Global stock markets followed crude oil and took a nosedive today as Saudi Arabia launched a devastating price war against Russia.
The ugly truth is that both oil-rich countries have enough resources to survive the plunging crude prices for the foreseeable future.
The real loser from the fallout of this battle is going to be the U.S. shale industry.
American shale oil companies are over-leveraged and debt-ridden, and a steep drop in oil prices will hurt their cash flow. This will have a direct impact on their ability to service this debt.
According to a Dallas Federal Energy survey, the average breakeven oil price in the U.S. is in the $48 to $54 per barrel range. Producers may be able to bring down the breakeven price by lowering costs. But a sustained oil price of under $40 per barrel is going to be devastating for the industry.
U.S. oil stocks were already in terrible shape, and the crude crash can prove to be the final nail in the coffin.
Over the last few years, U.S. oil producers have witnessed a sharp rise in their debt-to-equity ratios.
The industry already experienced a sharp surge in the number of bankruptcies in 2019. The previous year saw a staggering 50% of them go belly up.
With crude oil prices down sharply, highly-leveraged balance sheets will come to haunt the industry. Consequently, a litany of energy companies should go bankrupt in 2020 as well.
Over the last few years, the U.S. has sharply boosted its oil and gas production and leapfrogged Russia and Saudi Arabia.
Russia and Saudi Arabia stand to gain substantial market share by bankrupting the U.S. shale oil industry. And they know the U.S. producers do not have enough capital to withstand a large drawdown in crude prices.
So, it’s no surprise to see neither Russia nor Saudi Arabia back down from the price war.
President Donald Trump has called for lower oil prices in the past. And he feigned praise for today’s gas price plunge.
While a lower oil price may appear beneficial for the U.S. consumer, Trump is ignoring the devastating could impact it could have on Texas and North Dakota. These two states are responsible for the majority of the oil and gas production in the country.
Due to the high output, these two states hoard a lot of reserves. North Dakota and Texas saw the second- and third-highest net gains in crude oil and lease condensate reserves in 2018.
Consequently, companies in these states are stuck between a rock and a hard place. Low oil prices and a high amount of debt – which will make securing future financing difficult – could be a deathblow for shale oil producers.
Russia and Saudi Arabia’s decision to boost production could prove to be a masterstroke. When U.S. oil and gas stocks start going bankrupt, these two energy-producing rivals stand to gain the most.
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