Bleak Financial Outlook for US Fracking Industry

Yves here. Some astute financial commentators were early to point out that fracking was uneconomical and depended on access to cheap funding. For instance, we cited the Financial Times’ John Dizard in a 2014 post:

John Dizard at the Financial Times (hat tip Scott) gives a more intriguing piece of the puzzle: the degree to which production is still chugging along despite it being uneconomical. The oil majors have been criticized for levering up to continue developing when it is cash-flow negative; they are presumably betting that prices will be much higher in short order.

But the same thing is happening further down the food chain, among players that don’t begin to have the deep pockets of the industry behemoths: many of them are still in “drill baby, drill” mode. Per Dizard:

Even long-time energy industry people cannot remember an overinvestment cycle lasting as long as the one in unconventional US resources. It is not just the hydrocarbon engineers who have created this bubble; there are the financial engineers who came up with new ways to pay for it.

But with Uber as an example of how long a money pit can keep going….

By Justin Mikulka. Originally published at DeSmogBlog

In early 2018 when major financial publications like the Wall Street Journal were predicting a bright and profitable future for the fracking industry, DeSmog began a series detailing the failing business model of fracking shale deposits for oil and gas in America.

Over a year later, the fracking industry is having to reckon with many of the issues DeSmog highlighted, in addition to one new issue — investors are finally giving up on the industry.

Billionaire oil CEO Harold Hamm — who has been touted as a “Shale King” — made comments this week reflecting how weak investment interest is in oil and gas fracking, going so far as to say that it wasn’t worth being a publicly traded company. “In today’s market, we don’t see a lot of value in it,” he said on his company’s earnings call.

A similar sentiment has appeared in The Financial Post, which this week reported how “unloved” by investors the Canadian tar sands industry — which DeSmog also has highlighted as a financial disaster — currently is.

General investors are saying, ‘To heck with energy,’” Jennifer Rowland, an oil and gas analyst for Edward Jones, told The Financial Post.

After years of patience as the fracking and tar sands industries continued to pile up losses, investors are understandably tired of losing money.

2019 Quickly Becoming Another Financial Disaster of a Year

2019 was supposed to be the year that shale oil and gas producers finally reined in spending, with the goal of funding all new development from free cash flow. And just like every other year, it didn’t take long for those plans to unravel.

An analysis of 40 U.S. shale oil companies by Rystad Energy, an independent research organization in Norway, revealed how badly things had gone in the first quarter of 2019: “The gap between capex [capital expenditures] and CFO [cash flow from operating activities] has reached a staggering $4.7 billion. This implies tremendous overspend, the likes of which have not been seen since the third quarter of 2017.”

In other words, the capital expenditures, or money spent drilling oil, outpaced the cash flow from operating activities, or the money made by selling oil, by nearly $5 billion, in the first quarter of 2019 alone.

And the announcement of second quarter results brought no better news, with many shale companies suffering major drops in value.

New Dire Warnings About Peak Shale

Undeniably, the so-called “shale revolution” has produced record amounts of oil, with steady growth over the past decade. The dual techniques of horizontal drilling and hydraulic fracturing, or fracking, are very effective at producing large amounts of oil and gas, but that production has resulted in chronic industry overspending by approximately a quarter trillion dollars over the last decade.*

Investors have been told to wait for the industry to figure out how to produce the oil and make a profit, but a new problem looms that could complicate those plans: Shale companies are running out of the “good rock” that produces plenty of oil.

In the past, shale producer Pioneer Natural Resources has been criticized for its overly optimistic forecasts for increased oil production, but company CEO Scott Sheffield has been singing a different tune lately. Sheffield now is warning that most of the oil from so-called “sweet spots,” or “tier 1 acreage,” has already been extracted.

Tier 1 acreage is being exhausted at a very quick rate,” Sheffield told analysts on a call about second quarter results.

A similar warning is found at oil and gas industry news site under the headline, “Is the US Shale Boom Winding Down?

New well flows are not what they used to be, since wells are drilled further away from sweet spots or placed too close to each other in order to make the most of all that very expensive acreage,” notes the story.

And financial industry site Seeking Alpha recently echoed all of these concerns, including the “growing scarcity of tier 1 acreage.”

