Sunday, January 27, 2019

Has U.S. shale oil entered a death spiral?

The bad news coming out of the shale oil fields of America could all be put down to slumping oil prices. That is certainly a big factor. But as investment professionals like to say, when the tide goes out, we all find out who's been skinny-dipping.

The pattern of negative news from shale country is not just related to price, however. Oil production, it seems, is being overstated industry-wide by 10 percent and 50 percent in the case of some companies, according to The Wall Street Journal.

The CEO of one of the largest players in the industry, Continental Resources, predicted that growth in shale oil production could fall by 50 percent this year compared to last year. In reality, we should expect worse as the industry for obvious reasons tends to exaggerate its prospects.

The place where the damage to investors has become severe is in private equity firms who hold a large portion of the shale oil industry's high-yield debt. The plan for the firms was always to unload the debt on somebody else when better opportunities presented themselves. But the firms overstayed their welcome and are having a hard time even finding a bid in the market for these bonds.

With the big Wall Street players now questioning the value of their existing investments in shale oil, the industry is finding it hard to raise money. Not a single bond sale has come off since November in an industry which must continuously raise capital to survive.

To add to the problems, the future of U.S. shale oil production seems to be in the Permian Basin in Texas which has been providing the lion's share of oil production growth for the entire country. But ongoing drought in an already arid West Texas has raised doubts about whether the Permian will have enough water to meet all the demand for fracking new wells.

Because of the rapid declines in the rates of production from shale wells, companies must first drill enough new wells to offset the loss of production from previous wells—a task akin to walking up the down escalator.

This was not such a difficult task when the shale boom was just beginning. But with the huge increase in the number of operating wells, companies are having to spend more than half of their capital budgets on simply replacing lost production before drilling wells that add to production. That number is expected to reach 75 percent by 2021. At some point it could reach 100 percent. (For this reason some analysts refer to shale oil development as a Ponzi scheme.)

With rig counts dropping; capital expenditures likely to be cut in the face of low prices; and more and more of that budget being used simply to replace existing production, it's possible that the death spiral long anticipated by the industry's critics has arrived.

Shale players for years have been unable to finance their drilling programs out of operating revenues as free cash flow (operating cash flow minus capital expenditures) remains wildly negative for most companies. In other words, what companies spend on acquisition of leases and land; drilling and well completion; current operating expenses; and general and administrative expenses far exceeds the cash generated by their sales of petroleum and related products from existing wells.

That means the companies must borrow from investors (usually in the form of high-yield debt) or get them to buy new shares in order to raise the money needed not only to drill enough wells to make up for lost production from declining wells, but also to drill enough to grow production—something investors have been counting on to secure the value of their bonds and increase the value of their shares.

If the needed capital is not forthcoming, it means that companies will be faced with declining revenues from declining production. With lower operating cash flow and little access to additional capital, these companies will be unable to drill enough wells to offset declining ones. That means even lower revenues in the future which will mean even lower investment in new wells. That's what a death spiral looks like.

Of course, oil prices could revive and with it investor interest. No one can know for sure. But the big question is this: The next time oil prices do rise, will investors risk getting caught during a subsequent downturn with shale oil company bonds that can't catch a bid in the market (or shares that could end up worthless)?

Of course, if the current downturn in oil prices continues, there might not be a next time for many shale operators.

Kurt Cobb is a freelance writer and communications consultant who writes frequently about energy and environment. His work has appeared in The Christian Science Monitor, Resilience, Common Dreams, Le Monde Diplomatique,, OilVoice, TalkMarkets,, Business Insider and many other places. He is the author of an oil-themed novel entitled Prelude and has a widely followed blog called Resource Insights. He is currently a fellow of the Arthur Morgan Institute for Community Solutions. He can be contacted at


Joe said...

I have yet to see an answer to the most important question. If a shale production company stopped drilling completely, closed up shop and spent no more money, would the remaining productive potential from its existing wells be enough to pay off all its existing debt?

If so, the debt is sound and will eventually be paid back as relatively cost-free oil comes out of the ground, albeit at declining rates. And once they become nearly constant-production stripper wells, the owner could expect years of modest profits from thousands of legacy wells.

I guess we will eventually find out whether the net present value of all future cash flow is greater than these shale companies' existing debt, but if it is, they may still get some funding from folks who are willing to wait for the return of their loans' principle.

sv koho said...

All of us in the energy analyst field have wondered how long this Ponzi would last and this post by Kurt aggregating some recent news is adding to the recent negative news surrounding the shale patch. There are patches and then there are patches. The elephant has been the Permian and previously the Baaken. This possible downturn has been long warned by independent analysts with a Geology background like Art Berman.When they were losing money some years back drilling sweet spots with oil at $100 one wonders how they would fare at $40. Now we see they aren't. Not all the firms are deeply cash flow negative and there are rumors that the big boys like Exxon might be stepping in to pick up the pieces for chump change on the dollar. That remains to be seen but at least Exxon could hide the losses in its upstream and downstream conventional holdings. But check how much debt that Exxon has piled on in the last 8 or 10 years. Not good. Almost as alarming is the data from the JOFI database on worldwide diesel production showing a decline for the past 2 or 3 years. Diesel is best made from the heavier grades not the volatile thin frack grades.Link:

Anonymous said...


