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NM at an energy crossroads

Copyright © 2020 Albuquerque Journal

Coil tubing operators Oscar Sepulveda and Jeremiah Brown replace a leaking gasket on the fracking stack at Regeneration Energy’s Blue Moon well site in Malaga, south of Loving. (Jim Thompson/Albuquerque Journal)

This story was updated Sunday morning to add material that was inadvertently omitted from the earlier version in the editing process.

New Mexico is headed for another record year in oil production, despite the pandemic.

Output for the first nine months of the year reached 265.2 million barrels, up 10.3% from the 240.4 million barrels produced in the same period in 2019, according to the latest statistics from the state Oil Conservation Division.

In fact, output surpassed 2019 levels for nearly every month this year from January to September. Production declined only in May, when most producers shut in existing wells and stopped drilling new ones to await better prices, which had plummeted from about $60 per barrel in January to the mid-teens as the pandemic swept across the U.S. and other countries.

Since then, prices have rebounded back above $40 per barrel, and some activity is picking up again in the Permian Basin in southeastern New Mexico and West Texas, said New Mexico Oil and Gas Association Executive Director Ryan Flynn.

“We’re on track for another record-setting year,” Flynn told the Journal. “Unless the fourth quarter is terrible, we’ll beat 2019. Production remains at very high levels.”

That’s good news for New Mexico’s fiscal health, which depends on revenue from the oil and gas industry for nearly one-third of the state’s general budget every year.

But it comes as a surprise because the industry is still mired in the worst crisis it’s ever faced since oil and gas began fueling society well over a century ago.

The pandemic knocked the industry on its heels last spring as people stopped driving and traveling. That caused an unprecedented market collapse that sliced oil prices and thrust New Mexico into a fiscal crisis.

Legislators cut the state budget for fiscal year 2021 in a special session last June, because revenue projections for the new year that began July 1 had declined by $857.1 million after the pandemic exploded. Oil and gas activity accounted for more than 70% of the revenue drop as prices crashed and producers slowed operations to a near halt in the spring, according to the state Legislative Finance Committee.

However, as prices began to rebound over the summer, operators reopened the spigots on existing wells, and at least some companies began drilling new ones again, contributing to an improved outlook for FY 2022. Last week, the LFC projected $169 million in “new money” for next year’s budget, or about 2.3% growth over the current budget.

But with the pandemic still raging and demand for oil and gas still well below 2019 levels, the industry is facing a long, rocky road to recovery. That’s because most producers need prices to stabilize well above $50 per barrel to again begin widespread drilling of new wells, and that’s unlikely to happen until after the pandemic ends and life returns to normal.

Outlook hazy

To be clear, New Mexico production remains high because the impact of fewer new wells being drilled has yet to hit. Production could start to drop in the months ahead, as output from existing wells inevitably declines, and few new wells come online to replace them.

As a result, a new, national debate is gaining momentum about the industry’s future prospects for growth, with many questioning whether it will ever fully return to pre-pandemic levels.

One organization – the Institute for Energy Economics and Financial Analysis – says the domestic oil and gas industry has entered a historic, irreversible decline that will chronically threaten New Mexico’s financial health and stability unless urgent action is taken to end state dependence on hydrocarbons.

In a new report released in October, IEEFA said the industry slid into a long-term financial decline years before the coronavirus hit, reflecting chronic instability created by the shale revolution, plus a global rush to replace fossil fuels with non-carbon energy sources to stem climate change.

This drill head was used to open up Regeneration Energy’s new Blue Moon well.

The pandemic greatly aggravated those problems, IEEFA said, likely accelerating the decline as the world now steadily moves toward alternative power, consumer and industrial energy consumption changes, and market investment shifts away from hydrocarbons.

Industry leaders and local economists say the study’s “doomsday” analysis is fundamentally misguided. Flynn called it “biased” and “deliberately misleading.”

IEEFA is a national think tank supported by philanthropic organizations. It studies energy markets, trends and policies, producing domestic and international reports to accelerate the transition to a diverse, sustainable and profitable energy economy, according to its mission statement.

But despite IEEFA’s pro-renewable stance, most industry experts do recognize the stark challenges facing oil and gas. Indeed, few believe the industry will roar back to pre-COVID levels after the pandemic ends. Recovery will take years, they say, and the heyday of booming shale-based gushers that pushed production to records in recent years will not return.

Fracking sand used at the Blue Moon well site.

Still, most believe the industry will emerge on solid footing once the pandemic ends, although at a much slower pace of growth in future years, and with a markedly reduced workforce and fewer producers overall as weaker companies disappear and stronger ones consolidate through mergers and acquisitions.

The transition to a non-carbon economy will gain momentum, they say, but that transformation will take decades, with demand for oil and gas continuing for many years.

Green shift

Right or wrong, IEEFA’s study reflects a rapidly emerging national debate as President-elect Joe Biden prepares to take office in January with an aggressive green agenda, including new federal programs to accelerate wind and solar energy development, increase production and adoption of electric vehicles, and possibly limit expansion of oil and gas activity on federal lands.

Tom Sanzillo, IEEFA finance director and study co-author, said the new report is a wake-up call for New Mexico to take heed of an “unprecedented sea change” in domestic and global energy markets.

“It’s the beginning of the end for the abundant revenues that New Mexico has received for years from the oil and gas industry,” Sanzillo told the Journal. “It’s a warning that local politicians, business leaders and New Mexicans in general need to recognize that change is coming, and that everyone needs to come together to plan for it to protect community interests throughout the state.”

Shale roots

While New Mexico’s coffers benefited from the shale-oil revolution, IEEFA says that revolution – not the pandemic – created many of the basic problems now facing the industry.

