Despite Falling Oil Prices, U.S. Production Cuts Remain Unlikely

What Happened

In a March 20 op-ed in Bloomberg, Texas Railroad Commissioner Ryan Sitton proposed a 10 percent oil production cut involving Texas, Russia and Saudi Arabia to manage coronavirus-related drops in global oil demand. Wayne Christian, the chairman of the state commission — which regulates Texas' behemoth oil sector — has since expressed doubts over such an intervention, saying that he had a "number of reservations." On March 19. U.S. President Donald Trump also said he wanted to find a "middle ground" with Moscow and Riyadh, who have been engaged in a costly oil price standoff since the two failed to agree on OPEC+ production cuts March 6. Trump's statement, however, fell short of mentioning when such negotiations would occur, and whether U.S. production cuts would be on the table.

Challenges to U.S. Production Cuts

Even as oil prices continue to remain below $30 per barrel, a production agreement curtailing any U.S. production — whether it be initiated through the White House or the country's largest oil-producing state — remains unlikely due to the following factors:

1) A Divided U.S. Oil Industry

Despite feeling significant pain from coronavirus-induced declines in prices and demand, U.S. oil companies are divided in their thresholds for financial pain and their susceptibility to bankruptcy. Tight oil-focused companies, such as Parsley Energy and Pioneer Natural Resources, and especially the smaller independents may face an existential crisis over COVID-19 market shocks and Saudi-Russian price war. Larger Exploration and Production (E&P) companies, such as ExxonMobil and Chevron, are also seeing their share prices plummet, but are better equipped to weather the storm. A mass wave of bankruptcies and defaults in the shale patch, in fact, actually provides these E&P firms with a long-term opportunity to expand their market share by buying up failing companies and their assets.

Major U.S. refiners with little to no exposure to upstream oil and gas operations, such as Valero, would also likely oppose moves to cut production or foreign oil imports to prop up prices. Moreover, these companies would be concerned that market intervention by regulators to restrict output would be a slippery slope, and one that a future, left-wing White House administration could conceivably try to use down the road if a national emergency around climate change is declared.

2) U.S. Political Realities

Political divisions in Washington would present significant hurdles to organizing a U.S. cut in production as well. In the lead up to the election in November, the optics of Trump negotiating an agreement with Saudi Arabia and Russia to support the oil industry would provide perfect fodder for Democrats. But in crucial battleground states like Michigan, Wisconsin and Florida — none of which produce significant amounts of oil — are actually beneficial for Trump’s re-election prospects. Supporting larger industries in those states, such as the auto sector in Michigan, would thus yield a higher value of return for his political capital than drastic measures to support the country's oil industry.

3) Texas May Not Be Enough

Texas has the legal architecture in place at the state level to restrict oil production, but production management in the rest of the United States — which collectively produces 7.4 million barrels per day (bpd) compared with Texas’ 5.4 million bpd — does not exist. Other oil-producing states such as North Dakota may be able to quickly legislate rules to organize a coordinated policy on oil production management. But for the vast majority of U.S. production, the Trump administration would likely need to rely on emergency powers around a national emergency declaration, which would prove unpopular.

4) Differing U.S., Saudi and Russian Motives

But perhaps most importantly is the fact that an agreement between Saudi Arabia, Russia and the United States is only possible under a worst-case scenario in which oil prices fall and remain below $15 per barrel for at least three months, which is unlikely. As sovereign states with significant reserves at their disposal, both Saudi Arabia and Russia can wait out the storm if oil prices remain where they are today, knowing that U.S. production will eventually subside regardless, along with the COVID-19 outbreak.

Despite signs that U.S. interests may be open to negotiating oil production cuts with Russia and/or Saudi Arabia, such an agreement would likely only occur in a worst-case scenario.

For Russia, having prices where they are now may, in fact, be better for the Kremlin’s long-term strategy of trying to make U.S. oil producers go bankrupt by increasing that process and potential recovery to global oil prices in the $40 range. This makes it extremely unlikely for Russia to be interested in any agreement unless the oil market is in a significantly worse position. A bilateral deal between just the United States and Saudi Arabia may prove easier to negotiate, but would come at a political cost. Saudi Arabia could use a deal with the United States – which may even cut more production than Russia ever did – as a face-saving move to pull back from its ongoing price war with Russia, which eventually risks cutting into Riyadh's vital oil revenue. But even then, a deal with Saudi Arabia would be a politically risky move for Trump, due to Saudi Arabia's controversial human rights record and Americans' generally low opinion of Saudi Crown Prince Mohammed bin Salman.