The messages coming from energy analysts, the financial industry, and the fracking industry all lead to the same conclusion: The U.S. shale industry has been a financial disaster for investors, with producers piling up huge amounts of debt despite extracting copious volumes of oil from disappearing sweet spots. Now, shale companies are under mounting pressure to pay back that debt by producing oil from lower tier acreage. If past performance is any indication, this approach is a major long shot.

General investors are finally catching up to the bad deal that fracking represents, but the question is: What took them so long?

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  1. kimyo

    war against venezuela makes a whole lot more sense if u.s. shale production is about to decline.

    1. Synoia

      Control of Venezuelan and Persian oil is better. A War is a way to attain that control.

      Coupled with Hudson article about the US being an oil-powered empire explains much.

      What happens when China discovers those huge oilfields that are probably under the South China sea?

      Large rivers appear somewhat correlated with large oilfields.

    2. rjs

      what we did in Venezuela made no sense economically; we needed that heavy oil to run our Gulf Coast refineries…our gasoline supplies had reached an all time record high near the end of January, they then fell by nearly 13% over 10 weeks while US Gulf Coast refineries were crippled by the Venezuelan sanctions, unable to secure supplies of the heavy crude they were built to use…it’s only recently that our refinery utilization has returned to normal, but for most of the past 6 months we’ve been importing gasoline at nearly a million barrel per day rate to cover the shortfall…

      don’t imagine that anyone in the administration has any idea what the unintended consequences of their policies are; they dont..

  2. @pe

    This is why I point out that a highly liquid market can not make economic calculations, since it responds “instantaneously” to the current state, and is thus driven by higher-order derivates.

    If you put charged molecules in water, the water responds “instantaneously” — it’s hot and the molecules are cold in physics-speak. You can only determine the current position of the molecules by the distribution of water, but can not determine the trajectory of the molecules, in fact the trajectory of the molecules have to be calculated from the varying instantaneous states of the water.

    So, neo-classical economic theory, in the regime where it works, must fail at it’s goal of using markets to drive the real economy in a planned way, instead the real economy becomes driven by fluctuations (noise) in the markets. Thus even if the math is right, the results are wrong and you must throw out Coase etc, who fail to do the sensitivity analysis of the system.

    And you get thing like Uber and fracking.

    1. Larry Motuz

      Given the assumptions of neoclassical theory, not only can it not tell us anything about ‘markets’ but it also precludes planning to use markets to drive the economy. (Er, you cannot improve on ‘perfection’.)

      1. @pe

        I meant by “plannning” that markets are supposed to do economic calculation which includes future prediction and response. Otherwise, markets are absolute useless — this was the critical pragmatic step of Mises and Hayek, that markets do better “planning” than intentional planning.

        But they can’t if they’re at equilibrium.

  3. PlutoniumKun

    Arthur Berman has been pointing out this problem for a decade or more. Many of the projections for fracking were simple extrapolations from early drillings, but as he pointed out, drillers were all aiming for ‘sweet spots’ which means that in reality as the boom went on, they’d have to spend more and more money and energy just to stand still in terms of output. So with constant low prices the point at which a drop off the peak production meets low prices (i.e. scarcity not pushing up prices as economists assume will happen) means financial catastrophe for the industry. Probably most in the industry knew this full well, but were happy to fill their pockets with cash while the going is good.

    And its not necessarily an environmental good if they all go bust – thousands of poorly capped wells will leak methane into the atmosphere for decades to come. It will cost many billions to repair the damage.

    And a collapse in shale oil in particular will bring the Canadian tar sands with it – because of the nature of refining capacity the two work hand in hand (also with Venezuelan heavy crude).

    The only beneficiaries of this are the Saudi’s who will find themselves the big swing producer again.

    The only thing that can save the industry now is a war in the Gulf spiking prices back up well over $100 a barrel. I’m sure those good honest people haven’t thought of that.

    1. Tyronius

      Soooooo you’re saying that Americans will gin up an excuse to kill thousands of innocent people in yet another foreign country because we’re financially shortsighted?

      Sounds legit. I’m sure we’ll make lots of friends along the way, too!

    2. Keith Newman

      Re PlutoniumKun: Not sure I follow your logic re the Canadian tar sands. Are you saying the heavy tar sands synthetic crude needs to be blended with light oil? Perhaps, but prior to large scale fracked oil output the tar sands did quite well. So if fracking shuts down, North American oil supply will drop considerably and the price of crude will go up. It’s hard for me to imagine that won’t offset refining capacity problems. Perhaps I’m missing something.

