Texas Shale Hit Hard By Hurricane Harvey

Crude oil prices are taking a serious hit from Hurricane Harvey, slammed on multiple fronts at a time when benchmark prices were already showing some signs of strain.

As has already been widely noted, Hurricane Harvey has knocked out major refineries along the Gulf Coast. Goldman Sachs said in a research note that an estimated 3 million barrels per day of refining capacity was offline, as of Monday. On Tuesday, ExxonMobil began winding down some operations at its Beaumont, TX refinery as the storm headed east towards eastern Texas and Louisiana. The outage at the 362,000 bpd facility would add to the region’s woes. Also, the U.S.’ largest refinery, Motiva’s Port Arthur facility, which produces over 600,000 bpd, has already curtailed its operations and was considering deeper reductions at the time of this writing.

Obviously, the outage of such a large volume of refining capacity is sending gasoline prices sharply up. But the effect on crude oil is the opposite – refinery outages mean a steep drop in demand. WTI is down nearly 5 percent since last week.

All of the damage from the hurricane not only means that refineries will be purchasing a lot less crude, but the millions of people along the Gulf Coast will also be consuming a lot less gasoline. That could blunt the impact in the refined products market, but it represents a double whammy for crude oil – less refining runs and demand destruction on the consumer end.

To make matters worse, some midstream operations are also affected. The closure of some key pipelines could halt shipments from Texas oil fields. That alone could disrupt operations at Gulf Coast refineries. For example, Reuters reported that Motiva was weighing cuts at its refinery not only because of the risk of floods, but also because it was having trouble obtaining enough crude from all the service interruptions elsewhere. Also, Marathon Petroleum Corp. said it could shut down its 451,000 bpd refinery in Texas City because of a shortage of oil, Bloomberg reports.

Ultimately, that could cause a huge problem upstream. “If there’s no place for it to go, you can’t keep jamming more crude into the line,” Libby Toudouze, a partner at Cushing Asset Management, told Bloomberg in a telephone interview.

“While it is premature to speculate on the ultimate impact to our production, we anticipate volumes will be restrained until Gulf Coast and Houston refineries are back online,” Gordon Pennoyer, a spokesman for Chesapeake Energy Corp., told Bloomberg.

As a result, the oil will be backed up in the shale fields of the Eagle Ford and even the Permian. That could force production cutbacks if there is no place to store the crude.

A lot of Eagle Ford producers were cutting back anyway as the storm hit, but the refinery and pipeline outages could hit the sector as a whole. “Given the enormous level of rainfall along the Texas Gulf Coast the past 3-4 days, we expect most operators in this area will experience near-term field level and/or takeaway issues,” Capital One Securities wrote in a research note on Monday. The WSJ, citing industry analysts, says as much as 400,000 to 500,000 bpd of Eagle Ford shale production could be offline, although some think the figure is much higher. Worse, once offline, shale wells could lose pressure, meaning that when brought back online, they could be less productive.

To recap, the problems for Texas shale drillers are multiple: refineries aren’t buying their crude, pipelines are shipping their crude, and regional consumers aren’t burning their crude. Plus the hurricane is forcing them to shut down wells, which could inflict permanent damage. Needless to say, Eagle Ford shale drillers are being hit hard. The share price of Carrizo Oil & Gas, an Eagle Ford-focused shale driller, has plunged by as much as 15 percent over the past week. And it isn’t alone. A lot of other shale E&Ps in South Texas are also seeing similar declines in their share prices, as CNBC notes.

The refinery outages could rise as the hurricane swings towards Louisiana. According to Tudor Pickering Holt & Co., as much as 30 percent of the nation’s refining capacity could be knocked offline if Louisiana facilities are forced to close, up from 15 percent over the weekend.

“This is a significant headwind for WTI,” Helima Croft of RBC Capital Markets told CNBC. “Undoubtedly, to have this much crude backing up, right before maintenance season, right before an SPR release, I mean, that is not good in any way for WTI.” It could ensure WTI doesn’t move back to $50 for the foreseeable future.

In a global context, however, the impact will be more muted on crude markets. Amrita Sen of Energy Aspects says global demand growth “is absolutely soaring right now,” which should ultimately push prices up. However, the disruptions in the U.S. Gulf Coast could lead to a much wider disparity between Brent and WTI, a gap that is now approaching $6 per barrel.

A lot of these effects could dissipate if the outages are short-lived, but if the disruptions persist, the effects will grow much worse.

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