Is The US Shale Boom Over? Four Major Threats To The Fracking Revolution

The U.S. is awash in cheap shale oil and gas. After decades of declining U.S. oil output, the fracking revolution unlocked vast oil and gas deposits and made America the world’s No. 1 oil producer. The once-massive U.S. petroleum deficit — $436 billion in 2008 — turned into a surplus last September.

“We do not need Middle East oil,” President Donald Trump declared in January.

Yet just as Americans have begun to take cheap energy for granted, along with the jobs and extra spending money spawned by the shale economy, the U.S. shale boom’s next act looks uncertain. While the government projects continued growth for shale oil and gas production, that forecast may understate the threats. Political, financial, technological and geological pressures are closing in.

The 2020 election looms large. A Democrat president could usher in a new era of intense regulation — or worse. Meanwhile, solar and wind are set to overtake natural gas electricity production far faster than experts predicted just a year ago.

And the shale industry faces its own issues. Well productivity has peaked, while prime drilling areas may soon be fully tapped. Meanwhile, shale oil and gas companies — from pure plays such as EQT (EQT) to oil majors Exxon Mobil (XOM) and Chevron (CVX) — haven’t generated returns. Investors, who no longer want to finance expansion given environmental and political risks.

 

The growth phase of the shale boom is “screeching to a halt,” says Raoul LeBlanc, vice president for energy at IHS Markit. “We expect zero growth next year, and if the coronavirus continues, we could have negative growth this year.”

LeBlanc sees big reasons for the abrupt slowdown that have nothing to do with the Covid-19 virus.

“The technology has largely matured,” he said. After a period of big well productivity gains, “we’ve largely optimized what we can do.” Further, the best ground for drilling will be exhausted in about five years, LeBlanc says.

Another reason is all about cash. Shale companies simply haven’t made much money from the fracking revolution.

“This is one of the most capital-intensive businesses in the world,” LeBlanc said. “Investors that were willing to fund this massive growth are starting to focus on profitability and getting money back,” LeBlanc said. That means spending less on drilling new wells.

On Thursday, Exxon Mobil said its Permian shale operations will operate at a “reduced pace” in 2020 and 2021 vs. its prior plans. The Dow Jones energy giant sees its Permian production at 360,000 barrels of oil equivalent a day this year, though Exxon still plans to nearly triple output in the area by 2024.

Financing problems for the shale oil and gas sector will only grow.

“In the long run, demand for oil is uncertain, at best. Fear is starting to decapitalize the sector, compounding the lousy returns and making it easy for people to say ‘I’m not going to invest here,’ ” LeBlanc said.

Dems Spell Doom To Shale Boom?

Bernie Sanders, whose Democratic presidential hopes are down but not out, just authored a bill that would shut down all fracking on federal land by 2025 and halt federal permitting of pipelines and LNG export terminals.

The nomination of Sanders would make the future of the shale boom central to the 2020 election. Sanders says he would phase out fossil fuels in electrical generation and transportation by 2030. Even the more moderate Democratic candidates, including former Vice President Joe Biden, all sketched out plans to achieve net-zero emissions by 2050.

Any move to halt fracking would face legal challenges and may be an overreach, S&P Global Platts Analytics figures. The most a Democratic president could do in the next four years via emissions and permitting restrictions would be to halt the growth of shale oil, it says.

In addition to a reserve of uncompleted wells, oil and gas companies “have a backlog of permits they can draw on in coming years,” said S&P Global Platts energy analyst Tyler Jubert.

And if a Democrat prevails, Platts expects a “spike in permitting” before Trump leaves office.

Anti-Fracking Legislation Would Face Senate

Because the regulatory process is so cumbersome, forcing significant outright cuts in energy output would require anti-fracking legislation, says Roman Kramarchuk, who heads energy scenarios, policy and technology analytics at S&P Global Platts.

Even if Democrats win the uphill fight for control of the Senate, such legislation looks unlikely, he says. “The Senate is the sticky wheel,” especially with the filibuster in place, Kramarchuk said. In any case, Democratic senators from energy-producing states such as Pennsylvania, New Mexico, Colorado, West Virginia may not fall in line.

Bottom line: Under a tougher regulatory regime and fewer permits, U.S. crude oil production would slip to 12.7 million barrel per day by 2024, about 300,000 below current levels, instead of growing to 14.3 million bpd, Platts says. That might only mean a $5-per-barrel rise in crude oil prices.

Fracking Ban Would Have Big Economic Impact

Yet others fear a President Sanders would do what he promises: halt all new drilling. If that happened, rapid production declines from existing shale oil wells could have an abrupt impact on supplies, consumption and prices. In a worst-case scenario modeled by the U.S. Chamber of Commerce, crude oil prices could soar to $130 a barrel by 2025, killing millions of jobs.

While Sanders and Elizabeth Warren promise a green-energy jobs and infrastructure boom to counter the effects of a fracking ban, there are limits to how fast renewable energy can displace fossil fuels. For his part, President Trump will argue that stunting or halting the flow of oil and gas would push the U.S. into recession.

