The financial state of the US shale oil industry is much worse than the still impressive production figures would lead us to believe, writes energy expert Jilles van den Beukel, a former geophysicist with Shell. Shale oil producers and investors have managed to postpone the day of reckoning, but the fundamentals of the industry make a shake-out inevitable.
To assess the prospects of the US shale oil sector, it is important to understand that shale oil is fundamentally different from conventional oil production in important ways.
Firstly, shale oil requires continuous drilling as the production of wells declines rapidly (with typically about 50-60 % of production during the first year of production).
Secondly, shale oil requires the drilling and fracking of many wells that are very similar in design. Like other industries that involve oft repeated processes, the shale oil industry has become very efficient at this. It is more similar to the manufacturing industry than conventional oil.
The steep rise in US shale oil production, and subsequent drastic cost reductions, have no doubt been a major achievement, but the US shale oil industry now seems as competitive as it can possibly be, at least in the short term
Thirdly, whereas conventional oil is mostly about finding oil in the first place, shale oil is rather about finding those places where the oil can actually be produced at commercial rates. Oil in the Bakken for instance was already discovered in the 1950s. Within a single play the EUR (estimated ultimate recovery) per well is highly variable. The key to success therefore is finding the sweet spots, with systematically higher EUR’s. Even within a single sweet spot area well performance is highly variable, however. So far the industry has not been very successful in predicting sweet spots. As a result, it takes many wells before sweet spots (which may be the only places where commercial production can take place) can be located with some confidence. Hundreds of wells are needed to properly evaluate the play. Subsequently many thousands of wells are needed to produce.
As a result, in each play different areas have highly variable break-even oil prices. For the Bakken, for instance, the break-even oil price ranges from about $25–100 per barrel (at current cost levels). For the larger companies the average breakeven price currently ranges between about $40 and $70 per barrel. Ranges for the other plays are not markedly different.
The rapid increase in shale oil production would not have been possible without the easy money that was readily made available during the 2010-2014 period
The best areas with a break-even oil price below $30 per barrel are very small, however (about 1% of the total Bakken area) and are already starting to deplete. They could be depleted in approximately 5-10 years at current production rates. [Intense drilling at increasingly smaller distances implies that wells increasingly interfere with each other.] This means that further technological advances are needed to sufficiently lower the breakeven price in the next best areas. It is quite possible that this will happen – but by no means a given.
Productivity gains
Throughout the years, the shale oil industry has seen impressive gains in efficiency and productivity. Two different sets of factors come into play here. The first relates to our increased geological knowledge (resulting in a better delineation of the most productive areas) and increased efficiencies and knowledge in drilling (longer horizontal well productive sections, faster drilling) and fracking (larger number of fracs per well, larger fracs). It seems likely that these factors (which should be sustainable in a potential future high oil price world) had reached a plateau by 2014.
The second set of factors relates to the current low oil price world in which companies are making an all-out effort to survive. This involves a much more increased focus on the most highly productive areas (whilst suspending activities in all other areas), the continuation of these more limited activities with only the best performing rigs and fracking crews and the overall decrease of service industry costs and rig rates. The majority of advances in the last 2 years seem to come from this second set of factors.
After a prolonged period of cut-throat competition between service providers this second set now seems to have reached a plateau as well. EIA monthly drilling reports suggest that the added production per Bakken rig is about to reach a plateau.
The steep rise in US shale oil production, and subsequent drastic cost reductions, have no doubt been a major achievement, but the US shale oil industry now seems as competitive as it can possibly be (at least in the short term – even for a mature industry further technological breakthroughs in the long term cannot be ruled out).
Financial
Most US shale production comes from smaller, independent companies that lack the financial robustness of the larger companies that dominate conventional oil production. Compared to these larger companies they rely to a greater extent on bonds and asset backed lending and to a lesser extent on equity. US corporate bonds in the energy sector rapidly increased to about $800 bn (an increase that abruptly stopped in late 2014). The rapid increase in shale oil production would not have been possible without the easy money that was readily made available during the 2010-2014 period.
Virtually all US shale producers are currently cash flow negative. Even in the 2010-2014 high oil price world, however, most US shale oil producers were already cash flow negative. Apart from higher costs and lower well recoveries at the time, this was primarily due to the money spent on acquiring leases and building infrastructure.
