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27 August 2020

Hurricane Laura could be final nail in US oil’s coffin

Hurricane Laura made its first contact with land today (Thursday), in southwest Louisiana, and looks set to be one of the most powerful storms in the state’s history. Add in Covid-19 and an abundance of oil in strategic reserves, and this will come as yet another blow to the country’s heavy producers – a blow that they are unlikely to ever fully recover from.

The headlines behind the storm include winds which will reach 150 miles per hour, with speeds of 85 miles per hour already sustained at Lake Charles, just one hour after landfall. Forecasters have stated that the storm could also push a massive wall of water as far as 40 miles inland from the coast. The hurricane is also expected to spawn tornadoes in Texas and Mississippi, as well as flooding across all neighboring states and around the Gulf Coast.

The big worry, as far as the US energy sector goes, is the security of its oil. Nearly half of the US oil refining capacity is dotted around the Gulf Coast. In recent Hurricanes like Harvey in 2017 and Katrina in 2005, these refineries were force into closure, US supply went down, and price surged, but without bringing additional revenues to oil producers.

The phenomenon only lasted a few weeks in these cases. Most refineries managed to get back up and running fairly quickly once the storm passed. Following Katina, with oil prices spiking above $80 per barrel, from levels closer to $60, President Bush decided to release 30 million gallons from the country’s Strategic Petroleum Reserve (SPR).

But in 2005, the US wasn’t facing the worst impacts from a global pandemic and its oil industry wasn’t trying to bounce back from the lowest prices seen since the turn of the millennium.

As today’s oil demand starts to regain momentum, with prices back up at $45 per barrel from lows below $20 in April, the US will want to hold onto its market share in production, and certainly won’t want production to fall below the agreed limits following the fracas between Russia and Saudi Arabia. With the SPR currently full to the brim after a period of surplus supply, President Trump will almost certainly offload some oil onto the market, so prices will not rise as much as they would have done otherwise.

A small rise has already been seen. RBOB gasoline futures, the benchmark for wholesale petrol prices in the US, is up 7%; West Texas Intermediate (WTI) is up 1% to $42.70 per barrel; and Brent Crude is up 1% to $44.80, following the precautionary shut down of around half of the oil production in the offshore Gulf of Mexico.

Traders are clearly worried about the disruption to fuel supplies, which seems reasonable when you consider that the Gulf Coast has historically handled around 10% of global oil demand. But looking at the number of drilling rigs for shale production, which is at a four-year low, there are no clear-cut signs that activity is back to normal.

US exploration and production companies are also swimming in debt of around $170 billion at the end of July according to Haynes and Boone, double what it was four years ago.

So if these oil sites and refineries have shut in, bringing them back online in a market where oil prices are still low comes with significant financial risk, especially with the uncertainty that a second wave of Covid-19 would pose upon near-term demand. This will only be compounded while storage resources are still relatively full and there are many valves left to open.

The possibility of any gains will be limited, and even without these facilities, the US could still be in a state of oversupply in the long run. Gasoline consumption in the US is down 18%, and trending down. Prices in Asia, which usually dictate crude prices as refiners seek to maximize margins, are also trending down.

The refineries may rush to reopen, but either way, there’s cause for huge uncertainty, so views that investors will flock back to oil are ridiculous. Refineries are already closing. Phillips 66 recently announced that it would convert its Rodeo Plant in California into a biofuel plant by 2024, while it will also shut down a further plant in Santa Maria. Marathon Petroleum has also this month announced that it will close its New Mexico refineries in Martinez and Gallup.

The writing is on the wall for US oil, and its vast reserves will suppress prices for too long for industry giants to keep their operations running. Russia and Saudi Arabia will know this, and will happily run their operations at low margins, or even at a loss, for several years if they can squeeze the US out of the market.