Shale Profits Remain Elusive

This time was supposed to be different.

By Nick Cunningham,

This time was supposed to be different. This year was supposed to be the year in which the U.S. shale industry proved that, after years of frustrating investors, they would finally start dishing out hefty returns after earning stacks of cash.

The International Energy Agency said a few weeks ago that 2018 was shaping up to be a turning point. “Higher prices and operational improvements are putting the US shale sector on track to achieve positive free cash flow in 2018 for the first time ever,” the IEA said.

The industry had succeeded in lower costs so much that they could turn a profit – the thinking goes – even with oil prices trading at around $50 per barrel. The rise in oil prices over the last year was supposed to be an unexpected bonus, definitively pushing drillers into profitable territory.

But a new report from the Wall Street Journal finds that the shale industry is once again coming up short. Using data from FactSet, WSJ found that roughly 50 major U.S. oil producers burned through $2 billion more than they generated in the second quarter. While shale drillers succeeded in lowering costs during the oil market downturn that began in 2014, those efficiency gains have largely been tapped out.

Moreover, beginning last year, a renewed drilling frenzy, particularly in the Permian, has led to a rebound in costs. Many shale executives had promised that the cost efficiencies were structural, locked in, and would not reverse. But that is now looking to be overly optimistic.

The financials “have improved, but they’re not there yet in terms of making money,” Todd Heltman, a senior energy analyst at investment firm Neuberger Berman Group LLC, told the WSJ. “The realization is setting in that it’s going to take longer than investors thought for them to generate free cash flow and deliver more powerful earnings.”

Pioneer Natural Resources, a top driller in Texas, conceded that costs are rising faster than expected. “We’ve had a more significant increase in cost issue than we would have assumed,” Timothy Dove, Pioneer’s CEO, told investors on an earnings call. The company had higher costs for electricity because of hot weather in Texas in May and June. Labor costs also continued to climb higher.

The problem grows worse for Permian producers that have not secured hedges for their oil sales. Higher costs are running up against pipeline constraints, which has led to discounts for oil in Midland in excess of $10 per barrel relative to WTI in Houston.

Costs for sand, water, drilling crews, equipment and other services have all been rising. The WSJ reports that more than a dozen shale companies announced in their second quarter earnings reports that they either would have to spend more to produce the same amount of oil and gas, lowered this year’s production guidance, or they missed second quarter production figures. The WSJ singled out Noble Energy, which revised up its expected spending levels for this year, while conceding that its production would come in at the lower end of its expected range. (On an unrelated note, Noble is also uniquely vulnerable to potential drilling restrictions in Colorado’s DJ Basin that will be put up to a public referendum in November).

The flip side of that is that slower activity could keep cost inflation in check, something that Pioneer’s Timothy Dove tried to tell shareholders. A slowdown in well completions “does not bode well for increases in costs when activity levels are coming down,” Dove said on an earnings call. “And you see some of the big service companies now saying we’re not bringing additional, for example, frac fleets into the basin while margins are not improving any more than they are.”

The slowdown in drilling could ease the pressure, he argues. “And so I think we could have a situation where if we can stagnate oil prices where they are today, we might be able to put more of a lid on service cost increases and cost increases in general in 2019 as compared to this year, just a product of a slowdown in relative completion activity.

But that isn’t a saving grace for companies are that are also cutting back on expansion plans. And when pipelines do come online over the next few years, drilling activity will pick up all over again. Shale companies will rush to work through the backlog of drilled but uncompleted wells (DUCs), which has exploded over the past 18 months, potentially all at the same time. “[T]hat could be another period of inflationary activity to the point where everyone is trying to get their DUC count reduced,” Dove said. “And so I would say the bigger risk inflation-wise is really past 2019. It’s really 2020 and 2021.”

In short, the cost inflation that many in the shale industry had hoped to keep at bay is only getting started. By Nick Cunningham,

“There’s a really big gap between what foreign governments are saying and what companies are saying.” Read…  How Bad Is Iran’s Oil Situation?

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  35 comments for “Shale Profits Remain Elusive

  1. cdr says:

    I’m good with cheap oil. Speculators love higher prices since it appears most like to go long, rather than speculate on volatility. It’s hard to understand pity for those who endure low oil prices. Nice to see competition in natural resources, rather than pricing for all based on the cost of the last barrel. Now, for the price to fall at the pump.

