By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Wolf Street.
Fracking has caused an uproar in local communities and split some in two. It has brought environmentalists to a boil. It allegedly caused tap water to go up in flames. A documentary was made in its honor. It caused earthquakes in Oklahoma and other places. It caused Wall Street to froth at the mouth. And now it is causing the balance sheets of oil and gas companies to blow up.
It always starts with a toxic mix. Now even the Energy Department’s EIA has checked into it and after crunching some numbers found:
Based on data compiled from quarterly reports, for the year ending March 31, 2014, cash from operations for 127 major oil and natural gas companies totaled $568 billion, and major uses of cash totaled $677 billion, a difference of almost $110 billion.
To fill this $110 billion hole that they’d dug in just one year, these 127 oil and gas companies went out and increased their net debt by $106 billion. But that wasn’t enough. To raise more cash, they also sold $73 billion in assets. It left them with more cash (borrowed cash, that is) on the balance sheet than before, which pleased analysts, and it left them with a pile of additional debt and fewer assets to generate revenues with in order to service this debt.
It has been going on for years. In 2010, the hole left behind by fracking was only $18 billion. During each of the last three years, the gap was over $100 billion. This is the chart of an industry with apparently steep and permanent negative free cash-flows:
And those shortages in each year forced the companies to raise more debt and sell assets to fund more drilling, other capital expenditures, operational costs, dividends, and stock buybacks.
Of the three sources of cash – operations, net increase in debt, and asset sales – during the first quarters going back six years, net increases in debt accounted for over 20% of the incoming cash since 2012. For instance, In 2013, cash from operations supplied only 60% of the cash needs; most of the rest was borrowed, and some was covered by asset sales:
The EIA was quick to minimize the issue, claiming that this debt that has been spiraling out of control wasn’t “necessarily a negative indicator.” That low interest rates allowed companies to get fresh debt capital to cover their operational cash shortages. And that piling on debt “to fuel growth is a typical strategy, particularly among smaller producers.” And besides, this ballooning debt would be “met with increased production, generating more revenue to service future debt payments.”
This is where debt smacks into fracking. Fracked wells have nasty decline rates. They differ from well to well, with some estimates pegging the average declines at 50% to 78% by the end of the first year. After a few years, production might be down to less than 10% of production in the first year. In other words, the cash that has been drilled into ground has to be earned back within a terribly short time and has to be used to pay off the debt incurred in drilling the well. If not, the debt is left over, when the well is producing just a trickle.
This is exactly what is happening. It’s a horrendous treadmill. Just to maintain production, companies have to drill more and more and incur more and more debt, even as revenues are disappointing. In addition, drillers with heavy reliance on natural gas have faced prices for dry gas that have been so low for years that most wells will never generate enough cash to cover the costs of production. And much of the capital that went into them has been destroyed.
A Bloomberg analysis of 61 companies drilling for shale oil and gas found that debt among them nearly doubled over the past four years, while revenues inched up only 5.6%. And interest payments on that ballooning debt is taking up an ever larger portion of the revenues – even at today’s record low interest rates – with 12 of the companies already paying over 10% of their revenues in interest.
The financial hype around fracking, the limitless, nearly free liquidity provided by the Fed since late 2008, and investors so desperate for yield that they’re willing to incur just about any risks in their vain battle to come out ahead have had Wall Street frothing at the mouth. The sweeps of creative destruction have broken down. Instead, the boundless stream of money has been searching for a place to go, and it went to an economic activity – fracking – where money goes to die. What’s left is debt, and wells, especially gas wells, that will never produce enough to pay off the debt that was incurred to drill them.
These binges can go on for a long time, for far longer than a sane person in normal times would think possible. But with revenues barely growing, cash flows from operations stagnant, and debt levels that are soaring, at some point, something has to give.
Fracking isn’t the only place where the Fed’s policies created havoc: homeownership hit the skids when homes became a highly leveraged asset class, flipped and laddered by speculators, rather than lived in by normal folks. Read…. Here’s the Chart that Shows Why the Housing Market Is Sick
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Here’s an idea.
