No, the US is not an oil swing producer – there’s a pile of bankrupt companies to prove it

A recent article implied that the US is now the global oil swing producer. Actually the article more or less stated it, not implied it. The thesis was based on an interview with some random self-interested market commentator, yet is now well on its way to becoming an accepted truth because of Bloomberg’s credibility. Not that half baked theories are anything new to the web, of course; such ill-documented speculation is what breathed life into the internet so stories like this shouldn’t be a surprise. However the article and proposition were widely circulated and read, and the idea makes for such a snappy and memorable sound bite that it tends to stick.

Much harm can be done by these offhand and somewhat brainless declarations. These sorts of baseless but widely disseminated headlines stick in the pop culture consciousness (to the extent that pop culture pays attention to anything meaningful) and over time become accepted as truths. This one in particular authoritatively states that the US will now be the fulcrum on which the globe’s oil market balances. Left unchallenged, it enters the common lexicon as easily as the moronic “nuke-ular” pronunciation.

First of all, as one should do with any sound entering the head, consider the source. The article linked above quotes one Dan K. Eberhart as proof of the theory, which Mr. Eberhart enthusiastically endorses. The article also notes that Mr. Eberhart is “an expert on U.S. and international energy policy.” Hmmm. Mr. Eberhart is also CEO of a rapidly-growing US oilfield services company (the self proclaimed “sixth largest wellhead company in the US”. He also is a lawyer, so thick leather gloves are required, but at any rate it is at best self-serving for such a person to be considered a global expert on the topic. A 2 minute analysis of the article should give pause for thought.

Looking beyond that warning sign to the meat of the article itself, it also doesn’t take long to see that the meat is from a squirrel. Mr. Eberhart states that “America’s shale producers are increasingly in the drivers seat on world oil prices.”

It would be beneficial at this juncture to point out that America’s shale producers are going bankrupt at an astonishing rate. If they are in the drivers seat, they also have pepper in their eyes. The notion that a small uptick in prices, or even a material one, will flood the market with oil again is laughable. Capital and debt markets have been decimated, and those markets and their vast mountains of money were required to finance the shale boom in the first place (cash flow never came remotely close). There is no source of funding to dramatically increase production in the short term. Yes, the healthiest, lowest cost producers will begin drilling again, but that alone won’t flood the market, and even that inevitability may be a short lived phenomenon. Consider this remarkable quote from Scott Sheffield, CEO of Pioneer Natural Resources, one of the most successful US shale players, from their recent Q1 results conference call: “We had a first-quarter adjusted loss of $104 million or $0.64 per diluted share. What’s more important is that the company hit record production again first quarter of 2016, 222,000 barrels of oil equivalent per day, 55% oil.” When you consider Sheffield’s statement, don’t you think they should aim for losses of a billion dollars, since imagine what the “more important” production levels would be then!

Furthermore and more pertinent to the point, the US is not and never will be a ‘swing producer’ pretty much by definition. A swing producer has the capability of raising or lowering production levels to achieve a desired price or production target. Implied in this is the ability (both physical and financial) to greatly increase production to achieve this goal. The US is not in that camp, at all. US production is governed by prices. The more prices rise the more likely it is that production will increase. A swing producer can raise production at will regardless of price. Cartels can play with production levels to achieve prices, assuming non-cartel production can’t easily materialize. Saudi Arabia was a swing producer for the longest time, with the ability to flood the market. That ability is arguably gone because Saudi Arabia is working overtime to flood the market at present, and their stated intent to do just that implies that they are doing whatever they can to flood the market. To think they hold spare capacity would be to believe that they are trying to flood the market and keep prices down, but not really. It doesn’t make any sense.

The US can never be a swing producer when it’s governed by market prices and not acting as a cartel to maintain a certain price level. This time around, it’s market forces that are adjusting production, and we’ll soon find out how well that’s working.

Read more insightful analysis from Terry Etam here