Robert Perkins examines the delicate balance act of financing shale oil production in the US in this week’s Oilgram News column, Petrodollars.
The US shale industry took a high-profile bashing this month from David Einhorn, the US hedge fund manager who gained notoriety by shorting Lehman Brothers a year before the bank collapsed in 2008. In a May 4 presentation, Einhorn claims that “frack addicts” are not only wasting money but destroying value by developing uneconomic US shale.
Singling out Pioneer Natural Resources as the “Mother-Fracker,” Einhorn alleged that — under his own valuation metrics — shale players are burning through huge amounts of cash with few prospects of sustainable returns. So much so, Einhorn believes, that Pioneer is actually losing $12 for every barrels of oil equivalent of shale it develops.
Whether viewed as serendipitous or sensationalist, Einhorn’s comments bring into sharp relief the delicate financial balancing act of the US shale industry. At current WTI prices of around $60/b, many shale players are still laboring under negative free cash flow, a key marker for future growth, despite slashing spending, slowing drilling and shedding staff.
Details aside, Einhorn’s broader point is that ‘self-help’ such as drilling efficiencies and internal cost cutting, on their own, may not enough to keep the shale business model afloat. He is also not alone in raising these concerns.
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The Bank of International Settlements, the central banks’ central bank, estimated in March that the global oil and gas sector increased its debt burden more than twofold since 2006 to $2.5 trillion in 2014. Much of the total, it notes, has been borrowed by US independents developing shale oil. More recently, US shale players saw their cash flow positions worsen by $1.5 billion quarter on quarter at the end of Q1 despite massive spending cutbacks, according to Energy Aspects.
“There is an obvious underfunding issue,” the UK-based oil research group said in a May 12 note. “The nature, volume and rate which debt is accumulated by tight oil producers stands out as a cause for concern.”
Without a doubt, shale’s much-cited price elasticity — its ability to scale up or down in response to price fluctuations — is being tested. With the number of active US rigs more than halving since a peak last October, shale output growth began reversing last month for the first time in years.
The US Energy Information Administration estimates that output from US shale plays such Bakken and Eagle Ford will fall by 86,000 b/d in June to a five-month low of 5.56 million b/d. But what has taken many by surprise is the apparent resilience of light, tight oil players almost a year into one of the biggest oil prices routs in history.
The shale producers themselves are quick to point out that breakeven prices are falling as the impact of supply-chain deflation and fracking improvements become baked into outlooks. Many concur that the reversal of the US shale boom may be short-lived. The 45% rebound in WTI crude since mid-March has given a fresh lease of life to some US shale producers. Rigs for drilling oil in the huge Permian shale basin of West Texas and New Mexico actually rose in early May for the first time in months.
Spurred by recent bullish comments from the US’ two biggest shale players, Pioneer and EOG, the markets seem to have factored in a shale recovery. Both frackers say they are learning to drill faster and cheaper.
After Brent oil cratered in January, the IEA said over 40% of US shale output was still profitable at $50/b and conceded that shale will remain the top source of global incremental supply. Hedging has also helped, as producers seek to lock in higher future prices by taking bets on the back of the recent price recovery.
Certainly initial fears that the US shale sector would undergo a radical shake-out as players default on loan or bond commitments has failed — so far — to play out. But the financing gap for over-leveraged US independents still leaves them vulnerable to interest rate hikes and any events damaging credit conditions, analysts conclude. A change of appetite by private equity funds — many of which have invested in shale — for energy investments would also bode poorly for the sector.
Einhorn estimates that large US shale producers have spent $80 billion more than they have received from selling oil since 2006. It’s numbers like these that fuel concerns that the shale industry is being kept afloat by credit markets willing to finance their operations until prices or returns recover. For now, at least, confidence that credit markets and investors will continue to bankroll the shale boom appears to remain upbeat.
“Despite the dire financials, which will matter in the long run, for now, as long as the funding is there, production will continue,” Energy Aspects notes.
Investors seem to agree. Far from taking on Einhorn’s shale revelations, Pioneer’s shares dipped 6% on his remarks to close less than 2% lower on the day. — Robert Perkins in London