US Shale in 2021: Global swing producers or dead cats bouncing?
Frontispiece: In the last two “super cycles” US Shale has played the role of global swing producer, with higher oil prices leading to higher rig count and shale development and production, leading to action from OPEC to regain market share. The events of March last year were particularly dramatic, with Saudi Arabia taking action to increase supply just as the pandemic began to choke demand. The oil price has gradually been creeping back up since and now with demand approaching pre-pandemic heights, US rig count is on the up. But what will Shale 4.0 look like? A new beginning? Or a dead cat bounce? (Source: with apologies to the Salt Lake Tribune)
Recent oil price rises over $70 has had some pundits ballyhooing about the renaissance of the US shale oil industry and the need for global investment in new developments. I imagine that the petrostates are quite happy with the price heading towards $100, as most of them need $80+ to support their country’s fiscal demands. In previous super cycles US shale has in some ways behaved as a counter-balance or check valve to oil price rises because these higher prices enable more marginal barrels, with higher breakeven costs, to be economic to be developed and produced.
While profit and positive free cash flow haven’t always been familiar words in the lexicon of US shale, the exodus of investors in the period of 2018 to the beginning of 2020 seems to have shown the wiser companies that they need to deliver real returns, and real cash back to shareholders.
What role will US shale play in this cycle?
Figure 1: The US shale supercycles of rig count versus oil price (Data: EIA; Graphic: Capriole Energy).
I have argued previously, that even in the best of oil price times, shale is a risky business model, basically relying on high oil prices to function, but then typically being checked, by contributing to oversupply and price decline, and/or by being outproduced by OPEC as they grab their market share back.
In the turmoil of last year, US rig count fell to a level not seen in three decades, with the most recent low of a similar scale being in the crash of 2015-16 (Figure 1). If shale 1.0 was the drilling (mainly for gas) in the first decade of this century, and shale 2.0 was the move to light tight oil in 2007 to said 2015-16 crash, shale 3.0 was a significantly less spectacular return to growth of US rigs, although total production peaked in this period as developers bludgeoned more and more oil out of the rocks. Shale 3.0 was brought to an end by the events of March 2020; how will shale 4.0 turn out? A new renaissance or a dead cat bounce?
Figure 2: An example of value destruction by US shaleco EOG. (Data: Yahoo Finance; Graphic: Capriole Energy)
The inescapable fact that US shale has been an exercise in value destruction over the last two decades can be illustrated by looking at the financials of any of the players, even the best ones like EOG (Figure 2). In nearly every case, a pattern of outspending operating cash flow by capital expenditure, funded by increasing debt is revealed. For many companies, whether private or publicly held, the burden of debt and negative cash flow is heavy and the price lows of 2020 brought many operators and their suppliers crashing into bankruptcy. High capital intensity, to replace rapidly declining wells, in offset rocks that are not as good at the previous infills, in many cases only accelerating recovery, not adding to reserves all combine to a very inefficient natural resource business. Add to that high emissions intensity and other environmental impacts, leads to a proposition that just isn’t attractive, whether an investor cares about climate change or not.
So I expect Shale 4.0 to be a new peak of rig count and development to follow the valley of death of 2020. Shale will not reach the rig count heights of 2018, let alone 2010. US shale oil production has also peaked for good, and with that the myth of energy independence is exposed.
US shale is in decline, any new high will be a bounce by the dying cat. As I’ve written before, America needs to wake up to the brutal facts that there other critical reasons to get off oil, as well as the need to address climate change.