Energy Transition

How low oil prices affect shale-oil producers

Charles Esser
Writer, GE Look Ahead

When oil prices fell from about $105/bbl in June 2014 to around $50-60 today, many expected the financial distress of US shale oil producers to make them ripe for acquisition.

With the notable exception of Noble Energy’s acquisition in May of Rosetta Resources, however, and despite a 60% increase in M&A activity in the overall US economy compared with the first half of 2015, consolidation in the upstream unconventional (shale) oil sector has not happened.

Instead, as David Kirsch, managing director for research and advisory at Energy Intelligence notes, M&A activity slowed significantly for the sector in the second half of 2014, and “fell off a cliff” in the first quarter of 2015, when price uncertainty made deal valuation very difficult.

Shale oil firms in the US also reacted to the changed price environment, with the valuation mismatch giving them time to focus on the most productive acreage and improve efficiency. While the number of active rigs has been cut by half since the beginning of the year, for example, the average new-well oil production per rig increased by 23%, according to the EIA, thus making up for some of the loss.

Hedging, along with greatly reduced payments to service companies and contractors, also helped sustain financial viability. Hedging accounted for the majority of cash flow for nearly half of the largest shale extracting and producing companies.

The overall result, as Julius Walker, senior consultant with JBC Energy, puts it, is that at “$50-60 per barrel crude has been enough for most companies to hang on”.

The paucity of M&A in the sector may be about change, however, with a new round of borrowing-base resets (the semi-annual recalculation of the value of properties that energy companies have staked as loan collateral) set to take place this fall.

During last spring’s reset, valuations were not greatly reduced, partly on the expectation that the price decline was temporary—and could thus be more easily managed. Now, however, the realisation that a sustained bear oil market is in place has set the stage for more distressed assets and stricter revaluations in the autumn.

As always, price volatility will tend to work against deal-making. However, companies that have reached the point where their debt simply can no longer be serviced will be vulnerable. A study by The Economist of the 62 largest shale exploration and production companies in the US has found that nearly half of them (29) had net debt of more than eight times their annual cash flow. It also found that without hedging, the industry would have to cut capex by 70% to balance its books. This could be problematic over the medium term as shale oil assets deplete rapidly once production begins and thus require high capital expenditures to maintain production—and profits.

Production-related sectors, like service companies or midstream companies, could also be exposed. The former will be vulnerable because of lower returns from reduced fees and overall capex, while the latter could be coveted for their favourable tax treatment and steady cash flow despite gyrations in the price of  crude oil. Just a few weeks ago, for example, Energy Transfer Equity tried to acquire Williams to create one of North America’s largest networks of oil (and gas) pipelines. While the bid was unsuccessful, Energy Transfer Equity is still actively pursuing the buyout.

Whether upstream or midstream, in the long run, market dynamics will see the least-efficient and most debt-burdened companies have their resources acquired by others, auguring greater profits when oil prices eventually rise—even if most analysts do not expect them to reach the $80/bbl mark any time soon.

This article is published in collaboration with GE Look Ahead. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Charles Esser writes for GE Look Ahead.

Image: Employees work on drilling rigs at an oil well operated by Venezuela’s state oil company PDVSA in Morichal. REUTERS/Carlos Garcia Rawlins 

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