Fracking Revolution Dividend To Americans

Low energy prices, courtesy of the shale boom, have boosted discretionary income by $2,500 per year for a family of four, White House economists estimate. The creation of hundreds of thousands of high-paying jobs, which helped spur recovery from the financial crisis, and low-cost energy for U.S. manufacturers are other big dividends from more than $1 trillion in cumulative investment, mostly across seven major shale regions.

Some of those regions include electoral battlegrounds. The Marcellus and Utica shale reserves run through Pennsylvania and Ohio, two battleground states. Pennsylvania saw oil and gas jobs more than triple to 31,000 from 2007 to 2014, with extraction jobs paying well over $100,000 per year. Since then, Keystone State shale jobs have been through more downs than ups, including hundreds of layoffs announced last year by Chevron and EQT.

Nationwide, oil and gas extraction jobs, including support activities, rose by about 250,000 from 2006 through 2014. Shale-related employment slid over the next two years and is now about 100,000 below the peak.

The bulk of recent shale oil growth has come from the Permian Basin. That covers parts of West Texas and southeast New Mexico — a state that Trump hopes to put into play. Colorado has been trending Democratic, though voters in the No. 5 oil-producing state last year defeated a ballot measure that would have banned fracking within 2,500 feet of a residence.

Shale Boom: From Climate Hero To Villain?

The fracking revolution arrived at a fortuitous time for a U.S. economy hit hard by the financial crisis. The shale boom, first in natural gas and later in crude oil, provided a burst of job creation and eased tight supplies that had led energy prices to soar in 2008.

It also was seen as a climate-change reprieve. An abundance of cleaner-burning natural gas offered a smooth transition from more carbon-intensive coal-fired electricity generation.

The White House Council of Economic Advisers estimates that shale gas cut annual carbon dioxide emissions from the electric power sector by 506 million metric tons, or 21%, from 2005 to 2018. But recent research casts doubt on fracking’s climate legacy.

Natural gas is cleaner than coal when burned, but not when it leaks into the atmosphere. Emissions of methane, the primary component of natural gas, are far more potent than carbon as a global warming contributor.

Atmospheric levels of methane stabilized in the decade before the shale boom, then took off. Just how much of that can be attributed to shale gas is in question, but there’s a clear connection.

Shale gas producers voluntarily report some methane leaks, and infrared cameras have detected otherwise invisible leaks in natural gas infrastructure. Further, some shale gas recovered by fracked oil wells is intentionally vented in areas with limited pipeline capacity.

The Rystad Energy research and consulting firm says venting and burning of excess natural gas production from the Permian basin hit 810 million cubic feet per day last year. That’s more than enough to power every home in Texas.

Regardless of who wins the 2020 presidential election, it’s not clear who would fund another wave of growth. Investors are wary after shale oil stocks tumbled in recent years and shale gas stocks cratered.

Shale Companies Aren’t Making Money

Even before coronavirus concerns escalated, no quick relief was expected for low natural gas prices. The EIA expects output to slip in Appalachia’s Marcellus and Utica regions. But associated gas output from Permian basin shale oil producers has contributed to a glut.

Chesapeake Energy (CHK), once the No. 2 gas producer, has lost 99% of its value as it struggles under $9 billion in debt. Shale gas development has been “an unmitigated disaster” for investors, says Steve Schlotterbeck, former CEO of No. 1 natural gas producer EQT, whose stock has fallen 90% from its mid-2014 peak.

Bankruptcies among fracking-focused exploration and production companies covered $26 billion in debt held by 42 firms last year. That doubled the $13 billion in debt a year earlier, according to law firm Hayes & Boone.

S&P Global Ratings this month cut credit ratings of six shale gas producers, including EQT, citing the outlook for natural gas prices.

“We are particularly concerned about some of the issuers’ ability to access the capital markets given investor aversion to the space,” S&P said.

Just a few days earlier, CNBC host Jim Cramer exclaimed, “I’m done with fossil fuel,” after disappointing earnings reports from Dow Jones energy giantsChevron and Exxon Mobil.

“We’re in the death knell phase,” he warned.

Even Major Oil Companies Struggle

The so-called oil majors were late to the shale boom. But their stocks only look good in comparison to natgas stocks.

Chevron, which in December wrote down the value of shale gas assets by $5 billion, is down 25% since mid-2014. Exxon Mobil has lost 50%. Over the same time, the S&P 500 index has climbed more than 60%.

Here’s the big picture: Shale oil and gas companies have produced energy security for the U.S. even as most have failed to produce positive cash flow. They’ve been running on a treadmill, constantly plowing oil and gas proceeds back into new wells. Now investors want off the treadmill.