With regard to costs, a distinction needs to be made between full cycle cost (which also includes the costs of acquiring leases) and half cycle cost (including drilling and fracking costs but excluding leases). As long as oil prices stay above half cycle costs there is an incentive to keep on drilling, in order to minimise losses.
Adapting to a low oil price world
The resilience of US shale oil production in 2015, following the dramatic fall in the oil price, has surprised many analysts. Production declined later and less than expected. From a peak of 5.6 mb/d in March 2015, shale oil production had fallen by no more than 0.6 mb/d by the year end. As regards the major plays, production has been the most resilient in the Permian and the least resilient in the Eagle Ford. No massive wave of company bankruptcies has materialised.
On the technical side, there has been an increased focus on the best producing areas. Activities in poorer producing areas have been much reduced or stopped. Rigorous cost cutting has taken place throughout the industry. A significant part of the 2015 shale oil production had been hedged (for approx 50% of production of smaller companies, for prices anywhere in between $60 and 100 per barrel). Hedging contributed to over 30% of revenue in US shale oil in 2015. Hedging of 2016 production at attractive prices is much less prevalent.
Shale oil producers and their financiers are trying to sit out the current low oil price world – something that is becoming increasingly more difficult
For many producers, in order to minimise losses, it still makes sense to drill (as long as the oil price stays above half cycle costs). In some cases, producers are forced to drill in order to keep their leases. For some companies with lower quality assets (half cycle cost greater than oil price) it makes sense to stop operations entirely. These companies (known in the industry as “zombies“) are trying to survive without any drilling or fracking of new wells, just waiting for the oil price to recover.
The key factor in the resilience of US shale oil production has been the continuation of funding. No additional money is flowing into the US shale industry but the existing money has not been (and cannot be) taken out. During the last round of loan extensions and associated reserves re-determinations in October 2015 banks were only able to cut funding limits by a small amount (although in some cases they were able to raise interest rates substantially). Bankruptcies and asset fire sales are in no one’s interest in the current low oil price world. Hence the tendency to be rather lenient regarding loan extensions. Both shale oil producers and their financiers are trying to sit out the current low oil price world. Covenants for the extension of funding are being re-negotiated with minimal publicity.
Overall the financial state of the US shale oil industry is much worse than the resilience of production would lead us to believe. Few bankruptcies have materialised so far but share prices have gone down significantly (often by as much as 90%). The yield of the Bank of America Merrill Lynch US energy high yield bond index has climbed to close to 20%. The average high yield US energy bond has slid to 56 cents on the dollar.
Easy money enabled the rise of the US shale oil industry in the 2010-2014 period. It kept it alive in the following low oil price world in 2015. Now, what will happen next?
Looking ahead
Oil prices have been close to $30-$40 per barrel during the first months in 2016. The short-term outlook is highly uncertain. Global supply is only expected to become in line with demand in 2017/2018 as the drastic investment cuts in non shale oil take time to materially affect supply.
Oil prices this low will contribute to making 2016 a much more difficult year for shale oil producers than 2015. Hedging at attractive prices is no longer possible. More companies will suspend activities. The drop in the rig count has picked up again and the 2016 drop in shale oil production could be greater than the 0.6 million barrel/day 2015 drop.
It is in the financiers’ interest to continue and aim for a soft landing once oil prices pick up. But will regulators let them?
Shale oil producers and their financiers are trying to sit out the current low oil price world – something that is becoming increasingly more difficult. Financially more robust larger oil companies and private equity are waiting for bankruptcies, looking to pick up the shale oil producers’ core assets in sweet spots at rock bottom prices (much more attractive than taking over financially distressed shale oil producers and having to pay off their debts in full).
The key question is whether the next phase of loan extensions and reserve redeterminations in April 2016 will be as lenient as the preceding one in October 2015. It is in the financiers’ interest to continue and aim for a soft landing once oil prices pick up. But will regulators let them? And even if regulators let them: will the current situation start to undermine trust in financial institutions? Bankers may try to reassure us, claiming that the importance of the energy industry to the overall economy has diminished and that moreover these loans are backed by assets. These assets are worth much less, however, in the current low oil price world. Worldwide the level of debt of the energy industry stands at a record high of $2.5 trillion at a time that the value of assets backing these loans stands at a record low. The day of reckoning may be postponed but one day it will come.
Editor’s Note
Jilles van den Beukel worked as geologist, geophysicist and project manager and lastly as Principal Geoscientist for Shell in many parts of the world. In March 2015, he resigned to become a freelance traveller and author. This article was first published on his blog Jilles on Energy and is republished here with permission from the author.
