Would shale survive a bust?
Without oil recovery, Houston area could lose up to 20K jobs
While many shale companies can turn a profit with oil between $50 and $60 per barrel, few can survive at $30 without drastic cuts to production and staff.
The shale oil and gas industry faced an uncertain future long before oil markets crashed this week as burgeoning supplies, lackluster prices, dwindling capital and increasing competition from renewable energy squeezed profits, cut employment and pushed some companies into bankruptcy.
The dramatic plunge of crude to around $30 a barrel — half the price at the beginning of year — is likely to accelerate those trends, forcing more layoffs and bankruptcies and delivering another blow to the Houston economy. As with the last oil bust, which stretched from 2014 to 2016, only the strongest, best financed and most efficient companies will survive if prices remain depressed over a long period, analysts said, again reshaping the industry into one that is smaller, leaner and employing far fewer workers.
“We will see a lot of defaults and Chapter 11 bankruptcies. That will be inevitable at $30 a barrel,” said Alexandre Ramos-Peon, a senior shale analyst with Norwegian research firm Rystad Energy. “It’s going to be tough times.”
The cause of these tough times is a price war between Russia and Saudi Arabia that threatens to flood the global market with cheap crude, just as demand is weakening amid a economic slowdown caused by the novel coronavirus. Oil prices on Monday suffered their biggest one-day
decline since the first Gulf War almost 30 years ago, plunging 25 percent to settle in New York at $31.13 per barrel, the lowest price since the last oil bust hit bottom in early 2016. Prices have remained in the low $30s since.
Oil settled Friday at $31.73 a barrel.
U.S. shale companies will likely bear the brunt of the fallout. While many shale companies can turn a profit with oil between $50 and $60 per barrel, few can survive at $30 without drastic cuts to production and staff. If oil prices stay in the $30 a barrel range this year, as many as 20,000 energy jobs could be lost in the Houston area alone, according to Bill Gilmer, an economist with the University of Houston.
Energy companies have already begun to slash spending in response to the crash. Apache Corp., Devon Energy, Marathon Oil, Noble Energy and Occidental Petroleum this week reduced their capital budgets by about a third, each cutting at least $500 million from funds used for oil exploration and production across West Texas, New Mexico, Oklahoma and Wyoming. West Texas producers Diamondback Energy and Parsley Energy began idling oil rigs and laying off fracking crews.
The full impact of the oil price crash will play out slowly, since about about 60 percent of oil production from U.S. public shale companies is hedged, meaning they have locked in higher oil prices for a period of time as a form of insurance.
Rystad forecasts shale oil production will start dropping significantly as early as May when contracts locking in the higher prices expire. At $30 a barrel, the number of profitable wells plunges by 70 percent; at $25, it’s an 85 percent drop.
Enverus, an Austin energy research firm, forecasts oil prices to hold around $30 a barrel for the rest of the year, perhaps dropping into the $20 range. If the Organization of the Petroleum Exporting Countries is able to bring Russia and Saudi Arabia back to the table and health officials are able to contain the coronavirus pandemic, oil prices could rebound into the $50 to $60 range in 2021 or 2022. Shale drillers are unlikely to see prices in the $60 to $70 range before 2023.
“There’s no question our industry is challenged right now,” said Mike Sommers, chief executive of the American Petroleum
Institute, which represents more than 600 member energy companies. “We’re going to be in for some choppiness.” Short lifespans for wells
George P. Mitchell pioneered modern shale drilling, which combined the decades-old technologies of hydraulic fracturing, or fracking, and horizontal drilling to crack open shale rock and tap into previously inaccessible reservoirs of crude and natural gas.
The shale revolution, which kicked off in 2006 with natural gas and later shifted to crude oil in 2010, propelled the United States into the world’s top producer and a net exporter of oil and gas, weaning the country from its dependence on foreign oil. Shale drilling represents about 60 to 70 percent of U.S. oil production, averaging about 13 million barrels a day.
The average oil well in the Permian Basin, one of the most productive shale plays, costs between $4 million and $8 million to develop, and can start producing oil in three to six months. Shale wells, however, have a short lifespan, producing 60 percent of their total production in the first year.
