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Shale Bleeds Cash Despite Best Quarter In Years

Nick Cunningham

The second quarter earnings results are complete, and it was another rough three-month period for U.S. shale.

Oil prices climbed in the second quarter, with Brent topping out in the mid-$70s, before falling again after the U.S.-China trade war escalated. Notably, the extension of the OPEC+ cuts failed to rally oil prices amid growing concerns about demand.

For U.S. shale, higher oil prices helped to some degree, but by and large it was another period of disappointment for a sector that has underwhelmed for years. Investors are increasingly losing patience, punishing the energy sector as a whole, and financially-strapped companies in particular.

In a study of 29 fracking-focused oil and gas companies by the Sightline Institute and the Institute for Energy Economics and Financial Analysis (IEEFA), only 11 companies posted positive free cash flow. Even then, the figures were paltry. Collectively, the group only reported $26 million in free cash flow for the second quarter, “far too modest to make a significant dent in the more than $100 billion in long-term debt owed by these companies, let alone reward equity investors who have been waiting for a decade for robust and sustainable results,” the report said.

To be sure, the free cash flow result – only slightly positive – was the best result in years, the IEEFA/Sightline Institute report said. It points to progress for U.S. shale, a sector that routinely posted billions of dollars of red ink and negative cash flow in years past. The second quarter result stands in sharp contrast to the $2.81 billion the group of companies lost in the first quarter.

Yet, despite the dramatic improvement, the financial results remained unimpressive. It’s an indictment of the business that one of the best quarters in years was barely cash flow positive.

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“Last quarter’s cash performance—just a hair over breaking even—would count as a bitter disappointment in virtually any other sector of the economy,” the report stated. “But for an industry that has posted negative cash flows for a decade, these mediocre results represent a financial high-water mark.”

After years of waiting for huge profits, investors are growing weary. Shale production has never been higher, and continues to break new records. At the same time, the financial performances are uninspiring.

As IEEFA/Sightline Institute point out in their report, the top oil and gas ETF lost more than 26 percent in the last three months even as the broader S&P 500 gained 3 percent. “Clearly, investors are losing faith in the industry after decades of cash losses,” the report’s authors said.

Worse, the small positive result is largely an outgrowth of the relatively strong performance of one company – EOG Resources – which posted $1.1 billion in free cash flow in the second quarter, a result aided by a $437 million cut in spending. Excluding EOG, the rest of the 28 companies would have collectively been in negative territory.

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This is a broader lesson with the story of U.S. shale writ large. Fracking, horizontal drilling and mountains of cash from Wall Street have succeeded in producing wave after wave of oil and gas, continuously pushing output to record highs. But the profits have never really materialized. In fact, rapid production growth crashed prices for both oil and gas, undercutting the industry’s ability to make any money.

Importantly, the study conducted by IEEFA and the Sightline Institute consisted of 29 relatively strong companies. A much broader look at the shale industry would reveal deeper financial trouble, including a list of 192 companies that have declared bankruptcy since 2015. That list continues to grow.

“A few companies can now eke out modest positive cash flows,” IEEFA and Sightline Institute wrote. “Yet the sector as a whole has never produced enough cash to pay down debt or reward investors with generous dividends or share buybacks.”

The report concluded with a warning to investors to treat U.S. shale as a “speculative enterprise with a weak outlook and an unproven business model.”

By Nick Cunningham of Oilprice.com

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