Giovedì, 4 giugno, 2015
As regularly happens since oil prices started to fall in July 2014, prophesies about the imminent end of the shale oil industry continue to fill the newspapers.
The most recent and resounding attack came from the Lehman Brothers bankruptcy’s predictor, David Einhorn. At the Ira Sohn investment conference in New York on May 4th, he claimed that shale oil producers rely on a trashing business model. According to him, shale companies are playing a kind of a dirty game by overvaluing their effective reserves and referring to bespoke financial metrics, such as the Ebitdax. On the contrary, looking at the traditional metrics, it should be clear how they are just burning cash and inflating a new bubble that could burst at any moment. If investors would like to bet on price recovery, they had better buy oil.
Soon after, Saudi Arabia claimed that its oil price strategy is proving successful by deterring investors away from high-cost production, such as the US shale, while EIA forecasted, for the second month in a row, a faster than expected fall of the US shale output. Thus, according to all these statements, a hard rain is going to fall on the fragile and distressed shale oil industry.
However, other points of view seem to tell us a different story. The Saudi claim may just be politically driven and aimed at calming down domestic complaints about its price strategy. Meanwhile, more and more doubts are rising about the accuracy of EIA production data. In a harsh and half-stumbling attack to EIA forecast capabilities, Philip Verleger recently assessed that the energy department is underestimating the current US production. Moreover, the WSJ pointed out how the weekly EIA production data can be tricky, as they mix the reported Alaskan output with a forecasting model for the lower 48 states. Actually, the recently reported 36,000 b/d decline falls within the margin of error of the forecasting model, thus implying that output could even have risen. The deficiency of data collection should improve in the next months, as EIA has received approval from the White House to launch its own mandatory monthly survey. But until then, analysts and investors will lack a key data, such as US shale production.
On the contrary, looking at a more accurate data, such as the rig-count, shale situation seems not so bleak. Goldman Sachs pointed out how the recent slowdown in the rig-count decline, suggests that producers are increasingly comfortable at current prices. Rigs in the Permian Basin have even increased for the first time this year. A picture confirmed by some of the main shale producers, who assess that production could even boost this year if oil prices keep rising. Occidental has already increased planned production for the year; EOG could resume “strong double-digit growth” if WTI stabilises around $65; at $70, Whiting and Pioneer could start to add rigs; Concho, Devon, Continental made similar statements.
Fig. 1 – Capital spending and production changes (FT).
Of course, they may just have an ax to grind, especially after the unpleasant and hard-to-disprove Einhorn stance against them. However, there may be some cattle, besides the hat. Sharp efficiency gains are already taking place, in particular due to the “high-grading” of the drilling programs, while service costs are reducing drastically, by 15%-20% year-to-date. Maybe US shale producers won’t achieve the exact productivity performances projected for this year, but their results could prove to be remarkable anyway. Some even claim that, with a price around $65, shale can now offer the same returns previously seen with barrels at $90.
Cost reduction and productivity gains are the pillars of the shale producers’ unexpected strong resiliency, while fracklog should allow them to react quickly to price signals. Nonetheless, its potential impact is still hazy. The number of drilled, but uncompleted wells (DUCs), vary a lot (2,500-4,000) and it is still unclear how many of them can promptly and effectively come in to production at $65-70. Anyway, DUCs work as a natural oil storage and thus they prove to be a precious asset for the US shale producers.
Even more important for the future of the shale industry are the innovations still yet to come or to be fully deployed. The margins for further efficiency and technological improvements seem still very ample. It is not just about “re-fracking”, “multi-well pad drilling” or “down-spacing”, a continuous flow of innovations keeps flooding the industry. Statoil is experimenting new drilling tools and techniques to improve productivity. GE Oil & Gas is producing a new kind of pump that allows the operator to turn on and off the wells according to price signals. Maybe more noticeable, Liberty is testing an “oil factory” that promises to fully exploit the economies of scale of a vast acreage, by adopting a wide system of pipelines instead of the massive recourse on trucks. An innovation that would improve, not only the economics of shale activities, but also their social acceptability.
The business weaknesses pointed out by Einhorn are real, but so are the efficiency gains, the cost service reduction and the technological progress in oil production. Perhaps not everything has to be thrown away. According to FT’s editor Ed Crooks, the shale evolution looks more like the dotcom boom than Lehman debt bubble. Many companies will likely fall along the way, the industry may survive and grow.
A major role in this, will be played by the consolidation of the industry, that will leave the (shale) ground to the financially stronger companies. The recent announcement of Noble’s acquisition of Rosetta, for $2.1 billion, is just the first of a “flurry of mini-mergers” that may reshape the industry. A wave that may prove to be fruitful also for the investors of the weaker shale oil producers. Especially, if the deals provide a generous 31 per cent premium per share, like the Rosetta one.
Maybe we really are observing a chronicle of a death foretold. But whose death? And when?