Will U.S. Shale Ever See Another Golden Age?

Haps of unpaid debt, unsympathetic banks and investors, slow oil demand, and looming bankruptcies: this is the landscape in U.S. shale oil right now.  Most forecasts for the future, however, are upbeat, with analysts expecting production to actually rebound to pre-Covid-19 levels at some point in the next five years. But will it?

Since March, total U.S. oil output has declined by as much as 2.6 million bpd, thanks to the double blow from the oil price war and the coronavirus pandemic that shattered demand. Most forecasters, including Morgan Stanley, Rystad Energy, Wood Mackenzie, and IHS Markit, believe there is little chance that U.S. oil production will return to growth this year or next. But after that, there will be a rebound. By 2023, U.S. drillers will be producing more than 12 million bpd of crude again, if those forecasts pan out.

But not everyone agrees. According to industry vet Arthur Berman, the U.S. energy dominance agenda is dead. Berman expects oil production to drop by as much as 50 percent over the next 12 months, and not because of low oil prices but because of the number of idled drilling rigs.

"The U.S. tight oil or shale rig count has fallen 69% this year from 539 in mid-March to 165 last week. Tight oil production will decline 50% by this time next year. As a result, U.S. oil production will fall to less than 8 mmb/d by mid-2021," Berman wrote in an article for Oilprice.com, adding "What if rig count increases between now and then? It won't make any difference because of the lag between contracting a drilling rig and first production."

But to start returning drilling rigs to the field, shale drillers need to have the cash to pay the operators of the rigs. Moreover, they need to have the certainty they would be able to sell the new oil at a profit. Right now, they have neither.

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Cash is tight and, it appears, it has been tight since the start of the shale revolution, or Shale 1.0. A recent report by Deloitte calculated that U.S. shale producers have burned through a collective $300 billion in cash without making a profit. What's more, the industry also wrote down as much as $450 billion in invested capital in the last 15 years. And the only thing it has to show for it is record-high production, which made the U.S. the world's largest oil producer and helped swing the world into yet another oversupply that is now hitting U.S. oil producers hard.

Meanwhile, banks have grown cold to the industry that they happily funded for more than a decade. One of the reasons is the oil price crash. Another is the fact that oil well yields have fallen short of expectations. A third is the cash burning. As a result, banks are slashing credit lines, with Moody's and JP Morgan estimating the average asset-backed loan cut for the industry at 30 percent, which translates into billions of dollars. And existing debt is maturing, with more billions due to be paid over the next five years.

Capital is still flowing into the U.S. oil industry, even though the flow has slimmed down, beginning even before the oil price crash and the pandemic. And the companies are using this flow to reduce their debt loads and extend bond maturities, rather than for boosting production, according to Wood Mackenzie. 

Will this be enough to carry shale over the crisis and help it survive?

It may, with some help. The last crisis, when Saudi Arabia tried to stifle shale with overproduction, led to many bankruptcies. But it also led to a leaner and meaner Shale 2.0. Producers cut their production costs—with the help of oilfield services providers—and kept on pumping. A consistent growth trajectory in oil demand helped them, too. This time, they would need a deficit of supply to swing it, as the dominant opinion on demand is cautiously optimistic with many, including industry executives, uncertain about whether demand will ever recover to pre-crisis levels.

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So, the number-one question for U.S. shale, whose answer will determine whether it has a future as a disruptive force in the global oil industry, is whether the market will swing into a supply deficit before the money dries up completely.

According to JP Morgan's oil analysts, it will--and as soon as 2022. This would push Brent up to $60, spurring shale drillers into action. The deficit could then continue to widen by 2025, with Brent potentially hitting $100, effectively ushering another golden age for shale, or Shale 3.0.

But given that U.S. shale's biggest rivals in the Middle East and Russia are well aware of what price shale drillers need to get back on their feet, things may play out differently. The deficit may come later than hoped and be smaller than hoped. Because peak oil demand may be looming on the horizon, much sooner than everyone expected, thanks to the pandemic and its devastating effect on fuel demand.

"Shale is not broke; shale is not gone; shale will come back," ConocoPhillips Chairman and CEO Ryan Lance told IHS Markit Vice Chairman Daniel Yergin in June.

"But I do think it comes back slower because there's going to be pressure on companies to confine their capital program, maybe not grow dramatically as they were before, because I don't think the access to capital in the investor community, at least in the public side of the business, is going to be as robust as it was over the last decade," Lance added.

Perhaps this will be Shale 3.0, a lot leaner than Shale 2.0 and not as mean but rather more careful with its long-term strategy, after it became painfully clear how small the step could be between uncontrolled growth and bare survival.

By Irina Slav for Oilprice.com

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