In the UK, the recovery (such as it is) was driven to a non-trivial extent by the banks paying out about 15bn directly to their clients from the Payment Protection Insurance misseling. It has averaged around 450m per month since Oct 2011. So it’s about 0.4% of GDP per year (and that’s before any money multiplier)
As some of you know, UK is now a huge supporter of fracking, claiming the UK shale revolution meant cheap NG and spurned the US recovery (such as it is). If you take into account the article, I’d say that the fracking is then incidental, i.e. if the recover (let’s for a second assume there’s one) is driven by shale, it’s driven by the debt that the shale fracking companies took on, so in effect it’s driven by the debt/equity holders of the frackers..
I just wanted to point out the very serious omission in this article of any mention of the Obama Administration’s potentially irreversible, huge TTIP fracking expansion deal.
The rest of this article makes good points. Why did he leave TTIP out though? Red flags should be going off in that the resource is clearly being oversold to the American ratepayer – Nobody is mentioning the increased cooling and heating prices- will effect us all, because prices elsewhere are as much as three to five times what they are here. Then, we would be trapped. Because TTIP’s sneaky ISDS clause would put the US taxpayer on the hook if we ever decided to stop the exporting of energy fuels for any reason with only the most narrowly construed exceptions. Cost, is clearly never one of them.
Graph of World Natural Gas Prices.
Then we would have to go through the “manumission” procedure for that FTA. Would you want our nation’s energy fate being decided by a unelected, unaccountable private trade tribunal? (usually three corporate lawyers, moonlighting as judges). Also, its not immediate, the process can take years. Investors need stability, they say. people, we don’t even have standing, not being corporations, or states.
This seems like what would happen. The deal would be signed, and in 2016, the oil and gas would start to flow to the highest bidders, probably in Asia, then US prices would rapidly rise. How much? Less on a percentage basis for consumers than large luyers, no doubt. It depends where you lived. My guess is it would cost less in the South and more in the north. And more in rural areas. According to the LA Times, electricity prices track natural gas prices.
Then, all hell would break loose as thousands of businesses declared they would need to close or relocate. Its likely that a nation confronted with heating prices skyrocketing upward would demand a government extricate us from the deal, i.e. buy our freedom, at tremendous cost. As quickly as possible.
However, there is the matter of the fee to cancel. (Its based on the potential, not actual worth of the future market, which is tellingly being oversold) Such is what we will have to do with health care insurance services eventually. (See GATS Article XXI Procedure) That could be the biggest penalty ever. lets not add this on top of it.
To me the TTIP deal screams “another scam in the making”. The US is not the Saudi Arabia of fracking. Fracking involves the use of harmful chemicals, many of which are endocrine disruptors (dangerous to the reproductive organs and process) . Some EDCs also cause morbid obesity. Also, there is a problem with radioactive compounds as well as heavy metals sometimes being flushed out of the earth in dangerous quantities by fracking. Presenting an invisible danger to people who come into contact with the effluent, which is sometimes used instead of salt on roads in winter.
Cheap energy is one of the reasons businesses locate here. If our energy costs triple or more, as some have predicted, it may well kill the economy).
Also, imagine millions of US families and apartment building owners not being able to afford to heat or cool their homes or properties. being forced to go out of business by the sudden hike.
Paradoxically, approving a lot more energy exports in any way that starts the energy moving to Asia where it gets four or five times more as they get here, which is what they want, could do that.
Why? Because even when you get past the secrecy, the trade stuff is wicked complex (as it was designed to be obfuscatory by people who know how to do it as if their lives depended on it, which they do).
this is huge. it suggests that the oil industry is inevitably heading towards a bail-out.
a bail-out for oil companies, however, doesn’t have to come in the form of a direct levy on the taxpayers: a war will do just fine.
The post is intriguing, but doesn’t give enough larger perspective to assess the extent of a fracking bubble.
Sources and uses of cash is a flow quantity, but what about the balance sheet — specifically, debt-to-equity ratios? Is the energy industry over-indebted compared to its own history (e.g., in 1981, the last energy bubble), or compared to other industries?
Wolf’s post suggests that these questions would be worth researching. Anecdotal evidence (flat-out boom conditions in places such as North Dakota) indicates some excesses. But I’m not dumping my oil service stocks just yet. HAL and NOV have been on a colossal tear this year, and they seem to be on sale this week.
