US shale shakes off gung ho approach

At the KD barbecue house in Midland, Texas, one can see first-hand that the energy boom is still alive and well. Oil service workers, property developers and financiers stand in a line that snakes out onto the street to order their fabled tri-tip steaks and ribs.

In less than a decade, a boom in the country’s shale patch added a record 8 million barrels day and made the US the number one oil producer in the world at 12 million barrels a day. A large chunk of credit must go to the producers in the Permian Basin, a vast expanse of 222,000 square kilometres that borders west Texas and south-eastern New Mexico, which is responsible for about a third of America’s crude output.

During my visit to downtown Midland, often referred to as the capital of shale country, an electronic sign updated the active drilling rig count to 864, with nearly half of them at working in the Permian.

Scott Sheffield, CEO of Pioneer Natural Resources, embraced the shale revolution early on and over nearly two decades running the company has accumulated 680,000 acres of oil and gas territory. He firmly believes there is a very long runway of shale growth to come, allowing it to last another 100 years.

Outsize reserves

For perspective, that is five-times the projected lifespan of North Sea assets at current production rates. And the proven reserves in the Permian are in a word massive — with Sheffield suggesting that his estimates show a total of 160 billion barrels of recoverable reserves. That is in the league of Iraq and Iran.

According to OPEC’s “World Oil Outlook”, the shale boom will continue, taking US daily production to a whopping 20 million barrels per day in five years. This boom has far-reaching implications. US President Donald Trump is blunt about his unwillingness to deploy American troops to protect a free flow of crude.

Shift in strategic focus

Trump recently declared the US military was “locked and loaded” to strike Iran, but when a brazen attack in mid-September, often blamed on Tehran, against Saudi Aramco’s oil facilities did not trigger American military action in the region, many marked that event as a profound shift in US policy.

Not only has the shale expansion allowed for growing US energy independence, it’s created jobs in America’s oil and gas belt and allowed Trump to tout how lower prices at the gas pump have helped extend the country’s economic expansion. While many have focused their attention America’s rise to the world’s number one oil producer, unseating traditional heavyweights like Saudi Arabia, the prolific expansion of shale gas has also allowed the US to stand toe-to-toe with energy giants such as Qatar and Russia.

At the Sabine pass on the border of Texas and Louisiana sits Cheniere Energy’s shiny new LNG terminal. The group spent $12 billion to build the facility after legislation signed into law by US President Barack Obama lifted a ban on energy exports in 2015. Cheniere now exports liquid natural gas to more than 30 countries in Asia, Europe and South America.

Bankruptcies soar

But cracks are beginning to emerge in America’s fracking model, as Wall Street enforces financial discipline on the shale patch. There have been nearly 200 bankruptcies of shale producers in the last four years, with small and medium sized producers collapsing under more than $100 billion of debt.

Pioneer’s Sheffield, for example, postponed his retirement plans to return as CEO to cut $100 million in overhead and lay off 530 workers or a quarter of his workforce. And he is pushing an internal target of 15 per cent return on capital deployed after receiving feedback from Wall Street.

“Now they are saying, Slow down. You’re producing way too much. You’ve got too much supply in the US. It’s affecting world oil prices and start returning capital back to us,” said Sheffield.

The market capitalisation of energy companies in the S&P500 has been cut in half over the last four years, as institutional investors move out of the oil and gas sector due to squeezed margins and the threat to the industry posed by climate change.

While some believe this is a healthy shakeout to extend America’s oil and gas boom, three basic options have quickly emerged in shale country: to remain independent by slashing costs and enforcing production discipline, put up the “for sale” sign, or go bankrupt.

John Defterios is Emerging Markets Editor at CNN Business.