Shale Oil Growth Slows

Between lower commodity prices and investor-applied financial discipline, shale output growth has downshifted in a big way. U.S. crude oil output first hit 10 million barrels per day in November 2017. It surged to 12.9 million bpd by November 2019. The EIA expects output to edge up to 13.2 million bpd in 2020. The Permian basin will account for all of this year’s growth.

Signs of a more subdued future for shale oil and gas have been piling up. Companies including Chevron and oil services giants Halliburton (HAL) and Schlumberger (SLB) have collectively announced thousands of layoffs in recent months. U.S. oil and gas rigs engaged in drilling have fallen by 25% over the past year, according to Enverus Rig Analytics.

Meanwhile, the EIA estimates that the number of drilled but uncompleted wells (DUCs) has fallen by about 10%. The initial drilling costs are about 30% of the total for a fracked well. The dearth of new wells comes as companies are trying to stop burning cash.

“Rationalization is going to have to prevail in this market,” Cabot Oil & Gas (COG) CEO Dan Dinges told analysts on a Feb. 21 earnings call. The big Marcellus gas producer, which is slashing 2020 capital spending by 27%, aims “to be the last man standing.”

Permian-focused Concho Resources (CXO) said earlier this month that it will cut capital expenditures by 10%. Instead, it’ll hike its quarterly dividend by 60% to 20 cents per share.

Shale Oil Well Productivity Falls

One of the big unknowns about the future of fracking centers on well productivity. As shale regions mature, more companies are drilling without sufficient spacing, leading to disappointing production. Meanwhile, older wells are seeing output fall off more abruptly than expected.

“The average decline curve is becoming steeper than we thought because the wells are starting to cannibalize each other,” Raymond James analysts Marshall Adkins and John Freeman wrote in September.

A recent report from IHS Markit finds that “the speed of the treadmill” has picked up for shale companies. The annual decline in oil output from Permian wells now amounts to about 40%, or 1.5 million barrels per day. Growing shale output from here would require an unlikely drilling pickup in today’s more conservative environment.

A key question for investors is whether the sharp shale slowdown is temporary “or whether shale has reached an inflection point because the most productive areas of the main shale areas in the U.S. have peaked,” Christopher Wood, global equity strategist at Jefferies, wrote in November. If the latter, he sees scope for “one more major spike in the oil price” as supply fails to meet persistent demand, before the sun ultimately sets on the fossil-fuel era.

Cramer’s loss of faith in fossil fuel stocks, coming as Tesla (TSLA) stock went vertical, is understandable. Still, if he’s right about this being the death knell, the bells could be tolling for a long time.

Alternative Energy Powers Up

The EIA says rock-bottom prices should lead natural gas production to decline this year. But after a brief pause, the EIA sees a steady uptrend in natural gas output through 2050.

Crude oil output is seen rising to new heights over the next couple of years. It should hold steady for a decade, before shale oil output starts to wane.

Yet the eventual decline stems from fracking’s diminishing returns, not disappearing demand. EIA sees demand for transportation fuel falling about 10% from current levels over the coming decade, before resuming an uptrend. The outlook assumes that current laws stay in place.

Technological change is a big risk. EIA sees a relatively slow ramp for electric vehicles, with gasoline-powered vehicles still accounting for 81% of sales in 2050. That’s down from 94% today. But the auto market research firm Jato has predicted EV sales will overtake sales of gas-powered vehicles by 2030. Regulatory mandates will play a big role in how quickly electric vehicle sales take hold.

The government’s 2019 forecast for renewable electricity generation is already proving too conservative. In 2019, the EIA forecast natural gas electricity generation will grow to 39% of the market in 2050, with renewables second at 31%. This year’s updated outlook has renewable energy’s share doubling to 38%. EIA now sees natural gas dipping to 36% from the current 37%.

Thanks in part to federal tax credits that will phase out starting in 2023, the EIA says utility-scale solar capacity is in the middle of a 65%, two-year growth spurt. Wind capacity will grow 32% over the same period.

Thanks to Tesla stock, Auto-Manufacturers are ranked No. 1 out of 197 IBD industry groups based on price performance and momentum. The Energy-Solar group ranks No. 2.

Solar, Wind Power Become Price Competitive

Even without tax credits, a Lazard study found that electricity from new solar and onshore wind facilities costs about $40 per megawatt hour. That matches the EIA’s estimate for new natural gas plants. One caveat: The EIA cost estimate for natural gas assumes prices much higher than today’s.

Still, rapid growth is coming, and not just in states like California with renewable mandates.

Last year, Northern Indiana Public Service Co. said it came to a surprising revelation as it fielded proposals for replacing two coal-fired power plants. Based on lifetime costs, wind and solar “were significantly less expensive than new gas-fired generation,” Mike Hooper, senior vice president of the electric utility, told a webinar hosted by Advanced Energy Economy.

The power company decided to close its coal facilities earlier. In their place, it’ll use wind and solar, plus battery capacity to manage intermittent downtime.

Please follow Jed Graham on Twitter at @IBD_JGraham for coverage of economic policy and financial markets.

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