On Sunday, Chesapeake Energy filed for Chapter 11 bankruptcy, representing one of the most significant failures in the history of the U.S. shale industry.
Oil prices have climbed back from April lows, and there are signs that drilling activity is bottoming out. A tighter market could help shale bounce back, but the heady days of aggressive growth-at-all-costs drilling are long gone.
In April and May, 13 companies went bankrupt, tied for the second largest quarterly total in four years.
U.S. shale debt comes due
Roughly 227 North American oil and gas companies have filed for Chapter 11 bankruptcy since 2015, according to Houston law firm Haynes and Boone. In April and May, 13 companies went bankrupt, tied for the second largest quarterly total in four years, with the month of June not yet counted. The cumulative amount of debt represented in these failures tops $120 billion.
The case of Chesapeake Energy is one of the most iconic. The company was once the largest shale gas producer in the country, and it borrowed tens of billions of dollars to buy land and drill at a frenzied pace. But it was never able outrun its mountain of debt. Last year, the company warned that it may not be able to continue as a going concern – and that was before the coronavirus pandemic.
But while Chesapeake is illustrative of the reckless nature of shale growth, it is not the only company drowning in debt. The entire sector is over-leveraged, a reality made much worse by the coronavirus pandemic and the market downturn.
At the start of 2020, North American oil and gas companies were staring down $200 billion in debt that was scheduled to mature over the next four years, including $41 billion this year.
The U.S. shale industry has never been profitable.
In fact, collectively, the U.S. shale industry has never been profitable, according to a new report from Deloitte. While drillers succeeded in posting “phenomenal growth,” including the doubling of oil and gas production over the last five to six years, “the reality is that the shale boom peaked without making money for the industry in aggregate,” the consulting firm said. “In fact, the US shale industry registered net negative free cash flows of $300 billion, impaired more than $450 billion of invested capital, and saw more than 190 bankruptcies since 2010.”
Full rebound unlikely
There are more than a few signs that the U.S. shale industry is beginning to recover, although from a very deep hole. With WTI back close to $40 per barrel, buzz about a restart has dominated press coverage. Shut in wells have come back online, adding around 500,000 barrels per day. The rig count sits at record lows, but the number of fracking crews appear to be on the rise, according to new data from Primary Vision and Bloomberg. Share prices of most oil and gas firms have climbed significantly since March. The OPEC+ cuts have helped balance the market, and more than a few oil market analysts predict crude prices will continue to make steady gains.
So far, however, the rebound is somewhat marginal. Comments from companies like Parsley Energy and EOG Resources have focused on restarting shut-in wells, not necessarily drilling new ones. Producers may be fracking already-drilled wells, but fresh drilling is still at multi-year lows.
Oil and gas executives do not believe that drilling will return to pre-pandemic levels until at least 2022.
According to the latest survey from the Dallas Federal Reserve, oil and gas executives do not believe that drilling will return to pre-pandemic levels until at least 2022. “We do not know when we’ll be able to return to drilling and completing wells due to our lack of liquidity and no access to new capital,” one anonymous executive responded in the survey. Another echoed that sentiment: “We think there will be price volatility between $25 and $45 per barrel for the next three years, so capital spending will be slow for multiple years,” the executive said.
Even as publicly-traded companies slip into bankruptcy, private ones – often backed by private equity – are also in trouble, according to S&P Global Platts. “I think you are going to see the energy private equity world shrink — their next funds are going to be smaller as institutional investors are abandoning the energy sector,” Pickering Energy Partners LP founder Dan Pickering told S&P Global Platts. It remains to be seen if that is a permanent fixture on the shale landscape; a downturn tends to be the time when private equity goes on the prowl.
U.S. shale production may begin to rebound after a lengthy downturn, but the roughly 13 million barrels per day of American oil production seen earlier this year may prove to be the high-water mark.
Meanwhile, the brightest part of the oil market narrative – the rebalancing of the market and the rebound in oil prices – remains at risk. The global Covid-19 pandemic is accelerating, not slowing down. New closures of bars and restaurants are rising in Florida, Texas and California. The virus is also spreading quickly in Brazil, India and other emerging markets.
“As Covid-19 cases go up, the oil prices cool down,” Louise Dickson, oil market analyst at Rystad Energy, said in a statement. “Brent is again sputtering, losing some of this month’s hard-earned gains, a telltale sign that it’s break over $40 isn’t sustainable on the prospect of more lockdowns and mobility restrictions in key markets, from the US to Brazil.”
Raymond James published a new report on Monday, projecting oil demand will remain below pre-pandemic levels until at least 2022. The investment bank said that demand was coming back along with “reopenings” around the world, but it warned that there are “heightened risks during the upcoming Northern Hemisphere winter.”