Will the U.S. Unconventional Oil and Gas Industry Survive the Coming Bankruptcy Blitz?
With so many companies already teetering on the edge because of precariously low oil prices and piles of debt, the double set of perfect storms that are hammering the industry now will make those earlier predictions seem like "lollipops, rainbows, and cheese" (Aldous Snow).
I'm not going to cry in my Lone Star State for some of the culprits that will be going down sooner rather than later. But no soothsayer could have predicted the onslaught caused not only by the COVID-19 pandemic but also by the showdown between Saudi Arabia and Russia.
Let's look first at the hole a lot of these companies dug for themselves. Then we'll peer a little deeper into how a tiny virus and two giant oil-producing countries have created what's sure to be a bankruptcy bonanza.
The Risks of a Business Model Built on Debt
The shale oil industry began to boom after the great recession as bankers and investors poured money into companies large and small, lured by oil prices clinging above $100 per barrel.
It seemed like any kind of speculator could find a bank or investors to finance their venture, and, with interest rates low and oil prices high, the debt-fueled industry expansion continued unabated. Even the most high-risk ventures found financing through the junk bond market. The New York Times noted in an article in March that energy companies led the junk-bond market for 10 of the past 11 years.
Of course, all of that speculation, all of that expansion, and all of that drilling led to a huge increase in oil output in the United States — driving production up to 13 million barrels a day. The U.S. went from being an overall oil importer to being an oil exporter.
Anyone with even the most remote understanding of supply and demand, a concept that's likely been around since shortly after Adam and Eve started procreating and populating the Earth, could have predicted what would happen next.
Yep. Oil prices began falling, and those expensive-to-operate shale oil ventures began collapsing under their mountain of debt. Remember, the incredible technology developed to reach these trapped molecules was more expensive than existing methods. Traditionally, technology reduces costs. In this case, costs increased.
Haynes and Boone's Oil Patch Bankruptcy Monitor reported in January that, since 2016, 208 North American producers have declared bankruptcy, drowning under an aggregate $121.7 billion in debt. Forty-two of those filings came during 2019, after only 28 filings in 2018 and 24 in 2017.
Oil field service companies also experienced an uptick in bankruptcy filings late in 2019, with 17 of the year's 21 filings coming in the second half of the year. That portion of the industry had remained relatively stable during 2018 and the first half of 2019.
Experts were forecasting the continued increase in bankruptcies into 2020. The same experts noted that many companies survived the initial downturn because their debt hadn't come due, but that screw is about to turn.
Moody's Investor Services reports that oil exploration and production companies have $86 billion in debt coming due in 2020-2024. Pipeline companies look even scarier with $123 billion in debt coming due during that same period. The oil field service sector appears in just as bad of shape with $32 billion in debt due in that same time frame, with roughly two-thirds of that carried by smaller and more speculative companies.
And investors and bankers no longer want to play the game. Michael Bradley, an energy strategist with Tudor, Pickering, Holt & Co., offered this gem of a line that I'd like to steal: "Most people are saying we don't want you to spend money on growth. We want you to give the money back because you are dummies."
The Coming of Two Perfect Storms
A lot of these dummies were going down under the conditions that ushered in 2020. But the economic world has turned upside down, at least for a short duration, by the spreading menace of COVID-19.
The drastic steps taken by China to stem the initial outbreak there dealt another blow to the oil and gas industry. Demand plunged as China shuttered factories and locked down travel. That cut in demand meant prices hovering in the $60 per barrel range started slipping down into the $50s and even $40s.
While some shale producers were able to hang on while oil prices remained in the $60 yellow zone — bouncing around in that area marginally above production cost — the drop in demand sent oil prices solidly into the red zone, where more producers are likely not going to survive.
In reacting to the projected effect of the coronavirus spread from China, the Saudi-led OPEC+ alliance tried to convince the Russians it was in both entities' best interests to cut production to stem the price slide. The Russians, however, caught the world off guard by rejecting the proposal.
Saudi Arabia's response of starting a price war by cutting prices and increasing production sent the market into a free-fall that likely will decimate the shale oil industry as we know it. And now that it is on pause / pulled-back, will it make any difference?
Few in the shale oil business, even the smart ones and those without monstrous debt burdens, can survive $20 a barrel prices.
Some in the industry now are predicting that 70 percent of the 6,000 shale drillers will lose their businesses. A third of the oil field workers are expected to face the chopping block.
Companies are resorting to paying the penalty fee to shut down drilling operations in the middle of a drill, rather than complete the contract and be left with another money-losing hole in the ground.
Even the mighty Chevron is cutting $4 billion from drilling in the Permian Basin. On top of that, the company stopped its stock buy-back program to preserve cash.
There was some speculation when the price war began that the Russians were out to destroy the American shale oil industry. They could be close to achieving that goal.
Rosier prognosticators note that even if U.S. oil production falls off from 13 million barrels a day to 8 or 9 million, we'll still be one of the top producers in the world.
Furthermore, shale and oil, in general, is not going anywhere. If prices rise again, the companies remaining will be poised to fire up operations and boost production back to current levels.
Will the Money Be There?
That's the million-dollar question: if or when global oil prices rise enough to make shale oil drilling profitable again. None of the experts agree or know how long the COVID-19 pandemic will linger as it moves rapidly around the globe disrupting commerce and everyday life for months to come. Economic experts can only guess about how long an economic recovery will take.
In the meantime, oil demand likely will continue to decline around the globe and keep pressure for oil prices to remain low. Despite the U.S., Saudi Arabia, and Russia led pact to slash production, it likely won't bring prices back into the profit range for shale oil producers especially as we are seeing games being played out using discounts (see Saudi's latest pricing war just launched a few days ago).
That leaves us peering into a crystal ball for the days beyond COVID and price wars. Will enough shale oil producers weather the storm with enough strength to salvage the industry?
The better question is: Will there be any capital available for the survivors and the speculators to make another go of it?
A good number of banks and investors have been badly burned through this cycle of the oil industry. And the oil industry always is moving in cycles. Investors grow glossy in the eyes when oil prices start climbing. They see huge pots of gold at the end of the rainbow and just can't stop themselves from chasing those rainbows.
Shale oil drilling is expensive. It requires great sums of cash to crash the party. It also relies on oil prices maintaining a steady, high price to feed those pots of gold.
The greatest speculators already tried their hand at backing the shale industry. Many of them won't be back. They'll move on to shiny, new opportunities.
A Different Future for Energy
Another scenario is that the energy industry will move on from its complete and utter dependence upon fossil fuels and the volatility they create. Newer, cleaner energies are already taking their place at the table and certainly will pique these investors' interest. I have already heard an investor describe moving from oil & gas to renewables as a "flight to quality."
Clean energy companies certainly have experienced their share of failures, leaving investors skeptical. But we're still in the birthing stages of the clean energy business, and it's going to go through its growing pains. But as technologies develop and we get a better handle on what works and what doesn't, clean energy promises a more stable future than the constant boom-and-bust cycles of the oil and gas industry.
The smart investors and maybe even some of the smart speculators will understand this and find ways to succeed and make money in the energy business. The dummies are welcome to go cry in their beer. And if you have a different take on the price war, COVID-19, or how the two are shaking up the industry, let me know about it.