    • raxadian says:

      Is basically a scam that makes shale oil producers flood the market with cheap on so everyone can just ignore that Solar and Wind power are becoming cheaper and cheaper over the years. Coal is basically almost dead, nuclear can only subsist with Government funds.

      Sure oil still has many decades of use left, but the glory days are ending.

  2. Prairies says:

    I don’t think the oil companies in my area of the world were included in the dozen used for WSJ. Service providers were cut to 50% of what rates were 4 years ago, only to see a 10% bump from the beginning of 2018. Oil prices tripled over the last 3 years, but rates went up -45%.

    These companies are dinosaur Tesla models, all speculation. Oil doesn’t just flow from the ground in the west, so it costs a lot of money to force it out. That’s why an old saying in the patch is: “spend money to make money.” They just need to work on their Twitter stock manipulation skills.

    • DV says:

      Good observation. All costs savings came primarily from squeezing vendors, service companies in particular. Those now want their margins back and are talking tough. So if shale drillers want these companies to stay squeezed, they would need to slow down drilling/completions substantially. But can they? It does look like even today what they drill is mostly just to maintain production. The recent increases were primarily in Alaska.

      • Prairies says:

        In our area the oil producers are running out of vendors to squeeze, lately a lot of companies have changed hands for pennies on the dollar. Over the last 4 years they have caused bankruptcies to vendors in an attempt to keep their stock valuations inflated and their bonuses paid. Unless they increase rates they will continue to see low production numbers and fail at increasing their stock value.

  3. drg123 says:

    Midland to Houston is 500 miles. A trailer can hold 250 barrels of oil. Seems like an opportunity for truckers to make money if the premium is ‘in excess of $10/barrel’ for WTI delivered in Houston.

    I think I read somewhere about increased trucking demand. Where did I read that…

  4. Unamused says:

    Our Mr. Cunningham has written about this before:

    Why Is The Shale Industry Still Not Profitable?

    It seems that productivity gains have been, well, overstated.


    How Wall Street Enabled the Fracking ‘Revolution’ That’s Losing Shale Oil Companies Billions

    “How big of a problem is this business of loaning money to an industry burning through billions and burying itself in debt? So big that the CEO of shale company Anadarko Petroleum is blaming Wall Street and asking its companies to please stop loaning money to the shale oil industry.”

    Translation: “Stop us before we drill again!”

  5. OutLookingIn says:

    Banks and loan vendors are now cautiously looking at shale oil companies, in an attempt to determine loan valuation levels. This will spell doom for many smaller oil and gas producers, as credit lines will be reduced and liquidity is withdrawn.
    The dark cloud on the horizon is $775+ millions of bonds that come due in 2020. Many have sunk below 29 cents on the dollar, from 90 cents since the end of last year.
    I suspect the boom to be lowered (pun intended) in October since that is when banks look at collateral to determine each loan valuation level.

  6. Rates says:

    For the shale producers, but for shovel sellers like Caterpillar, shale looks amazing!!! “Here’s more shovel guys. We are raising our estimates for the year!!”

  7. Bill from Australia says:

    What is environmentally suicide ? financial stupidity? morally abhorrent? you got it FRACKING the answer to a question that should not have been asked. FRACKING is at best a ponzy scheme .U.S.A. a global exporter , a self reliant energy nation ,please stop this self flagellation.NO fracking COMPANY MAKES ANY MONEY FULL STOP…

    • Augusto says:

      Bill, I don’t agree, and I worked in the industry and looked at these plays. There is so much potential not yet even touched. What this article fails to understand is that once the infrastructure is in place, these areas will continue to produce for years-to keep the investment alive they will continue to invest. Technology gets better, drilling gets better, cost management gets better by the year. I remember a geologist showing me how there were 12 potential rock formations below the one being fracked, not yet touched. In other words, 12 more areas to potential work once the current formation is exhausted. And what does exhausted mean, we are just starting secondary recovery techniques, field management practices, etc…on those fields being worked. The shale oil/gas part of the business is barely 10 years old. To me, this article is just one of those finance genius analysis-if its not cash flow positive is two years the world comes to an end. You are talking about fields that will produce for 70 or 80 years, maybe longer with technology. Sorry, fracking is not a Ponzi scheme, but I will say there are lots charltons and schemers in the business.

