The U.S. Shale Oil Industry is Collapsing

Shale and the Global Oil Market

There are very few commodities or natural resources in the world that receive more attention from economists than crude oil. The price and overall consumption of oil provides a great deal of insight into a number of indicators related to the health of the global economy. Moreover, oil is one of the most actively traded commodities in the global financial market. In addition to being at the center of numerous conflicts and all-out wars, oil can fuel geopolitical tensions, exacerbate social unrest, increase inflationary pressure, and influence the development and duration of an economic recession (Gunderson, 2020). Since oil has the ability to affect a wide array of political and economic systems, economists have become increasingly worried that the collapse of the U.S. shale oil industry will have a devastating impact on the American economy as a whole.

Shale Oil Reserves

In 2016, the World Energy Council released a scientific report that revealed how global reserves of shale oil could equate to roughly 6.1 trillion barrels of oil. (Huang et al, 2020). However, as oil prices have collapsed as a result of the global oil supply glut, the coronavirus outbreak, and an oil price war between Russia and Saudi Arabia, the American shale oil industry has experienced some of the most devastating consequences.

Shale oil is known as a certain type of petroleum that can be found in bedrock formations of low permeability. While conventional oil and gas extraction only involves drilling because the pressure differential forces oil upwards towards the surface of the ground, shale oil extraction requires a combination of hydraulic fracturing and horizontal drilling (Bret-Rouzaut and Favennec, 2011). These relatively new technologies have made shale oil commercially accessible for today’s oil and gas producers. The development of these energy-intensive oil extraction technologies was made possible by the period of high oil and gas prices prior to the financial crisis of 2008 (Alquist and Guénette, 2014). As the price of oil shot up significantly, oil and gas producers were able to invest in operations that required greater inputs of energy and economic resources. However, as oil prices collapsed, the economic viability of shale oil extraction has come into question.

Boom and Bust

While global oil prices have fallen as a result of an oversupply of oil and fears that demand will continue to decline, some economists have pointed to the U.S. shale oil boom itself as a factor that has contributed to the collapse in oil prices. As technological breakthroughs were transforming small towns like Midland, Texas into some of the world’s most important players in the oil and gas industry, the global oil market started to experience periods where the supply of oil exceeded the demand for oil. As the U.S. began to see an unprecedented surge in oil supplies after over two decades of declining production, the price of oil collapsed in the summer of 2014.

After hitting a high of $120 per barrel, the price of oil plummeted below $28 by January 2016, which is representative of a 75 percent drop. While the shale-drilling frenzy dramatically boosted the local economies of boomtowns in West Texas, North Dakota, and parts of New Mexico, the massive surge of oil supplies ultimately helped to contribute to the global oil supply glut. As a result of this production growth in the shale oil industry provided by fracking and horizontal drilling technology, the International Energy Agency (IEA) has predicted that U.S. oil production could equal the combined production of Saudi Arabia and Russia by 2025 (Worland, 2019).

Growing Levels of Financial Stress

Some economists and energy analysts say that the drop in oil prices that began in 2014 may not have been initiated by the surge in shale oil production. Instead, arguments have been made that a drop in global demand has been the main factor that has spurred oil price fluctuations. Slow growth in emerging global markets has had a tremendous impact, particularly once the coronavirus outbreak occurred at the beginning of 2020. As oil prices continued to fall below $20 a barrel through March and April of 2020, shale oil drillers started to experience an enormous level of financial stress.

The crash of oil prices led shale producers in Texas, Oklahoma, New Mexico, and North Dakota to shut down a significant portion of oil drilling operations. As the drilling and fracking came to a halt, tens of thousands of workers in the oil field lost their jobs. As endeavors to combat the COVID-19 pandemic grounded aircraft, decreased driving, and forced the global economy towards a recession, the demand for fuel faced a sudden drop of 30 million barrels per day (Hiller and Hampton, 2020). A 30 percent reduction in global oil demand meant that there was no need to pump more oil. In fact, the situation has become so dire that the world is running out of places to store excess oil.

Dwindling Production Contracts

As existing oil production and leasing contracts expire, many oil and gas producers worry that they may not be able to find new contracts. Without contracts to buy oil, producers have no reason to produce oil. Oil refiners have already started to issue ominous warnings to producers alluding to the possibility of new contracts at a price that sits below the cost of shale oil production. Prices already remain below the cost of production for many oil producers. While the U.S. was once at the helm of an energy revolution that made America the world’s top oil producer, the oil production boom has essentially died. According to Rystad Energy, up to 240,000 jobs in the oil field could be lost in 2020 alone, which is representative of about a third of the country’s total oilfield workforce, both onshore and offshore (Hiller and Hampton, 2020).

