and complete a new well, meaning the operator needs to produce at least 167,000 barrels to earn back investment before generating a profit.

At $40 per barrel, the net income declines to about $27, meaning the new well must produce at least 250,000 or more barrels to recover investment. And output from new shale oil wells rapidly declines over the first 18 months, making it harder to achieve a return at today’s prices.

In addition, if operators must increase the length of horizontal drilling to reach more pockets of crude, the well price increases substantially.

“It’s simple math,” Miller said. “At $30 per barrel or less, it doesn’t make sense to drill and complete a well. Higher prices are what makes it economic.”

And downward pressure on prices continues. In August, OPEC reduced its production cuts by 2 million barrels a day, from 9.7 million from May-July to 7.7 million. U.S. output is also edging back up as shut-in wells are reopened.

As a result, U.S. crude inventories rose by 2 million barrels the first week of September, following six weeks of consecutive declines, pushing total domestic inventories to 500.4 million barrels, or about 14% above the five-year average for this time of year.

That – combined with ongoing coronavirus outbreaks that have stoked fear of renewed lockdowns in the fall – pushed oil prices down again in early September to about $37 per barrel.

Hit to NM industry

Meanwhile, fallout from the industry bust is severe. About two dozen oil companies have gone bankrupt in the U.S. since March, and the industry has laid off more than 100,000 employees nationwide.

The loss of 70 rigs in New Mexico means up to 2,800 workers directly lost their jobs here, since about 40 employees are connected to each rig. But thousands more in related industries and at businesses in southeastern New Mexico that depend on a healthy oil-and-gas sector are also impacted.

“People are hurting,” Flynn said. “Everyone in southeastern New Mexico is feeling the brunt of the downturn.”

The state as a whole is reeling from lost oil and gas revenue, estimated at about $1 billion less for the fiscal year that began July 1, compared with FY 2020.

Given all the industry uncertainty, forecasting is extremely difficult, said Sen. John Arthur Smith, chairman of the Legislative Finance Committee.

“I’m not certain it will actually be a $1 billion shortfall at this point,” Smith told the Journal. “But we also don’t know how long the downturn will continue.”

The future won’t become clearer until the global pandemic is under control, economic recovery gains force, and oil demand grows again.

“We have to get past the pandemic,” Flynn said. “There’s no silver bullet. We need a vaccine, and then people need to become confident again to travel, fly and lead a normal lifestyle.”

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