Shale-oil has gotten a lot of the blame for oil prices plummeting from $100 highs to $30 lows per barrel. How exactly did the US wind up with so much unexpected output and what is happening to the nascent fracking industry now?
US shale-oil producers rely on hydraulic fracking to access oil too expensive to access with traditional drilling techniques. The realization that largely untapped resources were up for grabs in a time when oil prices were 300% higher than they are now led to aggressive speculation. A quote from Daniel Yergin of IHS Cambridge Energy Research sums up how this was possible: “It takes $10 [billion] and five to ten years to launch a deep-water project. It takes $10 [million] and just 20 days to drill for shale.” In other words, shale drilling requires a fraction of the time and capital of other high-cost extraction projects. Combined with an abundance of deposits in the US, the method has exploded in popularity within our capital-rich nation.
Oil prices have been below profitable levels for most shale-oil producers so when and how will oil output start dropping? Well, in spite of shale drilling being cheaper than offshore drilling, traditional onshore drilling methods are still the lowest-cost method making it a certainty that drops will have to come from the less established shale-exclusive companies. The EIA is forecasting a decline of 700,000 barrels per day in US oil production for 2016, and 300,000 in 2017. This drop primarily driven by bankrupt shale-oil producers and general cutbacks in investment throughout the US oil-and-gas industry. But even as companies go under, private-equity equity firms are prepared to snatch up the best assets those exiting have to offer.
Individual firms, both small and large, are under significant pressure as oil and gas prices are set to stay below $40 for the better part of 2016. With low prices causing oil-related assets to drop in value, even companies like Shell are having trouble explaining acquisitions like BP Plc to shareholders who fear the effects a lower-for-longer environment would have on dividends and growth. Credit rating agencies are similarly skeptical of the prospects of oil producers. S&P has already downgraded Chevron and Shell, and Exxon is one of many others on credit watch over poorly performing investments and weak incomes. For the hundreds of energy companies struggling with debt burdens, the downgrades hitting most the industry only add to their pain. Poor returns for oil will at least keep the M&A teams of the industry busy as drilling investment money shifts towards buying up distressed rivals so companies can hold more reserves, a key indicator of a companies ability to grow. The longer the glut continues, the more companies will be forced to accept lower valuations from buyers.
No matter what happens to individual firms, fracking technology is only going to improve and spread. If Saudi Arabia’s attempt to force back the tide of shale-oil by resisting production cuts worked for now, then it is only a temporary victory against a many-headed hydra. For every company lost to low prices, two or more will replace it as soon as prices recover.