      1. Buckeye

        Yes, heavy oil is used to blend with the “light tight” oil from fracking. Fracking oil has a very high viscosity, typically 35-45 degrees. It needs heavy oil to thicken it for easier refining.

        If the price of oil goes much above $80 it will drag the economy into deep recession. If oil stays above $100 for a long period it will likely cause a deep depression.

        Read Gail Tverberg and her blog for a very deep discussion of the price issue, from the standpoint of an actuarial. The article is from
        November 28, 2018. Titled “low oil prices: an indication of major problems ahead?”

      2. Pym Of Nantucket

        I would say the Canadian situation is very different. Traditional oil investors would invest based on reserves and production rate and fracked oil is turning out to only give you the production rate today. I think that is the crux of the problem. Simple investing strategies based on estimates of reserves are not working out because these plays deplete so rapidly and its making it hard to determine value. The Canadian reserves are massive and their problem is getting them out of there and onto a tanker, being in the middle of nowhere (where I live) and landlocked.

        Right now the hottest plays in Canada are fracking for extracting wet condensate. Wet gas is produced while the gas, which almost has no market value because of the glut in gas, is sold for almost nothing. The light liquids go to help move oil down the pipe to the US or to the west coast. There is also a lot of light oil in the ground in the same region (called the Duvernay and Montney plays) ready for fracking but it is not being produced because of the costs.

        There may be some misconceptions about what you do in refining, but to point that out, first you separate (distill, just using temperature to boil out the light stuff), and then if you have heavy left over, you crack that (that’s a chemical reaction where you chop up large molecules to lower the molecular weight – since you need hydrogen for this, it uses steam, natural gas or piped in hydrogen). Mixing light stuff with heavy just _decreases_ the viscosity but doesn’t change the final challenge in the upgrading, which is the cracking part (the distilling is pretty easy). So the North American refining infrastructure has different amounts of ability to handle different amounts of heavy. If the Venezuelan heavy isn’t coming in, you get unused capacity which needs the Canadian heavy to use and depreciate the refining assets. Canada is in a situation where it produces more heavy oil than it has the capacity to upgrade. The problem with those stocks (I think) is that the producers that rely on other entities to refine, make investors wary of obstacles that can prevent a company from getting value – especially over a multi-decade life cycle. The big factors are pipelines, competition with Venezuela and now new marine fuel rules. Suncor has quite a bit of its own refining and doesn’t sell as much WCS (the Canadian blended version of WTI) on the market. I’m pretty sure there stock is doing fairly well.

        There is some complex things being done by some of the bigger companies to tie up transportation capacity, so the bottleneck that is felt in transportation is felt well before you reach pipeline capacity. Although we didn’t reach our pipeline capacity over the past couple years, the WCS price collapsed and the government invoked supply management. This was because some majors reserve capacity and don’t use it. All this makes investors skittish, but lack of reserves is certainly not an obstacle whatsoever.

        This is a good little tutorial

  4. cnchal

    > What took them so long?

    They were blinded and misled by the FED? All this debt shooting for the investment stars is outrunning societies ability to pay it.

    What is really astounding is the radio silence by eclownomists. None have called throwing money down an oil rathole what it is, insanity. As is wrecking groundwater with this “advanced” technology.

    As for the Alberta tar baby, it’s dig dig dig. Canada’s leadership is fully on board as this headline from the Globe on July 26th explains.

    “Review panel backs Teck oil sands mine, saying jobs, economic benefit out weigh environmental impact”

    A joint federal- Alberta review panel is recommending approval of Teck Resources Ltd’s proposed Frontier oil sands mine, despite finding it would have a serious environmental impact and might make it difficult for Canada to meet its climate change commitments. . . .

    “Although we find that there will be significant adverse project and cumulative effects on certain environmental components and Indigenous communities . . . we consider these effects to be justified and that the Frontier project is in the public interest”, the three-person panel concluded.

    Did fear of seven thousand temporary workers to destruct the place over a number of years and the two thousand expected to keep it running, coming after the “leadership” with pipe wrenches and welding torches if they didn’t have jawbs cross their minds or owners of Teck wanna make moar money?

    The legal ground has to be dug before the real digging begins, and here is the setup for a future disaster. And three assholes on a panel decide for Canadians, destruction is in their best interest.