The answer is company dependent. In particular, some companies have an "overhang" from wells drilled prior to 2015 when prices were 100+ (granted many of those have gone bust already). but clearly there is a difference in companies still carrying that debt load versus those who already flushed it via BK.

But on a going forward basis, projects are meant to be NPV+. Of course time will tell. But companies are not looking (nor should they) at new projects based on the old problems. That is called the sunk cost fallacy.


1. Did you predict the shale performance so far? The massive rise, especially AFTER 2016?

2. Have you previously (many times over the years) predicted shale was about to die when it didn't?

Note: this is not to hurt your feelings but to make a logical point. If you have been wrong in the past, shouldn't we take your comments now with some skepticism? Even worse is if you are not acknowledging mistakes or learning from them. It becomes an unscientific attitude if you don't self calibrate. I think you are a high IQ guy and calm in manner so hopefully you can do better. [I know you will delete the comment...but I am talking to you individually.]

Kurt Cobb said...


You aren't hurting my feelings. Yours is a legitimate question and I wish it were directed at those in the oil business who have made consistent erroneous forecasts. It's true that the miraculous resurrection of shale oil production after the price collapse ended caught me by surprise. But my analysis has been consistent: Most of the players in these deposits are free cash flow negative even when prices have been high. That's just a fact.

What is surprising is that so-called smart money (they seem dumb to me) keeps pumping money into the free cash flow negative firms. And, they didn't seem to have learned from the price collapse in 2014 through 2016. They keep putting money in and stepped up investment as prices rose. But didn't it occur to them that another price collapse might be right around the corner if they funded these companies to overproduce? Apparently, not.

My main point is that as long as investors are willing to throw good money after bad, companies which are simply consuming people's capital will go on drilling. When the investment spigot stops, and it largely has now, these companies simply don't have enough money to replace their production. Not every company is in the same situation. But most of them are.

This reminds me of the craze of the late 1990s. It just kept going and going and going with investors throwing money at things that had never made any money and never would. But anyone who dissented from the view that tech was the place to be looked like an idiot, that is, until the bust.

I'm not in the investment advice business. People who are looking for investment advice shouldn't look to me. What I'm more interested in are the fundamentals of oil supply and the sustainability of a business model that doesn't make any money but purports to "solve" the oil supply problem for the long run.

There are certainly people who've made money in shale oil. They tend to be managers who pay themselves in stock options and huge bonuses. That's investor money essentially being squandered. Anybody who has been a long-term investor in these companies as a whole (keeping in mind that you must include the ones that went out of business because they were available for investment at the start of the boom), those investors have been sorely disappointed. Can someone trade the swings in price and if they are lucky time it right? Sure. And, I have no objection to that.

(See the continuation of my comment)

Kurt Cobb said...

(Continuation of my comment)

At some point the jig will, in fact, be up. Investors will stop pouring money into a losing proposition in the long run. The fact that they continue to subsidize oil for the rest of us and the lifestyles of the company management is puzzling. The numbers have been available for years. I think most investors don't understand resources investing and the managements have been able to almost continuously bamboozle them.

So, while I've been surprise at how long people can be deceived about the economics of this kind of oil production, that doesn't change the facts. Just as I was surprised at how long people could invest in companies with a .com at the end of their name when those companies has little revenue, no profit and no viable business proposition.

The tech boom simply hurt a bunch of gullible investors. The propaganda that is coming out of the shale patch doesn't just threaten a bunch of gullible investors, it threatens the entire future of human civilization by giving us misleading information about the sustainability of oil supplies from this source.

It is a fact that if society subsidizes something with money (which are really energy certificates), it is taking energy away from something else. Subsidizing this kind of oil production (even if it is a private subsidy) means we are simply stealing energy from elsewhere to get energy that is not economically viable. That's what is happening in the shale plays.

See my recent analysis that outlines this in detail: Shale oil becomes shale fail (and a nice subsidy for consumers)

Michael V said...

Kurt, when it comes to forecasts I am always reminded of quote that I cannot find the reference to.

"Growth typically goes on far longer than is rational or reasonable and the fall happens far quicker than expected".

These things are so hard to predict, I remember people saying the bubble would tank in 2013. If people were rational, it would have happened. Like you said, people will throw money at some incredibly bad bets despite all signs against it. It is hard to use rational thought to predict and irrational system. Eventually you will be right, standing in the rubble of all this mess saying "I told you so" but it will be difficult to say when. You won't be a winner because you are in the same boat as everyone else but at least will be a little more mentally prepared for the decline.

Shawn B said...

Many astute observers have been surprised by how long the shale game has gone on. Some of those same folks have been surprised by how much money the central banks around the world have been able to “print” in the last 10 years (without inflation), and how many more trillions of debt could be accumulated by governments businesses and consumers in that same period. I would suggest that the Shale game should be seen in this larger monetary and fiscal context. How this ALL ends is anyone’s guess, but repayment of any significant portion of the accumulated debt and fiscal obligations seems unlikely at this point.

