The Fuse

Shale Slows Amid Financial Pain, But Offshore Drilling Picks Up

by Nick Cunningham | July 31, 2019

Even as production climbs, the U.S. shale industry continues to stumble, facing financial stress, operational challenges and investor scrutiny.

The rig count continues to decline, even as production has managed to edge up. But production gains cannot mask the problems facing the industry. Meanwhile, the offshore sector is seeing an increase in activity. The role reversal – shale down and offshore up – cuts against the narrative that oil producers are resolutely focused on shale and short-cycle drilling.

The red flags for the U.S. shale sector are more visible than ever.

Shale stress
The red flags for the U.S. shale sector are more visible than ever. The rig count has plunged by more than 100 since hitting a recent peak last year, a decline of more than 12 percent. There are some shale companies that are posting positive cash flow, but on the whole, the industry hasn’t ever really been profitable. That wasn’t much of a problem when drillers were in a growth-at-all-costs mode and Wall Street was willing to stomach temporary losses, so long as huge production increases eventually translated into profits. But, even as the U.S. continues to break production records, profits have proved elusive.

As a result, pressure on the industry is mounting. “We calculate that an output-weighted basket of small company equities (less than 20 thousand barrels per day, kb/d) has lost 66% of its value since the start of 2018,” Standard Chartered wrote in a July 23 note. “The basket of medium-sized company equities (between 20 kb/d and 70kb/d) has lost 54% of its value over the same period.” Meanwhile, large companies have only lost 28%. The oil majors will continue to have little trouble financing their expansion plans, but for companies relying on capital injections, the room to maneuver is shrinking.

U.S. oil production has continued to climb, but the pain could yet lead to output stalling out. Standard Chartered cited data from the Kansas City Federal Reserve, concluding that most shale companies will refrain from increasing activity until WTI reaches $66 per barrel. “US oil drilling is at a 17-month low, and is unlikely to rebound swiftly,” Standard Chartered concluded. Production growth could “remain muted in H2-2019,” the bank said.

Sifting through the comments from anonymous oil and gas executives in Texas, responding to the Dallas Fed survey, one can’t escape the conclusion that the sector is in deep state of despair. “Futures prices continue to decrease as expenses increase. We are experiencing very tough, and unpredictable, business conditions,” one executive said.

“It is very true that cash is drying up, and it is going to be hard to get financing to drill our wells,” said another. “It looks like another round of bankruptcies and mergers,” yet another respondent lamented.

Adding to the sector’s woes is the recent plunge in natural gas prices

Adding to the sector’s woes is the recent plunge in natural gas prices, which recently fell to their lowest level in years. Contracts for Nymex gas for delivery in September dropped to $2.14/MMBtu in the last week of July. “There are approximately 75 rigs running in Appalachia today and 50 in the Haynesville. We believe the vast majority of these rigs are subeconomic at strip pricing,” Kyle Derham, head of investor relations at EQT, told investors on a conference call.

The oilfield services companies are somewhat of a canary in the coal mine for the state of drilling. Halliburton just slashed 8 percent of its workforce in North America due to the shale slowdown and also decided to idle unused drilling equipment. As Bloomberg pointed out, Halliburton was the worst performer in the S&P 500 over the past 12 months prior to its latest earnings release. Notably, after the company cut jobs and idled equipment, its stock price surged.

“Finally, we have stacked additional equipment throughout the quarter and will continue to do so where we do not see acceptable returns,” Halliburton CEO Jeff Miller told analysts on its earnings call. “The pressure pumping market remains oversupplied and we’re not afraid to reduce our fleet size, as it contributes to righting the supply and demand imbalance.”

Offshore sector sees rebound
The oilfield services giants are downbeat regarding the state of play in the U.S. shale patch, but they are much more optimistic about drilling offshore and around the world. Schlumberger, the largest oilfield services company in the world, saw its offshore North America revenue rise by 10 percent in the second quarter. “In the international markets, we continue to witness broad-based activity growth,” incoming Schlumberger CEO Olivier Le Peuch told analysts on its second quarter earnings call. He said customer interest is “high,” and the company saw strong revenue growth in Latin America, Europe and Africa.

The main driver of employment is shifting from shale to offshore

The contraction in shale and the rebound elsewhere “means the welcome return of a familiar opportunity set for Schlumberger,” outgoing CEO Paal Kibsgaard said. “For the first time since 2012 and 2013, we see high and single-digit growth in the international markets, signaling the start of an overdue and much needed multi-year international growth cycle.”

Employment data backs up this trend. The “main driver of employment is shifting from shale to offshore,” Rystad Energy said. “This is a clear effect of the increase in offshore sanctioning. We expect offshore commitments to nearly double from 2018 to 2020, and sustain high levels of spending over the next five years,” Matthew Fitzsimmons, vice president on Rystad Energy’s oilfield services team, said in a statement. The market for offshore services could rise by 45 percent between 2018 and 2025, reaching $442 billion.

The growth is somewhat new, following several years of painful contraction. Companies heavily invested in the offshore sector saw employment drop by 31 percent between 2015 and 2017, but the “tides are now turning as the offshore market gains momentum,” according to Rystad.

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