Market observers call new flow of capital in US oil production unlikely
When Paul Murphy, the chairman and CEO of Cadence Bank (NYSE: CADE), got on his recent earnings conference call, he described the bank's approach to new lending into the energy patch in words that could have been uttered by many of his peers.
"With respect to any new energy loans, we are highly cautious. It is a very high bar you must clear for any new energy originations," he said, according to the transcript supplied by SeekingAlpha. "Our intent is to keep the portfolio flat or see it reduce over the near term."
Or consider a Canadian company called Pengrowth Energy. On Friday, it announced it was being sold to Cona Resources. Cona is paying C$740 million to take on Pengrowth's debt. It's also buying all its common shares....at five Canadian cents per share. Five years ago, the common shares were trading at more than C$4.50. In the statement announcing the sale, Pengrowth cited among other things "a severe funding crisis in the Canadian energy capital markets which impeded the Company's ability to achieve a funding solution."
There are all sorts of stories like this through the oil patch. And yet, the weekly estimate by the Energy Information Administration (EIA) on oil production has been at its all-time high of 12.6 million b/d for several weeks.
How is that possible? It can happen because investment into the upstream doesn't necessarily turn into production quickly. The 12.6 million b/d figure represents investments made awhile ago.
That weekly number is also seen as an estimate. The monthly figure put out by EIA is considered more accurate. But if you average the four weekly estimates for August put out two months ago and compare it to the 12.365 million b/d for August that was released this past week, it's only about 10,000 b/d more than the average of the weekly numbers. So it's close.
The focus is more on the future. Can the U.S. keep its output on an upward trajectory? Consider the past two years. At the end of 2017, according to EIA data, U.S. crude production was running at approximately 9.97 million b/d. At the end of 2018, it was just over 12 million b/d. If the current weekly reports turn out to be accurate and hold through the rest of the year, it would be 12.6 million b/d. A 2 million b/d jump between 2017 and 2018 would have fallen to a 600,000 b/d increase a year later.
Consider also the rig count. The figure from Enervus for the total U.S. rig count was 718 in the most recent week, down from 731 just a week earlier. A year ago, it was 943.
"While there is consensus that modest production additions will likely persist, we are clearly witnessing significant deceleration in the pace of this growth," Artem Abramov, head of shale research at Rystad Energy, said in a recent release from Rystad about its estimates. "The impressive 2 million bpd year-on-year increase in US oil output seen in 2018 is not about to be repeated, neither in 2019 nor in 2020."
What this comes down to is not geology. It's capital. A steady and rising flow of capital has been pumped into the shale industry for more than 10 years. Every so often, it would take a breather and slow. But it would resume after that hiatus.
"This time it's different" is a phrase jokingly used to describe a situation that the speaker knows really isn't different.
But this time it's probably true. There are simply too many bad loans and weak companies out there to envision a rising flow of new capital into the business. An IPO by Magnolia Oil & Gas in 2017 is believed to be the last IPO in the U.S. oil business, and launching another one while Saudi Aramco is getting ready for an investment dollar-sucking IPO of its own would be challenging.
Before any of that happens, debts will need to be cleaned up. As this chart from the Oil Patch Bankruptcy Monitor of the law firm of Haynes & Boone shows, oil patch bankruptcy filings in the third quarter continued to rise. It was highlighted by the Chapter 11 filing of Sheridan Holdings, which had more than $1 billion in debt, and Halcon Resources, a publicly traded oil and gas company with debt a little less than $1 billion that filed a pre-packaged bankruptcy and is already out, with $750 million in debt wiped out.
A second chart shows the debt status of the 110 oil and gas companies rated by S&P Global. Only 18 of them have ratings that would be considered investment grade. Those are the small slices on the pie chart. The biggest slice is the B rating, which is firmly in the speculative, non-investment-grade part of the spectrum.
The possibility of a slowdown isn't coming just from banks. On its earnings call this week, the CEO of Continental Resources (NYSE: CLR), Harold Hamm, was reported by Dow Jones as saying reduced U.S. production by 2020 was a real possibility despite most assumptions that see it continuing to rise. "The estimates were much too high in the US. Capital discipline is working as it should be," Hamm said, according to the Dow Jones report. He added that a slowing of drilling activity is "needed."
It's been said that looking at the rig count is no longer the best barometer of upstream activity because efficiencies in drilling have led to more productivity per well. You want to know how things really are, given that disconnect and the delay in getting accurate output information? Look at the frac sand market.
The price of frac sand is not transparent on a daily basis. But the recent earnings call of U.S. Silica laid out just how bad things are in that market. CEO Bryan Shinn said U.S. Silica faced energy markets that "deteriorated further and faster than expected during the quarter as E&P budget exhaustion slowed completion activity, resulting in lower demand and pricing pressure. We started to experience this midway through the quarter."
Sales volumes were flat but pricing was "significantly lower," Shinn said.
From the perspective of trucking companies, the U.S. oil patch is doing a great job: producing enough oil to keep the price firmly in the $50-$60/b range for WTI and Brent. But it's questionable how long they can keep that up given the tightening financial squeeze.
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