The rapid increase in supply from tight oil sources in North America, particularly shale formations in the United States, was largely responsible for a massive supply imbalance which is only now nearing a tenuous correction. While growth in supply by Organization of the Petroleum Exporting Countries, OPEC, over the past decade remained within a narrow band, that from the US and Canada rose steeply. From a modest level of 92,000 barrels per day (bpd) in 2008 for example, light oil additions (year-over-year) from US shale and tight oil liquids rose to a staggering 1.6 million bpd in 2018 according to Rystad Energy data.   By 2018, the US oil production had overtaken those of Saudi Arabia and Russia for the first time in decades to become the world’s largest.

The response from OPEC, led by Saudi Arabia and other Gulf producers was a laissez-faire supply ramp-up, a thinly-veiled attempt to drive the then higher-cost (shale) producers offline and secure greater market share. This “sheik-versus-shale” face-off, as it was then widely alluded to, only served to exacerbate the supply imbalance.                                                                                                                                                                   

The US Energy Information Administration’s Drilling Productivity Report for November 2019 shows that production from three US shale plays in the states of North Dakota (Bakken), Texas (Permian, Eagle Ford) and New Mexico (Permian) account for about 83% of that country’s total shale oil output, the Permian accounting for 51%. More than 28 billion barrels of oil have been produced by the Permian alone which has seen very significant upward reserve revisions by the United States Geological Survey (USGS). 

Despite such impressive output, signs are emerging that the United States shale train may not be headed for the promised land after all. This year for example, the 19% drop in Permian drilling activity has had a significant impact on jobs there. A recent report by the Federal Reserve Bank of Dallas shows that through the first ten months of the year, the basin lost 400 jobs, a massive change from the 16,700 jobs added in the same period last year.

The knock-on effects are also significant: hotel revenues — many of the workers do not reside there — housing sales, suppliers of fracking chemicals, equipment manufacturers, among others have all been negatively affected. And just recently, the multinational Norwegian energy firm Equinor, announced its plan to quit the Eagle Ford shale play, even as the independent, ConocoPhillips, attempts to veer operations away from the US shale industry.

Fundamentals

One major consequence of that supply imbalance was the precipitous fall in oil prices. For example, Brent spot prices plummeted 77% between June 2014 and January 2016. Average annual spot price for Brent fell from US$109.56 per barrel in 2013 to US$45.64 per barrel in 2016. Several — especially the higher-cost — producers were put out of business and many investors sustained heavy losses. Five years on, prices have recovered somewhat but nowhere near those elevated values.

Crude oil prices are often driven by global economic activity and projections by the International Monetary Fund, IMF, for global economic growth have seen significant downward revisions. The IMF in its World Economic Outlook report for October 2019 noted:

Momentum in manufacturing activity, in particular, has weakened substantially, to levels not seen since the global financial crisis. Rising trade and geopolitical tensions have increased uncertainty about the future of the global trading system and international cooperation more generally, taking a toll on business confidence, investment decisions, and global trade.

The current trade spat between the United States and China has taken its toll on global economic activity; and many analysts fear it may get worse. Just a few days ago, Henry Kissinger, former US Secretary of State warned that the United States and China are “in foothills of a cold war". As US oil exports rise above 3 million bpd, it remains uncertain how sustainable that rise would be without China, the world’s largest demand market. What could be a substantial loss for US producers, would be a gain for other producers around the world.

Accounting and professional services firm, Deloitte, in its 2020 outlook outlined macroeconomic risks which could impact the oil and gas industry, including trade tensions which could create uncertainties and disrupt established supply chains. It forecast a slower growth in US gross domestic product as well as a 25% chance of a recession in that country.

The downturn in global economic activity is adding to a fragile outlook for oil demand growth; with rising shale oil supply, the prospects of a protracted global supply overhang would be high, and such imbalance conduces inevitably, to lower oil prices. The International Energy Agency in this year’s World Energy Outlook, reports in its Stated Policies scenario, that although US oil supply “slows from the breakneck pace seen in recent years”, it still accounts for 85% of global oil supply growth to 2030; and with most of US tight oil supply coming from the Permian Basin. In what would only add to the global oil supply imbalance, OPEC, in its recent World Oil Outlook, reports that growth in non-OPEC supply will exceed that in global demand by 2024.

Crude oil prices have remained largely range-bound over the past few months; and based on current fundamentals, save for a major industry shock such as the Khurais facility attack, a spike is not expected any time soon.

Production Techniques

Output for oil wells drilled across US shale formations typically have high decline rates. Compared to conventional oil wells which for example may present decline rates of 8-10% per annum in the first few years of operation, these shale wells show decline rates as much as 65% in the first year of operation alone. In the wake of that precipitous oil price decline, producers employed different cost-saving techniques to enable them stay profitable.

One such technique was high-grading, which entailed focusing on output from resource-richer acreages and that led to comparatively higher output/cost ratios. However, in the protracted low-price regime for oil, many producers exhausted their resource-rich acreages and have been turning to lower quality ones; and prices for resource-rich acreages where available, have risen substantially.

Other techniques include drilling longer laterals and child wells. When these child wells have been drilled too close together — as has often been the case — output has been impaired by as much as 20%, exacerbating production costs.

Investor Backlash

The steep output decline rates for shale wells mean that a lot of money, sometimes as much as 120% of revenue is expended just to keep production going. In the early days of that frenzied shale production, credit facilities were easy to come by and banks were willing to fund such operations; but since the price crash of 2014, that willingness has waned significantly.

Many of the investors that sustained heavy losses in that oil price crash have been reluctant to reinvest. In addition, quite a number of private lenders are no longer willing to collateralize shale assets and shareholders in shale oil firms are demanding greater returns for their investment. Some producers that are able to secure loans, do so at higher cost. S&P Global’s Market Intelligence recently reported that:

“18.4% of less-than-investment grade borrowers are paying 10% or more for loans, while the average spread among speculative oil and gas borrowers has widened to 3.49% above the risk-free T-bill rate, from 2.31% in July 2018.”

Producers’ market values have seen a 21% fall this year; with rising debt and reduced access to credit, many now face bankruptcy. The corporate law firm Haynes And Boone, LLP, in a recent report, itemized an increasing number of bankruptcy filings among North American oil and gas producers.

According to the report, from 2015 through September 2019, a total of 192 oil and gas producers filed for bankruptcy, involving an aggregate debt of US$106.8 billion. During that period, Texas with 87, accounted for the highest number of those bankruptcy filings. On the upside, these shale bankruptcies may provide a window for high net-worth investors such as billionaires as well as oil majors angling for assets at distressed prices. On the downside, the outlook for oil prices remains tenuous.

All said, while these headwinds for the US shale industry are surmountable, it is pertinent to note that two of the shale industry’s pioneers are now warning that the days of massive shale oil production growth in the US are coming to an end.