Yves here. Back in what now seems like ancient history, when oil prices fell from $90 to the $30s and have bounced around a great deal, we posted the work of multiple energy experts who argued that shale wells, with few exceptions, weren’t economical unless oil prices were $70. That appears to be holding true.
By Nick Cunningham, a freelance writer on oil and gas, renewable energy, climate change, energy policy and geopolitics based in Pittsburgh, PA. Originally published at OilPrice
The second quarter earnings results are complete, and it was another rough three-month period for U.S. shale.
Oil prices climbed in the second quarter, with Brent topping out in the mid-$70s, before falling again after the U.S.-China trade war escalated. Notably, the extension of the OPEC+ cuts failed to rally oil prices amid growing concerns about demand.
For U.S. shale, higher oil prices helped to some degree, but by and large it was another period of disappointment for a sector that has underwhelmed for years. Investors are increasingly losing patience, punishing the energy sector as a whole, and financially-strapped companies in particular.
In a study of 29 fracking-focused oil and gas companies by the Sightline Institute and the Institute for Energy Economics and Financial Analysis (IEEFA), only 11 companies posted positive free cash flow. Even then, the figures were paltry. Collectively, the group only reported $26 million in free cash flow for the second quarter, “far too modest to make a significant dent in the more than $100 billion in long-term debt owed by these companies, let alone reward equity investors who have been waiting for a decade for robust and sustainable results,” the report said.
To be sure, the free cash flow result – only slightly positive – was the best result in years, the IEEFA/Sightline Institute report said. It points to progress for U.S. shale, a sector that routinely posted billions of dollars of red ink and negative cash flow in years past. The second quarter result stands in sharp contrast to the $2.81 billion the group of companies lost in the first quarter.
Yet, despite the dramatic improvement, the financial results remained unimpressive. It’s an indictment of the business that one of the best quarters in years was barely cash flow positive. Related: Is Renewable Hydrogen A Threat To Natural Gas?
“Last quarter’s cash performance—just a hair over breaking even—would count as a bitter disappointment in virtually any other sector of the economy,” the report stated. “But for an industry that has posted negative cash flows for a decade, these mediocre results represent a financial high-water mark.”
After years of waiting for huge profits, investors are growing weary. Shale production has never been higher, and continues to break new records. At the same time, the financial performances are uninspiring.
As IEEFA/Sightline Institute point out in their report, the top oil and gas ETF lost more than 26 percent in the last three months even as the broader S&P 500 gained 3 percent. “Clearly, investors are losing faith in the industry after decades of cash losses,” the report’s authors said.
Worse, the small positive result is largely an outgrowth of the relatively strong performance of one company – EOG Resources – which posted $1.1 billion in free cash flow in the second quarter, a result aided by a $437 million cut in spending. Excluding EOG, the rest of the 28 companies would have collectively been in negative territory.
This is a broader lesson with the story of U.S. shale writ large. Fracking, horizontal drilling and mountains of cash from Wall Street have succeeded in producing wave after wave of oil and gas, continuously pushing output to record highs. But the profits have never really materialized. In fact, rapid production growth crashed prices for both oil and gas, undercutting the industry’s ability to make any money.
Importantly, the study conducted by IEEFA and the Sightline Institute consisted of 29 relatively strong companies. A much broader look at the shale industry would reveal deeper financial trouble, including a list of 192 companies that have declared bankruptcy since 2015. That list continues to grow.
“A few companies can now eke out modest positive cash flows,” IEEFA and Sightline Institute wrote. “Yet the sector as a whole has never produced enough cash to pay down debt or reward investors with generous dividends or share buybacks.”
The report concluded with a warning to investors to treat U.S. shale as a “speculative enterprise with a weak outlook and an unproven business model.”
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I think a key point about a future shale bust is that it will leave very little in long term assets. In other busts, someone comes along to cherrypick the assets with potential profitability – its the early investors who get burnt. But if shale operators aren’t even breaking even on cashflow excluding early borrowings, then its likely that any attempt to consolidate and shrink the industry to make it profitable would fail in the absence of a significant price rise. Since a typical fracked well for tight oil or gas has about 18 months production, this means that constant capital inputs are essential, an investor can’t just get a free ride for a few years on past investments.
What this means in reality is that a year or more after the inevitable bust, there will be a massive drop off in production. Ironically of course this will lead to exactly the sort of price rise the industry is craving – but by then it may be too late. It could of course also be highly disruptive to the world fuel market if the US suddenly finds itself needing a few million barrels a day of SA crude.
