Source : THE AGE NEWS
Oil is a commodity acutely sensitive to shifts in demand within the global economy. Not surprisingly, it’s also demonstrating a very strong inverse correlation with Donald Trump’s tariffs.
Trump might have wanted to usher in a “golden age” for the US oil industry, but so far this year, it’s been fool’s gold for the US industry.
The oil billionaires who poured more than $US450 million ($705 million) into his election campaign should have been more careful what they wished for, with the US domestic oil price tumbling from just above $US80 a barrel in the days preceding the Trump inauguration to about $US63.50 today. It has been below $US60 a barrel this month.
The price of oil has been highly sensitive to Donald Trump’s pronouncements on tariffs.Credit: AP
There is a clear relationship between the price and Trump’s tariffs.
Before “Liberation Day” – April 2, when Trump theatrically unveiled his baseline universal tariff and his so-called “reciprocal tariffs” in the Rose Garden – the West Texas Intermediate price was just above $US71 a barrel. A week later, it was $US59.58 a barrel. On April 9, however, Trump paused the reciprocal tariffs for 90 days and the price bounced back above $US60 a barrel.
That sensitivity to every Trump pronouncement/social media post on tariffs is not surprising.
The tariffs will depress US economic activity – the International Monetary Fund said last week they would reduce US economic growth this year from the 2.7 per cent it forecast in January to 1.8 per cent – and therefore domestic demand for oil and gas.
The tariffs and retaliation from China, and perhaps elsewhere, will also affect global growth. The IMF has cut its forecast for global growth this year from 3.3 per cent to 2.8 per cent. The average global growth rate this century has been 3.7 per cent.
Thus, both US and global growth are expected to slow, with a consequent impact on domestic and global demand, and oil prices. The international oil price, Brent Crude, has fallen from $US82 a barrel in January to $US67 a barrel, with its fluctuations mirroring the West Texas Intermediate price.
The International Energy Agency had forecast demand for oil would increase by about 1.03 million barrels a day. After Liberation Day, it cut that forecast by about a third, to 730,000 barrels a day, saying about half that reduction was attributable to lower demand in the US and China as a result of the trade war.
Demand is, of course, only half of the equation that generates prices. The other half is supply, and it is increasing even as demand is falling.
On the day Trump unveiled his new tariffs, OPEC+ said they would unwind the 6 million barrels a day or so of cuts made over the past three years at a faster pace than they previously planned, adding about 411,000 barrels a day to supply from next month.
The move is seen as an attempt by Saudi Arabia, which has borne the brunt of the past cuts to production, to punish those members of the cartel that haven’t met their own commitments to constrain their production. Kazakhstan, the United Arab Emirates, Russia and Iraq have all been producing above their agreed caps.
Trump’s “Golden Age” for US oil won’t happen if demand weakens even as supply increases. He has said he wants to double US oil production, which reached record levels during the Biden administration
He may get the other thing he wished for – lower US gasoline prices – but for less palatable reasons than the giant surge in US production he anticipated.
The US shale sector is unlikely to take heed of his urgings to “drill, baby, drill” while domestic oil prices are languishing at their current levels.
While break-even levels for shale producers vary according to the richness and productivity of the various basins, a rough guide is that to break even – pay all costs, including operating and financing costs and also pay a dividend – US onshore oil companies need a price between $US62 and $US65 a barrel.
Today, however, it isn’t just the oil price that dictates whether they drill wells or not. Drilling rigs require lots of steel and many components imported from China. Trump’s steel tariffs and his 145 per cent tariff on most imports from China are driving up the sector’s costs.
Today’s shale industry has been heavily consolidated and is financially disciplined, with a focus on returns on capital.
Where once Wall Street rewarded shale oil and gas companies for their production, now it rewards them for their returns on capital and punishes sub-optimal activity.
According to energy technology company Baker-Hughes, about 23 fewer oil rigs are operating today than a year ago and, at 483, only just over half the record 888 rigs set in 2018. Industry executives are warning that if prices fall back further, the number of operating rigs will fall much further.
With the best fields’ reserves declining and costs increasing, the US shale sector was never going to double its production. While production was expected to continue to grow incrementally, peak production was expected to occur before the end of the decade, although Trump’s deregulation and opening of federal lands to exploration and drilling might have stretched the timeline.
A US and, perhaps, global recession would, of course, further darken the outlook for demand and undermine the economics of production. While those recessions are not yet seen as probable, both the IMF’s odds on a US recession and those of private forecasters have been shortening.
The risk of a severe downturn in the economy adds another layer of uncertainty to the outlook for US energy companies, as does the potential for Trump to do a deal with Vladimir Putin that would lift the sanctions on Russian oil (Russian drilling has already begun increasing in anticipation) and add to the global surplus of supply.
Early this month, Trump’s energy secretary Chris Wright told the Financial Times that the shale producers could boost their output even at $US50 a barrel. Less than a fortnight later, he said $US50 a barrel oil wasn’t sustainable for producers.
Wright, before taking up the role in the administration, was chief executive of Denver-based Liberty Energy – America’s second-biggest “fracker” – which earlier this month announced a first-quarter profit of $US20 million, down from $US82 million in the same quarter last year and the $US52 million it earned in the December quarter last year.
Liberty’s share price was around $US22.60 when Trump took office again. Today it’s just over $US12. The company’s market capitalisation has slumped from $US3.7 billion to $US1.97 billion over that period.
The current chief executive, Ron Gusek, believes producers can maintain their drilling at current levels as long as the price remains in the low $US60s a barrel, but are likely to start shutting down wells if the price drops any further. Maybe he had a chat with Wright, although the precipitous fall in his old company’s share price might also have grabbed Wright’s attention.
Trump’s “babies” aren’t going to increase their drilling and production at current prices. At best, they will, regardless of his urgings, try to maintain current levels.
At worst? Trump’s tariffs, a US and global economic slowdown/recession and rising production volumes from OPEC+ will result in production cuts to a sector that generated more than 15 per cent of America’s exports last year and gave the country a $US45 billion energy surplus.
The billionaire donors to Trump’s campaign should, perhaps, have been more careful of what they wished for, looking beyond his energy and tax policies to his wider platform, and the trade policies in particular.
