Crude Oil Market Crash Impact on Kansas

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Companies That Survive May Find Opportunity

By Nicole Koelsch, CPA

The recent unprecedented drop in crude oil prices was rooted in actions taken months ago half a world away, but the impact of those actions was heightened to devastating levels by the COVID-19 crisis. The result is a battered crude oil market that many Kansas producers may be forced to exit.

For some Kansas oil companies, already weakened before the current crisis hit, bankruptcy may be the next step, either Chapter 11 reorganization and restructuring of debt or Chapter 7 liquidation of assets to pay off debt.

How did we get to this point?

Over the past month, demand for oil has dropped precipitously with fewer cars on the road, fewer airplanes in the air and factories being shut down due to COVID-19. But worldwide production has not slowed during the pandemic, and storage facilities have reached capacity sooner than anticipated.

A longstanding agreement between Saudi Arabia and Russia that lowered production and propped up oil prices worldwide fell apart last month, resulting in a flood of excess supply on the world market just as the COVID-19 pandemic was shutting off demand.

It is a perfect storm that brought the law of supply and demand into sharp relief, and on April 20 crude oil prices dropped below zero for the first time in history, at one point hitting a level of negative $35 a barrel.

While prices have climbed back above $10 a barrel, lifting costs in Kansas are approximately $25 a barrel.

As a result, Kansas oil companies are, in many cases, turning off pumps and walking away.

Ripple effect – impact on workers, suppliers

The economic ripple effects throughout Kansas will be significant as oil companies reduce operations or go out of business. Shutting down even one well affects many people, including service and supply companies and self-employed individuals such as pumpers. You can ask yourself how lean you can operate a well, or look for rate reductions, and offset those against the cost and ramifications of shutting the well down. But in an environment of crude prices below $10 a barrel, the traditional strategies employed to make it through a bust may not be enough.

Opportunity

The companies that survive this bust – and that have strong financial positions – may find this an opportune time to grow and acquire more properties. Producers exiting the market may put wells, equipment and other assets up for sale, enabling the surviving companies to build their holdings and position themselves to capture greater market share once the crisis is past.

But the immediate priority should be placed on evaluating current financial positions and weighing options:

Ripple effect impact on local tax base

The impact of the current oil bust will be felt in many corners of the state, not the least of which will involve the local tax base. Low valuations in the oil and gas industry will impact tax revenues of local government, including counties and school districts.

At the state level, slowing exploration, shutting down wells and sending oil to storage will impact state collections of income tax and severance tax payments from the oil companies themselves, and lower income tax revenues from owners and employees.

What does the future hold?

No one can predict how long this current oil bust will go on. For perhaps the first time in history, oil prices cannot be controlled simply by ratcheting worldwide production up or down. With COVID-19 as a complicating factor – one which has an unpredictable end date – leaders in the oil industry, whether in Saudi Arabia or Kansas, are at the whim of an unmanageable element.

There is no one-size-fits-all approach or solution for Kansas oil companies. For an analysis of your company’s financial position and a discussion of reasonable steps to handle this crisis, please contact ABBB’s advisors.