The Fuse

Despite Years of Red Ink, Shale Companies Itching to Grow Again

by Nick Cunningham | February 04, 2021

Oil prices have shot up in January, rising to their highest level in a year. At the start of February, WTI was above $56 per barrel and Brent crude was starting to get close to $60.

The U.S. shale industry suffered a devastating blow last year when the market melted down, compounding existing problems and derailing the drilling boom entirely. Some of the scars will be permanent. But drilling activity is starting to pick up again, and there are growing questions about whether or not drillers will try to return to aggressive growth despite calls for restraint from investors.

The U.S. shale industry burned through more than $340 billion over the past decade.

Drilling picks up
The U.S. shale industry burned through more than $340 billion over the past decade. They also burned through most of their goodwill with Wall Street, which has by and large demanded an end to the grow-at-all-costs business model. Through several downturns, the industry trumpeted a mantra of “capital discipline,” only to be recapitalized by investors, kicking off another round of drilling.

But the pandemic-induced downturn of 2020 was the deepest of the multiple downturns over the past decade. More importantly, it came at a time when investors were souring on the shale industry anyways, fed up after years of red ink. As a result, it is not clear that drillers will be able to tap financial markets for another go, at least not to the same degree as years past. Nevertheless, there are signs that drilling is indeed picking up.

The North American oil and gas rig count remains a shadow of its former self. In the last week of January 2021, the total rig count stood at 384, roughly half of the number of active rigs from January 2020. But the rig count has climbed back from the nadir of 244 reached last August. In the third and fourth quarters, the U.S. oil industry steadily added rigs, with more than half of the additional rigs concentrated in the Permian basin.

It is important to note that the uptick in rigs is the result of plans put in place months ago. The most recent increase – with WTI and Brent surging to one-year highs in late January and early February – hasn’t yet showed up in the drilling data. That suggests more gains in the rig count can be expected in the weeks ahead.

That raises familiar questions on fourth quarter earnings calls currently underway: Will shale companies once again throw caution to the wind and recklessly expand drilling? Time will tell.

At $45 WTI, the U.S. shale industry would remain stuck in “maintenance” mode.

According to December 2020 analysis from Rystad Energy, at $45 WTI, the U.S. shale industry would remain stuck in “maintenance” mode, drilling and completing wells just to keep production flat over the course of 2021, with “very rare cases of gradual growth offset by some declines from operators which filed for Chapter 11,” Rystad analysts said on a January webinar.

Is this time different?
However, the firm says that with WTI potentially averaging around $53, for example, the industry would have much more cash flow to work with. In years past, Rystad added, it would be safe to assume that all additional incremental cash flow would be funneled back into more spending and more drilling. This time around, investor scrutiny prevents that to some extent. Instead, Rystad forecasts that roughly half of additional cash flow this year goes into improving the balance sheet (paying down debt) or returning cash to shareholders. The other half may go into higher spending and more drilling.

In other words, attempts at growth are not entirely a thing of the past. The recent rally in prices could result in more rigs by March, a higher number of completed wells by the end of the summer, and more production coming online by September.

To be sure, oil executives have gone to great lengths to try to reassure investors that this time is different – that restraint and discipline will guide them. But there is “zero value” in such reassurances, given the industry’s track record, as one energy investor framed it in an interview with Bloomberg.

“I do believe we have a lot of proving to do to get investors back,” Vicki Hollub, head of Occidental Petroleum, told the FT.

Roughly 250 North American oil and gas companies have filed for bankruptcy since 2015.

Consolidation is now in full force. Roughly 250 North American oil and gas companies have filed for bankruptcy since 2015, and more bankruptcies are expected with a colossal wall of debt coming due in the coming years. The next phase of the shale industry will be one of fewer, larger companies. Instead of hundreds, the shale industry will be whittled down to dozens, with the oil majors dominating the landscape.

ExxonMobil, for instance, plans to nearly double its production in the Permian basin to 700,000 barrels of oil equivalent per day (Boe/d) by 2025, up from 367,000 Boe/d last year. However, that is actually a big cut from its previous forecast of 1 million Boe/d, evidence that even the largest oil companies are coming under withering pressure from investors to rein in the profligacy.

Meanwhile, a large portion of questions put to ExxonMobil’s top brass by analysts and investors on the company’s fourth quarter earnings call on February 2 was related to Exxon’s greenhouse gas emissions, its financial risk related to the energy transition, and how prepared the company was for a rapidly changing world. In years past, those same analysts would pepper executives with questions about production rates in the shale patch and how quickly production growth would proceed. Times are changing and this dynamic is not unique to Exxon.