U.S. Shale Is Far From Dead

In the last few weeks, we’ve seen a steady stream of stories announcing the death of the US shale industry. The narrative goes something like this; persistently low oil prices are squeezing producers to shut rigs and cut jobs. Closed rigs will lead to a steep drop in US production which will be highly bullish for oil prices in 2020. 

To be sure, there are plenty of facts to be cited revealing stress in the US shale patch. Active US oil rigs are down from 800 in May to 696 at the end of October and some of Texas' biggest independent producers have shed thousands of jobs this fall. There is already pain for shareholders of US producers with the XLE fund- a popular ETF of US crude producers- down 6% over the last six months opposite a 7% gain for the broader market. Most importantly, a steep drop in US crude production was observed this summer when output fell from 12.1m bpd in June to 11.8m bpd in July. There is no question the financial stress being felt by US crude producers is real and owners of their shares should be on alert for further stress. 

However, we seem to diverge with the herd in thinking that financial pain for equity and debt holders of US shale companies foreshadows bullish oil prices in 2020. Most importantly, we must remember here that financial losses for business investors won't necessarily mean fewer US barrels produced next year. 

Before we even discuss any numbers, let’s remember that a fair number of prominent commodity fund managers have gone bust in the last few years betting that shareholder pain for crude producers would lead to capex reductions, lower output and higher oil prices. While many of the managers were correct in predicting losses for bondholders and shareholders in the upstream business, the idea that capex reductions would translate into meaningful upside risk for oil prices has been massively incorrect. There is a very good reason why Brent crude has spent the vast majority of the last five years trading in a $45-$65 range and it has to do with the marginal cost of US output. Has every barrel of US production during this period been profitable? Of course not. But with low interest and high stock prices, shale producers should be able to source new capital to keep the pumps going. As the saying goes, never underestimate the willingness of a US wildcatter to poke holes in the ground with other people’s money. With the world’s central banks once again lowering rates, ‘other people’s money’ should be plentiful. We predict this industry will continue to innovate beyond expectations and find a way to continue to flood world markets with oil into 2020.  

August’s US production data should put another fly in the ointment of commentators who are declaring the death of US shale. After dropping from 12.1m bpd of crude production in June to 11.8m bpd in July, US producers bounced back to pump 12.4m bpd of crude in August. The EIA still predicts 2019 output of 12.3m bpd and 13.2m bpd in 2020. They may lose some of Wall Street’s money along the way, but the US shale patch will most likely continue to prove the naysayers wrong- and keep a lid on oil prices- in 2020.