Comments: In Search of Profitability
Authors: Donnelly John 
Published: June 2019

Editor's column

With the shale industry still awash in red ink, and oil prices falling, it may take more consolidation to try to bring some financial stability to the sector. 

The financing strategy of the shale sector has always differed from onshore conventional oil business models. The small and medium-sized independents that have dominated shale have operated with much higher levels of debt and, since the beginning of the unconventional rise, have operated with negative free cash flow. Although production has skyrocketed, profitability has not, and Wall Street investors have grown tired of financing a largely unprofitable piece of the oil and gas business.

The International Energy Agency (IEA) predicted last year that the shale industry would finally achieve positive free cash flow this year as oil prices rebounded and new pipelines relieved bottlenecks that had depressed prices. But the sharp downturn in oil prices in the fourth quarter and the recent decline to near $50/bbl (WTI) has not helped.

When the shale boom was taking off between 2010 and 2014, high oil prices led to huge financial backing. Investment quadruped during that period, according to the IEA, as oil production increased from 0.44 million B/D to 3.6 million B/D, the fastest oil growth since the advent of Saudi Arabia’s giant oil fields in the 1960s.

When oil prices tanked beginning in 2014, shale firms, along with the rest of the industry, switched to sharply cutting costs and trying to instill capital discipline. It was too much for some. More than a hundred shale firms filed for bankruptcy during 2015–16. Banks became more reluctant to lend money, even after oil prices began to recover, leading to a wave of lending from private equity firms. Production from the sector continued to defy odds, but profitability was still not in sight.

BP’s most recent bellwether Statistical Review of World Energy, released in June, noted that US oil and gas production growth accelerated in 2018 at another record pace. The production growth “exceeded any other country’s annual increase in our 50-year history” of publishing the review, said BP Chief Economist Dale Spencer. “Indeed, the US achieved a unique double-first last year, recording the single largest-ever annual increase by any country in both oil and gas production. In case there was any doubt, the US shale revolution is alive and kicking,” he said. Since 2012, US oil production, including natural gas liquids, has grown by more than 7 million B/D, “broadly equivalent to Saudi Arabia’s crude oil exports, an astonishing increase which has trans-formed both the structure of the US economy and global market dynamics,” he added.

But how long this revolution can continue without solid economic footing is unclear. One trend under way is consolidation. Two years ago, many independents began selling off assets so they could continue drilling. Today, many are pursuing assets sales, drilling partnerships, and other alternative financing strategies, according to an article in The Wall Street Journal.

A new wave of company consolidations and buyouts by larger firms may have started. Chevron attempted to buy Anadarko and its sizable presence in the Permian Basin but was beat out by Occidental. Although Shell and other majors have indicated that, while interested, current selling prices for some companies appear too steep, the Anadarko deal could be the first of many that attempts to bring some stability to the shale sector and increases the presence of larger, more diversified firms.