There is probably some boring real-world physical product to watch for, something either at the beginning of the process or that shows they’re trying to suck the last drops out of existing wells. The first might be fracking sand (tracked perhaps by rail shipments). “Twilight in the Desert” used a similar methodology; it looked at what Aramco engineers were publishing in their technical journals, and it was all “last drop” stuff. Not that there’s not still a lot of the black stuff there, but it’s not as easy as it was…
Proppant suppliers
http://www.carboceramics.com/proppant/
I dumped all my stocks in the entire oil industry several years ago, and I haven’t regretted it. What we’re watching right now is pure bubble; if you think you can time the market, go ahead and try to bail out at the top. If not, watch the fundamentals; exploration is dead (nothing profitable left to find), but the companies are still dumping money into exploration, which is a recipe for catastrophic bankruptcy. A lot of people will lose a lot of money on this, and frankly, most of ’em deserve it.
At this point a sensible oil company would go into runoff mode, terminating exploration, pumping out what’s left in their old wells for pure profit, and spewing out the profit as dividends. I don’t think there’s a single one which is doing this.
Wolf Richter is usually worth reading, but with this post he’s having an off day.
On the first chart, which shows uses of cash running well ahead of cash from operations, he notes that “Companies may close the gap by incurring debt and selling assets”. True as far as it goes, but they can also close the gap by selling equity. Selling equity is what you do when (1) you are maxed out on your credit with banks and other lenders, or (2) you see the butcher coming and want to find some bagholders. When you think you’ve got a good thing that is worth holding on to, selling equity is your absolute last choice.
According to Wolf’s post, to fill the $110 billion cash shortfall for the the twelve months ending March 31st, the industry raised $106 billion of (very cheap) debt – leaving room for only a tiny sliver of equity. This is not the behavior of people in a hurry to unload. They may or may not turn out to be right, but IMO cocksure predictions one way or the other are premature.
The oilmen think of themselves as oilmen. They are deluding themselves into believing that the oil exploration biz will go on forever. They’re not selling equity because *they* think they’re a future in their industry.
But they’re wrong. There is no future in their industry and so they’ll go down along with it.
@Vlade,
Fracking will be no panacea for the UK economy or for energy self sufficiency in the long run, quite the reverse, we are likely to see MP’s booted out of their constituencies if they support tracking, we are also going to see vandalism against tracking rigs equated with an act of “terrorism” and vast swathes of the UK public branded as terrorists.
Why should this be, well the British have a love for their gardens and this has been the case since WWI when gardening became a patriotic duty and then a national obsession – and as any gardener will tell you, one of the greatest obstacles they face is water supplies. Do you think for a second that our crackers are going to contribute to upgrading the UK’s dilapidated water infrastructure? What happens when the crackers have polluted so many water sources that you cannot water your garden with said polluted water for fear of poisoning yourself if you eat your garden produce.
Now, this is before we turn our attention to the supposed economic benefits of tracking for the UK, which are negligible given gas prices are set by a market benchmark, which is quite unlike the market the US utilises, so no decline in gas prices, quite the reverse all the investment has to sees very high return, so expect higher prices regardless. Further, the UK’s gas storage facilities are woeful to say the least when compared with say our German peers and the UK does not go in for longterm investment anymore, apart from grandiose projects with dubious economic returns such as the proposed high speed railway between the north of the country and London.
Nimbyism is alive and well, particularly in England, so I’d expect a lot of blowback over this in the coming years once our alleged “green and pleasant” land is covered by 10,000 tracking rigs and the pollution this causes.
I agree with you. One of my points – not that well made – was that the “it will help the UK economy” meme is spurious, since the “it helped the US economy” meme is wrong to start with.
I’m against fracking, as if we need the gas, it’s better to keep this off until we really really need it instead of driving the price down by creating a glut (and thus pricing-out any alternatives). If we don’t, then why frack in the first place? And that’s ignoring any externalities, and it seems like there’s quite a few of those.
Did you know they want to export it too? Which I think is a huge mistake. Read my post higher up about the insanity of the secretive, irreversible (except, of course, at tremendous cost) TTIP energy deal that they are pushing.