Aloysius Fekete says
A very informative article, thank-you.
There is push among some quarters of Europe to start fracking, I’m thinking about the UK and Poland. Given your analysis and the US experience, what are the prospects of fracking here in Europe?
Jilles van den Beukel says
I cannot see this happen in Europe (or at least not in Western Europe).
Technically, fracking in Europe is certainly possible (and it has been done for a long time). But not with the low cost as it is done in the US. Europe lacks the critical mass of activity needed to get costs down.
Environmentally, the sheer amount of activities and the size of the environmental footprint (many drilling locations, a lot of heavy transport) will make this very difficult in densely populated Western Europe. Personally, I find this to be the key issue. Fracking can be done safely – but I think we can not accommodate US levels of activities in densely populated areas in Western Europe.
Politically, the fossil fuels industry lacks the support needed to get this of the ground.
Geologically, there are no obvious plays as good as the major US plays (such as the Vaca Muerta in Argentina or the Bazhenov in Russia). They may be there but establishing them and identifying sweet spots will require a lot of drilling activity.
If anything comes of the ground I would say it will be shale gas in Eastern Europe. They have a stronger political incentive (reduce dependency on Russian gas) and in less populated areas it will be easier to accomodate a large environmental footprint.
Nick Grealy says
Thanks Jilles.
I think in Europe we’ll need to develop shale with European characteristics. It won’t look like the Bakken or Bazhenov becuse it’s crowded, but it the current drilling in Pennsylvania and Ohio can provide a better analogy. Both of them, especially the Ohio Utica, have developed with a far smaller footprint better suited to more crowded areas. We have a history of drilling in some areas that is relatively benign, as the Netherlands has already proved. The UKs Wytch Farm and the Beverly Hills oil field both provide examples of productive plays in difficult areas, and their examples are from well over 20 years ago.
The international hydrocarbon industry has been equal to the challenge of production in very difficult terrain: Arctic, Jungles, deserts etc. Horizontal drilling can be especially useful above ground in Europe. Technically , long horizontals work offshore Qatar, Sakhalin and Wytch Farm. Perhaps they can in Paris, Lower Saxony and brownfield UK too.
Problems can often be solved by looking at them from a slightly different perspective, and the best technology now coming out of the US can help.
Europe has several advantages. License areas are much larger is one example but the top two reasons play to Europe’s two gas advantages compared to the Bakken and Bazhenov oil plays. Europe has customers and take away capacity already in place is the first: monetizing any plays is far easier when the mid stream capacity will barely need to exist. But the other key difference is markets. Both NBP and Eurohub prices have a natural, and permanent, basis to Henry Hub that will always exist. European shale won’t need to have mega fields to make mega money for those who can grasp how important monetization is.
In a world of multiple stranded assets, Europe’s markets, like real estate is all about location, location, location
Jilles van den Beukel says
Nick,
I do agree there should be a place for limited activity / limited footprint fracking activity in Western Europe. I am not optimistic about the level of political support though.
Xiaoming Li says
But UK government now gave a yes to fracking in its land these days.
oncfari says
This so-called “recovery” is not a recovery at all — just a blip on the radar. All of the long-term fundamentals point to a sustained decline in oil prices caused primarily by the current and projected future inventory glut, probably at least through most/all of 2017, barring some geopolitical incident such as an oil embargo, etc.
On the shale front, these companies have $billions in sunk costs that will not be recovered/recoverable until/unless oil prices rise substantially, which is highly unlikely in the short term (see above). Therefore, they will continue to produce where the bulk of fracking costs are already committed, but reductions in credit facilities (caused by the lowered future production outlook) will eventually curtail that activity as well since OPEC has no incentive to (or intention of) let prices rise enough to make US shale production profitable.
Seth says
This article is more wishful thinking about the never-ending impending shale collapse. The real story is the amazing resilience of shale with production down only around 10 percent trailing 12 months after prices have dropped by more than 60 percent. Shale keeps getting cheaper and cheaper and acts as a permanent boot crushing the lost dreams of the destroyed organization known as OPEC.
Meanwhile, Europeans continue to burn coal because they think fracking is dangerous!
Jilles van den Beukel says
I do not think there is an impending shale collapse. Shale oil production is there to stay. Individual shale oil producers perhaps not. Some will go bankrupt; those that survive will not do so without substantial pain for their shareholders and bankers. This is a technical success story but not a financial one.
