The Fuse

Shale May Not Recover From Pandemic

by Nick Cunningham | July 15, 2020

The U.S. oil industry may have already peaked, with an all-time high in production reached just a few months ago.

The U.S. shale boom was already slowing down heading into 2020. The global pandemic and macroeconomic hit will leave permanent scars, from which shale drilling will be unlikely to recover.

Shale declines
U.S. oil production topped out at around 13 million barrels per day (Mb/d) earlier this year, and went into a sharp decline at the onset of the pandemic. For the last several weeks, the weekly EIA survey data puts oil production at 11 Mb/d, bouncing back from a low point after shut-in production was brought back online.

However, at this point, the deck is very much stacked against the shale industry. Mountains of debt accumulated over the past decade matures in the next few years, and drillers are in an extremely poor position to repay those obligations. Roughly 18 North American oil and gas companies filed for bankruptcy in the second quarter, the highest total since 2016, according to Haynes and Boone. In the first half of the 2020, chapter 11 filings involved $30 billion in debt, more debt than for the full year of 2019.

Oil prices have rebounded, but $40 is “not a sufficient clearing price for many heavily leveraged shale producers,” according to Haynes and Boone. More bankruptcies are expected.

Even industry executives recognize that fracking’s best days are in the past. “I don’t think I’ll see 13m [barrels a day] again in my lifetime,” Matt Gallagher, CEO of Parsley Energy, told the Financial Times. He admitted that the shale industry had “not been gifted with discipline.”

“I don’t think the industry will ever get back to where they were before the crisis.”

Other shale titans echoed that sentiment. “I don’t think the industry will ever get back to where they were before the crisis,” Pioneer Natural Resources chief executive Scott Sheffield told Texas Monthly.

The oil majors – mainly ExxonMobil and Chevron – are sticking with their plans of ramping up production in the years ahead, although they made sharp cuts to spending after the onset of the pandemic and they face their own questions about financial sustainability.

Leaving the majors aside, the rest of the shale industry is operating under more debilitating circumstances. Most regional firms “do not plan to increase production levels until oil prices recover more,” the Federal Reserve Bank of Kansas City said in its latest energy survey. A third of the oil industry executives surveyed by the Kansas City Fed said that they would likely be insolvent within a year if current crude oil prices – roughly $40 per barrel – are maintained.

“This has been a historically challenging down cycle. Many firms will not survive and there will be longer term damage than in comparable down cycles,” one unnamed executive said in response to the survey.

Oil production from the largest shale plays in the U.S. will lose another 56,000 barrels per day in August.

Drilling stalls
U.S. oil appeared to stabilize in recent weeks at about 11 Mb/d, but those figures were aided by a one-off return of shuttered production. Steep decline rates from shale wells all but ensures additional output declines are forthcoming. The latest EIA Drilling Productivity Report predicts that oil production from the largest shale plays in the U.S. will lose another 56,000 barrels per day (b/d) in August.

Production declines are all the more likely because there is little sign that the industry is stepping up drilling. The oil rig count fell to 181 for the week ending on July 10 (258 when including natural gas rigs), down almost 75 percent since mid-March.

Some analysts believe the downturn is only temporary. Investment bank Raymond James sees the rig count nearly doubling to 420 next year as WTI rebounds to around $60 per barrel.

However, because U.S. shale is short-cycle in nature, and also high-cost and dependent on generous capital markets, it not only turns off quickly when prices crash but also will require another round of financing in order to rebound. But a history of loss-making production, a poor market outlook, and heightened climate-related scrutiny from investors means that access to capital is closed off for the time being.

The majors may continue to ratchet up production, but the majority of shale companies do not have plans to increase spending after the latest round of capex cuts; any unexpected improvement in cash flow (from a higher oil price scenario) will likely be diverted to paying off debt.

Obviously, all of this does not mean that U.S. shale will disappear, only that it peaked and won’t return to recent production levels. The bulk of new drilling activity going forward will be concentrated in the Permian and Appalachia, according to Rystad Energy.

To be sure, the downturn is global. The number of wells drilled around the world is expected to fall to 55,350, Rystad Energy said in a new report, which would be down 23 percent from last year and would also be the lowest number of wells drilled in the 21st century. Rystad’s forecast for wells drilled stretches out to 2025 – the firm does not see the number of wells drilled returning to 2019 levels.

Ultimately, global supply will be constrained by demand, which may be permanently scarred from the pandemic.

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