The worldwide spread of the coronavirus demonstrates how disruptive a medical pandemic can be for the upstream sector of the oil and gas industry.
In addition to presenting a huge health challenge, the crisis likely means a substantial decline in world oil demand. The expectation of reduced consumption has already resulted in a sharp drop in crude prices.
But for the U.S. exploration and production sector, the effects of the coronavirus pandemic might not be completely negative, according to at least one analyst.
“I think in the long run it’s actually going to be good for the U.S. upstream sector,” said Kenneth Medlock III.
Medlock is a fellow in energy and resource economics and senior director of the Center for Energy Studies, at the Baker Institute for Public Policy at Rice University in Houston. He’s also a faculty member of the university’s Department of Economics.
Ripping the Band-Aid Off
In his view, the U.S. industry was already facing a period of contraction and consolidation, especially among shale players. He believes the effect of the pandemic will be to reduce the duration of that decline.
“You’re going to see that some bankruptcies that were going to happen anyway will be accelerated,” Medlock said.
“It’s Darwinian, in a lot of respects,” he added.
The coronavirus won’t lead to less overall consolidation pain for the U.S. upstream sector, Medlock noted. It just shortens the period of pain.
“If you’re going to pull a Band-Aid off, you don’t pull it off slow,” he said.
One result of the pandemic, and its resulting economic pressures, will be to speed up the transfer of U.S. acreage available for unconventional-resource development from small independents to the majors and other large companies, Medlock predicted.
That shift is already under way. A pullback by smaller shale players has increased the percentage of shale acres in the hands of the majors and other large companies.
“If what I expect to happen is going to happen, sometime in 2021 you could see that number pushed up to 40 percent or even 50 percent,” Medlock said.
While the coronavirus could slow the development of U.S. unconventional resources, the special nature of shale plays can insulate them from the worst effects of a production interruption, especially in terms of reservoir management, Medlock noted.
“Stopping production in shale does not destroy the reservoir,” he said.
And a decline in the rate of U.S. shale development won’t negate the long-term potential for shale production, he observed.
“The shale acreage doesn’t disappear,” Medlock said.
The Impermanence of Panic
In economic terms, lower prices typically stimulate demand. But the coronavirus has created a more challenging situation because the effects go beyond economics, he said.
“With this, though, it’s different because even with lower prices it won’t stimulate consumer spending, because consumers aren’t doing things. Lower prices aren’t going to make people go out and go to dinner or go to the movies,” he noted.
“The thing that makes this turn so difficult to think about is that the decline in demand is linked to fear. It’s just different from the way we usually think about things,” he said.
While economics will be depressed by the pandemic and a global recession is possible, the public “panic mode” caused by the coronavirus isn’t sustainable. As soon as the fear goes away, “people start to think differently,” Medlock said.
For oil prices, that will mean a strong resurgence at some point, followed by a slower climb as oil inventories are drawn down and global economics improve, he predicted.
“Demand will pop. Not necessarily suddenly, because there will be income consequences. But it will pop,” Medlock said.
“There will be a pop and then climb back up, because you’ll have to eat through inventory,” he added.
OPEC’s failure to reach an ongoing agreement with Russia, and both sides’ subsequent vow to increase oil production, helped push oil prices lower in March. But Medlock noted the coronavirus scare was already having a major impact at that point.
West Texas Intermediate crude began 2020 at about $60/barrel and had already lost a third of its value, he observed.
“Before the OPEC+ price war broke out, WTI was already at $40. That has already happened,” he said.
While nobody knows for certain how long the effects of the coronavirus pandemic will last, Medlock said he expects about a four-month cycle for containment in the United States, based on the course of the virus in China.
However, China will likely continue to be a drag on the world economy and could go through a prolonged period of reduced energy demand.
“The problem is, the things they make, they sell to the U.S. and Europe,” Medlock noted.
Another positive for the oil industry comes from its efforts in automation. It may be a glass-half-full, half-empty picture, but the industry’s capacity to operate remotely could help it get through the pandemic scare.
“That might be retrospectively a saving grace for the industry to keep operating and keep producing in this environment,” Medlock said.
Practical Lessons
Also, coping with the coronavirus will help the oil industry prepare for future pandemics. It’s a learning experience and Medlock said important lessons have already become apparent.
“Hopefully, the global community will internalize (the lesson) that containment is impossible with limited information,” he noted.
March showed just how quickly events can unfold with the spread of a pandemic disease. Right now, the prognosis for the energy industry appears to be a period of depressed operations followed by a gradual recovery.
Offshore platforms are a special challenge, and Medlock said offshore operations will be hit especially hard by the coronavirus.
“Offshore it’s worse, because you’re talking about a contained environment,” Medlock observed.
“They’ve got all kinds of contingencies, because if a member of your crew offshore gets sick, you’ve got a problem,” he said.
The spread of disease onshore compounds that problem. When a platform crew is quarantined for observation, another crew has to be tested and available.
“Then, do you have the people to get on the rig and work?” Medlock said.
Any positive news for the oil industry during the coronavirus spread is a positive for the world. Viable energy and power industries are essential because they literally keep a country going and keep the lights on during a pandemic.
Despite the immediate economic effects of the coronavirus on the upstream sector of the U.S. oil industry, “in the long term, it’s a good thing because the sector is going to be healthier,” Medlock said.
The bigger story, and the enormous challenge for the industry right now, is coping with the medical effects of the pandemic among employees, he noted.
“In terms of the coronavirus, it really is about the health and safety of the workers,” he said.