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Page added on August 19, 2014
The Shale Sugar Lick
A well known American comedian, Ron White, quips about the amount of sugar Americans eat by suggesting that certain restaurants install a sugar lick. Patrons can “belly up” and take their fill at the trough. Such an analogy might be apropos of some shale operators with regard to their addiction to debt.
A useful metric when evaluating a company is to look at the ratio between interest expense and operating income. A low ratio means that the company has not needed to borrow great sums of money to keep going. It generates sufficient cash to fund future operations without exorbitant levels of debt or shareholder dilution from issuing more stock.
Examining a selection of shale operators who are active in various plays in the US, one sees an interesting pattern. Perhaps it would be useful to define operating income. Operating income is gross income minus day to day costs of running the business including salaries and then subtracts depreciation. It is a metric that investors use to determine how much potential profit a company might generate. Obviously it gives a more accurate picture of a firm’s profitability than simply gross income because costs have been removed. But not interest expense.
Recently, the oil and gas industry’s appetite for debt has exploded primarily because cash is not being generated by the underlying business proportional to its needs. This is particularly true of some shale operators. EIA, the forecasting arm of the US Department of Energy, quantified this appetite for debt. EIA stated:
“The gap between cash from operations and major uses of cash has widened in recent years from a low of $18 billion in 2010 to $100 billion to $120 billion during the past three years.”
To demonstrate how this phenomenon translates to a company’s financial statement, one need only to examine the ratio between interest expense and operating income. The following chart shows the percentage of total operating income, or potential profit, that is being eaten up by nothing more than interest paid on debt at Range Resources, Devon Energy, Quicksilver Resources, Encana and Exco.
Shale operators have, indeed, parked themselves at the sugar lick debt trough for quite some time now. Could debt diabetes be right around the corner?
It is certainly not out of the realm of possibility.
2 Comments on "The Shale Sugar Lick"
shortonoil on Tue, 19th Aug 2014 1:55 pm
It is hardly surprising that the shale industry is building an upside down pyramid of debt, and some day it will all come crashing down with the rest of the world’s upside down debt pyramid. For production of a hydrocarbon to be sustainable it must be able to supply enough usable energy to the end consumer to pay for itself. Presently that amount is to about 13,000 BTU per gallon. Conventional crude (API 30-45) averages about 28,500 BTU per gallon. Shale production is less than a third of conventional.
Because shale lacks the molecular constituents necessary for it to act as an energy provider, it is only producible up the the limit that the economy can afford it. Past that point its production must be sustained with debt.
“Could debt diabetes be right around the corner? It is certainly not out of the realm of possibility. ”
It is a outcome guaranteed to happen, as long as the laws of physics hold. We’re betting that will be for some time yet.
http://www.thehillsgroup.org/
Northwest Resident on Tue, 19th Aug 2014 2:13 pm
The multiple reinforcing illusions that have been built up around the shale oil industry — energy independence, oil gluts, investment opportunities, etc… — will all come crashing down at some point, and probably not too far in the future. The only thing keeping those illusions alive are the millions of lies, zero percent interest rates, QE cash infusions and steady streams of propaganda that TPTB keep blowing into the Big Shale Bubble on a nonstop basis. One well placed pin prick is all it will take to end the charade. I expect that to happen within my lifetime, most likely within the next four to five years, quite possibly as soon as even next year. When it does happen, that swooshing sound you hear will be civilization as we have known it flushing down the toilet of history like one big turd, never to be seen again. What an experience it is going to be!