    1. Dr Mike

      Trudeau, trying to be Canada’s Obama, naturally learned all the wrong lessons. He opted for a “grand bargain” of sorts – carbon tax plus more pipelines to keep both progressives in Ontario Quebec and the west coast, as well as Albertan oil workers on board. It has failed, unsurprisingly. Any support for a carbon tax is called communism by the right, and his support of more pipelines and tar sands activity has disillusioned progressives who believed he was one of them. Typical radical centrism trying to keep every kind of voter happy through “common sense middle ground solutions” and pleasing none. The right was never going to back him anyway so all he’s done is depress young progressives who will stay home in the October election and the Conservatives will win. Sound familiar?

      1. eg

        It’s a bit early to credibly assume that “the Conservatives will win” though I don’t disagree that this “all things to all people” approach is a loser.

        1. Pym Of Nantucket

          A minority Liberal government followed by Kenney moving back to his home in Ontario/Ford Nation is now looking like a possible scenario. If the Liberals win and the carbon tax stays, Kenney may need to leave Alberta because his unilateral axing the Alberta carbon tax will turn out to be a bad move for Alberta. A lot can happen in two months though.

  5. Mike

    Question – how much of this financing is “effluent” from the Plunge Protection Team and its ability to create money where needed? Not going directly to the frackers, of course, but via the banks loaning to an endless loss and allowing bigger expense as time goes by. I know where I’d end up if that loss held over 5 years.

  6. Anarcissie

    ‘Uber’…. Well, if you make free or nearly free money — funny money — which you have kept away from the proles (as our masters do by basing the money on credit instead of printed paper) thus avoiding inflation in the real economy, then for a while you have lots of the stuff to play with, but it has to go somewhere: real estate, equities, bridges to nowhere, Uber, fracking, and so forth. I would guess that forward-looking plutocrats would skim off some real value (fortified compounds in the Caymans?) while the funny stuff is sloshing around and being poured down ratholes and dour old Reality has not yet set in. So in its way the shale and the tar sands are functioning correctly. And, ‘In the long run you’re dead’ and so is your country, but who cares? I don’t know why people support these unpleasant arrangements, but they do.

  7. Louis Fyne

    it’s a game of chicken/last man standing.

    A whole cohort of brand new natty-gas fueled electricity plants absolutely will need electricity for the next decade. near 100% inelastic demand barring a severe recession.

    And of course everyone up North has no choice but natural gas for heating—as barring crazy, crazy high natural gas, heating with gas is cheaper than heating w/electricity.

    1. Mike Elwin

      Um … except that knee-jerk environmentalists here are convincing themselves that natural gas is bad for us, so they’re going to ban its use in residences. It’s started already in, where else, Berkeley. Add the enormous increase in demand from all-electric vehicle fleets, and the last man will be standing on smoldering rubble of high power lines.

  8. Synapsid

    The article doesn’t give much attention to the quick peak/rapid decline pattern of shale wells.

    Production from a new well increases fast and peaks in a couple of years, and this attracts investment looking for quick yield. The peak is followed by rapid decline though, into a long tail of low production. To hold the interest of investors you have to drill more wells. The result is draining the sweet spots and shifting to less productive acreage, as described in the article.

    Five barrels of every six being produced in the Permian, the biggest play, only serve to offset the rapid decline (called legacy decline) characteristic of shale wells.

    1. Buckeye

      Absolutely right. There are TWO issues with fracking: one is the finance, described in the article. The other is the physical issue, the decline in physical oil production. I’m betting that the financial side kills the industry first, probably in the next 5 years. If that does NOT happen, the oil itself will become more and more scarce. By 2028 there will be a major supply shock several times worse than what happened in the 1970’s. Economic chaos follows.

  9. Reify99

    I kind of expect fracking companies to join other petroleum companies in quietly moving to “too big to fail” status as a group. (Will probably be covert, like a bankruptcy/take over and wipe out the common share holders kind of thing.)

    Or the always convenient “National Security Reasons” if we need a back up. Anyway..

    The US. does not have a plan B as regarding the petro dollar. When wells dry out we go to Artic circle, national parks, eminent domain for drilling, bombing our way to control and keep the price up, etc.

