A combination of factors has led to a rebound in crude oil prices. The initial decline in March was driven by a perceived collapse in demand driven by “stay at home” orders across the United States. Gasoline demand collapsed along with Jet fuel demand as most airlines continue to operate at a fraction of their normal rate. To offset this lack of demand OPEC cut output by 9.7-million barrels a day. Additionally, the price of oil pushed many US producers out of business. US oil producers have reduced supply by 2.1-million barrels a day in 2020, as hundreds of rigs have come off-line.
Rig Count Collapse
The oil supply and demand in balance have been equalized by a huge reduction in production. While OPEC+ decided to voluntarily reduce oil production, US shale producers were forced to reduce production due to the collapse in prices. According to Baker Huges, the oil service giant, oil rigs in the United States have declined from 504 to 188 in just 3-months. The decline in oil rigs
has significantly reduced oil production in the US which has dropped from 13.1-million barrels a day to a low of 10.5-million barrels a day.
OPEC Cuts
The decline in US shale oil production has been overshadowed by the huge cuts made by OPEC+. The group of petroleum producers on June 6, extended their pre-existing 9.7 million barrel per day production cut through at least July 2020. This cut is not inconsequential for OPEC producers. Many are facing financial issues as the price has declined below their break-even price. Break-even prices for a company are the minimum price to achieve profitability.
At the country-level breakeven price is the fiscal breakeven price which is the price needed for the country to meet its spending needs. These figures are different for each country which makes keeping a cartel agreement together in the face of financial distress difficult.
Supply and Demand
The cuts on OPEC+ and the cuts forced on US shale producers if sustained could produce a rebound in prices that would be driven by a surge in demand and reduction in production capacity. A recent study from the Dallas Federal Reserve shows that world demand would exceed world supply potentially in Q3 or Q4 of 2020. The global stockpile of oil would decline by -3-million barrels of oil per day in the Q3 and by 5-million barrels a day in the Q4. The Dallas Federal Reserve sees OPEC crude oil production at 24.41 million barrels per day in May of 2020 and rising back to 27-million barrels a day by 2021.
Additionally, global gasoline demand has been drastically reduced due to stay-at-home orders. The Dallas Federal Reserve estimates that global vehicle miles traveled declined to nearly 220 billion from nearly 280 billion miles traveled per year ahead of the spread of COVID. What has been a bright spot is the rebound in gasoline use in the United States. US gasoline use dropped from 8.5-million barrels a day in February to 5.33 million barrels a day in April but then rebounded to 7.13 million barrels a day in May.
Oil production in the United States is driven by Texas oil production. This can be gauged by the rig count in Texas. According to the Dallas Federal Reserve, the Texas rig count dropped to a decade low 127 oil rigs in May down from a high of 550 in 2019.
US Oil Producers Need Higher Prices
The collapse in US oil prices has pushed several US oil companies to the brink. In April, Whiting Petroleum a Colorado-based oil producer filed for Chapter 11. Oil prices have rebounded significantly since hitting their lows in April and have rebounded back to the $40 per barrel region by the end of Q2 2020. Unfortunately, for US shale producers to be profitable they need prices to move back above $50 per barrel. This is a deterrent to investing in crude oil. This creates a dynamic that could make it difficult for prices to continue to rise.
The Bottom Line
As oil prices eclipse $50 per barrel, US oil producers will attempt to start up production. This will likely come just as OPEC producers start to ramp up production. The key will be demand. While the Dallas Fed believes demand could exceed supply, it will need help from airlines to generate global consumption. TSA traffic in the United States is still well below the numbers seen in February. TSA traffic for travel in the United States is down 75% year over year. Global jet fuel demand is approximately 8-million barrels a day, according to the International Energy Agency. This is likely to fall by 26% year over year in 2020 and will need to rebound for oil prices to gain further traction.
