War and disease: The US oil sector circa April 2020

by Clay Jarvis20 Apr 2020

Had the COVID-19 pandemic not ballooned to the point where it demands almost all of the world’s attention, it’s fair to assume that much of the talk over the past several agonizing weeks would have shifted to the disruption currently being seen in the global oil sector.

For originators, a portion of that chatter would have undoubtedly gone toward predicting the damaging impact instability could have on commercial real estate markets that rely on petroleum jobs to drive retail and multi-family expansion.

And that’s just on the back of the Saudi Arabia-Russia tiff over production levels, a conflict that drove oil prices below $20 per barrel in a few short weeks. Although a historic agreement to cut supply levels by 10 million barrels a day was reached last week between OPEC and its allies, prices have yet to rebound.

That’s unlikely to change, as COVID-19 lockdowns have decreased demand across the planet, not only among drivers who have nowhere to drive, but in petroleum-heavy industries like air travel and manufacturing.

A lack of demand means production cuts. The U.S. Department of Energy estimates the nation’s oil producers are on track to reduce production by 2 million to 3 million barrels per day. A lack of production, particularly in segments of the industry that face high production costs, like shale, likely means a decreasing need for new hires.

In states that depend heavily on oil jobs to drive demand for retail, office and especially multi-family properties – think Texas, Colorado, Ohio, Oklahoma and Pennsylvania – a significant drop in employment could mean empty storefronts and vacant apartments on a depressing scale. In smaller communities with less diversified economies, things could get ugly.

“I think the damage is going to be quite considerable,” says R. Christopher Whalen of Whalen Global Advisors. “The commercial market in areas of the country where you’ve been having this private equity-fuelled boom are certainly going to hurt. There’s a lot of multifamily that’s been built to support shale up and down those corridors in the south.”

Whalen says there’s a comparison to be found between the current climate and what was seen in 2015, when oil prices fell precipitously, but it’s not a comforting one.

“2015 was billed as being really nasty, but it didn’t turn out to be that nasty,” he says. “When the private equity guys caught the knife and recapped a lot of shale firms, they kept them open. They continued to produce, they continued to employ people. That may not be the case this time.”

Whalen expects to see restructuring and the shuttering of a great deal of capacity. U.S. shale driller Whiting Petroleum, once one of the major players in the Bakken oil field, was the first major casualty, filing for bankruptcy on April 1. Other companies, such as Occidental, EOG and EQT, are in similarly compromising  positions.

A rise in bankruptcies and consolidation manoeuvres seems inevitable, much as it was in 2016, a year that saw no shortage of defaults and losses for CMBS loans backed by hotels and apartments in shale-producing areas like west Texas and North Dakota.

“I think the defaults are going to be significant,” says Whalen of the current predicament. “It will definitely impact commercial real estate.”

Despite the overwhelming power oil holds over the planet, it has failed to prove itself immune to two of Earth’s most unique commodities, war and disease. Juggling both at once is a tall order. Something is bound to get dropped.

“It’s extraordinary if you think of the two axes coming together,” Whalen says. “You couldn’t have dreamed up a worse scenario both in terms of real estate and the economy in general.”