US shale producers face cash constraint

US crude output may never recover from Covid-19 as the upstream industry focuses on stemming cash flow losses rather than growth.

"We see the rest of our peers, the private companies and even the major integrated companies all shifting to a more disciplined mode going forward," independent producer EOG's chief executive Bill Thomas says. "And certainly, we do not think we will ever really get back to the 12.8mn b/d before the pandemic."

Cash flow was never a priority for US shale producers in the past. "While fracking has led to a boom in US oil and gas output, it has consistently burned through more cash than it has produced," the Institute for Energy Economics and Financial Analysis (IEEFA) says. Companies collectively "racked up negative cash flows in every single year from 2010 to 2019", an IEEFA study* of 34 North American oil and gas producers shows. Producers still spent $3.3bn more than they made from sales as oil prices plunged in the second quarter, despite cutting capital spending by 45pc year on year (see graph).

US crude production plunged by 2.7mn b/d to 10mn b/d in April-May as operators delayed new well start-ups and voluntarily cut or shut in output. Output recovered to around 10.8mn b/d by August. But five months is a long time to press "pause" in the shale industry. Output from legacy wells was falling by around 500,000 b/d each month before Covid-19 struck, based on figures from the EIA's Drilling Productivity Report (DPR).

Well completions rose by 35pc to 369 in the seven shale regions covered by the DPR last month, as operators drew down a large reserve of drilled-but-uncompleted (DUC) wells (see graph). But well completions were only a third of the 1,103 completed in March before the big spending cuts. And the number of rigs employed to drill new wells remains at record lows as companies are reluctant to increase output in an oversupplied market. Few expect to see a sharp rebound in US production. The EIA's latest Short-Term Energy Outlook (STEO) sees output averaging 11.1mn b/d next year, 2.5mn b/d lower than its February forecast (see graph).

Cash flows

Companies were already trying to pacify investors before the havoc of Covid-19. Rig counts began to fall early last year and fewer new wells were drilled as they scaled back shale growth ambitions. Operators also began to draw down their huge inventory of DUC wells. This enabled the 34 IEEFA companies to report positive free cash flow in three of the six quarters since the start of 2019.

But activity has slumped to unsustainable levels. Shale operators will struggle to hold output steady and stem the relentless decline from legacy wells until oil prices recover further. Over 850 wells needed to be completed each month at the start of this year just to sustain output, the IEA estimates. "Shut-in production comes back on line" with WTI at $35-40/bl, midstream firm Plains All American's chief executive Willie Chiang says. Completions start taking place at $40-45/bl, and "we start seeing a significant increase in rig counts" at $45-50/bl, he says.

Cash-strapped shale producers need more positive market signals before they boost spending on new wells with WTI prices stalled at around $40/bl. "Historically, the shale business has been a very poor swing producer," independent Concho Resources president Jack Harper says. "We have not really paid attention to the signs all around us and I believe that has changed," he says. "I do expect activity to pick back up at some point but I do not think you will see a very quick ramp like we have in the past."

*Pandemic Accelerates Dismal Financial Performance of US Fracking Companies, IEEFA, September 2020.

By David Long

US producers free cash flow

US oil output

Shale oil production drivers