I tend to think of shale as an out of the money option, that the industry keeps on early exercising to generate the appearance of a going concern, despite it losing money. As absurd as this model of events sounds, it would predict that in a consolidation, these assets would be picked up by oil majors, who would “mothball” till higher prices. Of course the longer these bozos are allowed to pump at capital depleting oil prices, the less there is for the eventual buyer in bankruptcy.
It will leave a network of new pipelines, similar to the fiber-optic cables of the dot.com boom.
Future frackers (operating fewer wells pumping less oil and gas at higher prices) will be able to use those pipelines to get their product to market. Similar to the dot.com boom, both the frackers and the pipeline companies will likely have gone bankrupt with the assets picked up inexpensively and then operated at a profit.
Also burnt perhaps will be anyone who tries to bring a civil action for ruined wells, poisoned water, cancers, etc. That would be assuming that any such actions would even be successful. The liable entities would already be bankrupt and defunct. That’s just a coincidence, of course.
There’s an interesting story in Reuters today about how towns in the Permian are starting to make long-term bets on shale production there, in the form of investing in education and infrastructure. It seems like the entrance of oil majors sent a signal to people there that the bust hasn’t come yet and apparently won’t come for a little while. After reading the coverage of fracking on NC and Bethany McLean’s book Saudi America this seems like a bad idea, as the financial problems of fracking stem from physical limitations of the technology. It doesn’t seem like a big oil company would be able to solve this problem, besides maybe having deeper pockets and greater ability to ride out low prices, but that still doesn’t make fracking profitable, just less unprofitable. Here’s the link:
Texas shale towns grapple with growth as oil-bust fears fade
Yes, I fwded that link to Yves & Lambert earlier today – the key thing to me is that the oil majors don’t make such long-term investments lightly. From the story:
The link in the story is a little weird. Here is an excerpt
“First, renewable electricity, generated by the sun, passes through an electrolyzer where water molecules are split into hydrogen and oxygen, storing the renewable electricity as hydrogen gas. The newly-created ‘green’ hydrogen is combined with carbon dioxide and piped into the reactor where archaea microorganisms produce renewable natural gas by consuming hydrogen and carbon dioxide and emitting methane.”
This sounds quite a bit more complicated
Well the first part doesn’t sound complicated at all – we did it in 9th grade science class. The word “electrolizer” is hilarious when you realize what it actually is. Beyond that, what I guess is obvious to everybody in the energy business is why you have to take the step (which also doesn’t sound complicated? It’s just farming with really tiny cows) to make methane, but it is certainly not obvious to me. I mean we’ve been reading about hydrogen powered cars forever. And methane is bad stuff, so I need a really good explanation of the need for this conversion.
So if anybody knows why, please post.
probably because we have infrastructure for natural gas but nor for hydrogen, otherwise no real benefit.
The problem with ‘renewable’ hydrogen for energy storage is that its round trip efficiency is low unless all you want is heat. Up converting to methane just makes the equation worse.
Composting organic materials using a biodigester yields methane as a natural byproduct and is inherently more efficient- but only if one plans to use all of its byproducts; passing methane through a reformer and fuel cell gives heat, carbon dioxide, water AND electricity. All these can be effectively captured and used in an agricultural setting but not so much in automobiles or just for energy production by itself.
Horses for courses…
Or maybe the hydrogen could be stored in special hydrogen retention-tanks right there on site where the solar electricity is made . . . . and then burned back into water to use the heat to make electricity at night when the sun don’t shine, thereby solving the problem of “no solar electricity when the sun don’t shine”.
I’d guess methane is denser so easier to store and ship. This still seems like a laborious and expensive way to get methane. Maybe if renewable power was cheap and fossil fuels were highly taxed it might work.
This and other similar stories say that US unconventional oil is not economically viable (i.e. ignoring environmental impact).
The reason offered for not being economically viable, is losing money.
The reason for losing money is too low prices.
The reason for too low prices is too much supply (!) I.e. overproduction. (Demand for oil is inelastic on the 1.5year characteristic time scale of fracking)
The conclusion from this is, most unfortunately, not that oil use will go down. It is that either prices will go up, or non-shale production volumes will go up and reclaim market share from shale.
From an environmental, especially carbon, point of view, this situation remains a disaster.