      • Unamused says:

        ->Sorry, fracking is not a Ponzi scheme

        Just a really bad investment that gets worse the more you look at it.

        ->I will say there are lots charltons and schemers in the business.

        Don’t forget the PR flacks. They have to eat too.

      • Night-Train says:

        As a retired petroleum geologist, I remain skeptical of most of the shale plays. Most of them are not ever going to be profitable, unless oil can stay well north of $100 Bob. It just isn’t a reservoir rock by any conventional definition. Geologically, it is a source rock that has to be “manufactured” into a reservoir. True, new tech is developed and always cost more than that it replaces, while not always being cost effective when applied. I could go on and on, but this has all been said before. Oil shale plays for the most part are close to being Ponzi schemes.

  8. Night-Train says:

    Shale promises disappoint again. I’m shocked. Shocked I tell you. Not going to waste time with details. In the oil biz this time is always different. Yet again.

  9. Augusto says:

    I’ve spent half my life in the oil industry and am so tired of these old cliches “we’s not making enough”. There has never been a more profitable industry…management and employees are well paid with great benefits, land owners make money on royalties, the trades do well, not to mention unskilled labor, and lets never forget government. Has there ever been an industry that has provided so much in tax-gasoline taxes, sales taxes, excise taxes, corporate tax, and now carbon taxes? Also, can anyone think of an industry that has been around longer, hell half the Standard Oil Companies are still on the Dow (with other names). The oil industry spews out so much money, and everyone grabs it, but still investor/speculators keep coming…You know why? Because, they’re greedy for the next barrel, just like dot-comers, Emerging Market Investors, hedge fund gurus, or the other winners and losers who speculate.

  10. Lenard says:

    Shale Oil? It was really a money-losing proposition to begin with. Last I checked most of the major fracking fields are in decline or at the very least heading in that general direction. But like almost everything else, they’ll probably get bailed out by the American taxpayer in the end because the government will declare it a matter of “national security.”

  11. roddy6667 says:

    Time is not a friend to the shale oil industry. As years go by, they do gain efficiencies, but the wells taper off yields faster than that.

  12. nick kelly says:

    And…rising interest rates. Jamie Dimon is telling us not to be surprised if the ten year Treasury hits 5%.

    That would puncture a whole bunch of bubbles .

  13. Mike R says:

    Unless the improvements in fracking technology (productivity) can greatly outrun inflation, fracking is doomed to loose money. Still the government will support it. With printed money.

  14. kk says:

    Wolf, If, as your blog reports, Tesla , Uber, emerging markets, shale, China, European banks and housing are all debt bubbles (l may have missed a few), we are all doomed. The trouble is though, I distinctly remember being doomed in 1973……

    • Saltcreep says:

      kk, as I see it we were, but we’re just closer to it now.

      Exponentially increasing debts across sectors and borders have offset real productivity declines due to declining energy efficiency as our energy (and other resource) sources become more complex to tap, and the debt has kept resources flowing that are not really viable. We’re effectively using debt (that won’t be repaid in anything like real terms in the long run) to secure access to the energy required to extract less productive energy.

      Once the debt bubble finally pops I have a hard time seeing where our alternatives are coming from for keeping things smoothly up and running, unless some group of geniuses somewhere pretty quicksticks comes up with some market ready, versatile, incredibly efficient and exponentially scalable energy conversion technology.

      The debt has postponed our time of reckoning, but it has also considerably increased our dues. And that’s only looking at it from the energy perspective. Taking into account the rapidly declining state of our environment, we’re seriously screwed.

    • nick kelly says:

      In the 1973 the accumulated debt of the US since Independence, after to WWI, WWII, and Korea was one trillion dollars.

      Now the annual deficit is set to hit one trillion and the debt (NOT liabilities just the debt that pays interest to holders) is 22 trillion

      BTW: if you remember being doomed in 73, you remember what happened in 74. Because that recession was doom for a lot of businesses.

  15. A Citizen says:

    Well, I see a lot of knee jerks posting the usual ZH level of navel dust, countered by a couple of knowledgeable individuals that have a good understanding of the actual facts.

    The real story is about who winds up owning the DUCs, as opposed to who owns the costs of drilling them, after the fallout from the current rush to drill hits and the marginal players get rationalized.

