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Is The Shale Industry About To Experience A Shakeout?

By Nick Cunningham | Wed, 28 May 2014 21:54 | 2

The U.S. shale industry may be a lot less healthy than many people think. A new analysis from Bloomberg News found a startlingly high level of debt in the shale industry, with companies borrowing more and more money as revenues disappoint.

According to the report, debt among shale oil and gas companies has nearly doubled over the last four years. While drillers often need to borrow in order to expand, revenues have not kept pace, growing at a mere 5.6 percent over the same time period.

The problem is that many shale oil and gas wells offer an initial burst of production over the first year or two. After that, output drops precipitously, and if companies have not paid down debt, they may have much more difficulty in later years than they may have anticipated. They fall into a downward spiral in which a greater share of their revenue must go to paying down debt.

Bloomberg concluded that out of the 61 companies surveyed, around a dozen are spending more than 10 percent of their revenues on debt interest.

What’s the significance of so many shale drillers struggling to turn a profit? It means that the zeal with which investors poured money into so many shale companies may be at an end. The industry is due for a shakeout.

Related Article: U.S. Shale: Dazzling Numbers, But Also Divisions

The companies in the worst shape – those that are highly leveraged without a growing production portfolio – could be heading towards bankruptcy. As the weakest links drop out, the industry will consolidate and leave only the strongest and healthiest producers.

A shakeout is normal in any industry when the hyper-growth phase begins to slow. But unlike in the tech industry, for example, the shale industry’s economic fortunes have ramifications far beyond individual companies, their employees and investors.

If drillers begin to go belly up, oil and natural gas production growth could slow or come to a halt. The Energy Information Administration projects in its latest Annual Energy Outlook that U.S. natural gas production will grow at a steady rate of 1.6 percent per year through 2040. That would mean that over the next 25 to 30 years, natural gas production would expand by an astonishing 55 percent.

But that may be wildly optimistic given the fact that so many companies are struggling to be profitable right now in the shale patch. Or put another way, production may not be sustainable at current price levels, and would have to rise in order for growth to continue.

Either way, a lower growth trajectory or higher prices would seriously alter the expectations about the U.S. energy picture. For example, if natural gas prices need to significantly rise in order to maintain growth, the opportunity to export significant volumes of liquefied natural gas (LNG) overseas may be smaller as well. That’s because U.S. companies would not be able to arbitrage American gas as easily by liquefying it and selling it at a higher price to hungry consumers in East Asia.

Related Article: Is This Shale’s Power-to-the-People Moment?

As a result, the companies investing money into building LNG export terminals that costs billions could begin to look a bit inflated.

A shale shakeout would also reverberate through the electric power sector since plateauing shale gas production would be a boon for renewable energy. Natural gas was expected to gobble up an ever-increasing share of electricity generation because prices were expected to remain stable even as production rose. But if those expectations turn out to be wrong, that leaves a lot of space for other forms of generation. And with coal and nuclear power becoming increasingly uncompetitive in 21st century America, that leaves an enormous opportunity for renewable energy.

As for oil, lower production from shale would also mean that the U.S. would continue to rely on imported oil instead of domestic production. While that does not mean much on its own, the fact that the oil industry can no longer offer trite promises of “energy independence” means that Congress may have to face up to the fact that the U.S. needs to find alternatives to oil for the long-term.
 
The shale revolution has been an opiate for many of the U.S.’s energy problems for several years now, but that could begin to change if the industry begins to falter.  

By Nick Cunningham of Oilprice.com

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Nick Cunningham
Company: Oilprice.com

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Leave a comment

  • Lee James on May 31 2014 said:
    Nick, thanks for calling the kettle black.

    I've observed that folks just don't seem to be paying attention to the economics of shale oil and gas. Is it because people get all excited about increased production volume, without regard to production cost?

    Are people not paying attention because shale resources are an emerging industry, with understandably higher initial cost? And, we fully expect that technology will save the day?

    My take is that there's a significant trend going on with fossil fuels, and especially petroleum. The trend is toward increasingly higher cost. Now, just think of the costs energy consumers would face if had to, in addition, directly pay-as-you-go for social and environmental damage! --So much easier to pay later!

    What's wrong with this picture? As you have said, time to look much more seriously at alternatives!
  • Louis weckerling on June 03 2014 said:
    Did nobody see the profits of the oil companies last few years. Close margins my ass. Wake up America!!!

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