Memo to Trump: Don’t Bail Out the U.S. Shale Industry
— April 3, 2020
By Paul H. Tice
The greatest threat to the industry, though, may be the helping hand now being extended by the U.S. government. Many of the bail-out proposals currently being floated by the Trump administration would be ineffective over the short term and likely damaging to the industry over the long term. President Trump is meeting with U.S. oil executives at the White House today to discuss various ideas and potential next steps.
The federal government is already pushing forward with plans to provide oil market support by filling up the Strategic Petroleum Reserve (SPR), America’s emergency supply of crude oil kept in underground salt caverns along the Gulf Coast. Such SPR buying is not likely to move the price needle, however, since unused facility storage capacity only amounts to 78.5 million barrels at present. This is roughly equivalent to the amount of additional oil that Saudi Arabia is expected to pump during the month of April alone.
Notably, this SPR buying would be specifically targeted at domestic producers employing 5,000 workers or less, highlighting how the goal of this program seems to be less about boosting oil prices and more about propping up smaller players in the industry.
In a similar vein, the Trump administration has also proposed providing concessional financing in the form of low-interest government loans to this same group of struggling companies. This would only perpetuate the problem caused by cheap financing in the wake of the last oil price shock in 2014-2016 when the premature re-opening of the speculative debt markets cut short the restructuring of the oil and gas industry by allowing too many marginal industry players to survive.
Most recently, the idea of the U.S. government curtailing domestic oil production—along the lines of, and potentially in consultation with, the OPEC cartel—has been gaining traction, with the Texas state energy regulator and many companies reportedly on board. Aside from the logistical challenges involved with pro-rating supply cuts across the country’s diverse group of private sector producers and the fact that U.S. shale companies are not the specific target—but rather collateral damage—of the current oil price war, such U.S. government involvement in managing oil prices would be anti-competitive and antithetical to free market policies, while also forcing the federal government to choose between oil companies and American consumers who would stand to benefit from lower energy costs.
From the industry’s perspective, it would be foolhardy for U.S. oil and gas companies to willingly agree to such a regulatory regime during these climate change-crazed times, when fracking bans and the Green New Deal are viewed as serious proposals by far too many.
Back in the 1930s when American industries were failing across the board during the Great Depression, the oil and gas industry opted not to save itself from historically low oil prices by submitting to federal oversight, while the electric utility sector took a different regulatory path. That choice has made all the difference over the past decade as federal regulators have forced coal-fired power out of the U.S. generation mix due to climate change concerns, even as the U.S. shale industry has flourished on private lands under state law.
To see what would lie in store for oil and gas companies if the industry were to now strike such a Faustian bargain with the federal government, one need only look to the $50 billion bail-out package recently agreed for the airline industry. Many environmentalists and liberal politicians wanted to condition such federal aid on a commitment by the major U.S. air carriers to aggressively lower their greenhouse gas emissions over time.
None of this is to say that President Trump should not use diplomacy—as he already has—to mediate an immediate truce in the current price war between Moscow and Riyadh, which is the main source of pressure on the world oil markets at this point. Some U.S. industry players have pushed for the imposition of tariffs and/or anti-dumping duties on Saudi crude shipments, although such punitive trade measures would be complicated by the fact that the U.S. no longer imports significant Saudi oil volumes, while Riyadh is now dumping most of its incremental oil on the European market.
The U.S. government would appear to have meaningful political leverage with Saudi Arabia, the instigator of this latest market share battle, given that American troops now guard the kingdom’s cranking oil production facilities. Most importantly, any Saudi-led sovereign supply solution should not be allowed to rope in U.S. private sector producers. OPEC+ talks scheduled for this coming Monday offer the promise of peace in the current oil price war, but the devil will be in the details.
In the absence of an OPEC+ deal, the Trump administration should resist the political temptation to bail out U.S. shale companies and simply let oil prices run their course over the coming weeks and months, with the debt financing markets (banks and bond investors) deciding which energy companies ultimately survive. Any federal money to the industry should go directly in the form of enhanced unemployment benefits to oil and gas workers displaced by this latest downturn.
Given the oversupplied nature of the global oil markets in the post-shale era, there is a compelling argument to be made that U.S. oil and gas reserves and production need to be further concentrated in fewer, larger-cap companies with stronger balance sheets. Industry competitors need to be higher-rated credits with good liquidity and financial flexibility to deal with those increasingly frequent periods—such as now—when the bottom abruptly drops out of the oil market. Such consolidation would create a more sustainable U.S. shale industry in terms of cash flow and earnings over the long term.
For those energy companies still looking for a bailout from Washington, D.C., it would pay to remember Ronald Reagan’s warning about the most terrifying words in the English language: “I’m from the government and I’m here to help.”
Paul Tice is an Adjunct Professor of Finance at NYU Stern.