Even before Coronavirus and the oil price collapse, shale drilling was slowing down, and the industry as a whole was entering a dry season. But why? After ten years of seemingly successful shale drilling and achieving energy independence, why are oil and gas companies struggling? This is a brief summary of the analysis by Blue Mesa Minerals.
Hundreds of thousands of long fracked horizontal wells have resulted in an overproduction of oil and gas, causing prices to decline.
2. Parent-Child Well Spacing Problems
Drilling wells too close to each other reduces the amount of oil and gas produced by the parent and all child wells. Production forecasts were based on tight well spacing.
3. Reserves vs. Drilling Locations
Oil and gas company valuations used to be based on proven and producing reserves. Now they are based on potential drilling locations, which include "probable" and "possible" reserves. Forecasts are sometimes extrapolated using drilling locations, leading to inflated revenue estimates.
4. Growth vs. Profits
Companies focused on growth rather than profits, which lead to drilling uneconomic wells and taking on large amounts of debt.
5. Pump-and-Dump (or Find-and-Flip)
Rather than playing the long game, companies have a defined exit strategy, leading to a pump-and-dump mentality.
6. Lack of Due Diligence
Petroleum and reservoir engineers used to make drilling decisions, and lenders only financed what their experts deemed as economic projects. But now, even uneconomical wells are being drilled because the focus in on growth now profits.
7. Capital Drying Up
Lenders, particularly those in the North East, have been burned by investing in oil and gas without conducting proper due diligence and because of forecast errors.
The Coronavirus (COVID-19) has reduced the global demand for oil and natural gas, contributing to the current overproduction problem. This will be a temporary problem.
9. Russia Saudi Oil Price War
The Russians and Saudi's are playing a global game of chicken over cutting oil production, which caused the oil prices to collapse. Prices should recover, eventually.
Oil and gas is a cyclic industry. Over 100 companies have filed bankruptcy in the past year, and many more will follow before this downturn is over. The collapse in oil prices will continue for a while, until Russia and the Saudi's resolve the price war. However, the slowdown in US shale drilling will require a fundamental change in the oil and gas industry, where companies need to live within free cash flow and play the long game, developing fields for profit, not quick growth. This downturn will weed out the weak and hopefully leave the industry healthier.
Visit Blue Mesa Minerals, for a more detailed analysis of what is causing the shale drilling slowdown and what will be required to turn the oil and gas industry around.