Shale oil has been getting cheaper and cheaper, indeed. There, I expect that we have now reached a plateau and that shale oil is as competitive as it can possibly be (at least in the short term). Time will tell…
It is regrettable that much of the public debate on fracking in Europe is taken over by the fear mongerers on safety. Yet I cannot envisage fracking on the scale that it is happening in say the Bakken in my country of The Netherlands with an average population density of about 400 people per square kilometer.
Seth says
Jilles,
Thank you for the measured response, and as someone who has spent a lot of time in the Netherlands, I agree that your wonderful, densely-packed country is a bad choice for onshore fracking.
Fracking advances (equipment, techniques, big data, etc) is, if anything, accelerating and there are areas in the Permian basin that are profitable at $30 a barrel. I would equate the state of fracking (which has been going on for more than 150 years with computer technology in the 1990s.
“Today’s hydraulic fracturing technologies can trace their roots to April 25, 1865, when Civil War veteran Col. Edward A. L. Roberts received the first of his many patents for an “exploding torpedo.”
I do have an issue with your headline:
“US shale oil: the day of reckoning will come.”
I don’t think so! Certainly, OPEC’s day of reckoning has come and gone. It’s just amazing that us Americans who thumbed their noses at the Kyoto Protocols, now emit far fewer particulates than Europeans, with their bizarre aversion to fracking, their love of Volkswagen diesels, and of course heavy use of U.S. coal and wood pellets coming through Rotterdam.
“But behind the green growth is a filthy secret: In a nation famous for its windmills, electricity is coming from a far dirtier source. Three new coal-fired power plants, including two here on the Rotterdam harbor, are supplying much of the power to fuel the Netherlands’ electric-car boom.”
https://www.washingtonpost.com/world/electric-cars-and-the-coal-that-runs-them/2015/11/23/74869240-734b-11e5-ba14-318f8e87a2fc_story.html
Aloysius Fekete says
Fact check: “It’s just amazing that us Americans who thumbed their noses at the Kyoto Protocols, now emit far fewer particulates than Europeans…” – False
The Kyoto Protocols dealt specifically with GHG emissions, not particulates. The implication of this statement is that the US has lower emissions in general which is false on every relevant measure: energy intensity, carbon intensity and total emissions. Europe has lower emissions than the US both in absolute terms as well as per capita.
https://www.eia.gov/cfapps/ipdbproject/IEDIndex3.cfm?tid=92&pid=46&aid=2
https://www.eia.gov/cfapps/ipdbproject/IEDIndex3.cfm?tid=91&pid=46&aid=31
https://www.eia.gov/cfapps/ipdbproject/IEDIndex3.cfm?tid=90&pid=44&aid=8
Jilles van den Beukel says
Seth,
Thanks for your response and the link to an interesting WP paper.
On fracking advances:
I have the impression that, in the short term, the EUR of new wells for a given area in e.g. the Bakken has leveled of. But that is not an easy call to make. The EIA data I looked at when writing this paper concerned initial production for all Bakken wells lumped together. There are effects here of high grading (going for the sweet spots only) and production stategy (some operators may choke back initial production / hedge more attractive 2017 prices; others may install early ESP’s and maximise initial production as much as they can). Upon publishing this paper the site shaleprofile.com (by my fellow Dutchman Enno Peters) was brought to my attention. This site contains up-to-date information about the shale oil production in the major shale oil basins in the US, and production can be split out for different operators/counties/formations. Really usefull! Taking only those counties with the highest initial production rates in the Bakken (so taking out or at least reducing the effect of high grading) then initial production seems to have leveled of as early as 2014. Need to have a more in depth look at this.
I am curious about long term future fracking advances. I just don’t know. Perhaps there will be more focus on re-fracking of existing wells, or increasing recoveries in old fields / plays like the Permian? Can we better delineate sweet spots with seismic methods? I would be interested in links to review papers on potential future fracking advances.
On emissions:
I think the best thing about European emission policies is that it has created an enormous demand for renewables that has really helped in reducing prices (especially for solar). If that is now followed by a similar reduction in cost of energy storage then we are getting somewhere..
I think the worst thing about European emission policies is that it has spent an enormous amount of money with very little to show for in terms of reduction of global CO2 emissions in the short term. I am not going to defend new coal plants..
