The Fuse

Shale Slams on Brakes As Financial Stress Deepens

by Nick Cunningham | January 27, 2020

As oil prices suffer a renewed slump on the back of weakening demand and chronic oversupply, the U.S. shale industry has slammed on the brakes.

The U.S. shale campaign is facing fundamental questions about its longevity.

The rig count has been declining for more than a year, and the pace of production growth has slowed dramatically. Bankruptcies are once again on the rise, and some of the largest oilfield services companies are starting to look elsewhere. Most analysts see production continuing to rise, at least for a while, but after a decade of growth, the U.S. shale campaign is facing fundamental questions about its longevity.

Shale drilling slowdown
The U.S. shale industry is “facing its biggest test since the 2015 downturn with both capital discipline and slowing leading edge efficiency gains weighing down activity and production,” Halliburton CEO Jeff Miller said on a January 21 earnings call. “Halliburton has continued doing what we said we were doing, stacking equipment to improve our returns.”

One of the largest oilfield service companies in the world is removing equipment from the shale patch. Halliburton reduced its fracturing fleet by 22 percent compared to third quarter 2019 levels. Meanwhile, Schlumberger, the largest oilfield services company, is doing the same. Schlumberger has now removed half of its fracturing fleet compared to the third quarter, the company said on its earnings call. It also cut 1,400 people from its payroll since then.

“This is just the beginning. We believe a lot more equipment will exit the market as lower demand, increasing service intensity and insufficient returns take their toll,” Halliburton’s Jeff Miller said. “We’re looking at 2020 with pragmatism. Early indications are that are U.S. land customers will reduce capital spending approximately 10% from 2019 levels.” Halliburton is instead looking offshore and overseas for its future growth.

The U.S. energy sector is the worst-performing portion of the S&P 500 so far year-to-date, extending a slide that began last year.

Some analysts argue that the capital restraint from shale E&Ps will boost their financial performances. “We estimate budgets will imply a free cash flow yield for oil producers above the broader market, a notable milestone for the sector,” Morgan Stanley said in a note.

The U.S. energy sector is the worst-performing portion of the S&P 500 so far year-to-date, extending a slide that began last year.

That is a notable prediction, given that the shale industry, in the aggregate, has not been able to prove that it can produce positive cash flow for any consistent period of time. An IEEFA survey of 38 publicly-traded oil and gas companies burned through a combined $1.3 billion in the third quarter of last year. “Fracking remains a losing proposition for investors,” Clark Williams-Derry, author of the report, wrote in November. Fourth quarter results will be published in the next few weeks.

But even as Morgan Stanley struck an upbeat tone on U.S. oil producers, the investment bank was noticeably more pessimistic on gas drillers. U.S. Henry Hub gas prices have fallen below $2/MMBtu, a price range that few, if any, gas-focused companies can profit from. “Gas producers, however, continue to face a difficult environment. With elevated leverage and a meaningful amount of debt maturing over the next several years, we expect these companies to spend at maintenance levels in 2020, implying outspend that will need to be bridged by asset sales,” Morgan Stanley said.

Between 2015 and the end of November 2019, roughly 208 North American oil and gas companies filed for bankruptcy, according to Haynes and Boone. In November alone five energy companies declared bankruptcy. But that number could continue to climb this year, and the pace of companies going under could even accelerate. According to the Wall Street Journal, the sector has $200 billion in debt maturing over the next four years, with $40 billion due in 2020.

Production peak?
The financial stress and drilling slowdown have slowed the rate of production growth. The latest Drilling Productivity Report from the EIA expects output to grow by 22,000 barrels per day (b/d) in February, compared to a month earlier. That’s a rate of growth two-thirds lower than for the same month in 2019. The EIA sees output averaging 13.3 million barrels per day (Mb/d) in 2020 and 13.7 Mb/d in 2021.

Some basins are starting to see production declines for the first time in years.

Some basins are starting to see production declines for the first time in years. For instance, Oklahoma’s Anadarko basin will see output drop by 16,000 b/d in February, while the Eagle Ford could dip slightly by 7,000 b/d. The Permian basin is now the only place in the United States where shale output is growing in any significant way.

But even the Permian could ultimately hit a peak. Because of the steep decline rates from shale wells, the “legacy” decline rate grows larger with each passing month. That makes intuitive sense – with more shale wells online, the base of eroding production is larger. The EIA expects existing Permian wells to lose 281,000 b/d in February, a sum that needs to be made up by fresh drilling.

That can be overcome as long as drilling occurs at a faster and faster rate. But the legacy decline rate is double what it was two and a half years ago. In other words, the shale treadmill is accelerating, forcing companies to drill faster if they want to continue to grow.

But because they are actually slowing down, overall production growth is now slowing, and could ultimately begin to contract at some point in the not-so-distant future.

 

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