In a White House race defined by the pandemic, the future of the US energy industry made a rare intrusion at the final presidential debate.
But for the US shale industry, whose pioneering technology and record-breaking production upended the global oil market over the past decade, job cuts are nothing new. With many operators financially stretched even before coronavirus crippled oil demand, bankruptcies are mounting and the employment picture deteriorating.
Hopes that America’s prized shale patch, one that stretches from Texas to Pennsylvania and up to North Dakota, would propel the US to energy independence appear increasingly forlorn. After years of stunning growth, domestic oil output is likely to fall this year by the biggest-ever annual margin on record.
“Christmas 2019 will forever be seen as the good old days of the US oil and gas industry,” said Adam Waterous, head of Waterous Energy Fund, a private equity firm that is now eschewing shale investments in favour of oil assets in Canada.
If an understandable gloom has descended on a sector now confronting a far less dazzling future, a consensus is emerging on its most urgent priorities. According to Daniel Yergin, vice-chairman of consultancy IHS Markit, repairing its relations with investors should top the list.
The sector burnt through $400bn of outside capital between 2008 and 2018, according to consultancy Rystad Energy, while barely managing to turn a profit. Even for the best operators, the cost of capital is rising — a reflection of shale’s poor returns and an investor base beginning to turn its attention to renewable energy.
“Even before Covid, shale needed a second revolution,” said Mr Yergin, author of a recent book on energy, The New Map. “It needed a revolution in terms of its relationship with its investors.”
Some investors hope that if oil prices remain around $40 a barrel, where they have been in recent weeks, then a wave of consolidation among operators will deliver a far more efficient industry — and one more enticing to Wall Street.
The momentum behind M&A is building. In the past month, Devon Energy bought WPX Energy, ConocoPhillips pounced on Concho Resources, and Pioneer Natural Resources announced its plan to buy Parsley Energy.
The bulls also look back to the shale patch’s recovery in 2016, when it emerged from an earlier price crash leaner and fitter, able to increase production rapidly at much lower prices.
Muqsit Ashraf, head of Accenture’s global energy practice, points to factors that have gained in importance since the industry grappled with the last swoon in oil prices. Digitalisation now allows for better well design, placement of well bores and understanding of the subsurface, which could all yield 20 to 40 per cent efficiency gains, he said.
But operators say repeating the simple changes — like fracking for oil around the clock rather than only in daylight hours — that drove break-even prices down during the last crash, is not an option.
“There’s only 24 hours a day,” Matt Gallagher, chief executive of Parsley Energy, said in an interview with the Financial Times this summer. “It will be single-digit cost reduction percentages from here.”
With squeezing costs and driving efficiencies harder than it was, it is little surprise that the consolidation of the past month has centred on the premium acreage of the Permian Basin, the prolific shale field located in west Texas and south-eastern New Mexico. It is an acknowledgment that only the best oil-bearing shale rock will offer profits in a world of lower oil prices.
Companies are now focused on the “core of the core”, said Mr Ashraf — the very best acreage, where crude can be produced cheaply. Parts of the Permian, he said, could break even in the low $20s or $30s a barrel.
But that is beyond much of the industry, said Mr Waterous, who argues “you need a price north of $70 before you start achieving a cost of capital”.
There is little doubt that the executives driving the past month’s dealmaking have one eye on Wall Street. Scott Sheffield, chief executive of Pioneer Natural Resources, told the Financial Times that in an industry littered with dozens of independent operators, only four companies were now “investable” — his own, plus EOG Resources, ConocoPhillips and Hess.
“Most companies are below a $10bn market cap. And so most investors are not going to look at the small companies to invest in,” Mr Sheffield cautioned.
Occidental Petroleum, which last year borrowed more than $50bn to buy Anadarko in a deal widely decried as among the worst ever bets in a shale patch that has not been short of them, did not make his list.
Few believe consolidation can stop here. But more bankruptcies might precede it, warns Chris Duncan, a director at Brandes Investment Partners, an advisory firm.
Thanks to a borrowing binge during the boom years and the more recent crash in the sector’s valuation, more than half of the industry’s operators now carry debts equal to or greater than their market capitalisation, said Mr Brandes.
Rystad Energy estimates that North American oil and gas sector debt this year had already hit an all-time high and could reach $100bn before the year is out — far more than in 2016, after the last price crash. As many as 55 E&P companies would go bust this year, it predicted.
That is a prospect that will deepen the sector’s pain, as unsecured debts are left to reverberate down a list of creditors that includes service providers and midstream companies.
“I don’t think it’s a matter of if more consolidation happens,” adds Mr Duncan. “It’s just how it happens and how fast.”
For Mr Ashraf, one consequence of the consolidation will be that the top 10 oil producers will provide as much as half the shale industry’s total capex in the next five years, up from less than 30 per cent during the past decade. The biggest beasts, including Chevron and ExxonMobil, will impose economies of scale concentrated on the Permian.
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If the industry’s future will be smaller and concentrated in fewer hands, most believe the halcyon days of giddy growth in production are also behind it. US oil output more than doubled between 2010 and 2019, hitting a record high near 13m b/d before the pandemic struck.
Mr Sheffield puts American oil production growth at 2 per cent a year over the next decade. Ryan Lance, chief executive of ConocoPhillips, told the FT that the collapse in capital investment could leave production next year 4m barrels a day below its recent historic peak.
“Shale shook the world’s oil market not just because the total volume was so large but because the annual growth rate was so rapid,” said Jason Bordoff, director of Columbia University’s Center on Global Energy Policy. “But those days are over.”