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Implications of COVID-19 for the US shale industry

Implications of COVID-19 for the US shale industry

Navigating the great compression in shale oil production

Starting in March 2020 with the onset of the COVID-19 pandemic, global oil supply and demand have diverged to an extent the world has never seen before. Our report explores the implications of COVID-19 for the US shale industry, the four factors leading to a great compression, and strategies to help shale companies Respond, Recover, and Thrive in this new environment.

Shales peaked without making money

The year 2020 marks the 15-year anniversary of the US shale boom, which heralded an era of US energy independence and more than doubled tight shale oil production over the past five to six years. But beneath this phenomenal growth, the reality is that the shale boom peaked without making money for the industry in aggregate. In fact, the US shale industry registered net negative free cash flows of $300 billion, impaired more than $450 billion of invested capital, and saw more than 190 bankruptcies since 2010.

Global oil supply and demand started to diverge in March of 2020. Petroleum demand, which was largely inelastic—changing by one to three percent annually—slumped by more than 30 MMbbl/d in April. Lockdowns of several nations across the world caused drastic changes in the crude oil market.

The result: Oil prices decisively broke the new normal of $50–60/bbl, with West Texas Intermediate (WTI) May futures prices falling even below zero (-$37/ bbl) because of low liquidity and limited available storage. Although the sub-zero price was a temporary dislocation, this intense volatility highlights the fragile state of the industry.

The great compression

The four driving factors of the great compression

The oil market has lost nearly all the momentum it gained in 2019 after COVID-19 lockdown mandates started sapping petroleum demand, especially that of transportation fuels.

It’s largely certain that 2020 will be a trying year for the oil and gas industry. The big unknown is the post–COVID-19 environment and the Organization of the Petroleum Exporting Countries’ (OPEC) role in balancing oil supplies. Oil demand, however, isn’t expected to return to pre-pandemic levels anytime soon due to the new norm of remote telecommuting, relatively stable and stronger prospects in natural gas, decapitalized and stable business profile of new energies, shortened supply chains, and regionalization of trade.

New telecommuting norm: Move towards remote working with 37 percent of US jobs done from home could impact associated transportation demand.
New fuel order: Oil-to-gas price convergence and relative strength in natural gas prices provide an upside to investment in natural gas.
Accelerated energy transition: Returns from new energy projects now at par with current oil company returns (~five percent to 10 percent), propelling energy transition.
Evolving trade and value chains: New potential wave of protectionism and shortening supply chains a threat to global shipping and marine fuels demand.

An economic storm on the horizon

What are the economic implications of COVID-19 for the US shale industry? Investor disenchantment with US shale isn’t new—but it appears to have worsened in the COVID-19 environment. From 2015–2016, at the start of the lower-for-longer downturn, the market seemed optimistic about shales. But in 2020, the double impact of COVID-19 and the oil price supply war seems to have led many investors to shun shale stocks. This appeared to be an extreme reaction, but not any longer, considering the record imbalance and extreme volatility in the oil market.

Significant resource impairments and asset write-offs are expected to hit the industry starting in Q2 2020. Although each company has its own impairment assessment criteria and follows different accounting methods, our analysis suggests that impairments in 2020 would be close to 2015 levels.

One may argue against reading too much into this “noncash” impairment figure of companies. Yes, it’s just an accounting adjustment. But it translates into writing off the invested shareholder’s equity and carrying a debt that may have been taken to develop or acquire the impaired asset. The result: an immediate increase in the industry’s leverage ratio from 40 to 54 percent, which can trigger many negative sequences of events, including bankruptcy.

Impairing the great shale play

In the first half of 2020, companies following the successful efforts (SE) accounting method will likely report significant impairment due to a lower future price strip. Either proactively or led by auditors and bankers, a significant portion of the SE companies’ carrying amount may not be recoverable and thus would need to be impaired immediately.

The companies, along with their auditors, should evaluate the long-term impact on the recoverable volumes for shut-in assets and assess whether restart capital will be required once prices recover. Both companies and auditors would be judged for their fair-value disclosures, changes in accounting estimates, reserve adjustments, and early warning disclosures.

Consolidation is a necessity, and even an opportunity

The grim financial position of many companies and weak economic outlook could trigger deep consolidation in the US shale industry.

Although being “adventurous” in today’s uncertain environment could be fatal, staying on the sidelines may not be an option anymore, either. The key question is what to buy and, more importantly, what not to buy. Any large acquisition or merger should be considered only if one plus one is greater than two on both operational and financial fronts.

Respond. Recover. Thrive.

Over the years, the oil industry’s stable and determinable demand profile has helped it resist many economic and supply shocks. But the COVID-19 pandemic has abruptly fast-forwarded the specter of peak demand to the present. Although demand for oil will sharply recover from the April lows and accelerated production shut-ins will help oil prices to recover from the sub-zero levels seen in the May futures contract, oil markets will likely remain volatile and uncertain. The lingering future of post-COVID uncertainty requires a 360-degree tactical and strategic refresh from the industry.



