The Fuse

Have We Reached Peak Shale?

by Nick Cunningham | May 27, 2020

The rig count in major U.S. shale basins continues to fall, breaking new record lows with each passing week. Thousands of jobs have been eliminated.

U.S. oil production has also fallen off a cliff faster than some may have expected.

U.S. oil production has also fallen off a cliff faster than some may have expected. Some of the production losses will prove to be temporary, with shut in wells brought back online once prices rebound to acceptable levels. But a growing number of analysts believe that U.S. production will never again hit recent highs.

Shale losses
The oil market downturn may lead to a $400 billion decrease in investment in the energy sector, according to a new analysis from the International Energy Agency (IEA). That is a 20 percent decrease compared to last year, and dramatic change from the pre-pandemic forecast of a 2 percent increase for 2020. “Some of the most dramatic cuts in the oil and gas sector – in many cases above 50% –  have been among highly leveraged shale players in the United States, for whom the outlook is now bleak,” the IEA said in its report.

U.S. Secretary of Energy Dan Brouillette said that more than 2.2 million barrels per day (Mbd) of oil production has been shuttered in recent weeks, a rapid decline that has helped balance global markets. He sounded optimistic last week about a swift rebound. “Hopefully that will allow us to stabilize this recovery and also begin the process of perhaps increasing our production and seeing this industry come back as strong as it was pre-pandemic and hopefully even stronger,” he said.

However, that outlook is far from the consensus.

The rig count has fallen by two-thirds since March, with the number of active oil rigs down to 237 as of May 22, down from 683 in mid-March. Oil production fell to 11.5 Mbd over the same timeframe, down from around 13.1 Mbd, although more accurate data from the EIA is forthcoming. The Permian basin was once considered the hottest oil field on the planet, but rigs, jobs and production are disappearing and an astonishing rate.

The problem is that U.S. shale was financially stressed even before the oil market meltdown.

The big question is if U.S. shale can ever return to pre-pandemic levels. The problem is that U.S. shale was financially stressed even before the oil market meltdown. As the WSJ noted, American frackers spent $1.18 trillion over the past decade but only brought in $819 billion from oil sales. Even during the best of times most shale companies were burning through cash.

The IEA said that because shale drillers were not free cash flow positive even when oil was above $50, “it is no surprise that at oil prices of USD 30/bbl or less, the outlook for many highly leveraged shale companies looks bleak.” Upstream spending on shale could collapse by as much as 50 percent this year.

Steep decline rates endemic to shale drilling mean that any pause on drilling quickly leads to production losses. The Permian basin is expected to lose more than 80,000 barrels per day in June, according to the U.S. EIA.

Peak shale?
Famed oil historian Dan Yergin told the Wall Street Journal that “February was peak shale.”

The obituary for U.S. shale has been written too many times in the past, and very few analysts expect shale to entirely disappear. But while shale drilling will certainly continue in the years ahead, the industry may have already peaked, potentially never climbing back to 13 Mbd again.

There are several reasons why today’s bust is unlike the 2014-2016 downturn, which saw a swift rebound in drilling. Today, debt in the industry is much higher, and recapitalization from Wall Street is not on the menu, at least not in the same way as in years past. Moreover, having already made substantial cuts during the last downturn, there is no fat to cut. There are fewer assets to sell.

That leaves the likely outcome a consolidation in U.S. shale. The oil majors – ExxonMobil, Chevron, BP and Shell – were already taking a larger share of the market before the pandemic. The extreme stress in the industry likely means that they scoop up distressed assets and capture an even larger share of production.

But the oil majors themselves are in a financial predicament. ExxonMobil, the most aggressive shale driller, has made several cuts to spending, most recently lowering capex by 30 percent. The majors have been spending beyond their means for quite a while. In the first quarter of 2020, four out of the five largest oil majors spent more on dividends than they generated in oil sales, according to the Institute for Energy Economics and Financial Analysis. The $9.9 billion shortfall was made up by taking on debt and selling off assets.

Around 250 companies are facing potential bankruptcy by the end of 2021, as a tidal wave of debt begins to mature. Few doubt that ExxonMobil and Chevron will continue to grow production in the Permian in the years ahead, but they will struggle to carry the load by themselves.