    If you are an investor or banker or driller and you don’t know who the mark is in this poker game, then the mark is you.

  16. Under the weather says:

    It was never meant to generate profits to begin with. It´s all about keeping the dollar status by any means necessary.

  17. Unamused says:

    It’s true that the U.S. shale industry is unprofitable, but Wall St. makes tons of money on it with fees and such, and you can be sure they won’t be holding the bag when it all goes pear-shaped.

    That’s where the profits are, and that’s the important thing. And any more that’s pretty much the only reason the industry exists. Why else would there be so much money underwater in such an unprofitable business?

  18. FlashFlud says:

    This article is great, but the amount of energy illiteracy in the comments is astounding.

    First, the rise in Brent this year took everyone by surprise. A ton of producers engaged in hedges in the last two years at (currently) below-market prices, so their cash return on new barrels produced this year will be lower as costs to drill rise.

    Second, those costs to drill keep rising – as the article points out, if sand, water, crews, and completions costs keep rising – this is indicative of good geology is in the areas where drilling occurs. Permian sand costs will be greater than Bakken sand costs simply because demand for oilfield services in one area outstrips supply. To keep it simple, rising drilling costs in the Permian say NOTHING about inherent well productivity or geology.

    Third, natural gas flaring permits and/or pipeline takeaway capacity are bottlenecks. To see the effect of this in action, check out Delek, a small US refiner. Look at their stock price over the past year. They are well positioned to purchase most of their crude from the Midland Hub at steep discounts because crude-by-rail and crude trucking are still slow. Additionally, if you can’t flare or transport away your associated gas, then you won’t complete the well and start producing barrels.

    You can see that in real data for free by checking out the EIA’s “drilled but uncompleted wells” figures by region in the Drilling Productivity Report.

    Last, the thing EVERYONE should be worried about are the decline curves on shale drilling. There’s a huge amount of oil at first, but then it slows to a trickle. Of course this will be different by region, and its the one thing companies are trying to make their best guess at through geology. If decline curves are steeper for shale than for conventional oil plays or even for offshore, that means more wells will be drilled more often… which means a lower cash return to shareholders since those barrels will be inherently more expensive.

    The reason why nobody pays as much attention to decline curves anymore is because the industry keeps beating the drum of “longer laterals” (i.e. longer horizontal drill shafts –> more surface area –> theoretically more oil) and “pad drilling” (i.e. a greater number of wellbores from a single location –> more surface area –> theoretically more oil).

    Trust me, if Wall Street gets a whiff that shale drillers are hoodwinking them on the decline curves (and they employ their own geologists), they will pull their money out.

    • Unamused says:

      ->Trust me, if Wall Street gets a whiff that shale drillers are hoodwinking them on the decline curves (and they employ their own geologists), they will pull their money out.

      They should be pulling their money out because it’s a losing investment that promises to keep losing.

      As already pointed out above, Wall St. banks make big money financing shale drillers and mostly aren’t on the hook for the losses, a quarter trillion and counting. So they’re going to keep doing it, even though the financial rationale just isn’t there. Whatever games drillers may be playing changes nothing. It’s another example of motivated misallocation of capital which ought to be obvious to anybody.

      • FlashFlud says:

        Sorry, but it’s hardly obvious. Shale is “value-less” only if the geology turns out to be worse than anticipated.

        You seem to be confusing buy-side and sell-side. Sell-side i-banks make their money off of transaction and deal fees. And it’s true they thrive in a cheap-debt, low corporate accountability environment like this one. But they can only thrive IF the buy-side is willing to buy, which they are. So…. the buy-side, which consists of mostly Wall Street connections, is on the hook if these shale plays don’t work out. In some cases the buy-side are asset management arms of the same banks that are fulfilling a sell-side function in these shale financing deals. So your premise is wrong.

        As I stated, the inadequacies of the cash returns on barrels that produced in shale plays (everyone in the media seems to be mostly focused on the Permian) seems to be first a function of what I talked about above – below-market hedging strategies, higher demand for oilfield services leading to higher drilling costs, and pipeline takeaway capacity/flaring permits. If an E&P can keep drilling, it will. If and when E&P’s stop drilling, more cash is available for debt service and equity shareholders but its production will start to decline (hence decline curve – I drink your milkshake). So why keep drilling right now?

