Home' Trinidad and Tobago Guardian : July 9th 2015 Contents BG8 ENERGY
BUSINESS GUARDIAN www.guardian.co.tt JULY 9 • 2015
Wall Street loves a good scrap
almost as much as the wild-
catters who drill for oil do. No
wonder that the fight over the
finances of America s shale-oil
industry has turned nasty.
In one corner are short sellers, including David Einhorn,
a hedge-fund manager whose scalps include Lehman
Brothers. They argue that "fracking," the business of
blasting oil out of rocks using water, sand and chemicals,
is a bottomless pit into which too much cash has been
In the other corner are America s oil pioneers, who say
that shale can thrive even though the benchmark American
oil price has dropped from more than US$100 a barrel
last year to US$57 today. The oilmen are backed by plenty
of other investors who are still pumping money into shale
firms: Some US$35 billion of equity and bonds has been
raised since December.
Both sides have a point. It makes sense to be cheery
about the long-term prospects for shale energy, but also
to be queasy about today s bunch of fracking companies.
Shale matters. The industry has become huge, and
listed companies have invested more than half a trillion
dollars of capital. Much of that money has been raised
through junk bonds: If you include privately held companies,
shale companies owe almost as much debt as Greece.
After drilling beneath much of North Dakota and Texas,
they account for five per cent of global oil output. The
health of shale companies affects people around the world,
from Western drivers and Saudi Arabian sheiks to Asian
The reason to be optimistic about shale energy is that
the industry has responded cleverly to falling oil prices.
Output surged in 2011-2014 because of a spending boom.
Bosses borrowed like mad, bid up land rights and drilled
indiscriminately. Gone, however, are the days when rough-
necks were fed lobster in luxury camps and Texan towns
were circled by Learjets. Instead the new mantra in Amer-
ica s shale basins is thrift.
Since December costs have been cut by a fifth, mainly
by squeezing suppliers. Texas has suffered 20,000 job
losses. Shale bosses say that their companies are con-
centrating on the best prospects and sucking more oil
from them. Production has held up, even though the
number of drilling rigs has fallen by half.
Lower costs and more selectiveness mean that new
investments should make money. Most companies boast
potential annual returns of 25 per cent or more on new
wells if oil costs US$60 a barrel. The industry s agility to
date suggests that costs will fall further.
If only shale firms could escape their past and concentrate
on this bright tomorrow. Alas, every corporation is the
sum of its existing, depleting assets and the promise of
its future ones. Many shale companies made rotten deci-
sions during the boom. This legacy means that a dose
of pessimism about them is in order.
The top 60-odd shale companies are making a return
of roughly zero on the swollen stock of capital they employ.
Despite this, investors value them at well above book
value, which suggests that their share prices are frothy.
Many firms are juicing up the cash they can crank out
of their old wells. In the first quarter of 2015, 31 per cent
of the cash flow reported by the top firms came from
derivatives, bets placed when the price of oil was high.
These hedges will expire during the next year or so, and
cash flow will fall.
That puts cracks in the shale barons claim that they
can ramp up production without further borrowing. With
less cash flowing in, shale firms need to slash their invest-
ment by more than two-thirds if they are to balance their
books. If spending falls, production will follow. The capital
markets may not always remain open: About half of shale
firms, owing US$85 billion of debt between them, have
distressed balance sheets. The pace of capital-raising has
slowed in the past few weeks.
The wild card is the price of oil. Many shale bosses
are betting that they will be bailed out by higher prices.
America s shale industry needs to drill through its past
if it is to emerge leaner and meaner than ever before.
From atop Houston s sky-
scrapers you can see evi-
dence of the good times
lately gone. New towers
still are being erected all
around the city centre, a
lagging indicator of the
energy boom that ended
abruptly in mid-2014 when the price of
crude in America dropped from US$100 to
US$43. Today it is around US$57.
The victims of that crash are harder to
spot. "Look, over there," an oil man said,
pointing down at the offices of Goodrich
Petroleum. A midsize exploration firm spe-
cialising in shale oil, its share price has col-
lapsed, its debts are six times as big as the
market value of its equity and it does not
currently have any rigs in operation. Goodrich
says that it has ample liquidity, however,
and may sell assets to raise funds.
At the start of 2015, it seemed that there
would be many more firms like Goodrich.
When OPEC, the oil cartel led by Saudi Ara-
bia, decided to keep pumping oil despite
plummeting prices, it hoped that lower prices
would irreparably damage the finances of
America s shale-oil companies. They have
revolutionised the energy industry, using
junk bonds and a technique known as frack-
ing---blasting water, sand and chemicals at
rock to release oil and gas---to boost America s
share of global oil production from eight per
cent a decade ago to 13 per cent today. Six
months after the oil-price slump, however,
only five firms out of the hundreds in the
shale-drilling business have gone bankrupt.
