From low oil prices to excess pipe inventory, the energy sector eagerly awaits recovery.
The energy sector has witnessed economic downturns over the past few years. The descent started before COVID-19, but the pandemic caused an even greater tailspin. Staggeringly low oil prices, an oil surplus, low demand for the product, as well an excess of line pipe and oil country tubular goods inventory have disrupted the supply chain. Add the coronavirus into the mix, and these factors are taking a heavy toll.
This year’s price war between Russia and Saudi Arabia contributed to the unprecedented decline in crude oil prices. So did the surplus of oil, coupled by low demand for it. U.S. energy technology helped contribute to the oil surplus.
“The U.S. has been very successful in new technologies over the last 10 years and in bringing more oil production off of domestic land wells to market,” says Paul Vivian, partner of the Ballwin, Mo.-based Preston Pipe Report. “The ability of the U.S. to grow oil production has outgrown world demand growth.”
The oil surplus was intensified by the lack of demand driven by the coronavirus. “When the virus struck back in January and really started increasing in the awareness of the public, people quit flying and quit driving and these are two very, very large sectors of the world economy,” says Bill Buckland, president of Mandal Pipe Company, Auburn, Ga. The business specializes in large-diameter line pipe used in oil and gas transmission for onshore pipelines and offshore drilling.
Vivian agrees the pandemic decreased demand for oil. “The COVID-19 situation shut down the economy and had a further impact on the demand curve. All of a sudden, the demand curve, which was sloping downward, went straight down and hit a wall and stopped,” he says. “Even the people who trade these [oil] products for a living had an outlook so negative that they said that people who are producing the product had to pay people to take it.”
On April 20, the price of oil hit negative numbers. “That has never happened in the history of tracking oil prices,” says Vivian. “That was trader-driven, but it was just an indication of how the outlook in the market had turned.”
Narayan Bhargava, president of Houston-based SDB Steel & Pipe concurs. The business is a master distributor, primarily for OCTG casing and tubing. “On April 20 when the May contracts were expiring, a lot of traders were trying to dump their positions because of their inability to take physical possession of the oil and global crude storage capacity was nearing its limit. So it went into a negative position for the first time ever,” he says. “Since then, oil has recovered, but in terms of the OCTG business, it’s been terrible.”
Like many businesses worldwide, SDB Steel & Pipe did not expect such a downturn. “For us as a company, 2020 was actually positioning to be better than 2019. We had exposure to some wonderful end-users who have strong balance sheets and we were going to be doing a lot of drilling, and so we were really excited,” says Bhargava. “We had a great January, February and March, and then this pandemic hit and oil prices went for a toss, and drilling activity came to a standstill.”
It’s no wonder, then, why the rig count has been decreasing rapidly. Although in 2019 it was already on the decline, once the pandemic hit, the rig count dropped even more.
According to analyst Baker Hughes, as of Aug. 14, the U.S. rig count was 244, down from 935 a year earlier, while the Canadian rig count was 54, down from 142 in 2019. Internationally, the rig count in July 2019 was 1,162, while in July 2020 it was just 743. Pipe Inventory and Pricing
Overall, the outlook for energy pipe and tube pricing is poor, partly due to the overabundant supply of pipe and tube. “We had a total breakdown. The supply chain was broken and so those people who had inventory, especially in the OCTG market, were left with a tremendous inventory of tubular products that couldn’t be sold,” said Buckland. “OCTG is just annihilated. This sector suffered the most and is probably still having a lot of trouble.”
“Yards are full of pipe,” he continues, “so it backs all the way up to the producers. Most people don’t think about this: if you’re not using steel pipe, beams and plate and everything that goes into production and building, it backs up into the manufacturing end.” He adds that many people are afraid to purchase inventory because of uncertainty.
Vivian points out that poor pipe pricing is not solely due to the coronavirus. “Pricing isn’t good, but to have said that pricing was good before [the pandemic] would not be the right statement. Pricing has not been good for a while,” he says. “It hasn’t been good for a while because of too much supply.”
According to Bhargava, pipe pricing has been struggling for over a year, although Q4 of 2019 witnessed the pricing increase slightly. His company’s optimism about this was short-lived, however, as since January it has gone down about 15 percent. In addition, the company entered 2020 with a significant amount of inventory.