    Meanwhile, some examples from those countries following the Paris Accord—

    Orsted, now the world’s largest offshore wind farm company, was formerly Dong Energy, the biggest petroleum co in Denmark. Each year they publish the percentage of revenue from green sources, and as of 1st half 2019 they are 78% green. There are still some coal plants switching over to wood chips, some petroleum based local utility cos they are trying to unload, and “long term LNG delivery contracts.”

    Wartsila, (needs some um lauts), is a Finnish co that has a marine division with hybrid tugboats (think Toyota Prius), autonomous ferries, etc. They have an energy division which sets up power grids, providing or contracting with solar, wind, battery companies.
    Their bread and butter legacy has been big dirty fuel oil engines for ocean going vessels,
    and near shore. They still sell those, (cleaner), as well as models that use ammonia, ethanol as fuel.
    Their energy grid work specifically sees developing counties as a market, where they can provide the whole package, renewable and conventional, with systems to maximize the efficiency of the mix. Can move quickly to 80% renewable, they say.

    In the most recent (kind of sad) Corp presentation the CEO said their renewable related revenues were about 30% of the total. Developing countries are reportedly more cautious about committing to big projects, citing political uncertainty, trade wars, etc. The marine industry is slow to change. “No orders have been canceled” yet.
    Their sexy new stuff is often still in demo mode or a one off.

    There are some signs of progress in that a number of European ports will soon, 2020 I think,
    go to mandatory low sulphur fuel. (Fuel for ocean going ships has historically been quite dirty).This will make the smoke stack scrubbers Wartsila provides for cutting emissions from dirty fuels obsolete. Moving to a cleaner petroleum based fuel is something, if incremental, and we know fracked gas is not clean when one considers multiple methane leaks at drill sites and the fuel used to transport LNG. (We, of course, must to freeze out Russian nat gas even if more economical. Trump: No new pipeline! Slap!)

    The only reason I know anything about this is that I REFUSE TO OWN MUTUAL FUNDS (or ETFs) because you can’t know what’s in them and I don’t want to subsidize frackers or UBER, etc. There is a great asymmetry of information to contend with so, caveat emptor.
    (I can see the tree tops from my semi-retired financial glide path. So beautiful, but uncomfortably close.)

    There are worldwide efforts to provide practical renewable solutions out there but Trump’s “slap therapy” is gumming up the works to some extent. (Tariffs, bombs, bellicosity.) So much for the USA “leading the world.”

    1. Pym of Nantucket

      Coal has already joined the club of propped up legacies. For oil, using a war to bump up oil prices eventually helps renewables. The price window gets tighter each day: production cost rising from below and alternate energy sources coming down from above.

      But it makes sense that the importers should be driving the electric bus to a zero carbon emitter future. The producers will hang on as the market gets tighter. What choice do they have? That said, we haven’t seen the day when world oil production steadily begins to drop. When that day comes, it will be like a fire in a movie theatre, or the Danny DeVito speech from “Other People’s Money”.

  10. John k

    Cheap gas was the bridge from coal to solar. Thanks, easily scammed foolish investors. Also thanks to low rates that encourage foolish investments.
    Higher gas prices will shorten the bridge.
    It’s all good.

  11. Reify99

    How does the bridge to the “solar-dollar” work?
    Because, it seems to me, that a big reason for the mess we’re in is about controlling access.
    Were the USA able to put up screens in space and extort payment for sunshine I’d be in agreement with you. The bridge would be as short as the time it took to hang the screens.

    As it is, there are way big subsidies for the fossil fuel industry in place. The persistence of fracking proves the point. Inertia, including investor/voter lack of attention, slows down change. Passively.

  12. William Hunter Duncan

    Back in 2012 I called into a Minnesota Public Radio show to respond to an Ivy-league professor extolling the virtue fo fracking and the new era of American Energy Independence. I said on air that fracking had all the hallmarks of an asset bubble, like the tech bubble and the housing bubble before it. I was mocked in that serene way only Ivy-league db’s have, and the oblivious host parroted his talking points.

    I told a gay friend of mine recently that I thought the Trump phenomenon in part, is a shadow response to ecological limits, like one last grasp of global resources before this thing we call modernism starts disintegrating around us. His response was that fracking had given us another 200 years of steady oil. I didn’t have the heart to tell him that he had been told a thing he wanted to believe…

    That said, fracking is like the modern equivalent of a public utility, insofar as it will be propped up until is cannot be propped up anymore, no matter how much money investors lose in the near term (the biggest of whom will surely be made whole with another round of QE).

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