July 2019

The last barrel

Enough already!
Craig Fleming / World Oil

In 1979, escalating crude prices, combined with the repeal of federal oil price controls on U.S. production by President Jimmy Carter, started a drilling boom in the U.S. of unprecedented proportions. In 1981, the U.S. rig count averaged 3,970 units for the year, and hit an all-time high of 4,530 on Dec. 28, 1981. Crude also peaked at the end of 1981, reaching $37/bbl ($100/bbl in constant dollars, as of April 2019).

Boom turns to bust. The event that initiated the bust occurred in July 1982, when Oklahoma City-based Penn Square Bank (PSB) failed, due to highly questionable leading practices by loan officers that were convinced that virtually any lease or producing property was a good investment. The ripple effect caused 139 other banks in Oklahoma to fail and led to the collapse of Continental Illinois National Bank, which had to write off $500 million in loans purchased from PSB.

While I was suffering through the mega-bust years between 1985–1989, a bumper sticker appeared on many cars and trucks that read, “Lord, grant me one more boom and I promise not to screw it up.” Yes, I thought—if only we could get a second chance! I figured, based on lessons learned, U.S. operators would self-regulate and pay OFS companies a fair price for their tools and services. Our industry leaders would act responsibly next time, and not repeat the painful mistakes of the past, right? (Visions of drilling rigs danced through my head).

New boom starts in 2008! Lo and behold, enter the shale revolution with its miraculous extended-reach horizontal drilling and high-tech staged fracing techniques. Since the start of 2012, U.S. oil production has increased steadily, reaching an all-time high in May of 12.24 MMbopd. But the increased production has come at a high price.

Shale folly begins. Similar to the PSB debacle 37 years ago, operators, and the investment community, seem to believe that any DUC is a good investment and are apparently labeling these wells as proved non-producing assets (collateral for more loans). As of May 2019, operators working the U.S. shale plays have managed to archive 8,283 DUCs, with 48% of that total in the Permian basin. That’s a significant amount of stranded capital. How much has our industry “invested” in DUCs? And when can investors expect a return? And, similar to the over-drilling scenario during the 1979–1983 boom era, activity in the Permian continues at a blistering pace, with an average 399 rigs running in RRC District 8 and New Mexico in June, 41% of the U.S. total.

Winning at any cost. Who pays? Immediately following Occidental’s victory in its battle for Anadarko, its shares dropped to a 10-year low. The $38-billion deal, which has shaved 23% off Oxy’s market value, was partially financed by a $10-billion investment from Warren Buffett, which enabled CEO Vicki Hollub to increase the cash portion of her bid to avoid the need for a shareholder vote. The financing comes with a hefty price tag, with Buffett to receive 100,000 preferred shares that will accrue premium dividends of 8% annually (Bloomberg). Investor Carl Icahn also filed a lawsuit against Oxy for its “fundamentally misguided and hugely overpriced” bid for Anadarko. The suit also questions Hollub’s deal with Buffett. “A 90-minute ‘negotiation’ with one of history’s canniest investors, is no place to gain M&A experience—if you care about protecting your stockholders.

In June, Rex Tillerson said, “We probably paid too much,” referring to Exxon Mobil’s $31-billion purchase of XTO (Bloomberg/KPMG). “At the time, we were looking at gas prices to stay around $5-$6/MMBtu. I’m still proud of the deal—but wish I’d got it for less money—the shareholders would have been better off,” Tillerson concluded.

Despite these massive investor losses, Anadarko CEO Al Walker will receive a bonus of $98 million following his company’s sale to Oxy. The payout is part of $300 million that will be shared among six Anadarko executives (SEC filing). And despite a $5-billion loss in market value over a five-year period, EP Energy approved a retention program that includes awards for five executives, with CEO Russell Parker snagging $2.4 million to stay with the company another 13 months. I suggest “another type” of HR action would have been more appropriate.

Seeds of bust starting to germinate? Wall Street’s pursuit of companies to prioritize investor returns over growth is driving some U.S. shale producers into financial distress. The boom in crude output is masking ongoing woes at several smaller producers, and the OFS sector in general. Energy-related bankruptcies are up this year, and some companies are warning of more stress ahead. Schlumberger, Halliburton, NOV and Baker Hughes’ stock prices are down 40%, 48%, 48% and 24%, respectively, over a one-year period, and Weatherford filed for bankruptcy July 1. The distress is caused mainly by operators that will not pay OFS companies sustainable prices for tools and services. Shale companies Halcon and Alta Mesa have raised doubts about their ability to stay in business. Additionally, California Resources’ bonds are trading at yields 10% above U.S. Treasury benchmarks, a sign of distressed debt.

And you can forget about the majors buying up struggling independents. Years of costly drilling and frantic buying sprees have gutted shareholder returns. Exxon Mobil, Shell, Chevron and ConocoPhillips have all said they won’t be buying smaller companies, when sellers are demanding premium payouts.

Back off before it’s too late! According to philosopher George Santayana, “Those who cannot remember the past are condemned to repeat it.” It’s hard to imagine that today’s industry leaders don’t remember the circumstances that led to the bust of 1986-1989, but that’s apparently the case. I guess the only thing we can do now is start printing more bumper stickers. WO

About the Authors
Craig Fleming
World Oil
Craig Fleming Craig.Fleming@WorldOil.com
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