@Vlade,
The issue at hand is actual energy self sufficiency for the UK, and given all the costs associated with tracking, and I do mean all the associated costs, among them environmental destruction of our water table, the one project that is known to be able to contribute to this energy issue is the one that the ConDem government has taken off the table, which is the idea of a Severn Estuary tidal barrage able to produce an abundance of energy over an extensive timeline. On present estimates such a barrage we are told could contribute a minimum of 5% of the UK’s present energy requirements for an investment less than the costs associated with HS2.
Given the huge environmental concerns associated with the barrage, my own opinion is that engineers could not only up the actual power potential available from any barrage, but engineer out most of the environment concerns, which probably would add at a minimum 50% to any existing costs. But lets just say the barrage could contribute at a maximum 7-9% of all the UK’s existing energy needs, and that’s not taking into account energy conservation measures to reduce our actual consumption, such as upgrading the energy efficiency of the UK’s housing stock and making it mandatory that all electrical devices have standby power removed, which can be achieved via the simple expediency of rechargeable batteries, or dispensing with this completely.
The knock on effects of a £40 billion project to South Wales and the South West would be huge, and that’s before we look at Thorium as a replacement for our nuclear generation capacity – I’m strongly opposed to building further nuclear capacity based on third generation technology, with said technology supplied by the French and Chinese – we should do a Manhatten project on Thorium and place a greater emphasis on renewables, specifically wave generation given the UK after all is an island. Fracking is just madness and as usual a short term solution at best to our country’s energy requirements.
Mr. Rogers;
There are always technical solutions to most problems. Political will is almost always the missing ingredient. I believe you hit the nail with your last sentence; “…a short term solution….” Until government is disenchanted from the glamour of wealth, little will change. Short of a revolution, and one which does not promise untold riches for certain class of people, disaster may well be our only hope. (A manageable disaster, even though an oxymoron, might be an optimal strategy. In such a scenario, terrorism will be a patriots duty.)
Fracking chemicals are endocrine disruptors.
Fracking Chemicals Disrupt Hormone Function
Also see:
EHP – Radionuclides in Fracking Wastewater: Managing a Toxic Blend
Something to think about is that if global warming decreases rainfall in an area, the percentage of contaminants in its water will rise. And that won’t go away.
So, short term gain, which all goes to a very few, but then long term, very long term loss. Which society must bear
Then, the WTO and friends say, they can sell us clean water, which is worth a lot, just like a life saving drug, (cost to manufacture is irrelevant) and they will.
This post is too funny. Debt is increasing bc capital investment is as well. Production and cashflow will follow. Yes decline rates are high but oil engineers know this. Please don’t be a hater on the one area the US is actually spending money on and generating jobs. The environmental argument is where you should focus the critique.
Except this article is saying the gas and oil companies can’t extract a profitable amount due to the low cost of gas and sharp decline in extraction of many wells.
What happens to this analysis if oil prices increase 50%?
Sir;
I read between the lines here. It sounds like that is one probable outcome. As for the social disruptions this will entail; that’s someone else’s problem. “I’m alright Jack!”
Maybe the better question is how long will it take for oil to reach that price and how much debt will they accumulate in the process of fracking?
If oil prices were to increase by 50%, the world would enter state that makes the Great Depression look positively prosperous. This would of course drive down oil prices. In short, oil prices are not going to increase by 50%.
You are assuming that wages will not increase by 50% too.
If oil prices increase by 50%, demand for oil crashes. Because the price advantage of electricity becomes much larger.
Either way, the oil companies lose. There’s a nice Deutsche Bank report about the likely dynamics:
http://www.petrocapita.com/attachments/128_Deutsche%20Bank%20-%20The%20Peak%20Oil%20Market.pdf
Oh it get’s better. These wells peek very quicly. They may last only ten years. With many peeking out in as little as five years. This is no where near what they need in order to produce suffichent returns given the start-up cost for each new well, This trend is already reflected in the chart above. It’s only a mater of time before they start running out of sights.