“One blessing we had – for those of us in OCTG but also in the steel business in general – is that if you’re holding inventory right now, you’re not sitting on inventory that’s too expensive because you already dealt with price decreases in the second half of 2019. So some of the new inventory that we had late last year and the beginning of this year is already at a pretty low price. If and when things do eventually bounce back, we’ll be able to make money on that.”
Regarding the line pipe industry, Vivian notes, “We’re drilling less, so we’re going to have less oil and gas that needs to be transported so at some point announcements of new projects begin to be delayed, if it hasn’t started. Secondly, then they become canceled, and third, new projects don’t get announced. We’re seeing some cancellations.” He adds that Dominion canceled a big pipeline on the East Coast, as well as a number of similar situations, and this has created an uncertain atmosphere.
Vivian also notes that in June, operator consumption of OCTG pipe was 30 percent less than in June 2019, due in large part to the pandemic. “So here you are going along in January and February, thinking life is pretty good and you’re buying your pipe for June, and then in March the world changes – literally,” says Vivian. “As a result of that, you can’t cancel those orders without a big legal fight, so the pipe just kept coming in.”
Despite the economic downturn, talk of recovery abounds. However, no one truly knows when recovery will begin. Some experts believe drilling will recover in the first half of 2021, but Vivian believes it’s going to be later than that. “You can certainly see yourself in the very tail end of 2021 before you begin to see things humming anywhere near the level they were humming when we turned off the supply,” he says, adding that the recovery seems U-shaped.
There’s certainly optimism about the energy industry making a comeback. Bhargava is cautiously optimistic. “We’re seeing a slight uptick in oil prices, and they’ve been holding steady,” he says. “There’s more confidence in the market from a consistency perspective.”
Buckland believes that the future holds great promise. “The world runs on oil and gas and is built on steel and concrete,” he says. “This [pandemic] is like a boxer getting hit in the face. You kind of stagger for a minute and you shake it off and go back. And that’s what we’ve done.”
[sidebar]Bankruptcy and Consolidation
Unfortunately, when the energy market takes a hit, so does the supply chain. “In a market like this, we’re seeing lots of notable names declare bankruptcy,” says Paul Vivian, partner of the Preston Pipe Report in Ballwin, Mo. “The industry is consolidating. Any time there’s a downturn, there’s consolidation. We’re seeing that happen today.”
According to S&P Global Platts, “For many companies, a reduction in capex won’t be enough to survive the low oil price environment. S&P Global Ratings and S&P Global Platts have identified 29 companies (17 exploration and production companies and 12 oilfield services companies) that have defaulted on debt, with several of them filing for bankruptcy due to financial hardship.”
S&P Global Platts states that on April 1, Whiting Petroleum was one of the first and largest exploration and production companies to file for bankruptcy. “The company hopes to reduce a significant amount of its debt and establish a more sustainable capital structure moving forward. With a recent draw on its credit facility of $650 million, the company plans to continue its daily operations with minimal interruptions.”
Other petroleum companies would follow suit.
“In the OFS [oil field services] sector, Pioneer Energy Services had to abandon drilling in the Bakken after 20 years of service, mainly due to one of its largest customers, Whiting Petroleum, filing for bankruptcy earlier this year.”
Bankruptcies occur whenever there’s a downturn. And the business landscape of 2020 is no exception.
“You’ve got your giants – Chevrons, Exxons, etc. who are very strong companies and have been strong companies for decades and decades, and they’re going to go buy assets on the cheap, for example the Noble deal just recently,” says Narayan Bhargava, president of SDB Steel & Pipe in Houston of the July deal where Chevron acquired the Houston-based exploration company.
“Nobody believed that Noble was going to be sold for $5 billion dollars. I bet that company was probably worth $30 billion dollars just the year before. And so this is nothing new.
“In the energy private equity space, we saw a lot of portfolio company consolidation in 2015 to 2016. Prior to 2008 there wasn’t a lot of private equity money in the industry, but you have certainly seen the giants coming in and eat companies up in the past to improve their asset position.”