American oil production actually has risen
slightly, reaching 9.6 million barrels per day
in June. Output of shale gas, the other com-
ponent of America s fracking revolution, is
holding up too. In Houston oil men proudly
declare victory: The Saudis have failed to
put Texas out of business.
The industry argues that the past six
months have shown its true grit. Before shale
came along the oil industry relied on mega-
projects. Kashagan, in the Caspian Sea,
involves one autocrat, 10 man-made islands,
20 years of toil and US$50 billion, and has
yet to deliver more than a drop or two of
oil to the Western firms who bet on it. In
contrast the typical shale well costs only
US$10 million and can be producing within
a matter of months.
That means that the industry can adapt
fast. Since December shale firms have cut
costs by between 20 per cent and 25 per
cent, according to Bob Brackett of Sanford
C. Bernstein, a research firm. This has been
achieved by brutally squeezing the oil-ser-
vices firms that provide them with rigs,
pumps and staff. Big services companies
such as Halliburton have started losing money
and small ones are on life support.
The shale producers also have cherry-
picked which wells they drill, concentrating
on the best prospects and fine-tuning their
engineering methods. As a result the number
of rigs active in America has dropped by
half since the start of the year.
This era of frugality can be seen in Mid-
land, a Texan town in the Permian basin,
one of six big shale areas. Midland has wit-
nessed multiple booms and busts since the
1920s. Graced by Ferraris during the 2012-
2014 boom, its highways now are populated
by pickup trucks. Some 20,000 to 30,000
temporary workers have left. On the town s
outskirts idle equipment is being auctioned
off at 20 cents on the dollar, burrito vans
ply a dismal trade and the trailer parks adver-
Viewed from a plane, however, Midland
is surrounded by wells as far as the eye can
see, most still busy pumping.
The shale industry s dazzling response to
low prices---austerity combined with growing
production---has enthralled Wall Street, which
has continued to supply shale firms with an
abundance of their most vital raw material,
capital. So far this year oil-production firms
have raised US$15 billion of equity and US$20
billion of bonds, helped by frothy markets,
a near-zero Fed funds rate and a partial
recovery in the price of oil. In February even
Goodrich, the troubled firm in Houston,
managed to issue US$100 million of "sec-
ond-lien" debt, which is secured against
assets, at an eight per cent interest rate.
Most firms have paid far less than that on
The buyers of these securities are main-
stream investors on the hunt for yield, but
also distressed-debt funds that were set up
in early 2015 to pick over the carrion of the
shale industry. They have found fewer car-
casses than expected and instead are bidding
Exuberant when oil prices were high and
resilient when they are low, the shale industry
appears unbeatable. How good are its
finances, though? The Economist has exam-
ined the books of the 62 largest listed explo-
ration-and-production companies in America
whose collective output is mainly from shale.
The results suggest that many firms are more
vulnerable than the bullish noises from their
There is another, less rosy scenario for
America s shale barons, however. Oil prices
may remain flat. If that happens, toward the
end of this year their hedges will run out
and shale-oil production will dip markedly
as the lagged effect of capital-investment
cuts kicks in. Output already has dipped in
the Bakken basin in North Dakota.
With growth evaporating and cash flow
faltering, it will become harder to sell shares,
and indeed the pace of capital-raising has
slowed in recent weeks. The junk-bond mar-
ket will become jittery and shale companies
will start to worry about refinancing the US$
66 billion of debt and interest that is due
in 2016-2018. As companies oil-reserves
estimates are marked down to reflect lower
prices, banks will cut their loans, which they
typically tie to reserves figures.
In this eventuality, indebted shale firms
would slip into crisis. This being America,
their fields would keep pumping as their
balance sheets were restructured. Their assets
would be sold, probably to the bigger explo-
ration-and-production companies or global
majors. There might still be a dip in the one
per cent to two per cent of global oil supply
that they account for, however, and as their
reserves deplete they might not be entirely
replaced. There would be a bad-debt problem
among banks and investors.
Shale energy is here to stay. There are a
lot of rocks and clever people between the
redwood forests and the Gulf Stream waters.
The industry has proven its entrepreneurial
spirit and its skill in both geological and
financial engineering, and its new invest-
ments are likely to earn better returns than
Not all shale firms will survive, however.
If oil prices do not rise soon, their viability
will deplete even faster than their wells.
@2015 The Economist Newspaper Ltd.
Distributed by the New York Times Syn-
Showdown at the
Shale oil and gas:
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