ENERGY MARKETS

EVs, shale and Trump: 5 takeaways from the oil crash

Oil companies cut their spending yesterday as the double shock of the coronavirus epidemic and an oil price plunge spread through the economy.

While the Trump administration said consumers would benefit from lower prices at the pump, a prolonged slump or a recession could hurt the president's reelection chances, analysts said.

"There are a lot of unknowns, but it would create an undeniable headwind for President Trump and his campaign," said David Flaherty, CEO and founder of the Republican polling firm Magellan Strategies in Colorado.

The White House has reportedly called a meeting with Wall Street executives tomorrow to discuss the coronavirus's impact, and talk may touch on possible ways to support the energy sector.

The oil market shake-up also prompted Trump to make his first public appearance at the administration's coronavirus task force briefing yesterday since he appointed Vice President Mike Pence to lead the group.

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Trump said that the administration is considering cutting payroll taxes as an economic stimulus, along with other unspecified steps such as relief for hourly workers who are forced to stay home and help for the hotel, airline and cruise ship industries.

"They will be very dramatic and we have a great economy, we have a very strong economy, but this came, this blindsided the world," Trump said.

The coronavirus, which has spread to more than 100 countries and killed at least 3,800 people worldwide, was already dampening the world economy before Russia walked out of negotiations over the weekend with Saudi Arabia and its allies over a plan to cut production and prop up oil prices.

In retaliation, Saudi Arabia cut its prices and announced that it would ramp up production. The news sent world oil prices plummeting, and it's not clear when the oil-producing countries will negotiate a truce.

U.S. crude oil fell more than one-fourth, the most since 1991, to just more than $30 per barrel yesterday. International crude hit just under $35 a barrel. The International Energy Agency said oil consumption would fall in 2020 compared with 2019, the first year-over-year drop since 2009 (Greenwire, March 9).

The price plunge hit energy leaders like shale drilling magnate Harold Hamm, executive chairman of Continental Resources Inc., who was knocked off Bloomberg's billionaires index as his company's stock fell by more than half.

"How long this price war plays out and what comes next largely depends on how committed Riyadh and Moscow are to these respective goals," Reed Blakemore, deputy director of the Atlantic Council's Global Energy Center, wrote in an email.

Here's five takeaways from the oil crash:

Climate U-turn?

Daniel Raimi, a senior research associate at Resources for the Future, said the recent oil price drop is not likely to alter the long-term climate commitments of major oil and gas companies, who are already anticipating declines in future oil revenue.

Smaller companies, however, will have tighter budgets because of the downturn, he said.

"There will probably be less appetite for deploying technologies to reduce the environmental footprint of their activities," Raimi said of the non-majors. "If we think about something like rules for methane emissions, one could imagine that broadly speaking — across the industry — lower oil prices means less money available to invest in methane reduction, which means that firms are likely to be less open to policies that require such reductions."

Raimi said the price plunge will not have a big impact on clean energy for power in the short term, as oil doesn't really compete in the U.S. electricity sector. Most of the country's oil-fired power plants have closed over the last 20 years, he said, and oil and natural gas prices have become more and more decoupled because of the U.S. shale revolution.

Still, parts of Texas, Oklahoma, North Dakota and New Mexico have become increasingly dependent on oil production to support their local economies, and thousands of people will experience "substantial economic hardship" because of the lower oil prices, Raimi said.

Gregory Wetstone, president of the American Council on Renewable Energy, said the price drop shows the need for the United States to move away from oil and gas.

"Today's volatility is just the latest reminder that our nation's continued reliance on fossil fuels leaves us vulnerable to the gyrations of global oil markets and foreign actors," he said in an email.

Electric vehicles

The nosedive in oil prices is good for the wallets of drivers of traditional cars — and mostly bad news for electric vehicles.

The bad news is immediate. One of the chief selling points of an EV is that filling a battery with electrons is cheaper than filling a tank with gas. That's still true in most places but is less true than it was last week.

That calculation is at least part of the reason that EV companies' stocks got pummeled yesterday. Tesla Inc.'s stock dropped 13% on the Nasdaq Stock Market, while Nio Inc., one of China's leading automakers, dropped 7% on the New York Stock Exchange. Geely, an EV maker and Chinese parent of the Volvo and Polestar brands, dropped 4.5% during China's first trading day this week.

The good news for EVs, if there is any, is entwined with bad news for the global economy.

It has to do with the major ingredients in an EV's battery. EV makers know they must make the battery as cheap as possible for the overall vehicle to be competitive on price with today's reigning gas-powered cars.

Prices for those ingredients, such as cobalt, nickel and aluminum, have seen their prices drop 10% to 15% along with oil's declining fortunes, said Dan Hearsch, who studies automotive supply chains at consulting firm AlixPartners.

But that's a long-term silver lining. Automakers making EVs are more likely to be concerned with the dark and short-term cloud of gas prices.

"If oil stays cheap as it is and gas stays down, it will sway people from buying EVs, at least until batteries get to parity, which is at least a few years away," Hearsch said.

Tesla's outlook was further darkened by the key role of China in the company's growth plans.

The company's stock skyrocketed in early 2020 as Tesla seemed poised to sell a ton of vehicles there. In January, the company opened an enormous factory in Shanghai, its first outside the United States.

Now those predictions face headwinds.

Sales of all passenger cars — not just electrics — fell off a cliff in China last month. The China Passenger Car Association reported that sales tumbled 80%, according to Reuters. While China's coronavirus epidemic appears to be waning, it is unknown if the economy will bounce back.

