The Shale Field’s Walking Dead

December 10th, 2015 by

ABANDONED SHALE OIL FIELDOil prices are at seven-year lows, and falling. OPEC remains resolute in its quest to kill off competition, by pumping as much crude as possible. Russian oil production continues to grow to break new post-Soviet records.

In this petroleum dystopia, the rollicking shale fields of North Dakota, Texas, and Alberta, Canada are just a memory. Many drilling companies are barely hanging on, with just enough cash flow to pay the interest on their debt. There’s no money for exploration, to find new wells as the old ones run out. Wall St. analysts call these shale companies “zombies,” the walking dead of the oil boom

Shale: Life in the Fast Lane

abandoned-gas-well-oilOne reason the collapse in oil prices is hitting the shale fields hardest, is that drilling companies must constantly be drilling new wells. Where a traditional oil well can produce for 20 years or more before becoming uneconomical to run, the average Bakken shale well has a life of less than 5 years. Volume on a shale well drops an average of 72% in the first year, compared to a drop of between 2% and 5% for a traditional well.

This means that those “zombie” drilling companies that can’t fund exploration will be either bankrupt, or default on their debt in a few short years. Credit ratings agency Fitch recently reported that defaults in oil and gas companies are already at the highest levels since 1999.

Days of Easy Money Gone

chasing yieldsAnother reason for so many shale companies becoming the walking dead is that access to cheap money has dried up. When oil was selling for $100 a barrel, projected revenues gave these companies access to a huge line of credit. It also made the yield they had to pay when issuing bonds much lower than normal. Crowds of investors hungry for yield lined up to buy these bonds.

It’s a much different story today. Plunging oil prices have forced shale companies to drastically cut revenue and profit projections. This lower cash flow increases their credit risk, which makes issuing new bonds more costly. Investors who were clamoring for these bonds are now wary of default risks, and are shying away.

Another blow from the rout in oil prices is reduction in the assets of drilling companies, due to the forced writedown of proven reserves. Under accounting rules, companies can claim oil that is still uptapped, but they are reasonably certain can be extracted profitably, as assets.

Billions of barrels of oil that were profitable of exploit at $100 a barrel, are money losers at $45 a barrel. This has a drastic effect on the balance sheets (and credit worthiness) of many shale companies, making it even harder to refinance high yield (aka “junk”) debt that is maturing.

Racing the Red Queen

Oil producers from OPEC to Alberta have been offsetting losses from lower prices by increasing production. But as supply increases, prices fall even more. This leads to more production increases, which depress prices even further.

redqueenThis is what is known as the Red Queen’s Race, from Lewis Carroll’s book Through The Looking Glass. In the story, the Red Queen and Alice are running as fast as they can, just to stay in the same place.

The problem for “shale zombies” is that they’re running out of road. With all revenue going toward servicing debt, there is no money left to replace rapidly depleting wells. Things aren’t going to get better anytime soon. Common consensus is that we won’t see oil above $50 a barrel for another two years.  With the short lifespan of the average shale well, many of these zombies won’t be around to see a new dawn for the dead.

 

The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.