That process began about 15 years ago when hydraulic fracturing, horizontal drilling and other technologies allowed producers to cut into hard shale rock to tap huge hydrocarbon reservoirs they couldn’t reach before. That opened up vast new oil and gas deposits in aging fields like the Permian Basin in southeastern New Mexico and West Texas, and entirely new hot spots in other states.

As a result, U.S. production surged to record levels, particularly in the Permian Basin. Last year, New Mexico reached an all-time high of nearly 332 million barrels of oil, compared with 60 million in 2008. And that, in turn, generated a gusher of new oil- and gas-related income, accounting for an unprecedented 39% of all state revenue in fiscal year 2019.

But the surge also flooded global markets, chronically depressing prices. New Mexico oil fell from an average of $86 a barrel between 2010 and 2014 to an average of $48 between 2015 and 2019, according to IEEFA.

Still, production continued to climb, largely because producers found innovative ways to cut costs to continue operating at lower prices, but also because most companies racked up massive debt to finance operations even as profits markedly declined.

“As New Mexico was posting record oil and gas revenues, largely due to the sector’s high productivity, the industry itself was experiencing steep losses,” the IEEFA report says.

ExxonMobil, for example, returned only 6.5% on capital deployed in 2019, down from 25% in 2012. Its market capitalization fell from $527 billion in 2007 to $150 billion now, with $60 billion in outstanding debt.

Exxon and other publicly traded companies have been paying shareholder dividends by selling assets and incurring new debt. And equity markets have dried up as investors demand more return on investment and less spending to pump up production.

According to IEEFA, the industry needs a return to $80 per barrel for several years to restore financial strength. But that’s highly unlikely as energy markets shift to renewables and alternative fuels, and as oil demand drops through new technology and efforts to achieve greater energy efficiency to lower consumption.

Market nosedive

The U.S. Energy Information Administration says the amount of energy needed to sustain U.S. economic growth has steadily dropped for decades. It projects that by 2050, domestic energy use associated with each dollar of national growth will be less than half of what it was in 2005.

Steady improvement in fuel efficiency is also curbing gasoline consumption. And BloombergNEF projects electric vehicles will grow exponentially in coming years, reaching 28% of passenger vehicle sales by 2030 and 50% by 2040.

Finally, many utilities are now choosing renewables and battery storage to replace coal generation rather than natural gas, a trend likely to gain momentum as batteries and other energy-storage technologies improve and costs decline.

The global pandemic immensely aggravated those problems, thrusting the industry into an unprecedented crisis that cut world oil demand by more than 20% last spring. And even after the pandemic ends, demand may never fully recover as many businesses and consumers opt to continue working and shopping online.

“The industry is unlikely to come back as it has in the past, because the world has changed,” IEEFA finance director Sanzillo said. “Industry doesn’t want to acknowledge the problem, but New Mexico can no longer expect oil and gas revenues to bounce back. The state needs to prepare for that.”

Industry pushback

Local industry experts say IEEFA is greatly exaggerating the problems, even if many of the underlying challenges it cites are accurate.

“I don’t think the oil industry is dead by any means,” said New Mexico State University economics professor emeritus Jim Peach.

It’s true that New Mexico’s risky overreliance on oil and gas revenues must change, but that’s nothing new, Peach said. Public officials must reform the tax system to reduce that dependence, particularly loopholes in the gross receipts tax that drain away about $1 billion in state revenue each year, he said.

But the oil and gas industry has bounced back from steep declines in the past, Peach said. And it will likely recover again this time, although activity may be significantly reduced.

“One thing that won’t come back is the employment and income levels we’ve seen in the past,” Peach said. “We never fully regained employment from the last downturn in 2014, and that will likely happen again this time as the industry recovers.”

That reflects industry efforts to better control spending through greater operational efficiency, less debt-backed investment to continuously grow production, and more focus on profits, said Raoul LeBlanc, IHS Markit’s vice president for nonconventional oil and gas.

“The industry was in a growth-at-all-costs mode since before COVID, and it’s been working to change that,” LeBlanc told the Journal. “It will likely grow more slowly as it recovers from the pandemic.”

But IEEFAs claim of a historic, irreversible decline is misguided, LeBlanc said. The energy industry is certainly evolving toward more non-carbon resources, but that process will take decades.

People vastly underestimate the scale of oil and gas infrastructure and the time it will take to transition away from it,” LeBlanc said.

In addition, even as demand declines over time, New Mexico is better positioned than most places to withstand the changes given its abundant shale oil reserves and the comparatively lower costs to exploit them here compared with other basins.

New Mexico has some of the most economic wells in the entire country,” LeBlanc said. Its a hotspot for unconventional (shale-based) oil and gas, and it would be one of the last places to close down.”

NMOGA Executive Director Flynn said the pandemic has created huge challenges, but the industry remains very resilient.

The pandemic presented the greatest stress test imaginable, and its proven that the Permian Basin is, in fact, the most resilient basin in North America,” Flynn said. To set another production record in 2020 in the midst of COVID-19 is remarkable. We saw demand crater like never before and its been tough sledding for awhile, but the idea that the industry is in a cyclical boom-and-bust decline is simply wrong.”

Oil companies have dramatically slashed new investment in the Permian and elsewhere, which will reduce production growth in coming months, Flynn said. But that reflects prudent industry efforts to respond to the current crisis and emerge on stronger footing when the pandemic ends.

Everyone now is cost-sensitive, making sure that growth is fueled by demand not by debt, that they live within their means, and that they produce a return on investments,” Flynn said. But once demand returns, well see growth and investment return. It will be slower growth, not at the pace of the last few years, but the industry will continue to expand because we expect demand for our products to remain strong for years to come.”

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