Bloomberg Businessweek (Europe)

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”

- −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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