EnergyAudit said...

“No Energy store holds enough Energy to extract and collect an equal amount of the Energy it stores” (The Fifth Law).

Humans can not manufacture Energy. Energy is continuous, always and only comes from the past into the future.

And, humans have never managed to extract/produce one unit of excess Energy by expending less than one unit of energy in the process, since the days of early coal and early steam engines - by physics.

The classic EROEI calculus is hypnotic, as it fails to identify where the 1 in its infamous 4:1 or 15:1 formula has come from? Has it come from filling a jerrycan with fuel at a gas station?!

Not only shale oil but all fossil fuels extraction and production are energy-sinks and money losers.

Back in 1700's Britain, the early steam engines were fed with an un-audited amount of coal put into them at the mouth of the pit, under the doctrine of 'lease period' contracts. Palm oil lubricants kept the engines running were brought all the way from slavery-ruled Nigeria and others. Generations of animals and humans were born and die extracting coal until oil came around almost the same time when coal has peaked in Britain in 1913.

All that has been insanely encouraged by Adam Smith's Invisible Hand of Economics and the alchemy of 'Growth'.

Today, all hydrocarbon-rich 3rd world countries, China and Russia sell their hydrocarbon production by state-owned 'companies'.

Why? Because they are not obliged to audit how much the energy supplies they produce compared to the energy-cost building, maintaining and running the industrial base that manufactures those supplies. The ratio is likely 10000 units consumed to 1 unit produced.

It is a massively lose-win operation: the national hydrocarbon company burns huge amount of units of energy to produce one unit of energy, which is mostly reserved for export into the world Energy market.

Extracting shale oil, conventional hydrocarbons, the production of nuclear, fusion, solar, wind or hydro power are all massive energy sinks. This explains how humans have now depleted almost all the millions of years in the-making astronomical fossil fuels reserves in a mere 300 years since what is called the 'Industrial Revolution'.

Energy is not a playground for humans (or Aliens) on Earth or beyond, but likely a prison!

Tar-sand oil, shale oil, shale gas and low yielding conventional hydrocarbon reserves must from now on increasingly turn their operations into CGI graphics-practices, where rigs turn but not drilling, trucks move but empty, pipes installed but hardly put into them any real energy supplies and synthetic noise-generators are left running very loud mimicking real pumping stations at work.

Many think on the Internet that SpaceX landing its booster rockets vertically back on the ground, as seen in various videos while loudly cheered up by gathering fans, or Tesla car in space not fuming under the sun, is likely done that way - with a tremendous financial and media success.

Why not shale oil, fusion, tar-sand, deep-see oil, nuclear, solar, wind and others?!

The video below reports on an average of 800 cancer cases in children residents of Iraq's main hub of oil production and exporting operations, Basrah. One of the speakers says in effect, "we are chocking with disease-causing gases from oil production and gas flaring, but no spare energy to pave a road. Look around, it is all dirt".

EnergyAudit said...

ChemEng said...


Thanks for a very interesting article and discussion.

In a recent podcast at the Peak Prosperity site, Art Berman suggests that investors in shale oil projects are the true believers in the concept of Peak Oil. They are building up a stake in this business in anticipation of a jump in oil prices. Do you agree with that point of view?

Kurt Cobb said...


I doubt that investors in shale oil think very much at all. Someone on Wall Street tells them it is a good investment, the industry tells them that the Permian Basin is the next Saudi Arabia, and for a while things look good as long as the investment flows keep going. It's like the housing market. As long as credit is loose and buyers are flush, they can push the price of housing up. It's not because housing quality (at least for the existing housing stock) is getting better. It's just a phenomenon of credit flows. Then when the credit is no longer available or when investors flocks to the next investment that's going up, the bubble comes to an end.

There may be some truth to what you say when it comes to the oil majors, especially the ones who had the brains and patience to wait for the bust and pick up leases and operating wells cheaply the first time around. They can sit on these deposits until prices are sky-high and then put them into production. (By sky-high, I mean $120 to $130 consistently for oil from those fields which could be much higher for places such as the Bakken which have transportation issues.) They don't have investors clamoring for interest payments and dividends related to such properties. But the oil majors (with the notable exception of Total) have never embraced the peak oil thesis. If they did, it would mean the end of their business model. And, as Upton Sinclair once wrote: "It is difficult to get a man to understand something, when his salary depends upon his not understanding it!."

John Birk Johnsen said...

Thank you for that informative and well-written article. Here in Norway we have two big offshore drilling companies really taking the same view as you, that is that shale will not be able to compete with the convensional oil production. I would advice anyone who has doubts on shale-industry to have a close look at Borr Drilling, soon on for listing in New York. They know own 40 high-spec offshore drilling rigs, bought at a discount in 2016. The debt is starting to pile up, but this is a 2 year old company, and they don't want to commit their rigs at these levels of rates, they would rather wait until the shale-bubble burst around 2021-22. Also in 22 you will also see the effects of such massive drop in investments from 2015-2017 caused by the oil price drop. Thank you once again, will certainly stick around.