Seth says
Jilles,
I really appreciate your thoughtful replies. Here’s a link covering new fracking approaches.
http://oilprice.com/Energy/Natural-Gas/New-Fracking-Technology-To-Bring-Huge-Supplies-Of-Oil-And-Gas-To-The-Market.html
Charlie welsh says
I agree with Seth – as I read this article an image of the author took shape in my mind: a continental European wearing sandals with a pony-tail etc
This image was virtually confirmed when I read the editor’s note, that jilles had resigned to become a freelance traveler,…
Meanwhile the strategic benefits to the USA of not being reliant on OPEC producing nations that so openly hate this country are condicuously absent – possibly because such a positive outcome is inconceivable to anyone living in Europe
The glass is half-full Jilles, not half-empty!
Aloysius Fekete says
We would all be more interested in any substantive arguments you might have rather than personal attacks. Or perhaps you don’t have any.
To be fair, the author has made no value judgements on fracking and merely presented a well-supported view on the underlying economics.
Charlie Welsh says
I would classify the billions of dollars US taxpayers spend every day to facilitate global energy security by, among other things, ensuring the Suez Canal remains open, as ‘substantive’
I have no idea whether you, Aloysius, are contributing towards global energy security in the form of blood or treasure; however judging by the fact that you have also overlooked this important factor, I’m guessing you don’t
Jilles presents a compelling view and even though it seemed to me that he had a set agenda from the first graff, I’d rather not side-track the feedback and commentary with petty sniping
If my criticism was perceived to be gratuitous, I hope that you will come to see that it was meant to be constructive – focus on what I wrote, not how I wrote it and I in turn will try going forward to avoid making what you described as a ‘personal attack’
Jilles van den Beukel says
Charlie,
I would love to still have enough hair to be able to have a pony-tail (not that I would want one). Somehow, I have lost that in my 30 years in the industry. I would like to think that in those years I learned most about the oil industry in Texas and that I learned most about mankind in Africa.
Of course I see the benefits of shale oil and gas for the US. Energy independence. Low gas and electricity prices for the industry. That is not the subject of this paper. I wrote this paper to adress the fascinating combination of a technical success story and a financial (near-)disaster.
Larry says
Apparently these guys have a personal tie to fracking and are letting that cloud their judgement of your article.Your assessment is accurate and if they follow the oil patch they know that with a rise in oil prices there will be a surge in completed wells coming online,but this increase in production will drop quickly (the life of a frackers well being much shorter than a conventional well).By this time they have driven the price of oil back down a bit and then they won’t have the financing to go full tilt at drilling again.I think at that time there will be a spike in oil prices due to an overall dramatic drop in oil production.
Seth says
Larry, that is intellectually weak to claim that anyone not agreeing with Jilles has a “personal tie to fracking,” and I guess it’s easier to make a blanket statement than to use facts and and figures to make your own case.
I work for a technology company that has nothing to do with energy, and I own no stocks in oil/gas, which I find (for some reason) very interesting.
Jilles van den Beukel says
That leaves me as the one with “personal ties to fracking”, be it for tight gas wells in the North Sea some time ago, hope this does not cloud my judgement.
Seth says
Jilles, you made that clear upfront and the only concern would be if you’re regularly consuming space cakes. 🙂
Stroopwafels and Chocolade Hagelslag are fine.
Nick Grealy says
This peak oil rubbish is way past it’s sell by date. Fracking is here to stay and if Europeans don’t want to use their shale gas, then they will buy someone elses. It’s mad to buy high carbon low tax gas from someone else, but whoever’s gas or oil it is, it will be lower not for longer, but most likely forever. Stop being threatened by it, and embrace the changes, good and bad.
Aloysius Fekete says
Who said anything about peak oil?
Larry says
Frackers also need to realize that the possibility that if Hillary or Bernie are elected,it could prove disastrous for them.The EPA has been ruinous under Obama and with another Democrat giving them free rein the EPA will go after frackers with both barrels blazing.Pray someone else is elected to stop this nosedive from 30 thousand feet.
Vladimir Ingerman says
There is zero exploration risk development of shale plays because this is source rock. The key to success is finding the sweet spots that are different in the different areas of the same field. Amros technology http://www.amros.us uses standard open-hole log data to calculate a production profile that shows where the recoverable oil is located. It shows operators where to frack vertical wells and where to drill horizontal wells. It is available now.
Hagnismos says
Investment was showing signs of weakening in 2014. I think the shale oil play will implode sooner than we expect and the seemingly va quashed notion of peak oil will be at the top of the news by 2010.