Saudis ‘will not destroy the US shale industry’
By Paul Homewood
More news from the “Stranded Assets Dept”:
AEP writes in the Telegraph:
Hedge funds and private equity groups armed with $60bn of ready cash are ready to snap up the assets of bankrupt US shale drillers, almost guaranteeing that America’s tight oil production will rebound once prices start to recover.
Daniel Yergin, founder of IHS Cambridge Energy Research Associates, said it is impossible for OPEC to knock out the US shale industry though a war of attrition even if it wants to, and even if large numbers of frackers fall by the wayside over coming months.
Mr Yergin said groups with deep pockets such as Blackstone and Carlyle will take over the infrastructure when the distressed assets are cheap enough, and bide their time until the oil cycle turns.
“The management may change and the companies may change but the resources will still be there,” he told the Daily Telegraph. The great unknown is how quickly the industry can revive once the global glut starts to clear – perhaps in the second half of the year – but it will clearly be much faster than for the conventional oil.
“It takes $10bn and five to ten years to launch a deep-water project. It takes $10m and just 20 days to drill for shale,” he said, speaking at the World Economic Forum in Davos.
In the meantime, the oil slump is pushing a string of exporting countries into deep social and economic crises. “Venezuela is beyond the precipice. It is completely broke,” said Mr Yergin.
Iraq’s prime minister, Haider al-Abadi, said in Davos that his country is selling its crude for $22 a barrel, and half of this covers production costs. “It’s impossible to run the country, to be honest, to sustain the military, to sustain jobs, to sustain the economy,” he said.
This is greatly complicating the battle against ISIS, now at a critical juncture after the recapture of Ramadi by government forces. Mr al-Albadi warned that ISIS remains “extremely dangerous”, yet he has run out of money to pay the wages of crucial militia forces.
It is understood that KKR, Warburg Pincus, and Apollo are all waiting on the sidelines, looking for worthwhile US shale targets. Major oil companies such as ExxonMobil have vast sums in reserve, and even Saudi Arabia’s chemical giant SABIC is already nibbling at US shale assets through joint ventures.
Mr Yergin is author of “The Prize: The Epic Quest for Oil, Money and Power”, and is widely regarded as the guru of energy analysis.
He said shale companies have put up a much tougher fight than originally expected and are only now succumbing to the violence of the oil price crash, fifteen months after Saudi Arabia and the Gulf states began to flood the global market to flush out rivals.
“Shale has proven much more resilient than people thought. They imagined that if prices fell below $70 a barrel, these drillers would go out of business. They didn’t realize that shale is mid-cost, and not high cost,” he said.
Right now, however, US frackers are in the eye of the storm. Some 45 listed shale companies are already insolvent or in talks with creditors. The fate of many more will be decided over the spring when an estimated 300,000 barrels a day (b/d) of extra Iranian crude hits an already saturated global market.
Shale hedges on the futures markets – a life-saver in the early months of the price collapse – are largely exhausted. IHS estimates that hedges covered 28pc of output in the second half of last year for the companies it covers. This will fall to 11pc in 2016.
The buccaneering growth of the shale industry was driven by cheap and abundant credit. The guillotine came down even before the US Federal Reserve raised rates in December, leaving frackers struggling to roll over loans. Many shale bonds are trading at distress level below 50 cents on the dollar, even for mid-risk companies.
If the price of oil returns to a range between $50 and $60, this will bring back a lot of production
Banks are being careful not to push them into receivership but they themselves are under pressure. Regulators fear that the energy industry may be the next financial bomb to blow up on a systemic scale. The Fed and the US Federal Deposit Insurance Corporation have threatened to impose tougher rules on leverage and asset coverage for loans to fossil fuel companies.
Yet even if scores of US drillers go bust, the industry will live on, and a quantum leap in technology has changed the cost structure irreversibly. Output per rig has soared fourfold since 2009. It is now standard to drill multiples wells from the same site, and data analytics promise yet another leap forward in yields.
“$60 is the new $90. If the price of oil returns to a range between $50 and $60, this will bring back a lot of production. The Permian Basin in West Texas may be the second biggest field in the world after Ghawar in Saudi Arabia,” he said.
Zhu Min, the deputy director of the International Monetary Fund, said US shale has entirely changed the balance of power in the global oil market and there is little Opec can do about it.
“Shale has become the swing producer. Opec has clearly lost its monopoly power and can only set a bottom for prices. As soon as the price rises, shale will come back on and push it down again,” he said.
The question is whether even US shale can ever be big enough to compensate for the coming shortage of oil as global investment collapses. “There has been a $1.8 trillion reduction in spending planned for 2015 to 2020 compared to what was expected in 2014,” said Mr Yergin.
Saudi Arabia’s oil minister Ali al-Naimi
Yet oil demand is still growing briskly. The world economy will need 7m b/d more by 2020. Natural depletion on existing fields implies a loss of another 13m b/d by then.
Adding to the witches’ brew, global spare capacity is at wafer-thin levels – perhaps as low 1.5m b/d – as the Saudis, Russians, and others, produce at full tilt.
“If there is any shock the market will turn on a dime,” he said. The oil market will certainly feel entirely different before the end of this decade.
The warnings were widely echoed in Davos by luminaries of the energy industry. Fatih Birol, head of the International Energy Agency, said the suspension of new projects is setting the stage for a powerful spike in prices.
Investment fell 20pc last year worldwide, and is expected to fall a further 16pc this year. “This is unprecedented: we have never seen two years in a row of falling investment. Don’t be misled, anybody who thinks low oil prices are the ‘new normal’ is going to be surprised,” he said.
Ibe Kachikwu, Nigeria oil minister and the outgoing chief of Opec, said the ground is being set for wild volatility.
“The bottom line is that production no longer makes any sense for many, and at this point we’re going to see a lot of barrels leave the market. Ultimately, prices will shoot back up in a topsy-turvey movement,” he said.
Mr Kachikwu said Opec needs to call an emergency meeting to sort out what the purpose of the cartel now is.
Saudi Arabia has made it clear that there can be no Opec deal to cut output and stabilize prices until the Russians are on board, and that is very difficult since Russian companies are listed and supposedly answerable to shareholders.
Besides, the Gulf states are convinced that Russia cheated last time there was an accord in 1998.
Mr Yergin said those hoping for a quick rescue from Opec are likely to be disappointed. “This is only going to happen if the crisis gets even worse,” he said.
1) One of the factors AEP does not mention is the issue of marginal, or variable, costs. Whilst many oil fields may not be bringing in enough revenue to cover TOTAL COSTS (ie incl fixed and capital costs), they are making enough to cover MARGINAL COSTS. It therefore makes economic sense to continue pumping, as they will lose more money if they don’t.
2) US shale operators are particularly vulnerable to the inability to cover fixed and capital costs, as many borrowed money to fund these. If they cannot afford to pay back these loans, they will eventually go under.
3) However, while this may cause a lot of anguish on US bond markets, as AEP says, the oil is still there. This is where the hedge funds come in. They can buy up distressed assets at rock bottom prices, cap the wells, and be able to quickly resume pumping as soon as prices rebound.
4) As I think I commented a few weeks ago, low oil prices have already led to big cut backs in investment in new drilling. This will inevitably lead to shortages in a few years time, prices will rise, and the whole cycle will start again.
5) Interesting to note AEP’s comment “Yet oil demand is still growing briskly. The world economy will need 7m b/d more by 2020”. Does not sound much like a stranded asset to me!