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Boom to bust in the US shale heartlands

US oil and gas producers entered 2020 under the cosh — out of favour with investors and wilting under heavy debt loads. The Russian and Saudi oil price war was swiftly followed by Covid-19 and the subsequent collapse in global crude demand. Prices plunged, with West Texas Intermediate trading in negative territory for the first time in April. 

Re-ignited tensions between Washington and Beijing have already halted a nascent price rebound and the US oil benchmark is trading below $32 a barrel — barely half its level in early January and well beneath the break-even price needed by many producers.

For the shale oil companies, which pumped almost 13m barrels a day earlier this year and helped make the US the biggest crude oil producer in the world, the sector is now seizing up. The five charts below highlight a much-changed landscape. As operators idle rigs, sack workers and shut in wells, most in the business agree: the US’s worst oil downturn in decades is now under way.

Production drop

The pace of drilling new wells has fallen by half in the past month, a rate not seen since the last downturn in 2015-16, during an earlier Saudi-led price war.

However, part of that previous rig count drop was because of improved efficiency in shale production — fewer rigs were needed to supply the same output. This time around is different. The frac spread count, which measures how many crews are working at wellheads to prepare for hydraulically fracturing the shale, has crashed to record lows.

In 2015-16, drilling activity plummeted but these frac completions continued, albeit at a reduced pace. Today, both rig count and completions have dried up. The resulting production drop will be much greater.

Investment cutbacks

Chart showing the repeated cuts in the US shale basin

Producers were already starting to scale back their spending in 2020, trying to show restraint in the face of softening oil prices. Then came Opec’s price war in early March, just as the scale of the coronavirus hit to demand was becoming apparent. 

The WTI price collapse in March and April — from almost $50 a barrel to minus $40 — sent shockwaves through boardrooms. Capital expenditure plans were shredded by nearly half with some $29bn lanced off investment spend. Some big producers took more than one swing at their budgets, lopping off new chunks of spending with each lurch lower in the oil price.

A break-even price

Chart showing that shale oil producers would struggle to remain profitable at current prices

The Permian Basin of Texas and New Mexico is the most prolific shale oilfield in the world, let alone the US. But even here, prices above $45 a barrel or so, on average, are needed to turn a profit — almost 50 per cent above the price of recent days.

During the last downturn of 2015-16, producers streamlined operations, drove down costs, squeezed the oilfield services suppliers, and became more efficient. Operators talked up a manufacturing process in shale that allowed for efficiencies of scale. Today’s break-even price in the Permian is a product of those gains.

This time, there is much less fat to cut. The hard truth is that despite its engineering ingenuity, shale remains a relatively high-cost and capital-intensive method of recovering oil from rocks. Its growth in recent years depended on prices artificially propped up by the Opec cartel’s decision to keep cutting production.

Saudi Arabia claims its state company, Aramco, can produce oil for less than $10 a barrel.

Dragged down by debt

Chart showing that lower oil prices set to trigger wave of bankruptcies

A wave of bankruptcies is imminent, say restructuring specialists in the US. 

During the 2015-16 downturn, the biggest number of Chapter 11 filings among shale companies came as the market was picking itself off the floor in 2016. So far, in this year to April, seven companies have filed for bankruptcy protection, according to lawyers Haynes and Boone. 

Although a similar number went bust in the first quarter of 2019, what is notable this time around is that the debt burden carried by these companies in 2020 has been 2.8 times as large.

Shale producers and their lenders are feeling the pain. Oil prices are simply too low to generate the cash flow these heavily indebted companies need to pay their creditors or, in some cases, honour the terms of their loans.

Shut-ins

Oil production cuts run deep

Saudi Arabia and Russia ended their price war in early April, agreeing to cut oil supply — an explicit effort to prop up prices devastated by the collapse of demand and their own plans to open the taps. 

Their cuts were voluntary (albeit under pressure from President Trump). The US cuts, by contrast, are the outcome of market forces. 

Some lost US production is from the shutting down of wells (shut-ins) and some from the reduction of capex. All in all it has led to a reduction of 1.2 million barrels of oil a day being pumped from the heartlands of the US shale industry.


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