Pipeline shortages, unprofitable, high breakevens for many shale producers, trouble accessing capital, high debt levels – does this sound like a model Canada should encourage?
The Alberta oil and gas industry’s United States fetish is getting tiresome. Trump’s America has become a libertarian Utopia for some Canadian energy CEOs where everyone makes buckets of money free of regulation and government interference. That fantasy doesn’t exist. Some US shale producers make money, some are attracting capital, but many are struggling to find investment and even fewer are actually profitable.
“There is a big bifurcation between Canada and the United States,” Bob Geddes, Calgary-based Ensign Energy Services’ COO told Herald reporter Chris Varcoe Tuesday. “When I travel and I’m in Houston a week, a month, it’s like a different world.”
“There’s much less appetite to grow the production base in Canada, whereas in the United States, they are shooting the lights out down there,” Gary Leach, president of the Explorers and Producers Association of Canada, was quoted as saying.
Comments like these are common in Alberta news media, especially Postmedia newspapers and the trade press. And they’re increasingly common in studies, press releases, and public comments by industry representatives like Tim McMillan, CEO of the Canadian Association of the Petroleum Producers.
The idea that the United States industry is in high gear while Canada is stuck in bull low has become a meme, whose proper meaning outside of social media is “an idea, behavior, style, or usage that spreads from person to person within a culture.”
Like any meme, there is a kernel of truth in it.
US oil and gas production is booming. The US Energy Information Administration says that oil supply topped 10 million b/d earlier this year and will reach 12 million b/d by the end of 2019, driven by better technology that has slowed a high decline rate that previously bedevilled shale wells.
But that doesn’t mean everything is rosy in the American industry, according to economists Ed Hirs, University of Houston, and Phil Dunning of Denver-based Drillinginfo during interviews with Energi News.
In fact, there are serious structural problems that are conveniently ignored by the Alberta fan-bois.
One, shale producers have never been profitable.
“Wall Street took everyone to task last Nov., especially producers in the shale plays,” Hirs says. “The message was clear: ‘Guys, just building reserves isn’t enough, you’re going to have to start delivering cash flow and rates of return.”
Dunning says that after oil prices crashed in late 2014, companies were “spending everything,” leaving investors with “negative equity” that was essentially worthless.
“There’s definitely a push for companies to be proving that they can basically live within the cash flow that exists today. So, they can drill a well, get a return on that well, and basically live within that margin,” he said.
Two, some shale producers are going to have a tough time achieving that goal, even with West Texas Intermediate hovering between $US65 and US$70 – including some in the Permian Basin, home to the best breakeven economics in the US, according to Drillinginfo’s head of research, Bernadette Johnson.
“Not all leases and holdings are created equal. We’ve taken a look at all the companies operating here and ranked them by output and breakeven prices showcasing which operators are ‘in-the-money’ in today’s current price environment, as well as who can weather further price storms – and just as importantly, who cannot,” said Johnson.
“Some will thrive while others will barely survive.”
Even companies with the lowest breakevens are suffering, says Hirs.
Take Pioneer, literally the pioneer of hydraulic fracturing and horizontal drilling in the Permian. The company acquired its acreage for peanuts by getting in early, avoiding acreage costs of up to $65,000 producers have paid recently, says Hirs.
Pioneer management entered into “swap contracts” – essentially a form of hedge against a drop in future oil prices – that backfired and cost the company hundreds of millions this year.
“Pioneer Natural Resources has recognized more than US$566 million in such losses for the first six months of 2018,” he wrote in an Energi News op-ed, noting that many US shale companies were “hammered” by the same mistake.
Pioneer never counted on a widening differential between WTI and Brent (world price) caused by pipeline shortages, a dire situation Alberta producers grappled with earlier this year when a leak on the Keystone line caused the WCS/WTI differential to soar from its historic $15/b range to around $38.
Dunning says capital has left the upstream sector and flooded into midstream as pipeline operators frantically build new capacity.
“The bottlenecks we’re having in the Permian are running differentials between like $5 and $15 a barrel which is a huge problem. Do companies really need more equity if they’re having that kind of issue?” he said.
Instead of equity, producers are turning to debt, which is becoming increasing difficult to secure: US upstream raised $5.7 billion via 12 bonds (down 45 % year-over-year and 19% less compared to Q1), according to Drillinginfo’s quarterly review of US energy capital markets, co-authored by Dunning.
“The majority of companies we see are taking out more debt than actually diluting shareholders,” he said during the interview.
Hirs says that the US oil industry has lost $250 billion of capital over the past few years, most of it from the shale plays, and that has made investors nervous and cautious.
“I think darn near everybody’s having trouble accessing capital unless they can demonstrate significant well economics and capital discipline. The capital that’s coming into the market is really coming in to clean up balance sheets and restore financial stability,” he said.
In other words, the US shale plays have their own set of challenges, just like Alberta. The big difference, according to Hirs, seems to be that US financial institutions believe Texas is more likely to solve the pipeline problem faster than oil sands companies believe Canadian projects Line 3, Trans Mountain Expansion, and Keystone XL will be finished.
Canadian oil-by-rail shipments are touching 200,000 b/d, according to the National Energy Board, and given the 500,000 b/d of new oil sands production coming online by the end of 2019, rail shipments are likely to grow and there is a real danger of the WCS/WTI differential widening, too.
Sure, the Americans are “shooting the lights out.” But given the plethora of other problems US producers are grappling with, Canadian producers and provincial governments would be shooting themselves in the foot by emulating the US model, as CAPP so often urges.
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