Via: https://www.ft.com/content/39125b8a-524 ... 1721a0541e
Wall Street calls time on the shale revolution
US fracking has survived dramatic price wars before but the latest shock is different
A decade of shale drilling has transformed US energy. The country’s oil output has more than doubled, cutting its dependence on foreign supplies, while an abundant supply of cheap natural gas has enticed power plants to switch from dirtier coal and helped lower US carbon emissions.
US oil production, just 5.5m barrels a day in 2011, is now a world-leading 13m b/d. Pipelines and other infrastructure have sprouted across the coast of the Gulf of Mexico to support a surging oil-export trade. If the US were a member of Opec, it would be among the cartel’s biggest exporters.
But this revolution is under threat, as US drillers are being pushed into the front line of a new price war declared in early March at Opec’s Viennese headquarters by Russia and Saudi Arabia — a fight launched just as the coronavirus pandemic arrived to cripple global oil demand at the same time.
The latest price shock, which has more than halved the cost of oil since the start of the year to under $30 a barrel, has further exposed a shale sector that depends on constant cash infusions and the dwindling faith of investors.
Shale is unusual in the oil business because of its high decline rates: a typical well produces prolifically for a year before output drops steeply in the second and then settles into a modest and diminishing flow rate thereafter.
Just to hold US shale production steady year after year, let alone increase it, requires ever more wells to be drilled. Of more than 14,000 new wells that had been expected this year, 85 per cent were needed to match last year’s level. All that drilling in 2020 was forecast to cost more than $100bn, according to Rystad Energy, a consultancy.
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The short-term impact on oil-producing states will be significant, as rigs are idled, their crews are sacked, hotel occupancy drops, and restaurants close, compounding the broader economic shock anticipated from the coronavirus pandemic.
Shale has been through a price war before and survived. That was in 2015-16, when Saudi Arabia, alarmed at the spectacular production surge in the US, opened its taps to drive down prices and break the Texan upstarts.
US production then fell 1m b/d. But the Saudi assault winnowed out the weaker shale producers and left a more cost-efficient business behind. When the kingdom and Russia reversed course and started cutting supply in 2017 to prop up prices, the shale sector roared back to life, adding more than 4m b/d in the years that followed.
This time, however, could be different for three reasons. First is coronavirus, which by wiping out millions of barrels a day of oil demand this year and driving crude prices to multiyear lows has demolished the business models for capital-intensive producers like those in the shale patch.
Second, Russia may prove a stronger adversary for shale producers than Saudi Arabia. Moscow is motivated both by anger at US sanctions on its own energy sector and a desire to recapture market share. The Russian government says its financial reserves will let it endure a price below $30 per barrel for up to a decade — a fight that may therefore last even longer than the virus.
The third reason is Wall Street. US investors were already unhappy with shale’s business model and the long-term outlook for fossil fuels well before the latest oil price collapse.
Many lenders say they will not return even if oil prices recover. “This industry has been a junkie hooked on access to capital, whether equity or development, that’s driven uneconomic growth over the past decade,” says Mr Portillo.
Many US shale companies will soon hit a debt wall and bankruptcy risks in the shale patch have risen sharply, say rating agencies.
Supermajors such as ExxonMobil and Chevron both still plan large oil output increases in Texas’s Permian basin in the coming years. Further consolidation in the distressed shale sector is likely and business that re-emerges will be more efficient. But its foreign rivals in the oil world — and its bruised backers on Wall Street — are not about to let it rise unchecked again.
The breakeven point for Permian shale, the best asset in the US, is $43/b. That's breakeven. Short of actual destruction of our rivals production capacity, there's really no way for this gambit to ever become profitable again.
Nerds at Rystad are projecting that 60% of US oil rigs will be idle by the end of the year, and it's a safe bet their internal estimates are even bigger.
It's staggering to contemplate all of this infrastructure being a waste, but -- most of it is. It's not especially portable and even though it's potentially profitable, it's going to be hard for these companies to sell off those assets in this climate, and even harder for them to refinance with their credit ratings downgraded to "junk" status.
You'll see a lot of paid pundit, Seeking Alpha types crowing about hedged production but nobody hedged for these kinds of numbers (except for some actual hedge funds, and remember, they're not drilling and selling oil, just screwing counterparties on option contracts).
Via: https://www.reuters.com/article/us-glob ... SKBN21027Q
With prices at three-year lows, shale producers also are exposed because they used options in such a way that their insurance erodes the more oil declines.
“U.S. production is likely less well hedged than the market realizes,” said Michael Tran, managing director of energy strategy at RBC Capital Markets in New York.
Shale companies protect their revenues with hedges because oil prices can swing wildly due to unforeseen events. About 43% of 2020’s oil production was hedged as of the end of the fourth quarter, according to Goldman Sachs.
But that 43% is not fully covered. Producers use a variety of methods to hedge production. The simplest is to purchase a put option that allows the holder to sell at a fixed price at a particular time, regardless of where oil prices are trading. That locks in a selling price of, say, $50 a barrel.
Many shale producers used a more complex strategy, known as three-way collars. Producers still buy the put options as insurance, but they also sell other put options, often with a lower price point - to lower or eliminate the cost of their insurance.
Effectively, this is a calculated bet that oil will fall to a certain level and no further. But that was not what happened.
“Using many of these structures, producers are price-protected unless prices fall below a certain threshold, and $45 a barrel was a popular strike level, at which point producers become fully exposed,” Tran said.
Which ties back to that breakeven point -- why pay extra for insurance past that? If you're fucked, you're fucked, period. One more nugget from that Reuters piece:
Shale firms are only now starting to hedge for 2021. Goldman Sachs said just 2% of production for 2021 has been hedged, and now companies face the likelihood that they will not be able to lock in prices that will guarantee profits given their costs.
In retrospect, all that "US Energy Independence" hype is looking pretty fucking dumb. It was always going to be a short term play and more and more sovereign and private players were squeezing into the same play.
That said, an awful lot of those players are still more fucked than the United States. Venezuela, Iran, Iraq, Nigeria, Azerbaijan and Kazazhstan...interesting times & etc.