        In a downturn (which is inevitable at this point), it’s MUCH better to have an inventory of drilled but uncompleted wells that you can turn on at a moments notice, OR sell to a major as a secondary source of liquidity. That’s what executives are thinking about.

        Again, the true issue is this: if the shale decline curves are worse than anticipated, then all that capital spending on drilling is far, far less accretive than advertised (more $ put in the ground versus barrels produced) and people stop investing in shale.

        I’m hardly a shale optimist but I feel like there are a lot of alarmists who don’t understand just how many levers these E&P’s can pull before they bite the dust.

  19. James McFadden says:

    The shale oil and gas fracking growth model has always required drilling more wells each year – exponential growth of well drilling – in order to show a growth in production to attract investors – which was not sustainable. When you frack a well, it sustains high output for only about a year or two then product falls rapidly – so you have to drill more wells the next year to sustain production growth. A second frack might work but it is also costly. Investors saw the growth, but didn’t look at the business model – or if they did, they knew to get out early. In addition, the sweet spots that make the scam look real are limited and are running out. The business model requires more investors each year to keep it going – i.e. a Ponzi scheme built on investor growth and debt. Clauses in contracts allowed some frackers to ride out the Saudi production increase. Others were gobbled up by the Big Oil companies to increase their paper reserves. But the sustained growth just can’t be maintained. Innovation and efficiency won’t make up for the decline in sweet spots — the wells are drying up, new wells produce less – new investors are needed – but the debt is still there. And now the fracking industry is cannibalizing itself.
    Like all bubbles it was built on credit and investor hopes of huge profits, but debt requires debt payments which can’t be made without the new money from investors – a giant Ponzi scheme. It will be interesting how long the hype can sustain the sucker investors. I guess Twain was right: “It’s easier to fool people than to convince them that they have been fooled.”

  20. R Davis says:

    Doesn’t the cost outweigh the returns ??
    It must therefore be classed – a labor of love.
    The oil industry is in denial, give it up guys while we still have a few drops of uncontaminated water to drink.
    In Australia, Queensland is being decimated in the desperate hope of finding ANYTHING.

  21. R Davis says:

    In Australia we have a hospital system that is hemorrhaging money & further, the whole of the healthcare system is hemorrhaging money & so are the Australian State & Federal coffers hemorrhaging money & we must not forget private healthcare insurance.
    We have private hospitals that serve “wine” I say this with marbles in my mouth to get the pretentiousness correct – all hemorrhaging money.
    Why ??
    Because not for profit is in play instead of corporate.
    We still love the them toff bastards & us lifestyle & it cost & costs & costs.
    But also it is a way of pushing suspect quality generic prescription drugs manufactured in DEVELOPING COUNTRIES ( third world) on the population.
    BigPharma cannot be releasing any profit pushing these substandard med around the world.
    It is all an illusion that is bankrupting the nations of the world.
    Who on earth, gave the keys of the kingdom to the lunatics in the asylum ??
    Australia desperately needs someone to come & take over the running of the healthcare system, desperately.
    Hospitals are multi billion dollar facilities that should be making money & not a not for profit three ring circus.

    • R Davis says:

      My daughter is corporate – she has private healthcare insurance cover – she needed a simple procedure – a private ENT fixed it once – due to error he had to fix it again = he got paid twice for the same simple procedure – clever monkey him.
      But it still was not right – so another ENT fixed it – & then had to fix it again – & one more time for luck.
      Her private healthcare insurance had to pay 5 time for a very simple procedure – clever monkeys them 2.
      This is the practice across the board, from all fields of service providers – Australia has 2 1/2 time more medical professionals than we need & they are bleeding the system for all they are worth.
      There is the belief of entitlement among the service providers.

  22. Kye Goodwin says:

    There’s been so much economic benefit to the US from the fracking boom that its hard to imagine how the hit to the investors could yet be bad enough to balance (cancel) all the positives. A lot of Americans have made money and a lot of oil has been produced, amounting to the bulk of the increase in world supply over the last decade, enough to keep the whole Age of Oil going. The history of this era would have been very different if a simple calculation of likely profitability, the kind that’s supposed to rule in capitalism, had prevented the boom from happening.

  23. A. Eroi says:

    I guess this is some kind of involuntary Socialism enabled by Capitalist investors.

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