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Difficult Times Ahead for US Shale Drillers

2015 was a tough year for US oil producers but with intimations of four more years of low oil prices, the New Year doesn’t look that bright. 2016 has only just started but the challenges facing the industry are still prevalent.

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While many in our industry are glad to see the back of 2015, it was a good year for Haynes and Booner, LLP. It’s an international law firm based in Texas with impressive Bankruptcy and Energy practices. Sadly the bankruptcy side is getting bigger. At the end of the year they issued the first Oil Patch Bankruptcy Monitor which revealed the growing numbers of Chapter 11 filings in this sector – 36 bankruptcies, and that was before Magnum Hunter filed with $1bn of debt.

If shale oil drillers have a better plan they’d better come up with it soon because OPEC is not for turning in 2016. It’s predicting four more years of difficult prices, rising only to $70pb in 2020.

US producers and OPEC went toe to toe in 2015. Despite OPEC throwing everything including the kitchen sink at them in an attempt to sink them, the renowned economist Mark J Perry tweeted on Christmas Eve, “Thanks to #shale, US is on track to produce new record amount of nat gas & oil this year, to +16.4% above the 1971 peak.”

To get there and cope with the drop in price from $112 to $50, they went full throttle: cutting thousands of jobs, cutting work on 60% of rigs and using cutting edge technology to get every last gallon of black gold from their best wells.

The problem is, as RT Dukes from Wood Mackenzie points out, “These drillers are not set up to survive oil in the £30s.” The data from Haynes and Booner, LLP proves it. “You are going to see a pickup in bankruptcy filings, a pickup in distressed asset sales and a pickup in distressed debt exchanges,” according to Jeff Jones from Dallas-based investment banking firm Blackhill Partners. “$35 oil will clearly accelerate the distress.”

They have few options. Having used their best wells and pushed the output to the limit, the wells are drying up. The rigs are down and the workers are out. As Alex Hogg wrote, “The Frackers printed money when crude traded above $100; coped at $70 and slashed costs to stay alive at $50. Below that level Frackers need to pull new rabbits out their hats.” He’s right, this will be a fascinating, edge-of-your-seats challenge.

The consequences of this face off aren’t confined to the US however. We know that every single member of OPEC is hurting. Libya needs $208pb to break even, Venezuela $120pb, Ecuador $115pb, Nigeria $100pb, Saudi Arabia $96pb, Iraq $76pb, Iran $70pb, Kuwait $52pb. Not a single member is cut out to break even at $37.11 which was the price on December 29.

People sat up when the IMF warned that unless Saudi makes changes to its economic policy it could go bankrupt. It has already revealed a massive budget cut for the year ahead – reducing government plans, reining in subsidies for water and energy products. A last resort would be unpegging the riyal from the dollar, more likely is the cutting back of foreign financial commitments. The kingdom uses its wealth to support schools and universities, media organisations and think tanks among other things. The country which benefits the most (and will consequently be affected most by a cut) from the overseas largesse is Egypt. It’s already showing signs of growing tension by confirming it has no problems importing Iranian oil, which won’t go down well with the Saudis.

Dhaval Joshi an economist from London-based research company BCA warns that prices could fall a further 35% – meaning prices would be at levels of around $25pb. That equates to a crisis for many huge economies.

Buckle in chaps, 2016 is going to be a rough ride..