Oil prices are crashing due to Covid-19. So what happens to American output?
Market reactions first, then political ones.
Well, first the oldest building in Dallas, circa 2019:
Yes, my shoes are bright blue.
Now market reactions to the Covid oil price crash.
Market
The “shut-in prices” is the minimum wellhead price operators need to continue producing from a production well. It’s equal to the amount needed to cover ongoing O&M, including where-necessary pumping and artificial lift, as well as water, gas and steam flooding and other secondary recovery costs.
The first wells to shut down are “stripper wells” nearing the end of their useful life. In the U.S. there are about 400,000 of these wells producing about 720,000 barrels per day. (I said they were small.) They usually rely on pumps to get the stuff out of the ground, meaning those famous mechanical donkeys you can still see in parts of California.
Next to go are wells that depend on secondary recovery. For example, in the Golden State companies inject about 400 million barrels of steam every year to get 161 million barrels of oil. (Governor Newsom has banned new wells using this technique.) These wells are high cost, but when shut down they tend to fill up fast with water. Companies that shut them down risk losing the remaining shut-in oil forever. In addition, companies that shut down wells risk losing their land leases. As a result, these wells don’t close immediately once they start losing money.
After that some wells will start to decline quickly in the absence of new drilling. Tight oil wells in North Dakota decline 65% in the first year and 77% over the first two years. That’s the next to go. In their early phase, however, tight oil wells can be easily shut-in and restarted. So tight oil production will decline in two waves, first by natural decline as new drilling collapses and then again as companies shut wells down. Since you can restart unconventional wells in about a week companies won’t be as reticent to stop production … if not for the fact that most of them are highly indebted and desperate for any sort of cash flow to satisfy demanding creditors.
This chart for tight oil plays in the Eagle Ford region of Texas gives you some idea of just how fast this decline can happen. Without new drilling, production would decline by about 700,000 bpd within a year from this play alone:
But production will decline faster than that, because unconventional wells can be shut-in fairly easily during their first year.
In other words, the current oil price crash will cause U.S. production to drop, and drop fast. That is, it will if it is sustained. That’s not a given: countries have already begun to reopen their economies. Oil demand will recover as a result, possibly to prices that might keep tight oil production alive and stop the shuttering of stripper wells.
Political
Of course, state governments can act via a process called “proration,” whereby they can order well-by-well output cuts. Back in the 1930s, Congress passed the Connally Act, which made it illegal to ship oil across state lines in violation of state output quotas. It also created the Interstate Oil Compact Commission (here is the law), which brought representatives together from oil-producing states to hammer out overall quotas, America’s own little mini-OPEC before OPEC. (For whatever reason, Illinois and California never passed proration laws, although the California government sanctioned a quasi-private commission that functioned outside the law.)
The IOCC still exists, but its powers have withered. It no longer makes decisions by majority vote. And it now includes 31 states, five Canadian provinces, two Canadian territories, plus Egypt (W?) and the other Georgia (WT??) and the Bolivarian Republic of Venezuela (WTF???). Plus, while Arkansas, Colorado, Michigan, New Mexico, Oklahoma, and Texas all passed proration laws, only Oklahoma and Texas still exercise the muscles. (The Rail Road Commission of Texas and the Oklahoma Corporation Commission still publish quotas, set above most wells’ maximum production.) Executive agencies function like muscles: use ‘em or lose ‘em. Those states would need to design regulations from scratch to impose quotas, and they would certainly be challenged in court.
Now, Texas is big enough on its own to mandate a production cut. And the Texan authorities are talking about it! But it’s all talk. And there’s no sign of the Trump administration trying to resuscitate the Depression-era laws that let it coordinate oil production cuts, or even coordinating talks among the IOCC states. But production is falling fast, so Trump could claim that he jawboned producers into it.
Hell, he could do that even if production wasn’t falling fast. That’s his M.O.
Conclusion
Which means that the ultimate question is whether OPEC wants to be fooled. If Saudi Arabia thinks that letting Mexico de facto defect while pretending to cooperate will not hurt their cartel agreement, then they’ll accept the bullshit. If they don’t, then they’ll reject the Trump-AMLO bamboozle.
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