Dan Ives, an analyst with Wedbush Securities, said yesterday that he still has confidence that Tesla can meet its goal of selling 500,000 vehicles in China this year, calling that target "an achievable bogey to hit."

A hit for U.S. shale

U.S. oil production has been boosted by small and medium-sized companies that have been drilling in the shale fields of Texas, New Mexico and North Dakota.

They're likely to be the first ones affected, because their costs are higher than in Saudi Arabia and Russia, and they're more reliant on debt to keep drilling.

Dan Pickering, an independent energy analyst, said the oil industry as a whole needs to cut its spending and let production fall until prices stabilize.

"There is no safety net," Pickering wrote on his company's website. "Companies that can embrace Value Over Volume have a shot at survival and regaining investor trust and interest. Companies that don't react quickly run the risk of insolvency and irrelevancy."

There were already signs yesterday that the industry was adopting that approach. Two oil producers centered in the Permian Basin of Texas and New Mexico, Diamondback Energy Inc. and Parsley Energy Inc., have already announced they're cutting drilling and hydraulic fracturing crews and reducing their long-term spending on production. Occidental Petroleum Corp., one of the biggest producers in the Permian, was also planning to cut its spending, Bloomberg News reported, citing people familiar with the matter.

"We will see a swift reaction to production," Bob Fryklund, the chief upstream strategist at IHS Markit, said in an email. "Look for most companies to focus on cash preservation and doing more with less."

The American Petroleum Institute said its member companies have become more resilient over the years and will weather the downturn.

"This is an industry that invests for the long term," API President Mike Sommers said on a conference call with reporters. "We've seen these kind of cycles in the past."

Price drop isn't the only problem

The oil industry was already in a tight spot before the price war broke out between Saudi Arabia and Russia, and companies have fewer tools to help them recover than they had in the past.

The industry is counting on economic growth in China, India and other developing nations to offset the falling demand for oil and gas in the United States and Europe. That long-term forecast helped the industry recover from the last price drop, which lasted from 2014 to 2016.

But the first casualty of the coronavirus was China's economy, as factories and oil refineries shut down due to the country's quarantines, and the rest of the world's economy was also starting to stagnate as the virus spread.

"This time, oil demand is also weak as the coronavirus outbreak depresses global economic growth," Tom Ellacott, a senior vice president at the consulting firm Wood Mackenzie, said in a research note. "The macro-economic backdrop is completely uncharted waters for oil and gas companies."

The Big Oil companies like Exxon Mobil Corp., BP PLC and Royal Dutch Shell PLC have the financial might to weather a downturn in prices. Many smaller companies have high debt levels, and they were already seeing a downturn in investment despite cutting their expenses to the bone the last time prices fell.

That leaves the smaller companies with few options, Ellacott wrote.

"There is much less obvious excess spend to cut this time around after five years of disciplined investment and austerity. Raising capital is also much harder now, especially for U.S. Independents," he said.

The drop in oil prices means consumers will see the price of gasoline and diesel drop, but that won't necessarily mean that they'll buy more fuel, Kevin Book, managing director at ClearView Energy Partners LLC, wrote in a research note.

"Quarantined people don't drive around the block twice when prices are low (our experience is that non-quarantined people don't usually do so, either)," he wrote.

Trump's reelection

Trump tried to play the precipitous plunge in oil prices as a benefit to consumers, but pollsters say it could reverberate at the polls in November if the price cut is sustained or leads to a deeper recession.

"Good for the consumer, gasoline prices coming down!" Trump tweeted yesterday morning.

Treasury Secretary Steven Mnuchin also predicted yesterday that the "the economy will be in very good shape a year from now. This is not like the financial crisis where there was no end in sight. This is about providing proper tools and liquidity to get through the next few months."

Meanwhile, the Department of Energy may explore its options regarding a planned sale of oil from the Strategic Petroleum Reserve. DOE was scheduled to sell 12 million barrels from the reserve, but there are concerns that doing so could further flood the market.

DOE spokeswoman Shaylyn Hynes said the country and the oil industry "can and will withstand this volatility."

"Thanks to President Trump's pro-growth policies, America will remain the number one energy producer in the world," Hynes said in an emailed statement.

But oil selling below $30 a barrel could cause a ripple effect in states with considerable shale oil operations, including swing states like Colorado and Pennsylvania and more reliably red states such as Texas.

"It begs the question of how much will these economic challenges weigh on folks supporting the president. It's going to be part of the politics, no doubt about it," said Flaherty from Magellan Strategies.

Flaherty noted that Trump could be helped, however, if the Democratic platform looks to ban fracking "or is very aggressive against the use of fossil fuels. That helps the president tremendously."

But he added that it appears increasingly likely that Trump will face a challenge from former Vice President Joe Biden rather than Sen. Bernie Sanders (I-Vt.), who backs a fracking ban. Biden has not advocated for a total fracking ban, instead calling for blocking new oil and gas permitting on public lands and waters.

James Henson, who directs the University of Texas/Texas Tribune Poll, said that if the market remains volatile and gas prices low, "it's obviously not good for the president."

Economic conditions have traditionally been one of the best predictors of presidential elections, and "turbulence is not a good indicator for reelection," he said.

"If this continues and we're into an outright recession, we're talking a different election environment," he added.

Written by reporters Mike Lee, Carlos Anchondo, David Ferris, Lesley Clark and Hannah Northey with contributions from the Associated Press.

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