How do shale drillers cope with $35 oil? They don’t

The in­dus­try could cope with $50 oil, but $35 is too low “You are go­ing to see a pickup in bank­ruptcy fil­ings”

Bloomberg Businessweek (Asia) - - Contents - −Dan Mur­taugh

In 2015 the frack­ing out­fits that dot Amer­ica’s oil-rich plains did ev­ery­thing they could to cope with $50-a-bar­rel crude. They fired thou­sands of rough­necks, fo­cused their rigs on the big­gest gush­ers, and used cut­ting-edge tech­nol­ogy to squeeze all the oil they could out of ev­ery well. To the sur­prise of many ob­servers, those ef­forts largely suc­ceeded. As of De­cem­ber, U.S. oil out­put re­mained within 4 per­cent of a 43-year high.

The prob­lem? Oil’s no longer at $50. It’s trad­ing at about $35. For an in­dus­try that was al­ready push­ing cost­cut­ting to the lim­its, the new de­clines are dev­as­tat­ing. Shale drillers are “not set up to sur­vive oil in the $30s,” says R.T. Dukes, a se­nior up­stream an­a­lyst for Wood Macken­zie in Hous­ton.

The U.S. En­ergy In­for­ma­tion Ad­min­is­tra­tion predicts that com­pa­nies op­er­at­ing in U.S. shale for­ma­tions will cut pro­duc­tion by a record 570,000 bar­rels a day in 2016. Sam­son Re­sources and Mag­num Hunter Re­sources are among the drillers that have filed for bank­ruptcy. “You are go­ing to see a pickup in bank­ruptcy fil­ings, a pickup in dis­tressed as­set sales, and a pickup in dis­tressed debt ex­changes,” says Jeff Jones, a man­ag­ing di­rec­tor at Black­hill Part­ners, a Dal­las-based in­vest­ment bank­ing firm. “And $35 oil will clearly ac­cel­er­ate the dis­tress.”

Frack­ing is ex­pen­sive: It re­quires drilling a long hor­i­zon­tal hole through the shale layer, then blast­ing that tun­nel with high-pres­sure bursts of wa­ter, chem­i­cals, and sand to cre­ate mil­lions of tiny fis­sures through which oil and gas can es­cape. Shale drilling made sense only af­ter rapid global eco­nomic growth in the early 2000s boosted en­ergy de­mand and raised oil prices. Out­put has leapt more than 60 per­cent since the end of 2010. As sup­ply over­whelmed de­mand, prices started fall­ing from more than $100 in mid-2014 to the $70s in Novem­ber of that year, and then, af­ter OPEC recom­mit­ted to keep pump­ing at near-record lev­els in De­cem­ber 2015, they dropped

into the $30s. “Shale is dis­rup­tive,” says Dukes. “It brought on big vol­umes in a short pe­riod and eclipsed de­mand growth, and the oil mar­ket be­gan to look worse and worse.”

When oil prices fell, pro­duc­ers slashed spend­ing, idling more than 60 per­cent of U.S. rigs. They drilled and fracked faster so that fewer rigs and work­ers could ex­ploit the same num­ber of wells. They fo­cused on their rich­est de­posits and used more sand and wa­ter in the frack­ing process to squeeze more crude out of each well. By April of last year, out­put was still ris­ing.

Yet those ef­forts ended up push­ing prices lower. Now shale com­pa­nies have played most of their best cards. “There is lim­ited scope for fur­ther pro­duc­tion cost re­duc­tions,” Mike Wit­tner, global head of oil mar­ket re­search for So­ciété Générale, wrote in a note to clients. “While tech­no­log­i­cal and ef­fi­ciency im­prove­ments may con­tinue grad­u­ally, oil com­pany rene­go­ti­a­tions with con­trac­tors are es­sen­tially done, and so is the rapid shift to fo­cus only on core ar­eas.”

Even a plunge in U.S. out­put may not be enough to drain a global sup­ply glut that has kept al­most 3 bil­lion bar­rels of oil and prod­ucts such as gaso­line in the stor­age tanks of de­vel­oped coun­tries, ac­cord­ing to the In­ter­na­tional En­ergy Agency. The world will likely be over­sup­plied by about 1 mil­lion bar­rels a day through the first half of next year, Jefferies an­a­lysts in­clud­ing Ja­son Gam­mel said in a Dec. 18 re­search note.

Shale drillers aren’t the only ones hurt­ing. OPEC’s strat­egy is caus­ing pain for its mem­bers. Saudi Ara­bia is said to be con­sid­er­ing sell­ing stakes in state-owned com­pa­nies to help stem a bud­get deficit that’s reached 20 per­cent of its econ­omy.

In the U.S., “most com­pa­nies have gone into shrink­age mode, say­ing their goal is to stay flat and make it through this mar­ket,” says Raoul LeBlanc, an an­a­lyst with IHS in Hous­ton. “The cur­rent price is un­sus­tain­able. Un­for­tu­nately, we have to sus­tain it for a while longer.” The bot­tom line Af­ter idling 60 per­cent of rigs and im­prov­ing ef­fi­ciency, shale drillers don’t have many op­tions to cope with lower oil prices.


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