Demand for oil has cratered because of the COVID-19 outbreak. That's causing crude to pile up in storage terminals around the world. Those facilities are quickly filling to the brim, which is causing concern that the industry will soon run out of space to store oil. That's leading pipeline companies and refineries in the U.S. to urge their oil-producing customers to reduce their output.

Continental Resources (NYSE:CLR) became the first one to heed that call as it pledged to slash its output by 30% in April and May. More U.S. drillers could voluntarily join it in the coming days as part of a semi-coordinated effort to ease the nation's glut of oil. Those supply reductions will make it easier for OPEC and its allies to end their price war and move forward with a coordinated effort to help stabilize the oil market.

Oil pumps in motion at night.

Image source: Getty Images.

Turning off the pumps

Continental Resources Executive Chairman Harold Hamm stated his belief this week that U.S. producers would voluntarily reduce their output by 30% to 35% in the near term. However, he said that those reductions wouldn't be part of a coordinated supply cut with Saudi Arabia and Russia. Instead, they will come out of necessity because America's oil infrastructure can't handle the volumes because of cratering oil demand amid the COVID-19 outbreak. Hamm, for example, noted that a refinery in Oklahoma that processes some of Continental's oil production in that state asked the company to cut its supplies by 25%. 

Because of that request, and the fact that global oil demand has cratered 30%, Continental plans to reduce its output by 30% in April and May. As such, it was the first U.S. producer to voluntarily shut in producing wells. 

Ready to flip the switch

Several other U.S. producers are considering making similar moves if others join them. Texas-focused producer Parsley Energy (NYSE:PE) has already started shutting in 400 lower producing wells, which aren't economical in the current environment. However, the company would be willing to turn off more pumps and slash its total output by 20% if others join the effort. Parsley and fellow Texas-focused producer Pioneer Natural Resources (NYSE:PXD) recently sent a letter to that state's energy regulator, asking it to coordinate a statewide production cut of around 20%. 

Parsley and Pioneer want not only their peers in Texas to reduce their output but also those in other areas of the country, as well as a coordinated global supply cut brokered by OPEC and non-member producers like Russia, Canada, Norway, Mexico, and Brazil. That's because the demand destruction and storage problems are worldwide; thus, a 20% production reduction by U.S. producers in Texas won't solve the issue.

Still, U.S. producers will need to be part of the global solution, even if they don't coordinate with OPEC on their effort. That's because the country is one of the top three oil producers in the world, meaning a reduction in output would help move the needle. Thus far, however, most U.S. producers are only reducing capital spending on new oil projects, which won't help address the industry's immediate issue with storage space.

Oil giant ExxonMobil (NYSE:XOM), for example, slashed its 2020 capital budget by $10 billion, or 30%. The bulk of the cut will be at its Permian Basin operations in Texas. However, Exxon only anticipates that the spending cut will reduce its output in the region by 15,000 barrels of oil equivalent per day (BOE/D) this year, which is minimal. It will have a much greater effect on 2021 output, with Exxon seeing its production in the region being 100,000-150,000 BOE/D below plan next year. 

Others are taking similar approaches by reducing their activity levels, not their output. Marathon Oil (NYSE:MRO), for example, now plans to stop completing new wells during the second quarter. While this will have some effect on Marathon's production as the output from legacy wells declines, it's not the near-term, needle-moving reduction the industry needs right now.  

U.S. production will fall, it's only a question of how fast

U.S. energy companies are running out of room to store their oil, meaning the industry needs to reduce its output. They can either voluntarily reduce it like Continental or wait until either a state like Texas mandates a cut or they run out of storage space. Either way, producers in the country need to cut their production until demand picks back up following the containment of the COVID-19 outbreak. If they don't, then oil prices could keep cratering until wells become unprofitable and must shut down, and more producers declare bankruptcy.