The Fuse

Shale Bankruptcies to Accelerate

by Nick Cunningham | May 04, 2020

The U.S. rig count has collapsed, falling by 384 rigs since mid-March. That is a decline of almost half in the span of just a few weeks, with the Permian basin suffering a particularly concentrated hollowing out.

Production is already declining because of low prices and dwindling storage space. But WTI prices at $20 per barrel or below is entirely unsustainable for U.S. shale drillers. Ultimately, a lot of companies will be forced into bankruptcy.

Bankruptcies could skyrocket
More than 200 North American oil and gas companies already went bankrupt between 2015 and the end of 2019. By that measure, the shale industry was in financial distress even prior to the global pandemic and oil market meltdown.

But the collapse of prices presents an altogether different threat to U.S. oil and gas. These are price levels at which most U.S. shale companies will not only struggle to turn a profit, but may not even be able to keep the lights on. Nearly 40 percent of drillers told the Federal Reserve Bank of Kansas City that they would be insolvent before the year was out if WTI averaged $30 per barrel.

More than 70 U.S. oil and gas companies could fall into bankruptcy this year if WTI averages $30 per barrel.

That assessment comports with other forecasts. More than 70 U.S. oil and gas companies could fall into bankruptcy this year if WTI averages $30 per barrel, according to an April analysis from Rystad Energy. If WTI remains stuck at $30 through 2021, the number of bankruptcies would balloon to 150 to 200 companies. “In our view we will need WTI prices of $40 to $45 per barrel to eliminate the upcoming explosion in the number of financially distressed US E&Ps,” Rystad Energy’s Head of Shale Research Artem Abramov said at the time.

The problem is that WTI at $30, let alone $45, is looking a little optimistic. WTI is trading at about $20 per barrel at the start of May and futures for every month left in 2020 have prices below $30.

Fitch Ratings has said that companies could default on around $43 billion in high-yield bonds and leveraged loans this year.

Some high-profile bankruptcies have already occurred. On April 1, Whiting Petroleum, a large Denver-based shale company, declared bankruptcy. On April 26, Diamond Offshore filed for bankruptcy protection as the market for offshore drilling “worsened precipitously,” the company said.

Chesapeake Energy is making preparations for a potential Chapter 11 bankruptcy filing. The Oklahoma-based company arguably represents the U.S. shale boom better than any other company. It scaled up by taking on debt and growing at an explosive rate, buying land and drilling at a frenzied rate while struggling to turn a profit. The company’s long slide may soon culminate with a bankruptcy, a prospect that S&P Global Ratings said was a “virtual certainty.”

The demise of Chesapeake is a fitting bookend to the latest chapter of U.S. shale.

The demise of Chesapeake is a fitting bookend to the latest chapter of U.S. shale. While the entire global oil industry is facing a massive crisis, and a substantial portion of conventional output is also at risk with low prices, the U.S. shale bonanza is decidedly over. That doesn’t mean production will go to zero, to be sure. But borrowing tens of billions of dollars from Wall Street to frack wells with questionable returns is a business model that has run its course. Drilling will surely resume at some point, but it will be done by fewer companies drilling fewer wells. Consolidation will sweep over the shale patch.

Production declines set in
But there is still a lot of debate about how far U.S. shale will fall. Production is already declining quickly, due to shrinking availability of storage. EIA data suggests output fell from 13 million barrels per day (Mb/d) to 12.1 Mb/d in just a few weeks. The rig count could soon drop to decade lows or even all-time lows. Forecasts of production losses run the gamut, but they all point down.

The extent of the production losses will help determine how quickly the oil market reaches some sort of “balance.” Goldman Sachs says that Brent oil prices could rebound as high as $65 per barrel by the fourth quarter of 2021. But it will only be able to do that because of the substantial decline in U.S. shale output. “Higher decline rates, sticky shut-in capacity losses and a much higher cost of capital for the industry will finally set the stage for both higher OPEC market share and prices, the structural consequence of the ongoing violent rebalancing,” Goldman analysts wrote in a recent note to clients.

Sunnier days for oil prices also depend on a return of oil demand, which, needless to say, depends on a rebound in economic activity. But the bottom line is that the economy is at the mercy of the global pandemic, which, at last check, was showing no signs of going away.

 

 

 

 

 

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