Author: Petar Kordic
In late 2014, an experienced oilman was discussing booming US oil industry on Bloomberg TV. He was long enough in the game to remember both booms and busts but he pointed out one peculiarity about this new age of crude – Oil & Gas conferences were dominated by bankers. He made a joke on cuff links, a fashion details not so popular with oilmen.
In US, hydraulic fracturing has been around for more than 6 decades, but only in the last 10 years shale oil became unavoidable part of discussion on US oil industry. Today, it’s the most important factor when discussing oil, globally. We will discuss two factors that contributed to the rise of hydraulic fracturing: high price of oil, and vast supply of money due to low interest rates. As graphs below show, a drop in interest rates after 2007 crash, and rise in price of oil in second quarter of 2000’s created a potent mix which allowed oil industry to invest in shale and try something that was thought to be possible technically however very expensive – to bring shale production to a level expressed in millions of barrels per day.
In 2000’s we witnessed growth in price of crude, which was caused by increase in demand for energy, and in later stages by interruptions in Iraqi production primarily. In the year 2007, extreme volatility started to occur and it lasted for two years. Financial crisis and attacks on installations in Iraq caused the price to bounce from one extreme to another. In second half of 2009, price passed the $70 mark and managed to stay above that level for next 5 years, trading between $80 and $110. Such a high price wasn’t unnoticed – not only by consumers at the gas stations, but also by investors and banks.
At the same time (2009-2015) interest rate dropped to 0.25. This was Fed’s response to the financial crisis, where it was recognized that markets need liquidity. With all the turbulence in equity markets in 2007 – 2009, expensive crude was able to attract investments easily. According to Bloomberg, in a year 2000 funding from stock and bond sales was at $24.2 billion, while in 2014 funding reached $209 billion. Shale oil production went from 0.4 mmbd to 4.6 mmbd at its peak in early 2015. Eagle Ford in Texas and Bakken formation in North Dakota led the charge.
Today, debt is coming back with a vengeance. More and more of operating cash flow is being consumed by debt servicing. Unlike in the 1980’s when crude price crash caused many banks to go bust in the Midwest, this time lenders are a little bit more cautious and Bloomberg data shows that between today and 2009, equity and debt sale covered approximately 50% of loans and debt restructuring in E&P sector in North America.
December decision by the Fed to increase rates from 0.25 to 0.5, and possiblefurther hike could be a sign of things to come. At this moment it is hard to see anything positive in the shale oil sector, except for increase in efficiency. There are some opinions that whenever the price of crude recovers, shale will follow and bounce back. After all, US currently has 59 billion barrels of oil in shale, second highest reserves in the world. But we must take into consideration scenario where oil prices remain low for some time before recovering, causing large scale bankruptcies and write-offs. Will capital intensive shale oil sector be able to attract capital easily again? Can it operate in the environment where money isn’t cheap due to a mix of higher interest rates and price risk? OPEC and few oil producers outside of OPEC certainty hope that the answer is no.
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