The Fuse

Shale Growth Faltering As Financial Problems Mount

by Nick Cunningham | November 06, 2019

One of the most iconic U.S. shale companies is in danger of failing to meet debt obligations.

In a recent securities filing, Chesapeake Energy admitted that it might not be able to outrun an extended period of low oil and natural gas prices. “If continued depressed prices persist,” it would raise “substantial doubt about our ability to continue as a going concern,” the company said.

The warning is arguably the strongest evidence yet that the U.S. shale revolution is running on fumes, even as production remains at record highs.

The warning is arguably the strongest evidence yet that the U.S. shale revolution is running on fumes, even as production remains at record highs.

Shale companies languish
Chesapeake Energy was one of the early shale success stories. Founded by the late Aubrey McClendon, the Oklahoma-based driller grew rapidly, becoming one of the country’s largest natural gas producers. However, Chesapeake has been in trouble for quite some time, and its fall from grace does not exactly come as a surprise.

Natural gas prices have been low for several years, and fell to new depths in 2019. The decline of oil prices compounded the financial pressure for many drillers. The business case for shale drilling has always had holes in it, but the problems are becoming increasingly apparent. The U.S. has added around 7 million barrels per day (Mb/d) over the last decade, much of it from shale, but the amount of debt amassed has been equally as impressive. Nevertheless, for years, capital markets remained friendly, expecting the long list of E&Ps to turn a financial corner as production grew steadily.

It has only been in the last year or so that embattled drillers have been running out of options as oil prices remain subdued. The financial squeeze resembles the pain during the downturn between 2014 and 2016, except for one key difference: the industry is no longer able to turn to Wall Street for fresh capital. “Operators were able to outperform the price collapse in 2015-2016 because they were able to vastly outspend cash flow thanks to accommodative debt and equity markets, while at the same time achieving huge leaps in well productivity and capital efficiency,” Raoul LeBlanc, vice president for North American uncoventionals at IHS Markit, said in a statement. “This time around, capital markets are skeptical and wary, and the scope for further productivity gains is limited.”

The withdrawal of capital could prove to be pivotal. U.S. shale production “is slowing down fast,” the new report from IHS Markit says. “The combination of closed capital markets and weak prices are pulling cash out of the system,” LeBlanc added. IHS says that U.S. shale capex could fall by 10 percent this year, 12 percent in 2020 and decline further by 8 percent in 2021.

The firm forecasts oil production growth of just 440,000 barrels per day in 2020, before flattening out entirely in 2021. “Going from nearly 2 million barrels per day annual growth in 2018, an all-time global record, to essentially no growth by 2021 makes it pretty clear that this is a new era of moderation for shale producers,” LeBlanc said. “This is a dramatic shift after several years where annual growth of more than one million barrels per day was the norm.”

“I don’t think OPEC has to worry that much more about U.S. shale growth long-term”

A few well-known shale executives admitted to analysts and shareholders just this week that the shale bonanza may be coming to an end. Production from the Permian basin is “going to slow down significantly over the next several years,” Scott Sheffield, CEO of Pioneer Natural Resources, said during the company’s third quarter earnings call. “I don’t think OPEC has to worry that much more about U.S. shale growth long-term,” he added.

Another notable chief executive agreed. “At a September investor conference, I predicted that 2020 total U.S. year-over-year oil growth would be 700,000 barrels per day which at that time was considerably below consensus,” Mark Papa, CEO of Centennial Resource Development, said on an earnings call on Tuesday. “Given additional data I now think that 2020 year-over-year oil growth will be roughly 400,000 barrels per day which is below current consensus.”

But Chesapeake’s admission in the SEC filing that it might not be able to avoid default, unless oil and gas prices rebound, is arguably even more momentous. Chesapeake’s aggressive, debt-fueled growth exemplifies the shale bonanza more than most other companies. As such, the prospect of a default marks a grim new reality for the company while also calling into question the future growth of the industry.

Chesapeake reported a $188 million loss in the third quarter, and production fell by 11 percent year-on-year. Its total debt exceeds $9.7 billion. The company’s share price plunged by nearly 20 percent on November 5, before melting down by a further 30 percent during midday trading on November 6. Its shares are now trading at around 90 cents, down from around $30 five years ago.

Oil majors take over
As more and more shale E&Ps slip into bankruptcy – there have been roughly 199 oil and gas bankruptcies in North America since 2015 – the era of blistering growth may be over. But that does not mean that the drilling is coming to an end.

The question is if ExxonMobil and the other majors can succeed where a long line of shale companies have come up short.

Production has never been higher, and output could continue to grow. However, instead of growth coming from the array of small, medium and even large companies, who took on mountains of debt in order to drill at a feverish pace, growth will increasingly from the very largest oil companies. The majors – BP, ConocoPhillips and especially ExxonMobil and Chevron – are set to account for an ever-larger share of production growth. Capital markets will remain open to them for the foreseeable future, and U.S. shale represents a crucial and growing portion of their core business.

Wounded, and weakened by debt, Chesapeake may continue to fade. The company said it would take an ax to spending next year, cutting capex by nearly a third, which will result in dwindling production. At this juncture, the question is if ExxonMobil and the other majors can succeed where a long line of shale companies have come up short.

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