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A fracking site owned by EQT, a pioneer in Marcellus Shale gas extraction, near Rose Friend’s farmhouse in Marianna, Pa., in this file photo from March 11, 2020. Natural-gas companies operating in the state were looking shaky before the coronavirus hit, and local economies are now at risk.

Ross Mantle/The New York Times News Service

For more than a decade, the American shale oil industry played a high-stakes game of chicken with Saudi Arabia and Russia – and kept on winning. In March, its luck ran out, big time, and the good ol’ boys in Texas are already pleading for mercy as oil prices plunge at unprecedented speed.

Any sense that the shale companies can tough it out as they did during the last great oil price downturn, in 2014 and 2015, is vanishing, even if a few stalwart optimists believe a rebound is inevitable, because the best cure for low prices is low prices. They are right. But when? The V-shaped recovery seen in the previous price collapse could prove elusive as COVID-19 acts like an indiscriminate economic wrecking ball.

On Monday, two prominent Texan shale players, Pioneer Natural Resources and Parsley Energy, formally asked Texas regulators to approve co-ordinated output reductions to avoid “wasteful production." The product that Texans once called “black gold” is becoming almost worthless.

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By this week, West Texas Intermediate, the U.S. benchmark, was trading at about US$20 a barrel, down from its 12-month high of US$66. The price of some minor grades of U.S. crude, such as the thick oil used to pave roads, actually turned negative, meaning the producer was paying the buyer to cart the guck away.

Production will have to be curtailed, but don’t feel sorry for the Texas shale guys. Their strategy of ramping up production by record amounts, to the point that the United States surpassed Saudi Arabia and Russia to become the world’s top oil producer, was bound to backfire at some stage (Canada’s rising output from the oil sands also helped to flood the market). The triggers were the pandemic and the decision by Saudi Arabia and Russia to pump like mad to intensify the shale industry’s pain. If they hand a life jacket to the shale boys, it will be made of concrete.

u.s. crude oil production

Crude oil production has risen during the past

10 years driven by shale oil

1940-2019, in millions of barrels per day

2019: 12.23

million b/d

14

12

2018: 10.99

million b/d

1970: 9.64

million b/d

10

8

6

4

2

0

1940

1950

1960

1970

1980

1990

2000

2010

JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE:

U.S. Energy Information Administration

u.s. crude oil production

Crude oil production has risen during the past

10 years driven by shale oil

1940-2019, in millions of barrels per day

2019: 12.23

million b/d

14

12

2018: 10.99

million b/d

1970: 9.64

million b/d

10

8

6

4

2

0

1940

1950

1960

1970

1980

1990

2000

2010

JOHN SOPINSKI/THE GLOBE AND MAIL

SOURCE: U.S. Energy Information Administration

u.s. crude oil production

Crude oil production has risen during the past 10 years driven by shale oil

1940-2019, in millions of barrels per day

14

2019: 12.23 million b/d

12

2018: 10.99 million b/d

1970: 9.64 million b/d

10

8

6

4

2

0

1940

1950

1960

1970

1980

1990

2000

2010

JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: U.S. Energy Information Administration

The U.S. shale “revolution,” as it was called, was aptly named. Less than two decades ago, America was in a low-grade panic about rising oil prices and its lack of energy independence, which had made it a hostage to OPEC – the Saudi-led Organization of the Petroleum Exporting Countries.

In 2007 and 2008, as prices vaulted past US$100 a barrel to almost US$150, the shale industry – backed by ingenious U.S. fracking technology and a borrowing binge financed by junk bonds – took off like a rocket. Last year, U.S. oil production surpassed 12 million barrels a day, making the country a net exporter of all oil products. Shale oil, largely from Texas and North Dakota, represents 60 per cent of U.S. production.

By 2014, the success of shale oil irritated the Saudis; they sought revenge by launching a price war that sent oil plummeting to less than US$40 from US$100. They were only partly successful. U.S. shale oil production fell by about 20 per cent. The shale companies adapted quickly by cutting costs. Oil started to climb in 2016, the junk bond financings came back, and shale oil production rebounded, setting record output levels every year.

The Saudis renewed their assault a few weeks ago even as the novel coronavirus crisis was intensifying, sending oil demand plunging. The trigger this time was the suddenly shattered alliance between Saudi Arabia and Russia, who had worked together since 2016 to curtail production to prop up prices. The result was a free-for-all, with Saudi Arabia trying to punish Russia and both countries trying to punish the U.S. shale producers.

The U.S. shale industry is more worried about its future than ever. The unprecedented demand from the Texan companies to curtail production says as much. They have good reason to be fearful, because this downturn is not like the last one. Of course, prices will reverse course once economies reopen, but anyone betting on a quick leap to US$65 oil – the price before the COVID-19 crisis started – might be in for a rude shock.

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Drilling shale wells is a costly business and no shale company is making money at US$20 a barrel. Some analysts put the break-even price at somewhere between US$40 and US$50. At current prices, their business model – drill often and sell junk bonds to pay for it – breaks down fast.

The weakest shale companies will go bankrupt and others will curtail production. With junk bond investors heading for the hills, it might be a long time before the industry gets off its knees. And don’t forget that prices for natural gas, another shale product, have plummeted, too. Energy investors might gravitate instead to renewable power, whose returns tend to be more reliable.

Saudi Arabia and Russia are the other big variables. They’re just starting to draw blood from the U.S. shale industry, so why curtail production now? That would wreck the fun of seeing American producers collapse. If anything, Saudi Arabia, which has ample spare capacity, will ramp up production until U.S. storage capacity runs out.

Given that most shale companies have hedged their production, it might take six months of extremely low prices to inflict mortal wounds on the U.S. industry. For the Saudis and Russians, which have relatively low production costs, that’s not a long time. The shale industry is going into quarantine. Like many coronavirus quarantines, it might not be lifted soon.

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