Insane Policy Driving Stupid Money to Fuel Tight Oil Boom
A recent post by Art Berman suggesting that the Saudi strategy of increasing production and keeping oil prices low is not so much a way to nudge out the shale oil producers but to protect market share. The oil glut is rather a case of stupid money pouring into the tight oil patches allowing them to over-produce.
The article also brings different perspectives as a way to illustrate the relative significance of shale oil as measured by conventional metrics.
Production and capex of oil extracted from different operating environment (source: Schlumberger)
One such perspective is an interesting illustration from Schlumberger which packs quite a few metrics on oil extracted from different types of operating environments, including the breakeven prices, relative amounts of capital expenditures (capex) required and their respective contributions to the overall oil supply. A few points of note:
- The breakeven price of shale oil around $75 a barrel versus about $10 and $20 for the Middle East and other conventional producers, respectively. Shale oil ain’t cheap.
- Shale oil is a minor contributor (5%) to the overall global supply.
- The relative large amount of capex (size of circle) spent by shale oil companies in extracting that 5% of oil, compared to the small amount spent by the Middle Eastern producers to get 25% of the global production.
Another diagram, also courtesy of Schlumberger, highlights the drilling intensity of various producers. The three top oil producers, namely, Saudi Arabia, Russia and the US, produced roughly the same amounts of liquids in 2014. The difference is stark, however, when it comes to the number of wells drilled to lift about the same number of barrels of oil out of the ground. Whereas the Saudis drilled 400 wells and the Russians 8,688, it took the US 35,700 or almost 90 times the number of wells to achieve the same daily production volume.
In other words, a huge amount of efforts and a ton of money literally drilled into the ground for a relatively tiny amount of oil compared to other operating environments.
Which goes back to the inconvenient question of whether the shale oil business model is viable at $75, let alone the recent price range in the $50s. Which leads, again, to the question of how it was made possible?
(Click for larger image)
A glance at the cash flows and capex from the universe of tight oil weighed E&P companies, as illustrated from the table above, reveals a pretty sad picture. Collectively the industry had been suffering from negative cash flow (revenue less capex) for the past few years, culminating in a dive deep into negative cash territory in 2014 when the oil prices plunged. Together these companies burned more cash than they generated from revenue to the tune of $21 billion in the past four years.
How was it made possible? Again, failed central bank (Fed) policies suppressing interest rates to near zero, forcing yield-starved but otherwise prudent investors to buy equities and junk bonds issued by the risky E&P companies cheered on by the investment banks. Hedge funds and pension funds alike are starting to have a first taste of haircuts and equity wipeouts as these companies begin to default on their payments. For those companies who are teetering on bankruptcy but are not quite dead yet, hail-Mary passes are being attempted as they desperately try to raise additional cash with increasingly unfavorable terms in order to survive, existing and now severely diluted equity investors and hair-cut bond holders be damned.