As expected, the news from U.S. oil producers is concerning. The former secretary of energy and former governor of Texas Rick Perry said on Fox News that "we are on the verge of a massive collapse of an industry that we worked awfully hard over the course of the last three or four years to build."
Whiting Petroleum (NYSE:WLL), one of the largest producers in the Bakken shale region in North Dakota, filed for bankruptcy on Wednesday, April 1. On the same day, Callon Petroleum (NYSE:CPE), an independent producer based out of Houston is hiring advisors to restructure its debt.
We knew U.S. oil producers would struggle tremendously with low oil prices and should expect more bad news like this on a regular basis. But that doesn’t mean U.S. oil production will plunge immediately.
Last Time Price Plummeted...
Look at what happened from 2014-2016, the last time U.S. producers faced a significant price drop. At that time, U.S. production peaked in April 2015. Production didn’t hit its nadir until September 2016.
The situation today is not exactly the same though. During March 2020, oil prices fell much more precipitously—30% in one day. However, what happened five years ago reminds us that U.S. producers will continue to pump even when they are losing money on each barrel. That's because they need revenue.
Furthermore, some U.S. producers have hedged, so they have contracts that pay over $50 per barrel, meaning they can keep pumping and receive more revenue. Enervus estimates that about 2.5 million bpd are hedged in this way.
Production will almost certainly drop, especially as assets and entire companies are sold to better-positioned firms that don’t need the revenue immediately. In some cases, wells may be abandoned. Oil in the U.S. has always been a boom-bust industry, and in the past we have seen producers just walk away.
Bankruptcy May Not Stop Output
It is vital for traders to understand what it means when a producer like Whiting files for bankruptcy. If a company in the United States can no longer pay its debts to its creditors, it can file for bankruptcy. With the help of the court, the company and the debt holders will reorganize what it owes. Some debt will likely be discharged. In the end, Whiting may emerge from the process significantly stronger.
Bankruptcy doesn’t mean that Whiting will halt or decrease production. Whiting may need to leave oil in the ground as an asset for sale, but it is also quite possible that part of the bankruptcy process will require Whiting to keep pumping so that it can pay its bills.
For now, there are reports that Whiting will continue to operate as before. So, when you read that a shale firm has filed for bankruptcy, you should understand that it is a sign of strain, but it is not necessarily a signal that production will decrease in the near future. In fact, it may indicate that production will not drop, at least for a while.
Yesterday’s EIA report on U.S. crude production ending the week of March 27 showed the U.S. was still producing 13.834 million bpd. There is no doubt that the U.S. oil industry is in trouble. However, as with individual companies, production from the industry at large is not expected to fall off a cliff tomorrow.
What’s Ahead?
On Friday, President Trump is scheduled to meet with the heads of various large American energy companies including ExxonMobil (NYSE:XOM), Chevron (NYSE:CVX), Occidental (NYSE:OXY), Devon Energy (NYSE:DVN), Energy Transfer (NYSE:ET), Phillips 66 (NYSE:PSX) and Continental Resources (NYSE:CLR).
No one knows if any policy designed to buoy the U.S. energy industry will result from the meeting, but it’s important to remember that these are all large American companies and their interests are often contrary to the smaller oil producing companies facing financial distress now.
Ideally, the U.S. government would prefer high American production and low oil prices for refiners and consumers, but that’s not a possibility. Which means we'll have to wait and see what happens next.