Wednesday, January 30, 2018
05.37PM / By Nick Cunningham of Oilprice.com
the criticism of too much hype surrounding U.S. shale from the Saudi oil
minister last week, a new report finds that shale drilling is still largely not
profitable. Not only that, but costs are on the rise and drillers are pursuing
"irrational production." Riyadh-based Al Rajhi Capital dug into the financials of a long list of U.S. shale
companies, and found that "despite rising prices most firms under our
study are still in losses with no signs of improvement." The average
return on asset for U.S. shale companies "is still a measly 0.8
percent," the financial services company wrote in its report.
Moreover, the widely-publicized efficiency gains could be overstated, at least
according to Al Rajhi Capital. The firm said that in the third quarter of 2017,
the "average operating cost per barrel has broadly remained the same
without any efficiency gains." Not only that, but the cost of producing a
barrel of oil, after factoring in the cost of spending and higher debt levels,
has actually been rising quite a bit.
Shale companies often tout their rock-bottom breakeven prices, and they often
use a narrowly defined metric that only includes the cost of drilling and
production, leaving out all other costs. But because there are a lot of other
expenses, only focusing on operating costs can be a bit misleading.
The Al Rajhi Capital report concludes that operating costs have indeed edged
down over the past several years. However, a broader measure of the "cash
required per barrel," which includes other costs such as depreciation,
interest expense, tax expense, and spending on drilling and exploration,
reveals a more damning picture. Al Rajhi finds that this "cash required
per barrel" metric has been rising for several consecutive quarters,
hitting an average $64 per barrel in the third quarter of 2017. That was a
period of time in which WTI traded much lower, which essentially means that the
average shale player was not profitable.
Not everyone is posting poor figures. Diamondback Energy and Continental
Resources had breakeven prices at about $52 and $37 per barrel in the third
quarter, respectively, according to the Al Rajhi report. Parsley Energy, on the
other hand, saw its "cash required per barrel" price rise to nearly
$100 per barrel in the third quarter.
A long list of shale companies have promised a more cautious approach this
year, with an emphasis on profits. It remains to be seen if that will happen,
especially given the recent run up in prices.
But Al Rajhi questions whether spending cuts will even result in a better
financial position. "Even when capex declines, we are unlikely to see any
sustained drop in cash flow required per barrel … due to the nature of shale
production and rising interest expenses," the Al Rajhi report concluded.
In other words, cutting spending only leads to lower production, and the
resulting decline in revenues will offset the benefit of lower spending. All
the while, interest payments need to be made, which could be on the rise if
debt levels are climbing.
One factor that has worked against some shale drillers is that the advantage of
hedging future production has all but disappeared. In FY15 and FY16, the
companies surveyed realized revenue gains on the order of $15 and $9 per
barrel, respectively, by locking in future production at higher prices than
what ended up prevailing in the market. But, that advantage has vanished. In
the third quarter of 2017, the same companies only earned an extra $1 per barrel
on average by hedging.
Part of the reason for that is rising oil prices, as well as a flattening of
the futures curve. Indeed, recently WTI and Brent have showed a strong trend
toward backwardation — in which longer-dated prices trade lower than near-term.
That makes it much less attractive to lock in future production.
Al Rajhi Capital notes that more recently, shale companies ended up locking in
hedges at prices that could end up being quite a bit lower than the market
price, which could limit their upside exposure should prices continue to rise.
In short, the report needs to be offered as a retort against aggressive
forecasts for shale production growth. Drilling is clearly on the rise and U.S.
oil production is expected to increase for the foreseeable future. But the lack
of profitability remains a significant problem for the shale industry.
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