The rebound of WTI from below zero back into the $30s led to a wave of bullish trading, with energy stocks rallying in response. One renowned industry expert recently celebrated the return of $30 oil:
— Donald J. Trump (@realDonaldTrump) May 18, 2020
But the enthusiasm in no way reflects the true state of the U.S. oil industry. Shale drillers were collectively unprofitable even when oil prices were twice today’s levels, and are drowning in red ink with WTI at $30 per barrel.
The poor economics predate the global pandemic and the market downturn. For instance, large U.S. oil drillers spent a combined $1.18 trillion over the past decade, but only generated $819 billion in cash flow from their operations, according to Evercore ISI and the Wall Street Journal. In other words, oil drillers are more than $350 billion in the hole over a ten-year period. For much of that time, oil prices were trading at $50 per barrel or higher.
Between 2015 and 2019, more than 200 North American oil and gas companies filed for Chapter 11 bankruptcy. The pace of bankruptcies actually accelerated last year as investors began to sour on the industry. Again, that predated the pandemic.
At $30, the financial blood-letting will continue. Roughly 73 E&Ps in the U.S. could be forced into bankruptcy this year if oil remains stuck at $30 per barrel, according to Rystad Energy. Another 170 companies would go under in 2021. If oil falls back below $30 per barrel again, the number of bankruptcies would climb even higher.
“I don’t think $30 oil saves a lot of those producers who are sitting in the emergency room on a gurney waiting on a heart transplant,” Buddy Clark, a lawyer at Haynes & Boone, told the FT. “There are more bankruptcies to come.”
In the first quarter, the top 39 publicly-listed U.S. independent shale companies posted a combined $26 billion in losses, due to a wave of write downs, Rystad data shows. The second quarter is going to be dramatically worse since the first three months of the year only partially captured the market crash.
The pain is visible in the rig count, which is now at historic lows. Last week, the industry shed another 21 rigs, 13 of which came from the Permian basin. At 237 active oil rigs, the rig count is now down by more than 65 percent since March.
U.S. oil production fell to 11.5 mb/d in mid-May, but U.S. Secretary of Energy Dan Brouillette estimated the shut ins have already topped 2.2 mb/d.
Some of that could come back online. “Most of the production that was to be shut is now already shut, and producers count down until the day they will be able to recover some of the output that’s put on ice,” Bjornar Tonhaugen, head of Oil Markets at Rystad Energy, said in a statement. “It is going to be a slow path to recovery though.”
But the steep drop in drilling quickly leads to production declines. According to ShaleProfile Analytics and Bloomberg, U.S. oil production from major shale basins would plunge by more than a third to under 5 million barrels per day if drilling came entirely to a halt. Of course, drilling won’t cease entirely, but the analysis illustrates how swiftly shale wells tend to decline.
This has been the problem of U.S. shale since its inception. It’s no secret that shale wells decline precipitously after an initial burst of production. As a result, keeping production aloft requires a certain amount of continuous drilling. Growing production requires a more aggressive level of spending and drilling increases. Whatever money comes out of the ground must be reinjected into the next well. This dynamic meant that the promise of huge profits proved to be a mirage in most cases.
Industry critics have pointed out these problems for years, but the COVID-19 pandemic, the collapse of demand, low oil prices, and a crippled shale industry has brought these problems to the forefront. The upshot is that we may have already witnessed the peak of U.S. shale.
“February was peak shale,” Daniel Yergin, vice chairman of IHS Markit told the Wall Street Journal. Yergin has been a shale booster for years, so that declaration will not go unnoticed.
By Nick Cunningham of Oilprice.com
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