Since shale oil is more expensive and energy intensive to produce, the shale oil sector has been one of the hardest hit subsectors of the oil and gas industry. If oil prices continue to hover around $20 a barrel, shale oil producers will continue to make less than half of the revenue that is needed to cover the costs of production. In March 2020, dozens of shale oil producers revealed plans to decrease spending, lay off workers, and take on worrisome levels of financial debt. The breakeven point for many shale oil producers is achieved with oil prices above $40 per barrel. Until this price is reached, shale oil production with continue to be financially unsustainable for the vast majority of American producers.

Avoiding Bankruptcy

As oil prices have failed to rebound, shale oil producers are taking extreme measures to avoid filing for bankruptcy. While some have already gone under, others are moving forward with plans to dramatically cut spending. According to researchers from Spears & Associates, oil-field related spending in 2020 will lower 21 percent to $211 billion, which is the lowest level of spending seen since 2005 (Hiller and Hampton, 2020). In addition to cutting spending, shale oil companies are seeking to take out more loans to cover costs. However, while lenders were inclined to let oil producers take on more debt during the 2014-2016 oil crash, lenders have been less willing to make more financing opportunities available in 2020. High uncertainly about the global economic situation has made financial institutions rethink efforts to disperse more funding to an industry that may not experience a turnaround in the near future. On the other hand, some banks have expressed interest in buying out failed shale oil producers, with the intentions of restarting operations in the coming years if oil prices rebound.

No More Lifelines for Shale Producers

The U.S. Energy Information Administration says that U.S. oil production will fall by 500,000 barrels per day in 2020, which would bring total average daily production to 11.8 million barrels of oil. In 2021, the U.S. Energy Information Administration expects production to sink by another 700,000 barrels per day. After years of strong gains in the country’s production of oil and gas, the economic downturn is poised to bring production levels below previous record highs that were experienced in 2019. Lance Loeffler, the head of finance at Halliburton (the top U.S. fracking service provider), says that there are no more lifelines available for shale oil companies (Hiller and Hampton, 2020). While investors on Wall Street had begun pulling out from investments in the shale oil industry following the 2014-2016 oil price collapse, the outlook after 2020 has led investors to question the prospects for future investment returns.

With few options for refinancing or seeking new investors to prop up the industry, the majority of America’s shale oil producers are barely staying afloat. As pipelines and storage facilities are already awash in excess oil, there seems to be no room for future oil production operations in the near future. Instead, shale oil producers will have to continue to burn through their finances with the hope that demand will start to pick up as the economy bounces back. Scott Sheffield, the CEO at Permian Basin producer Pioneer Natural Resources, said that his company had already been warned that their primary refiner may have to refuse any additional shipments of oil, which would render Sheffield’s company completely out of work. While refiners are starting to refuse shipments, state governments in Texas and Oklahoma are evaluating options to mandate upwards of a 20 percent production cut in order to prevent producers from continuously flooding the market with more oil.

Prospects for Survival

The Texas Permian Basin is ground zero for the fallout of the global oil price collapse. While local economies recently experienced explosive economic growth, a surge of new jobs, and higher wages, massive layoffs and production cuts are now crippling the region. While the oil industry has always been relatively volatile, especially since the 1973 Arab Oil Embargo, the 2020 oil price crash has been one of the worst to ever hit the industry. Some economists say that the industry will ultimately bounce back as it has previously. Following the 1980s, when oil prices dropped throughout the decade, the economy within the Permian Basin eventually rebounded. Over the course of 15 years after the 1980s slump, Texas producers were able to triple crude oil production to roughly 3.6 million barrels per day (Wallace, 2020).

Many of today’s economists are bearish about the prospect of a near-term bounce in oil prices. Prior to the 2020 collapse, shale oil exploration and drilling companies were already financially stressed. The collapse initiated by the coronavirus and the drop in global oil consumption is likely to yield one of the most challenging periods in history for American shale oil producers. While the demand for oil won’t disappear forever, many American shale oil producers may not be able to survive long enough to see prices rebound. 

Sources

Alquist, R., and Guénette, L. (2014). “A Blessing in Disguise: The Implications of High Global Oil Prices for the North American Market.” Energy Policy. Vol. 64: 49–57.

Aslam, N. (2020). “Crude Oil Below $20, Trump Needs To Save U.S. Shale Oil Industry.” Forbes.

Bret-Rouzaut, N., and Favennec, J. (2011). “Oil and Gas Exploration and Production: Reserves, Costs, Contracts.” Paris: Editions TECHNIP.

Gunderson, T. (2020). “The Impact of U.S. Supply Shocks on the Global Oil Price.” The Energy Journal: Vol. 41

Hiller, J., and Hampton, L. (2020). “Oil in the age of coronavirus: a U.S. shale bust like no other.” Reuters.

Huang, C., et al. (2020). “Energy solutions for producing shale oil: Characteristics of energy demand and economic analysis of energy supply option.” State Energy Center for Shale Oil Research and Development: Energy, 192.

Wallace, J. (2020). “Amid Price War, Texas Oil Patch Is Coming Up Empty.” Foreign Policy.

Worland, J. (2019). “How an Oil Boom in West Texas Is Reshaping the World.” Time.