Why Is The Shale Industry Still Not Profitable? by Nick Cunningham, January 29, 2018, Oil Price
“Echoing the criticism of too much hype surrounding U.S. shale from the Saudi oil minister last week, a new report finds that shale drilling is still largely not profitable. Not only that, but costs are on the rise and drillers are pursuing “irrational production.”
Riyadh-based Al Rajhi Capital dug into the financials of a long list of U.S. shale companies, and found that “despite rising prices most firms under our study are still in losses with no signs of improvement.”
The average return on asset for U.S. shale companies “is still a measly 0.8 percent,” the financial services company wrote in its report.”
Moreover, the widely-publicized efficiency gains could be overstated, [Of course! How else do you con investors, harmed communities and the public?] at least according to Al Rajhi Capital. The firm said that in the third quarter of 2017, the “average operating cost per barrel has broadly remained the same without any efficiency gains.” Not only that, but the cost of producing a barrel of oil, after factoring in the cost of spending and higher debt levels, has actually been rising quite a bit.
Shale companies often tout their rock-bottom breakeven prices, and they often use a narrowly defined metric that only includes the cost of drilling and production, leaving out all other costs. But because there are a lot of other expenses, only focusing on operating costs can be a bit misleading.
The Al Rajhi Capital report concludes that operating costs have indeed edged down over the past several years.
However, a broader measure of the “cash required per barrel,” which includes other costs such as depreciation, interest expense, tax expense, and spending on drilling and exploration, reveals a more damning picture.
Al Rajhi finds that this “cash required per barrel” metric has been rising for several consecutive quarters, hitting an average $64 per barrel in the third quarter of 2017. That was a period of time in which WTI traded much lower, which essentially means that the average shale player was not profitable.
Not everyone is posting poor figures. Diamondback Energy and Continental Resources had breakeven prices at about $52 and $37 per barrel in the third quarter, respectively, according to the Al Rajhi report. Parsley Energy, on the other hand, saw its “cash required per barrel” price rise to nearly $100 per barrel in the third quarter.
A long list of shale companies have promised a more cautious approach this year, with an emphasis on profits. It remains to be seen if that will happen, especially given the recent run up in prices.
But Al Rajhi questions whether spending cuts will even result in a better financial position. “Even when capex declines, we are unlikely to see any sustained drop in cash flow required per barrel … due to the nature of shale production and rising interest expenses,” the Al Rajhi report concluded. In other words, cutting spending only leads to lower production, and the resulting decline in revenues will offset the benefit of lower spending.
All the while, interest payments need to be made, which could be on the rise if debt levels are climbing. [Just ask Aubrey McClendon CEO of Chesapeake, oops, can’t chase and try to ask him anymore]
One factor that has worked against some shale drillers is that the advantage of hedging future production has all but disappeared. In FY15 and FY16, the companies surveyed realized revenue gains on the order of $15 and $9 per barrel, respectively, by locking in future production at higher prices than what ended up prevailing in the market. But, that advantage has vanished. In the third quarter of 2017, the same companies only earned an extra $1 per barrel on average by hedging.
Part of the reason for that is rising oil prices, as well as a flattening of the futures curve. Indeed, recently WTI and Brent have showed a strong trend toward backwardation [Perfect word summing up trying to make money frac’ing!] — in which longer-dated prices trade lower than near-term. That makes it much less attractive to lock in future production.
Al Rajhi Capital notes that more recently, shale companies ended up locking in hedges at prices that could end up being quite a bit lower than the market price, which could limit their upside exposure should prices continue to rise.
In short, the report needs to be offered as a retort against aggressive forecasts for shale production growth. Drilling is clearly on the rise and U.S. oil production is expected to increase for the foreseeable future. But the lack of profitability remains a significant problem for the shale industry. [Emphasis added]
Lack of profitability is likely why Canadian drillers head to the USA:
Some comments to the Financial Post article:
Phil LeGood
I’m not sure what FP’s insinuating here, but if they think this is new, Canadian drilling rigs moving south, it’s not. Even when oil prices were well above current price 10 years ago there were more than 60 rigs from one company in Canada working in North Dakota.
Phil LeGood
In the US according to Baker Hughes stats on rotary drill rigs as of this week there are still a substantial number of US drilling rigs sitting idle. There are just as many oil rigs sitting idle in the US as there are in operation. Since oil prices are rising so is the price for rigs. Could the desire for Canadian rig owners to head south have more to do with the CDN dollar advantage and higher prices paid for rigs than supposedly adverse drilling opportunities in Canada? I think so. Both the US and Canada rigs are sitting idle due to oil price but also flat consumption demand in North America. [and likely also debt problems and lack of profitability]