Via Financial Times

From the shale fields of Texas to deepwater projects in the North Sea, the price war launched by Russia and Saudi Arabia has sent shockwaves across the entire energy industry and triggered the biggest sell-off since the global financial crisis.

It has left some companies searching for strategies to protect profits and keep paying dividends. Others are fighting for survival.

“The price collapse could be the trigger for a new phase of deep industry restructuring — one that rivals the changes seen in the late-1990s,” said Tom Ellacott of the consultancy Wood Mackenzie. “Sustained prices below $40 a barrel would trigger a new wave of brutal cost-cutting. More highly-leveraged players will be forced to make the deepest cuts to stave off bankruptcy.”

Nowhere is that more true than in the shale industry, which helped end US dependence on Middle Eastern oil.

The oil price plunge that started on Sunday night left US benchmark West Texas Intermediate trading at just over $30 a barrel on Monday, well below the break-even price for most US shale oil wells. Saudi Arabia launched its price war on the weekend, after Russia baulked at plans to cut more output. Russia, angered by US sanctions on its energy sector, rejected the Saudi plan because it saw an opportunity to hurt US shale producers.

In the market meltdown that came on Monday, even the best-performing shale producers, such as Pioneer Natural Resources and EOG, suffered share price declines of more than 30 per cent.

For many industry players, the new Russian-led price war will trigger bad memories of the 18-month-long depression that followed Saudi Arabia’s decision to open the taps in November 2014.

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“The biggest difference is that these producers are all in a much weaker position,” said Jeff Currie, global head of commodities research at Goldman Sachs. “Their balance sheets are weaker, their stock prices are lower.”

Analysts said dozens of smaller shale companies would now go bust.

“This is the financial crisis for oil,” said Ian Nieboer, head of macro research at RS Energy Group, part of shale data provider Enverus. “Except the producers aren’t too big to fail.”

US production hit a record high of 13.1m barrels par day last month, more than double its level before the shale oil boom took off in 2010, and may even rise modestly in the coming weeks as working rigs finish drilling some wells. Many producers have also hedged output for 2020, insulating them from the price shock.

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But if current prices persist, activity will collapse by the end of this year as producer companies cancel contracts with oilfield services companies, said Artem Abramov, head of shale research at Rystad, bringing widespread misery in shale-dependent economies in Texas and North Dakota. US shale output could fall more than 2m b/d next year, Mr Abramov added.

Diamondback Energy and Parsley Energy, two of the Permian Shale’s leading independent producers, on Monday said they would pare back the number of their working rigs and reduce spending.

Yet even before the latest shock, shale producers’ recent focus on generating free cash flow has failed to renew their attraction to lenders, which have tired of a business model dependent on constant spending to the detriment of capital repayment.

Increasingly clear to investors is that the model also depended on Opec’s and Russia’s willingness to keep prices high, surrendering market share in the process. That generosity ended on Friday.

“If you’re Russia, you don’t want to bankrupt these shale companies, you want to turn them into zombies — don’t let them restructure, leave them debt-laden with the inability to invest and inability to grow,” said Mr Currie of Goldman Sachs.

Buffett-backed Oxy suffers, as do majors

Heavily indebted Occidental Petroleum was one of the hardest hit of the larger companies on Monday, with its shares opening down more than 40 per cent.

It was another devastating judgment from investors of both the company’s resilience in the face of the coming price war and last year’s takeover of shale rival Anadarko. Oxy took on $40bn last year to buy Anadarko — a bet on size and oil prices that was facilitated by Warren Buffett’s Berkshire Hathaway, which provided $10bn of financing.

Neither has come good and shares have trended lower since the deal closed in August. The latest plunge leaves Oxy’s market capitalisation now barely above $15bn, compared with more than $40bn at the time of the deal.

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The largest energy majors, particularly in Europe, are not immune. They have promised their investors they can do it all — from cutting costs and producing oil and gas at higher margins to paying down debt and ramping up shareholder payouts. They are also under pressure to invest in cleaner energies and the low-carbon technologies of the future.

“International oil companies will now need to consider where they can cut capital expenditure quickly. The average break-even in the sector is $55 a barrel,” said Jason Gammel, analyst at Jefferies.

“Buybacks and dividend growth are now almost certainly off the table,” he said. In fact, the industry is questioning which companies will be the first to cut their dividends.

BP fell almost 20 per cent, while Shell dropped 18 per cent. Both companies have the highest debt levels of the majors.

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Norway’s Equinor and Italy’s Eni, which have bigger exploration and production divisions as a proportion of their overall businesses are more tied to the oil price. ExxonMobil in the US, meanwhile, has a robust balance sheet but it is in focus because of a large capital expenditure programme.

For many of the independent UK oil and gas companies the new oil price environment means they could be in danger of breaching banking covenants later in the year. North Sea oil producer Premier Oil was the worst hit on Monday, down more than 53 per cent.

Analysts pointed to its significant debt as well as concerns around plans to refinance its $2.9bn of lending facilities and buy $871m worth of North Sea assets from BP and Korea National Oil Corporation.

The plans will be challenged in an Edinburgh court next week by Asia Research and Capital Management, a Hong Kong-based hedge fund, which is both Premier’s largest lender and holds one of the biggest short positions in UK history in the company’s stock.

Premier last week warned in its full-year results that if the refinancing and acquisitions do not complete and “downside [oil] price and or production scenarios materialise” then a breach of “one or more financial covenants . . . would arise” in 2020, although the company insisted there were a range of “mitigating actions” it could take to avoid that scenario, including reducing capital expenditure and further asset sales.

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Premier on Monday declined to comment.

Where are the winners?

Amid Monday’s carnage a few winners did emerge. Frontline, the Norwegian oil tanker group controlled by billionaire John Fredriksen, jumped more than 8 per cent, while rival Euronav advanced 7.4 per cent as charter rates soared.

With Saudi Arabia now offering unprecedented price discounts on oil, forward rates for very large crude carriers, capable of carrying at least 2m barrels of crude, jumped sharply on Monday, hitting $45,000 a day on the route between Saudi Arabia and the Far East, compared with a spot rate of $27,900 a day on Friday.

Vopak, a Dutch company focused on oil storage, rose more than 5 per cent on Monday as traders said it could be a big beneficiary from increased demand for storage tanks.

BASF, one of the world’s largest chemical suppliers, said the weakness in oil prices leads to a reduction in raw materials costs and so could “positively impact earnings”.

“The extent will depend on how long these lower oil prices will last as well as supply and demand for chemicals,” added the Germany-based company.

But many companies that use oil as feedstock — traditional winners from a price decline — were not celebrating. US chemicals producers that have invested billions of dollars to harness cheap gas from the shale boom risk losing their cost advantage over foreign rivals as a result of the oil slump, according to analysts.

Chart showing that oil posts its largest fall since the first Gulf war

Over the past decade companies such as Dow and LyondellBasell pledged more than $200bn to construct vast petrochemicals complexes that transform ethane from fracking wells into the basic building blocks for materials like plastics.

The precipitous fall in crude prices means the edge they have over competitors in Europe and Asia that use oil-derived naphtha could now shrink, industry observers said.

“The fact that the rest of the world doesn’t have access to cheap gas has given the US a competitive advantage, which has resulted in billions of dollars of investment focused on exports,” said Graham Copley, founding partner at the research consultancy C-MACC. “You start bringing crude oil price down and you take that opportunity away.”