Respond to the current market situation and safeguard the business by saving both capital and cost. With only 40 percent of the invested capital producing and the balance remaining undeveloped and thus non-revenue-generating, decapitalization should be the immediate priority of operators. Similarly, operators should identify cost takeout opportunities that can permanently reduce their selling, general, and administrative (SG&A) spend and improve back-office efficiency and service delivery.



The next phase could entail a rigorous operational diagnosis that’s powered by a new engineering mindset, metadata analytics, and sustainability measures. Additionally, breakthrough digital innovations for a complete transformation of operations may be required to turn the shale industry around once more.

Operators should also work with their vendors to not only automate and digitize operations to realize new savings, but also to shorten value chains and create new pathways for the impending energy transition. Taking this path, however, would likely entail breaking away from the typical M&A strategy of buying only for resources to creating new capabilities, where “one plus one is greater than two” on all fronts.



Finally, operators emerging from the crisis would likely have to reinvent to thrive and possibly be the nexus of the “new normal” ecosystem. Companies should work toward transforming themselves from an IT-driven mindset to an operationally integrated organization. Additionally, companies should learn to stay committed to making energy transition a way of business and find ways to make it competitive.

The far-reaching implications of COVID-19 for the US shale industry

The reverberations of the pandemic will extend beyond the US shale industry. Although US shales is less than 10 percent of global oil and gas production, it accounts for 40 percent of the global shale oil extraction activity and explains nearly 100 percent of the growth in US midstream and export-oriented refining and petrochemical sectors over the past 10 years. So any major developments in US shales will likely have a domino effect on the global oil and gas industry.


Source:  Google News

By:  Deloitte



Summary by CNBC:

Shale industry will be rocked by $300 billion in losses and a wave of bankruptcies, Deloitte says

A derrick man secures a length of drill pipe during drilling on a natural gas drill rig near Montrose, Pennsylvania, U.S., on Monday, April 5, 2010.
A derrick man secures a length of drill pipe during drilling on a natural gas drill rig near Montrose, Pennsylvania, U.S., on Monday, April 5, 2010.
Daniel Acker | Bloomberg | Getty Images

The U.S. shale industry is about to enter a period of “great compression” as low oil prices hammer the sector, according to a Deloitte study released Monday.

The firm believes that exploration and production companies could  write down the value of their assets by as much as $300 billion as they struggle to breakeven in a lower-for-longer oil price environment. Significant impairments are expected in the second quarter. Based on this, the firm envisions a wave of bankruptcies followed by mass consolidation.

“The oil industry is currently experiencing a ‘great compression’ in which companies’ room to maneuver is restricted by low commodity prices, reduced demand, capital constraints, debt loads, and health impacts of COVID-19,” the report said. “Unlike in previous downturns, these effects are now simultaneous — creating a higher level risk of technical insolvencies and building intense pressure on the industry.”

The coronavirus pandemic sent oil prices tumbling in March and April as billions of people around the world stayed home in an effort to slow the spread of the virus. By some estimates, global fuel demand dropped by a third as businesses shut their doors, cars remained parked and airplanes stayed grounded.

At one point in April, West Texas Intermediate crude plunged into negative territory for the first time as demand remained depressed and oil storage quickly filled.

Since then, the U.S. oil benchmark has gained more than 200% due to production cuts as well as improving demand. Still, on Monday the benchmark traded around $39 per barrel, far below the more than $60 it fetched at the beginning of the year. As recently as 2014, WTI traded above $100.

According to Deloitte, 30% of shale operators are technically insolvent with oil prices at $35 and 20% have “stressed financials.”

While some of the $300 billion in write-downs and impairment charges that the firm envisions is due to accounting practices, it’s also indicative of the fact that these companies are becoming riskier for equity holders. The charges signify a reduction in future earnings power, and with debt levels staying the same, a company’s leverage ratio immediately increases.

“As COVID-19 impacts amplify pressures on shale companies through 2020, a wave of impairments may prompt the deepest consolidation the industry has ever seen over the next six to 12 months,” said Duane Dickson, vice chairman at Deloitte.

Whiting Petroleum, once a big player in the Bakken shale region, was the first casualty of the coronavirus-induced drop in oil prices when the company filed for bankruptcy protection on April 1. And others are reportedly on the way.

The impacts will be felt across the oil and gas sector, as well as throughout the financial markets more broadly, Deloitte said.

“The reverberations of the pandemic will extend beyond the US shale industry. Although US shale is less than 10 percent of global oil and gas production, it accounts for 40 percent of the global drilling activity and explains nearly 100 percent of the growth in US midstream and export-oriented refining and petrochemical sectors over the past 10 years. Thus, any major developments in US shales will likely have a domino effect on the global oil and gas industry,” the report concluded.

Source:  CNBC

By:  Pippa Stevens@PIPPASTEVENS13

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