No wonder they seem so desperate to open up the UK.
cashflow isnt profit. Sometimes you need to spend money to make money. You have to depreciate investment over an applicable time horizon.
yes we are all jaded on corporate america CEO’s. But I dont think a whole industry is being developed on faulty assumptions. These guys know the decline rates of the wells, they know how much it costs. They are investing now to generate future cashflows.
And most projects assume prices are lower than today when they go for planning.
Look at a presentation from EOG or PXD. They are generating 70-80% returns on wells in the first year.
abee crombie
July 31, 2014 at 11:40 am
real estate…..
and related….bond rating agencies and MBS
Out of curiosity, does anybody know if Chesapeake is still screwing leaseholders out of their payments? Seems like a cultural tell for accounting control fraud, if you ask me.
It’s just not profitable. That was demonstrated in the post.
Capital investment in oil exploration is increasing, but it’s wasted capital investment. No production will follow it. That’s the whole POINT — the industry is dead and it just hasn’t noticed it yet.
It’s interesting to look at the psychology of the “oilmen” and try to see why they are deluding themselves into throwing good money down dry holes in the ground. I think it’s because they think of themselves as “oilmen”, and cannot imagine putting the money into a different industry (one with a future).
This sounds like a huge Ponzi scheme, with the added features of poisoning our air and water.
It’s a sickness of the Wall Street investor class.
I think that it may or may not be Ponzi but it is clearly some kind of con which seems to be the major growth industry in the Anglo-Saxon world.
Of course if you can start enough wars in enough other oil producing countries, you can goose the price enough to carry the debt, maybe even cash in!. Hmmmm…. our apparent clusterfuck of a Foreign Policy certainly makes petro-sence from a US producer perspective. But we would never start wars to protect our oil incumbents, that would be un-American.
To fill this $110 billion hole that they’d dug in just one year, these 127 oil and gas companies went out and increased their net debt by $106 billion. But that wasn’t enough. To raise more cash, they also sold $73 billion in assets. It left them with more cash (borrowed cash, that is) on the balance sheet than before, which pleased analysts, and it left them with a pile of additional debt and fewer assets to generate revenues with in order to service this debt.
Give the nice oil and gas companies a break. All they want to do is to make sure the men and two women that work on the rigs have jawbs, and that paychecks don’t bounce. Especially the paychecks of the executives.
The growing debtberg that pleases analysts has me confused. Why would an analyst be happy that the oil and gas companies are borrowing themselves to death? Might it be that the pleased analysts work for Wall Street Banksters, and the Banksters steal some of that borrowed money, and as a bonus, fatten the analyst’s pay? It seems that in this context, analyst is a euphemism for liar.
In this case, it’s a synonym.
I think you are right.
Wall Street analyst = liar
Much more on all this accessible at: http://shalebubble.org/wall-street/
Just a thought. Occasionally, we read of an entity saying that they are selling their investment in the Oil and Gas area because of Climate Change. It may be nothing more than a nice cover to get out while the getting is good and profitable. Nice cover and for I consider an excellent reason.
so maybe this is a GOOD thing; if they all go belly up, that would help a lot with our global warming problem.
Must read this- They want to put fracking export and expansion in TTIP, and that puts the US on the hook for billions if we want out.
Also, it lets them override tons of local laws, “regulatory coherence” they call it. Once they have a right to frack and pollute there will be no stopping them.
http://action.sierraclub.org/site/DocServer/Analysis_of_EU_Energy_Proposal_TTIP.pdf
This must be it- the scam you guys are talking about.
A really lame analysis. A four year old could do better. Financial reporters would do the public a great favor by becoming familiar with basic math and learning the difference between investment and annual expenses. First of all, The data is for the entire Major Oil company industry, and does not specifically address fracking projects. The analysis refers to total oil company activities, including refining and marketing and pipelines and non-fracking production, etc. Also, are these 127 major oil companies may not be the companies doing fracking? Fracking was started and developed by upstarts not majors. 127 companies exceeds the number of companies that most people would consider a major oil company. Lastly, the EIA article contains no mention of fracking.