That means that shale oil companies must drill — and spend — frequently to maintain their output, a prospect that is becoming more daunting as many of the topproducing shale formations have been tapped, leaving less productive oil fields to be developed.
Shale oil’s trajectory could mirror that of natural gas, said Bernadette Johnson, vice president of strategic analytics for Enverus. The Barnett Shale in North Texas once had more than a thousand natural gas rigs when gas prices ranged from $8 to $13 per million British thermal units before the shale revolution in 2008 unlocked vast reserves of natural gas in cheaper-to-drill shale formations such as the Utica and Marcellus in Ohio and Haynesville in Arkansas. Abundant supplies of natural gas have pushed prices below $2 per mmBtu, leaving just one rig in the more expensive-todrill Barnett Shale.
“U.S. shale plays are the highdollar cost plays across the globe for oil,” said Ed Hirs, an energy economist at the University of Houston. “In the commodities business, you don’t want to be the high-cost producer.” High costs
The break-even point for the most efficient shale producers is around $45 in the Permian Basin. Russian oil companies, in comparison, can still make money with prices in the $15 to $20 a barrel range, and Saudis can make money at around $25 a barrel, according to analysts.
Recent history shows the vulnerability of high-cost producers. Oil prices tanked in late 2014 after OPEC failed to agree on production cuts amid an oil glut, created in large part by the booming U.S. shale production. Oil plunged to a low of about $26 per barrel in 2016, down from more than $100 a barrel in mid-2014.
More than 250 U.S. exploration and service firms filed for bankruptcy, and nearly 100,000 energy workers in Houston lost jobs. Companies, which lost about $250 billion in stock market value, have recovered only about half of the jobs lost during that downturn. The rig count — currently at 820 — is lower than its previous peak of more than 2,000.
For most of 2019, oil prices hovered between $50 and $60, barely profitable for many shale drillers. Enverus expected oil prices in the $50 to $60 range this year, but then oil prices crashed.
Markets cratered after OPEC and its allies failed to strike a deal this month with Russia to lower production. Russia said its companies were free to pump as much oil as they wanted. Saudi Arabia responded by pledging to ramp up production to 12.5 million barrels. Deutsche Bank forecasts that crude production will exceed demand by 1.7 million barrels a day, adding to the oil glut.
At the same time, the new coronavirus, which causes a respiratory disease called COVID-19, has upended daily life in much of the world, threatening to drag down the global economy. The pandemic has sickened more than 156,000 people and killed more than 5,800 in at least 111 countries. It has led to cancellations of sports leagues and major events and steep declines in stock markets around the world.
The International Energy Agency forecasts oil demand this year will fall for the first time since 2009, the bottom of the last recession, by 1.1 million barrels per day.
On their own
During previous energy downturns, oil and gas companies were able to rely on new lines of credit from Wall Street to fund exploration and production. But after years of disappointing returns and growing public sentiment against oil and gas companies, investors have soured on the energy sector.
The S&P 500 Energy Index on Thursday fell to its lowest level in 16 years.
“The energy sector has been a monstrous laggard in the stock market for quite a while now,” said Fred Zeidman with the Gordian Group, an independent investment bank specializing in distressed companies. “Wall Street has gone on to greener pastures.”
Oil and gas companies must now fund exploration and pay back its debts from cash generated from operations. But after oil markets cratered last week, revenues are certain to fall.
“There’s going to be an awful lot of companies seeking bankruptcy protection,” said Mike O’Leary, a partner with Houston law firm Hunton Andrews Kurth. “Companies have a lot more debt than they can afford, and now cash flow is cut in half. Many of them are out over their skis.”
Despite the turmoil, the U.S. shale sector is expected to survive the latest bust as demand for oil is still growing long term, said Johnson, the Enverus analyst. Consolidation and bankruptcy can be good for the industry, culling weak players from the herd and pooling resources among the stronger remaining players, she said.
“U.S. shale is going to take a hit this year,” Johnson said. “Is it significant? Definitely. But it’s not the end of the world, and it’s not the end of shale.”