Al Attiyah Foundation Special Report: Difficult Decision for Oil and Gas Producers
Due to the recent reductions in demand for refined products brought about by lockdowns and travel restrictions, refiners are facing some difficult decisions.
In a normal year, refiners complete maintenance shutdowns to prepare the plants for a northern hemisphere driving season. In addition, refiners replenish Aviation Turbine kerosene for the holiday season and the annual Haj. They usually leave cold winters with gas oil stocks low, (used for space heating), and when heavy fuel oil demand is also reduced.
Instead, refiners are facing greatly reduced demand for their four basic products at a time when stocks are high, or in some cases where storage is full. Therefore, what would have once been a quite normal, well understood, and even a straightforward business decision, has become problematic.
Some of the challenges refiners now face:
The timing of maintenance turnarounds, following the shut-downs, due to the COVID-19 pandemic. Refiners do not wish to miss an upturn in the market, but need to ensure parts and labour can be secured in a timely fashion.
Should the refiners switch to a summer production slate, or will there even be a summer season? How can the production slate be aligned with demand when the demand is essentially unknown? What new trading strategies will be adopted?
Kpler (a market data company) estimates that there is a global storage capacity of 6.25 billion barrels and as of 31 March, stocks were at 4.51 billion barrels of crude, and is filling up at the rate of 100 million barrels a month. However, it also estimates, that well within a year, bottlenecks will appear unless demand picks up substantially.
If refiners slow down refining operations and crude storage is practically full, then crude producers must cut production. Whilst this may sound easy, it is not for technical, political and marketing reasons. Crude oil wells cannot just be turned off without harming the wells. Corrosion in the wells may result if they are merely turned off, or in the case of Russian crude, they could freeze. Wells which are pumped or undergoing water flooding may never recover.
In response to such challenges, there are several things that crude oil producers can do; postpone the drilling of new wells; lower rates of water injection; and slow down the production rate of existing wells. However, the laying off of rigs may be the first sign of cost- cutting and it is already happening.
Saudi Arabia technically can cut its production but does not want to do it alone and thus lose market share. It has strong gas driven wells that will probably not suffer extensively from being throttled back, and if enough wells are slowed down then a substantial cut in production can be achieved.
In Russia, the bulk of the oil fields are in Western Siberia and the wells are old. They cannot be turned down easily and if they are, then many will not recover.
In the USA, it is often stated that competition laws will stop producers coming together to control competition. Whilst this is the case at the Federal level, it is not the case at the State level. For instance, the Railroad Commission of Texas has a duty to protect the natural and mineral resources of the State, and as such it can order producers to cut production.
The commission will meet, by video conference in a few days to discuss ordering potential cuts, something it has not done since the early 1970s.
However, the USA can also react to low prices by letting uncompetitive shale oil wells fade away and discontinue routinely drilling new wells. Other small producing countries, of which there are many, have a similar combination of problems, or degrees of civil unrest prevents production being cut.
Producers who are net importers will be disinclined to cut production, of course, as will those who need production for domestic use. Many producers are also highly dependent on the income generated by their crude, whatever the crude price.
Below is a table of estimated oil production in 2019. Whilst some 2020 production figures are available, these are not considered reliable at the moment.
It is a time when crude producers and refiners are in a difficult position and cannot base their production decisions on purely business considerations. A cash crunch is with us.
Companies who do not take the right actions will not survive. There is an oil prospector’s adage, ‘in order to survive in the long term, one has to survive in the short term’.
For more special reports from Al Attiyah Foundation, visit abhafoundation.org.