US shale bust wrecks hopes for energy independence

The shale revolution that made the US the world’s biggest oil and gas producer and offered the prospect of energy self-sufficiency has run out of steam, as drillers slash spending and production in response to the coronavirus-led collapse of crude demand and prices. 

US oil output, now a record high of 13m barrels a day, will begin falling steeply in the second half of this year and could drop 2.5m b/d by the end of 2021, analysts have calculated.

Even a modest further oil price drop could cut US production back by almost 4m b/d, fully reversing three years of increases.

“Shale growth helped to lead the US out of the Great Recession, but may fall victim to the Covid-19-fuelled recession,” said Jamie Webster, head of BCG’s Center for Energy Impact. 

The capex cuts have come thick and fast since the collapse of the Saudi-Russian oil pact on March 6 sparked a market rout that has more than halved the price of West Texas Intermediate, the US benchmark, to about $23 a barrel.

Occidental, Apache, Diamondback Energy, Continental Resources, ConocoPhillips, Concho Resources, Pioneer Natural Resources, Parsley Energy and Cimarex are among the shale patch’s big producers to have collectively wiped billions from planned spending.

On Tuesday supermajor Chevron joined them, saying it would reduce its capex in the Permian shale this year by $2bn. The number of its operating rigs in the region would soon drop by more than half and output by year-end would be a fifth lower than planned. 

In total, capex across the shale sector will fall from $107bn last year to $64bn this year, said Rystad Energy, a consultancy — and the drop could be much steeper unless oil prices rise significantly. 

The collapse in activity will cause widespread economic pain in oil-producing regions of the US, where extensive services sectors — from hospitality to fracking crews — have sprouted up during three years of brisk business. 

It will also end the production boom that reduced the US’s dependence on foreign oil supplies — much to the delight of the country’s leadership — and allowed for a steady rise in crude exports. 

Rystad said it expected a decline of 1m b/d this year and another 1.6m to be lost in 2021, if WTI traded at $30 a barrel. At $20 a barrel — an unthinkable price a few weeks ago but now forecast by Goldman Sachs for the second quarter of this year — production would fall by 3.6m b/d.

Those declines are only slightly larger than those forecast by others. Output will drop 1.4m b/d by the third quarter of next year, Goldman predicted this week. RS Energy Group, a consultancy, said 700,000 b/d would be lost this year and 1.1m in 2021. 

“With WTI at $30 or Henry at $2 nothing works at scale in North America,” said Dane Gregoris, a director at RSEG, referring also to the record low prices now being paid for Henry Hub, the natural gas benchmark. RSEG estimates the break-even WTI price for production in the Permian, shale’s choicest area, to be $43 a barrel. 

During earnings season earlier this year, shale producers sought to assure shareholders that they were mending their ways, curbing extravagant growth plans to return investors’ cash and focus on living with a price of $55 a barrel. Then the market and producers’ models crashed. 

The oil rig count in the US, a good indicator of forthcoming activity, fell by 19 last week to 664, according to services company Baker Hughes, a division of General Electric. Rystad said it expected a 60 per cent decline in the count by year end. 

US producers are faced not just with the collapse in global oil demand as a result of the coronavirus pandemic but a forthcoming wave of new supply from Saudi Arabia and Russia, whose alliance to withhold production morphed into a price war earlier this month.

Russia saw the drop in demand and deteriorating market as an opportunity to squeeze out producers in America.

Equity valuations across the US oil and gas sector have slumped on average by almost half since just before the Saudi-Russia deal collapsed, about 20 percentage points worse than the S&P 500. 

Rating agencies have spent the weeks since reassessing the creditworthiness of US producers, and many debt issuers have crossed into high-yield, or junk, categories. This will make refinancing much harder for a sector that, thanks to a model needing constant cash injections to hold output steady, had already lost investors’ favour. 

Some producers, such as Concho, will be relatively insulated for a time because they hedged some of their production at a higher price, said Mr Gregoris. But others face a crippling deterioration in their ability to maintain funding of drilling in order to keep generating cash. 

Hopes across the sector — and among those still banking on the revolution delivering energy independence for the US — now rest on a swift oil price recovery. 

“Shale thrives at $100 a barrel, survives at $50 and dies at $25,” said Mr Webster.

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