Unease In The American Shale Patch

The current slump in global crude oil prices has exacted quite a significant toll on the oil and gas industry. Job losses worldwide are currently in excess of 200,000 and rising, billions of dollars worth of projects have been deferred or cancelled and there have been assets divestment as well as consolidation among companies in the industry.

That price slump derives in the main, from weakening demand and rapid increase in supply, with the United States shale oil output accounting for most of that increase. Without a doubt, the decision by Organization of the Petroleum Exporting Countries, OPEC, not to rein in supply, only widened the imbalance ― excess of supply over demand ― and steepened the slump.

Shale oil production in the U.S. rose from about 500,000 barrels per day (bpd) in 2005 to about 4.5 million bpd by the end of last year, or about 52% of that year’s 8.6 million bpd output. The massive ramp-up in shale gas output through hydraulic fracturing (or fracking) also led to the glut in U.S. natural gas supply and ultimately the commodity’s price collapse.

Impairments

The shale boom or shale revolution ― as that steep supply growth has come to be known ― was financed largely through heavy borrowing and in many cases, cash outflows substantially exceeded inflows. Loans were obtained against the values of proven reserves and most of those valuations were made when oil prices were close to US$100 per barrel; with oil prices currently less than US$40 per barrel, and projected to be little-changed in the near term, corporate assets may suffer critical impairments. The imminent rate hike by the United States Federal Reserve may even exacerbate the distress. 

According to Bloomberg, companies such as Chesapeake Energy Corp. (CHK) (45%), Bill Barrett Corp. (BBG) (40%) and Oasis Petroleum Inc. (OAS) (33%) stand to suffer substantial assets impairment. Many of the Wall Street firms that financed the shale boom have already been severely impacted.

With the inability of many shale operators to borrow against severely devalued reserves, the oil and gas sector faces a spike in downgrades and defaults, and investors in their bonds may witness major losses, the ratings agency, Moody’s reports. The agency also revealed that firms in the oil and gas as well as metals and mining sectors have since 2010 issued bonds worth nearly US$2 trillion mostly in the speculative or “junk bond” category. Market data show that the average yield on the debt of oil and gas borrowers has risen to near six-year highs.

A report by Oil Patch Bankruptcy Monitor details Chapter 11 (U.S. bankruptcy code) filings in 2015 for upstream oil and gas companies. In the filings, which totaled about US$13 billion in secured in unsecured debt, Texas leads North America with 17, while Delaware had the highest in terms of dollar value.

Waiting Game

For many of the severely impaired shale operators, redemption may never come ― save for a huge spike in oil prices ― if they are to operate within the precincts of their cash flow processes. Estimates of marginal production cost for a new barrel of shale oil range from US$65 to US$77. In only a few “sweet” plays, that estimate is as low as US$30. It then becomes a waiting game for oil price rebound though the prospects in the near term do not hold much cheer.

The current bid to lift the decades-old restriction on U.S. oil exports may not be of immediate benefit either. The U.S. grades would have to compete with well-established light, sweet crudes especially those of the Atlantic provinces of West Africa. Nigeria’s Bonny Light and Qua Iboe Light for example, are sold at premiums to the international benchmark North Sea Brent; but even those grades witnessed distressed or unsold cargoes as recently as first week of this month, according to Argus.

In addition, refiners may be slow to take on new grades over well-accustomed ones and with issues of arbitrage, the U.S. grades may not find the wiggle room in a low oil price regime to incentivize the refiners with suitable price discounts.

The U.S. shale oil industry may well be likened to a sleeping giant, ensuring that the country and perhaps the world will not be held captive by any future oil embargo. However, with slumping oil prices, it remains to be seen if for many of the shale operators, that slumber (or coma perhaps) will conduce to death.