The Fuse

U.S. Shale Industry Sees Bankruptcies and Consolidation

by Nick Cunningham | October 21, 2020

A series of high-profile deals in the U.S. oil industry point to a shift towards consolidation, as oil prices continue to languish at around $40 per barrel.

The latest acquisitions have occurred against a bleak backdrop, with the bankruptcy of smaller and more indebted companies on the rise. At the same time, drilling activity appears to have bottomed out, and oil executives are beginning to strike a more optimistic tone even as the structural headwinds remain daunting.

The U.S. shale industry has consistently struggled to post positive cash flow over the past decade.

Consolidation begins
The U.S. shale industry has consistently struggled to post positive cash flow over the past decade, piling up debt even as they succeeded in increasing production. Past calls for consolidation largely fell on deaf ears, but the pandemic, the market downturn, and the exodus of investors from the sector meant that the current makeup of the industry was very clearly untenable.

Chevron initially kicked off the latest M&A push when it announced in July the purchase of Noble Energy for $5 billion, adding positions for Chevron in the DJ Basin, the Permian basin and the Eastern Mediterranean. In September, Devon Energy purchased WPX Energy for $2.6 billion.

In just the past few days, a few more deals add momentum to the consolidation campaign. ConocoPhillips announced on October 19 the acquisition of Concho Resources for $9.7 billion, which would be the largest deal in the U.S. energy sector this year. Once combined, the company will be the largest independent oil producer in the country. “Sector consolidation is both necessary and inevitable,” ConocoPhillips Chief Executive Ryan Lance told analysts. “We both believe our industry needs solutions that address the lack of scale, poor returns and, increasingly, the challenges and opportunities of environmental, social and governance matters.”

As the Wall Street Journal pointed out, the industry has fallen a long way since Concho purchased RSP Permian for $8 billion two years ago. Now, Concho is selling itself for just a bit more than what it paid for the smaller driller back in 2018.

Still, the acquisition hands Conoco very large assets in the Permian basin, adding to Conoco’s production base in the Bakken, the Eagle Ford and in Alaska.

Finally, a day after the Conoco-Concho announcement, Pioneer Natural Resources announced its purchase of Parsley Energy for $4.5 billion. The executives of Pioneer and Parsley – Scott Sheffield and Matt Gallagher – are father and son, respectively.

According to Bloomberg, roughly $30 billion in M&A deals have now been announced in the past few weeks, a clear sign that the drilling frenzy of the past few years is now decidedly giving way to consolidation. Demand is down sharply, and there are questions about whether it will ever recover to pre-pandemic levels. In the meantime, the industry is forced to shrink its footprint.

The combined companies – Chevron with Noble, ConocoPhillips with Concho, and Pioneer with Parsley – create three very large producers in the Permian. Adding in ExxonMobil, EOG Resources, Occidental Petroleum and Devon Energy, and the U.S. shale industry (and the Permian in particular) will soon be dominated by a half dozen large producers.

More than 40 bankruptcies have hit the shale sector this year, representing more than $50 billion in debt.

At the same time, more than 40 bankruptcies have hit the shale sector this year, representing more than $50 billion in debt, including a couple of high-profile companies, such as Chesapeake Energy and Whiting Petroleum. More bankruptcies are expected going forward, especially if oil prices fail to rebound.

Taken together, major acquisitions and a growing number of bankruptcies will leave the U.S. oil industry will fewer companies and less oil production, although the large companies will survive and are poised to grow even larger.

Drilling bottoms out
More than 100,000 oil and gas workers lost their jobs between March and August, according to a report from Deloitte. The study says that around 70 percent of those jobs may not return before the end of 2021 at least.

In the short run at least, the worst may be over. The North American rig count rose by 12 for the week ending on October 16, the largest increase since before the pandemic began. The increase comes after weeks of little movement, and the uptick suggests that drilling has bottomed out and could be on the upswing. “Looking ahead to the fourth quarter, we expect North America land completions activity to increase by a double-digit percentage as operators deplete their DUC inventory,” Halliburton CEO Jeff Miller told analysts on an earnings call. Miller added that the industry “will continue to slim down,” but he said that it would create a “healthier” sector.

Still, a rebound in production is not imminent. While many see consolidation as a positive for the industry, others caution that any return to growth would be self-destructive. “Our industry, and particularly North American shale producers, must acknowledge two fundamental truths: we have a significant influence on the global oil market, and today that market is oversupplied,” Diamondback Energy CEO Travis Stice said in an operational update in mid-October.

“As such, if North American producers decide to grow again, even at mid-single-digit rates, we will magnify the issues our industry is fighting today and face repercussions from other global producers,” Stice said. He added that Diamondback would spend just enough to keep production flat this year, and that the company would stick with that strategy through 2021.

Importantly, investors are no longer rewarding growth. Unlike in past downturns, there is no appetite for another debt-fueled drilling binge.

Light tight oil production (a figure that excludes conventional and offshore output) is expected to fall from 8.6 million barrels per day (Mb/d) in 2019 to 8.2 Mb/d this year, according to Rystad Energy, before contracting further to just 7.7 Mb/d in 2021.

Rystad sees production rising again in 2022 and beyond. If that occurs, it will be done by many fewer companies.