The last barrel

Although my co-workers would probably disagree, I like to think of myself as a glass half-full type person. But with the 24/7 barrage of “this-is-the-end” news, it has been difficult for me to maintain a positive attitude. And with this avalanche of press related to the significant reduction in demand caused by the Coronavirus and the resulting collapse in oil prices, in addition to the on-going price war between Russia and Saudi Arabia, it appears we have some real issues. Combine this with the powerful pundits already lined-up against the industry, including the Democratic party and the environmental groups, and it’s difficult to see much cause for optimism.

Fuel for the fire. Energy firms that responded to the Dallas Fed’s latest quarterly survey, which took place on March 11-19, indicated that Texas producers are planning severe budget cuts for the next three months of this year. Shale drillers said the average price required to cover operating expenses was approximately $23/bbl in the Eagle Ford, and up to $36/bbl in other shale basins. Break-evens to drill new wells are roughly double those levels, with an average of $46/bbl required in the Permian. According to one oil executive, “at $40/bbl, you’re in the hole; at $30, it is hard to keep producing existing wells and nothing can be drilled at $30/bbl. And if WTI remains below $40/bbl, 15% of respondents said they would be insolvent in less than 12 months, with another 25% saying they would be bankrupt in 1-2 years. However, one shrewd executive said, “this will weed-out the Ponzi guys and companies with excessive debt.”

Slashing spending. The majority of Texas executives agree U.S. producers (and output) are going to take a bigger hit than during the 2015-2016 bust. Some predict up to 70% of the 6,000 shale drillers may go bankrupt, with 34% of shale-patch workers losing their job. And Wall Street has cut off the cash spigot (finally). Exxon will reduce this year’s spending by $10 billion (30%), and Chevron, which holds some of the richest acreage in the Permian, said it is reducing capex by $4 billion and halting share buybacks to conserve cash.

Remember, assets are still in place. Despite the dire forecast, U.S. shale will survive and thrive again. Let’s not forget the stunning rebound that occurred, starting in 2017, that turned the U.S. into a net exporter of crude, with production hitting another record-high of 13.01 MMbopd in February. Although it looks bad now, experts (and the glass half-full guy) predict it will happen again. When the irresponsible and debt-riddled companies are eliminated, the surviving shale players will be leaner and more tech-savvy, according to Daniel Yergin, vice chairman of IHS Markit. That means lower production costs and a greater ability to respond to the next price rebound. “Companies go bankrupt, but rocks don’t go bankrupt,” Yergin said in an interview. “When this all shakes out, there will be other people to develop shale.”

And according to Bloomberg oil analyst Vincent Piazza, “the weakest companies will go into stronger hands” leaving balance sheets stronger than in 2014-2016. “I wouldn’t underestimate the ability of the industry to re-create itself,” Piazza concluded. Yergin predicts oil will need to be between $50-60/bbl to reinvigorate shale. “At $50, we’ll start to see a recovery and a step up in investment, so long as people feel safe about the price floor beneath them.”

Silver lining. A major part of shale’s resilience lies in its unique geology. Unlike conventional fields in Saudi Arabia and Russia, U.S. shale is so dense that it doesn’t degrade or collapse, if production is interrupted. In other parts of the world, disrupting output can do irreversible damage to the reservoir, Yergin continued. That’s why the bulk of Chevron’s $4 billion spending cut will take place in the Permian, said CEO Mike Wirth. It’s rare, when production can be turned off almost instantly without adverse long-term effects. Because shale wells have high initial pressure, they can be shut-in and later resume production with limited lost capacity, according to Damien Courvalin, Goldman Sachs Group. With shale, “the assets don’t go away, because you haven’t destroyed the field,” said Ken Medlock, senior director of Rice University’s Center for Energy Studies. “We’ll see a thinning of the herd, but the hydrocarbons are still in place.”

Deal to balance oil markets. I have to commend President Trump for having the courage to broker a production cut deal to support the E&P industry, without regard for the political fall-out from the 40 non/low-producing states that thrive on cheap energy. Saudi Arabia and Russia were able to broker a 10-MMbopd production cut in OPEC+, but they are looking to the U.S. to share a further burden. This may require the participation of 6,000 U.S. companies, which haven’t faced output restrictions in 50 years, to unify.

API, which is dominated by large producers, wants the government to stay out of the domestic market and focus on diplomatic efforts. The prospect of capping U.S. production was blasted by many industry heavyweights, who are opposed to any broader effort. API called pro-rationing an “anti-competitive” effort, which would only harm U.S. consumers and American producers. So, to make sure I understand correctly, API is saying that the more U.S. shale companies go bankrupt, the better it is for ExxonMobil and Chevon, right?

Live within your means. Mickey Raney, CEO of Oklahoma City-based Impact Energy Partners, has some sage advice. “Our industry chose to accept Wall Street money that funded incompetent teams to drill wells that would never pay out. These executives made millions in high salaries, stock options and cash bonuses for leading their companies into bankruptcy. Properly managed companies must now find ways to survive in the mess we created,” Mr. Raney concluded. Now, we know which companies drilled the 7,637 DUC wells.

About the Authors

Craig Fleming

World Oil

Craig Fleming Craig.Fleming@WorldOil.com