Now let’s have an elementary lesson in finance. The analysis shows that major oil companies are funding roughly 80% of both current operating expenses and capital expenditures from internal operations. If this situation was occurring to companies that were just maintaining their productive capacity, it would be of concern, but tracking has increased production to previously unimaginable levels in only 5-7 years. Since 2010, oil production in Texas alone has risen almost three-fold. U.S. dependence on imported petroleum products has been cut in half and is expected to be a 1/3 of its peak by next year. The typical fracking project has a production of 20-25 years – the great majority of capital expenditures is in the first few years. Therefore, to be internally financing 70-80% of the greatest increase in production in perhaps a century is from a business standpoint awe inspiring.
Furthermore, in the US, this was achieved with private capital on private lands. If some companies fail, its no skin off the publics back. Cheap interest rates are not the driving force, high return on capital is. The low rates probably are affecting the share buyback part of the analysis more that the capital expenditure part.
Re:
“If some companies fail, its no skin off the public’s back.”
That’s right, no skin off the public’s back. Sheesh. Get real.
I would have thought someone with your modesty and expertise would have interrogated the financials of the following recognised TOP SHALE GAS outfits. Had you done so you would have noticed their cash flow is a perennial disaster, and, furthermore, that insiders, both directors and institutional investors, constantly dump the company shares. The PE and EROI figs. for unconventional gas are an absolute joke.
Fracked land becomes unproductive for any other purposes, mortgages, insurance and access to capital can be denied to the owners of fracked turf; It is a huge issue for the public good when these companies fold as there is no recourse for title holders of obliterated property Think too of wrecked roads, health bills, earthquakes, ruined water, etc. etc
APC,CHK,COG,CRZO,DVN,EOG,EQT,FST,GDP,KWK,NFX,RRC,SWN,UPL,XCO,SM,PQ,REX,EVEP
1) Why don’t the oil/gas companies reduce dividends and stock buy-backs instead of borrowing? Would this crash their stock price?
2) Is the financial sector encouraging the new oil/gas company debts? The financial sector would benefit (bank bailout if the debts aren’t repaid, while the bank execs giving the new loans surely make $$$$ in bonuses).
I worked in oil exploration in the 80’s and used to see frac trucks occasionally. Just looking at the operation, you can see it is not cheap. I had also heard (even back then) that the benefit is usually pretty short lived. I have wondered since about the economics of fracking operations – something about it didn’t seem quite right.
Thanks for a really interesting post.
They’re fracking near my house in PA. One well is producing enough gas to justify drilling another nearby–I got that notice 18 months ago. This year I was notified they are drilling two more wells for a total of four. If the company wasn’t making money, I doubt they’d be adding more and more wells all over this county and the county north of me.
I originally heard that there was enough gas to last for ten years of drilling. But a geologist friend says that is grossly underestimated and that there may be enough gas for 40 years of drilling.
It’s 10 years. Your geologist friend is wrong.
The business model for the fracking companies (such as Chesapeake) is not a model of producing oil or gas. It’s a *land-flipping* model. They drill a well, announce large first-year production, then sell it to a large integrated oil company with wild predictions of 40 years of production. When it runs out in 10 years, well, the fracking company has their money already, and it’s the integrated oil company which is holding the bag.
It’s a land scam like selling swampland in Florida. A very effective and profitable scam.
I have to wonder when the big oil & gas companies will figure out that fracked wells are a scam, and quit playing. We’ll know when they stop buying wells and just offer to buy the oil or gas from the wells. When that happens, things will get . . . . . . . . . . interesting.
Personally, I hope natural gas stays mostly cheap for another few years, to drive coal-burning power plants out of business by price competition. There was an article on Bloomberg recently about that: http://www.bloomberg.com/news/2014-07-24/coal-bankruptcies-loom-on-pain-from-cheap-gas-new-rules.html . Once the coal generators are out of business and dismantled, when gas goes up in price they won’t be rebuilt. By then wind and solar energy will be considerably cheaper than coal. Wind is already marginally cheaper, and solar photovoltaic is coming down fast.
…by the way, the fracking companies are usually grossly irresponsible, and cut corners on safety (as you’d expect from people operating a scam). The nearby farms are ruined, and property values crash. You would be well advised to sell your house NOW and move to somewhere with no fracking.
Fracking will be the temporary export boom economics and cash movement seen by voters and hence will be the fuel to return useless Democrats in 2016, because they are seen as less useless than Republican promises.