US shale running out of time
Financial conditions may have rallied, but the long-term survival of many firms still hangs in the balance
US shale is making a slow recovery. WTI prices have risen to above $40/bl after descending into negative territory at the tail-end of April, and producers are returning curtailments to the market.
But the economic crisis is far from over. Rumbling volatility resulting from Covid-19 and fears over future lockdowns have placed a ceiling on the rebalancing of oil prices. And much of the industry faces a wall of debt maturities in 2021 that could prove unsurmountable.
“While an improvement in oil prices towards $40/bl saved a significant number of E&Ps and prevented early Chapter 11 filings in June-July, the current price environment is in no way sufficient for a large number of the E&Ps in the medium-term,” says Artem Abramov, head of US shale at research consultancy Rystad Energy.
US shale producers have dialled back borrowing considerably since the 2010-14 credit boom. But lending in recent years has still been double the level recorded during the mid-2000s, according to research from US bank AllianceBernstein.
“Private equity seems to be closed, public equities closed, the debt markets are tougher” Leach, Concho Resources
The rapid growth of US shale has saddled much of the industry with massive debt obligations. Of the top 50 most indebted global E&P firms, 37 are based in the US and seven of these are in the top 10. US independent Chesapeake, which filed for Chapter 11 in June, until recently topped the list with $12.25bn in debt, followed by fellow indies Antero, California Resources, WPX Energy, Continental Resources, Freeport McMoRan and Range Resources.
There has already been a surfeit of bankruptcies this year. Law firm Haynes and Boones reported 32 Chapter 11 filings in the US shale patch in 2020, with c.$40bn in total debt. And around 118,000 US oil sector jobs have been lost because of the economic downturn, according to research consultant BW Research Partnership.
Too little, too late?
The oil price rally is of course good news for producers, many of which were forced to cut back capex and production. Over 700,000bl/d was curtailed in May, at the height of economic lockdowns, but this had improved to less than 100,000bl/d by August. The domestic rig count also appears to have stabilised after plummeting by 76pc since the start of the year, according to data from US oil services firm Baker Hughes.
But Rystad estimates the oil price may not be enough to meet debt maturities. The average debt taken on by companies across the sector has grown to $1.2bn, 160pc higher than the average debt during the 2015-19 period, underlining the precarious situation. Assuming oil at $40/bl, the consultancy forecasts another 29 firms will file for Chapter 11 next year and another 125 across the following two years.
In the absence of a further increase in oil prices, many firms may seek to tap credit markets. But banks are wary about further lending given the volatile conditions and the sector’s questionable growth model. “The first quarter of 2020 looks to have been relatively normal in terms of issuance,” says Nicholas Green, senior analyst at AllianceBernstein. “Data for Q2, however, suggests a complete drying-up of credit.”
The grim picture was shared by many producers during their Q2 financial postings. “There was not any capital available to our industry [in Q2],” said Concho Resources CEO Tim Leach on an earnings call. “Private equity seems to be closed, public equity [markets seem] closed and the debt markets are tougher.”
$1.2bn – Average company debt
Business models will likely be forced to change permanently to attract investment. Companies will need to restrict capex to 70-80pc of cash flow from operations, says US bank Jefferies, cutting growth into single digits.
But even with financial discipline, most of the sector needs at least $50/bl to survive. And this existential problem is hardly restricted to just US shale. AllianceBernstein adds that E&P debt stands at around $240bn globally, with the largest annual share due over the next two years. Much of the sector will suffer severe losses without a further recovery in prices, followed by stabilisation at this higher level.