Abu Dhabi, UAESaturday 24 October 2020

How Covid-19 is forcing the US to rethink its energy policy

The energy department is drafting a plan to pay producers to keep their oil reserves untapped

The United States, the world's biggest oil producer, has taken a few remarkable detours in terms of its federal energy policy over the last few weeks, as American crude sinks to a record low.

From opposing Opec, to then nudging the exporters' group into a meeting, to signalling US interest in being part of a global pact to cut production, agreements it has criticised in the past, to President Donald Trump pledging to make cuts on behalf of Mexico to secure an oil deal -- American energy policy energy has been clearly one of divergence.

There is now a proposal for the first time by the US energy department to pay American producers to keep their oil untapped as storage capacity in the country and the world nears saturation, demand for crude evaporates and the market deals with an excess of supply.

Here is why this step is unprecedented.

Global storage capacity scenario

Energy demand is at its worst in a quarter of a century, shrinking annually by one-third in April, according to the International Energy Agency, as countries keep populations under lockdown. However, supply is at a record high in April as Gulf oil producers pumped crude to honour earlier pledges to raise output following the collapse of Opec+ talks in March.

Although oil producers later agreed to curb output, such cuts will only be effective from May, leaving a bulk of new crude headed for storage at a time when tanks and floating storage capacities are filling up.

Opec, which called the demand and supply situation "horrifying", sounded the alarm on depleting storage capacity. If left unchecked, the group estimated that the oversupply would add a further 1.3 billion barrels to global oil stocks, thereby exhausting available global crude storage capacity by May.

The US situation

The US, ahead of the G20-Opec+ meeting, said it was filling up its strategic petroleum reserves (SPRs) as a way to soak up the supply from its independent producers. US energy secretary Dan Brouillette told Bloomberg ahead of the meeting that the country was opening up its SPRs to store as much crude as possible.

"This will take surplus oil off the market at a time when commercial storage is filling up and the market is oversupplied," Mr Brouillette said. Around 77m barrels storage space had been allocated to industry and the energy department was looking at "more opportunities" to ease producers' pain, he said.

US crude stocks at refineries and tank farms, which averaged 375m barrels at the end of last week have filled up 57 per cent of available capacity, according to the Energy Information Authority.

That is likely to increase after West Texas Intermediate, the US oil benchmark, fell to a historic -$40 a barrel before settling at -$37.63 on Monday after trading at $18.27 on Friday.

On Tuesday futures contracts rebounded to trade at $1.35 for May, at $21.13 for June and $26.92 in July at 7:05am UAE time.

Federal action and US mineral rights

The latest proposal by the US to pay producers to keep their oil in reserves is complicated. The US has a unique set of laws pertaining to ownership of mineral resources that distinguish it from other countries.

Mineral resources such as crude, gas, gold and copper are usually owned by the state in most countries, with the government then launching licensing rounds to allocate concessions to explore and extract these reserves.

However, US mineral rights allow for private ownership of reserves, which has long fostered an entrepreneurial culture in the energy industry. Lack of state interference and ease of ownership allowed the US independents to thrive and changed the dynamics of the industry to become extremely flexible to oil market volatility.

However, state payments towards oil producers, cited by some as a bailout for the hammered US energy industry, could also raise questions about the ownership of these resources in the future.

The payments would be in the billions of dollars and would be expensive for the American economy. The US, which has recently become more amenable to production cuts, could increasingly play a more active role in its energy sector, reversing years of policy to maintain its distance from such industries.

Updated: April 21, 2020 11:56 AM

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