Cash isn’t the only thing shale bleeds: Fracking’s methane leaks drive climate heat
The only thing in all this that is baffling me is that Wall st. just keeps giving loans to and buying bonds for these companies to the tunes of 10s of billions of dollars. Everyone on Wall St can’t all be willfully in denial and completely blind to the fact that these were bad investments from the beginning and that continuing to give them money is just throwing good money after bad. Everyone makes a bad investment from time to time, but the solution isn’t to just burn money indefinitely to turn it into a zombie corporation when there are no signs it will ever be profitable – indeed from what I have read fracking and shale’s best ROI is right after the well is turned on, after that it only gets worse so these bad investments are only gangrening and rotting faster and faster. Yet still, ever more more money from Wall st., the same people who chide any and all public services for being unprofitable and engendering unprofitable subsidized behavior.
So if they can’t all be that stupid, the only other explanation is that at least some of them are just plain evil. In this case that would entail them working on “greater fool theory” where they are planing something like the old sub-prime mortgage CDOs. Something like: 1. package all this festering financial garbage they created into illegible little financial products; 2. pay-off the rating’s agency to give this repackaged garbage AAA rating; 3. sell to sovereign wealth, retirement, and pension funds; 4. take out credit-default swaps and other bets against the garbage they have sold off because they know it is going to imploade; 5. run like hell; 6. blame poor people for destroying the economy while begging for a government bailout as a result of fallout from destroying the world again.
The Shale companies believe they can refinance at lower rates and put time on their side. Unfortunately for them there is a divergence between the oil price and oil stocks. Links…
https://www.wsj.com/articles/energy-stocks-diverge-from-oil-prices-11561489513
https://www.koyfin.com/research/2019/04/23/thoughts-about-the-divergence-between-oil-prices-and-energy-stocks/
Plus with oil stocks being valued lower by the market, and more natural gas & renewables coming online, and likely a worsening climate sooner rather than later, I believe we’ve seen top of market and it is clarified by the Saudis weak Aramco IPO interest.
https://www.aljazeera.com/ajimpact/dwindling-enthusiasm-fossil-fuels-hit-saudi-aramco-ipo-190820120106784.html
Totally agree. My only bafflement is why so much of Wall st. seems not to be able to see this obvious reality.
Eh, junk bonds are trading at negative yields in Europe. It’s not that the money people are dumb(exactly..) It’s that they have so much money to invest that negative yields aren’t ouffputting. Is natural gas/power likely to go to zero? No. Is there upside? Yes. So toss it some cash. Just my best guess…
Negative yields are very different from bonds and investments that are almost certain to default. People are tollerating the negative yields only because the underlying products are actually low risk and low volatility unlike shale debt which is high risk and high volatility. One stands a higher chance of loosing far more money invested in most US shale then one does buying the existing negative yielding debt. Additionally money can actually be made being long on negative yielding debt so long as yields continue to go lower, which has been a safe bet over much of the last decade where most of said debt has existed. As such your comparison doesn’t make any sence whatsoever, these are apples and oranges.
That “study” is a pretty cheesy piece of work.
I’m somewhat familiar with Noble Energy, one of the 29 companies the authors claim to have examined.
They report Noble as having a cash flow deficit of $499 million, a full 20% of their grand total for all 29 companies. The grand total, of course, purports to demonstrate the weakness of the US shale plays.
The thing is, the cash flow from Noble’s shale operations in Texas and Colorado is solidly positive. The company has a cash flow deficit because it is finishing up its share of the Leviathan project offshore Israel, which by this time next year will have that country energy independent while enabling a massive shift from coal to natural gas as their primary energy source. Not a bad thing, IMO.
The anti-hydrocarbon jihadists have some valid points, but they also generate a lot of propaganda that has no relation to reality. This “study” is an example of what happens when you know the answer you want before you do your investigation.
The risks and benefits of hydrocarbon energy is an important question. Unfortunately there’s a lot of garbage produced on both sides.
Why should the Shale Business feel bad about bleeding money? It isn’t their money. It is “other peoples’ money”. It is investors’ money. As long as the Shale Business operators are retaining for their personal selves some of the “investor peoples’ money” which they are bleeding from investors, why should they feel bad about it? Maybe their whole business model was based on bleeding other peoples’ money till other people have no more money left to bleed. . . . and keeping a little bit of the money-bleed for themselves.
It’s like with mosquitoes . . . . mosquitoes aren’t “bleeding” blood. They are sucking blood. It is the animals they are sucking blood FROM . . . which are bleeding blood. If the animals eventually die from blood loss, the mosquitoes at least got some blood in the meantime.
And so it is with the shale frackers. They aren’t bleeding money. They are sucking money. The investors they suck money from are the people who are bleeding money. And if the investors finally die from money loss, the shale frackers at least got some money in the meantime.