U.S. Oil producers struggle amid stagnant prices, rising production

In the days after a U.S. drone strike killed Iran’s top military commander, Qassem Solemani, U.S. oil producers found themselves a victim of their own success.

Crude prices started their predictable rise following the attack and the prospect of a potential military conflict that it unleashed. Tension in the Mideast has long been a driver of global prices, of course. But this time, something odd happened: nothing. West Texas Intermediate rose to $63 a barrel, then quickly settled back below $60. Prices had been higher last spring, when they briefly touched $66. 

Rising U.S. production —which hit a record 13 million barrels a day in early January — continues to put a damper on global prices. U.S. oil exports, which were a mere 600,000 barrels a day in early 2017, soared to more than 4 million barrels by December.

Ironically, none of this is good news for U.S. producers, even though they’re coming off a banner year. In Texas, which produces more oil than any other state, the industry paid a record $16.3 billion in taxes and royalties to local governments. But in the last half of 2019, the number of active rigs working in the Permian Basin, the state’s most prolific oilfield, fell dramatically. Job losses across the industry are rising, and so are debt defaults. Several producers have filed for bankruptcy.

Many companies had expected prices to rebound to the $70 range in 2019, and when that didn’t happen, they found themselves in a financial crunch.

Todd Staples, president of the Texas Oil and Gas Association, predicts the worst may be yet to come. “With production strained by prices, we may have additional bankruptcies and mergers,” he told reporters on a conference call.

With prices stubbornly hovering in the sub-$60 range, companies that invested heavily in shale plays are struggling to make debt payments. In the third quarter of last year, seven companies filed for bankruptcy after defaulting on $15 billion worth of bonds.

In January, some producers got a slight reprieve, not from higher commodity prices, but from investors’ increased appetite for riskier debt. Taking comfort in a strengthening economic outlook, investors snapped up $6 billion worth of bonds from companies with lower credit ratings, including offshore driller Transocean and shale producer Laredo Petroleum.

The spate of bond offerings came as surprise. The capital markets had largely shunned energy companies in recent months because of producers’ heavy debt burden, wanton spending on new drilling and land acquisition and dimming financial picture.

Laredo, for example, told investors in November that wells it completed in 2018 fell short of its production forecasts, in part because of the proximity of newer wells to older ones. The company said it will use the new debt — with interest rates as high as 10.25 percent — to repay bonds that were set to mature in the next three years.

All told, energy companies in North America face more than $40 billion in debt maturities this year, and over the next four years, that number rises to $200 billion, according to Moody’s Investors Service.

Wall Street has grown weary of the industry’s traditional financing model, in which companies emphasise production and acquisitions. As a result, more investors and companies are beginning to focus on free cash flow as a measure of their financial health. 

It’s not just the independents who are struggling. The major oil companies, which have pushed into the West Texas shale plays in a major way, face cash shortfalls to pay dividends. Some are selling assets to help make up the difference. A recent analysis by the Institute for Energy Economics and Financial Analysis found that since 2010, the cost of dividends and buyback have exceeded the free cash flow at each of the five majors. Four of those — Exxon Mobil, BP, Chevron and Shell — have made significant investments in U.S. shale plays during that time.

“This practice reflects an underlying weakness in the fundamentals of contemporary oil and gas business models: revenues from the supermajors’ operations are not covering their core operational expenses and capital expenditures,” the study said. “This helps explain why energy has been the poorest-performing sector in the stock market in recent years despite oil prices having more than doubled since hitting $29 per barrel in 2016.”

Since 2017, the majors have spent more than $10 billion buying acreage in the Permian Basin, according to the research firm Enverus. The big companies largely sat out the early phases of the shale boom, allowing independents to lead the technological innovation that unlocked shale reserves. But as shale plays matured and the Permian became the world’s top oil producer, the majors have swooped in to take a dominate position. Chevron and Exxon are now the biggest producers, having surged ahead of independents such as Pioneer Natural Resources.

Companies such as Exxon touted their strong balance sheets and deep cash reserves. The IEEFA report raises the prospect that the majors may be caught in much the same financial conundrum as the independents. 

A recent forecast by the U.S. Energy Information Administration offered little solace. The agency predicts crude prices to average about $60 a barrel this year and about $63 next year, which means the price rebound many in the industry were hoping for may not materialise. Another year of disappointing prices will add to the mounting debt concerns.

At the same time, production continues to rise. The EIA predicts an average output of 13.3 million barrels this year and 13.7 million in 2021. That’s up from 12.2 million in 2018. The industry, it seems, faces at least a couple of more years of wrestling with its own success.