No rebound in sight for US shale
Domestic crude production will continue to be squeezed despite the modest oil price upturn and faces a long-term existential threat in the form of the Democratic manifesto
US shale curtailments are starting to ease on cautious optimism that the gradual exit from lockdowns globally will aid an oil price recovery. Independents including the likes of Devon Energy, EOG Resources, Parsley Energy and Continental Resources have all pledged to revive deferred volumes over the summer months with WTI hovering close to $40/bl.
But hopes for a swift and painless shale recovery look unlikely to be realised. The Energy Information Administration (EIA) estimates that production from the Lower 48 states has dropped by 1.55mn bl/d since the start of 2020. Producers have scrambled to cut back guidance this year against a huge global supply overhang caused by the collapsed Opec+ talks and exacerbated by the Covid-19 pandemic.
Even if curtailed volumes return to market, US production faces inevitable decline at least into early 2021. The number of completed wells slumped by around 80pc during the peak of global lockdowns in April and May, while the rig count has fallen by 67pc since the start of January. The Bakken basin has been the worst-affected play, given its high breakeven and associated operational costs.
The steep decline rate in the shale patch means the downward trend will continue for many months unless there is a speedy upsurge in new drilled and completed wells. “Lower completion rates are pressuring US shale supply strongly, as they can no longer offset the steep natural declines that are typical for shale,” says Raphaela Hein, an analyst at research consultancy JBC Energy. “Declines will reach a maximum of 2mn bl/d in late 2020 versus February levels, before growing completion rates can turn things around.” Much of this will depend, though, on an oil price recovery that could yet be sunk by a second wave of Covid-19 infections.
Companies may decide to delay well completions as a temporary solution if economic uncertainty drags on, buying time and potentially saving capex.
In the last three months, the inventory backlog in the US has grown to 750 new drilled-but-uncompleted (Duc) wells. “Usually there is a typical Duc build-up during winter months and a gradual drawdown during the spring and summer months,” says Artem Abramov, head of US shale at research consultancy Rystad Energy. “Contrary to the norm, in the last three months this metric jumped to 15 to 25 months of frack activity.”
The breakeven for Ducs is around $30-35/bl, which given the recent WTI price uplift to near $40/bl makes production economically viable. Companies may also choose to build up their inventories into 2021 if economic conditions continue to be bleak. But bringing production online in this manner is only a stopgap and at best will maintain flat domestic production. With steep production declines, significantly more wells will be need to be drilled and completed before we see a return to growth again.
Beating the clock
Hedging offers another stopgap option for many firms in 2020. Research consultancy Rapidan Energy estimates US shale producers have safeguarded around 76pc of production for the second half of the year, at an average price of $48/bl.
But heading into next year, much of this protection will disappear. The volume of crude hedged for Q1 2021 so far is about three times lower than for the same period in 2020, at an average WTI price of $42/bl, according to Rapidan. If oil prices fail to recover into 2021, or if Covid-19 infections once more squeeze global energy demand, the relatively high shale breakeven will restrict capex spend and reduce well completions.
“Declines will reach a maximum of 2mn bl/d in late 2020 versus February levels,” Hein, JBC Energy
The result of this extended downturn scenario would most likely be a wave of bankruptcies throughout the shale patch, already a severe threat as showcased by the Chapter 11 filings of Whiting Petroleum, Extraction Oil & Gas and now former industry heavyweight Chesapeake Energy.
While the oil price may have reached its lowest point in Q2 this year, there is often a lag between prices falling and the first wave of bankruptcies. “We have counted 28 bankruptcies so far this year,” says Allyson Cutright, director of Rapidan’s global oil service. “In the last price downturn, the quarterly bankruptcy count peaked the quarter after prices bottomed—there were 28 bankruptcies in Q2 2016 when WTI bottomed at $26/bl in February.”
Cutright explains that the current price crash has increased pressure on many producers’ borrowing bases, compounding the financial hardship of curtailments. And with the extended Covid-19 uncertainty, she believes that WTI will not lift above $40/bl for the rest of the year, increasing the likelihood of more shale bankruptcies in 2020.
But defaults may give opportunities for other firms, particularly those with the most robust balance sheets, to mop up budget priced assets. “Given the majors’ growing technical capabilities in shale, it will be fascinating to see whether any companies use the downturn to cement their acreage positions, acquiring distressed E&P companies or other junior operators,” says Rob West, CEO at energy technology consultancy Thunder Said Energy.
An equally crucial factor for the long-term post-pandemic recovery of US shale is be the upcoming election. While President Donald Trump has pledged financial aid to the shale oil sector if he wins a second term, Democrat candidate Joe Biden has promised to overhaul the US energy mix, achieving a 100pc clean economy and net-zero emissions by 2050.
To reach this goal, Biden aims to ban all new federal land leases for oil and gas production, both onshore and offshore. The Democrat has called for the Arctic to be removed from consideration for oil drilling and wants to enforce stricter onshore regulations, adding costs and operating constraints for oil producers. Another of his key pledges is to support the growth of hydrogen produced from renewables, ultimately making it cost-competitive with shale gas, as well as to lower domestic oil consumption by 12bn bl over the period to 2025.
$30-35/bl – Duc breakeven
A Biden win would also likely have a bearish effect on global oil prices. Under the Trump administration, US sanctions have eliminated c. 1.8mn bl/d in Iranian oil production from the market. But Biden wants renewed dialogue with the Islamic Republic, and if elected president would likely resume negotiations to save the nuclear deal, known as the Joint Comprehensive Plan of Action (JCPOA). If a JPCOA settlement was reached, almost 2mn bl/d would potentially re-enter the market and likely encourage more investment into Iran’s oil sector, further squeezing prices. Rapidan Energy estimates that a Biden victory would add a $5/bl discount on WTI starting in the second half of 2021.
Since taking office, Trump has also ramped up US sanctions on the regime of Venezuelan president Nicolas Maduro. The Latin American former oil juggernaut has lost over 1.5mn bl/d in crude production in the last four years, and its marketing base has been reduced to just two major buyers, India and China.
But unlike with Iran, a Biden election victory in November is unlikely to result in any Venezuelan sanctions being rolled back. Both US candidates reject the Maduro government and want fresh and transparent elections. Unless there is imminent regime change, the country’s oil sector will continue to suffer severe financial hardship and lack the capacity to bring volumes to market.