Will Shale Production Centers Move Away from the United States?
Anwar Altaqi – Esam Aziz
Shale oil is giving many countries, deprived of traditional oil resources, a hope to be energy self-sufficient. Pakistan, for example, has recently concluded exhaustive research in cooperation with the United States Agency for International Development (USAID) on the country’s potential shale resources. The study, which covered the lower and middle Indus Basin, concluded that there are “massive shale oil and gas reserves” in that region. The Pakistani government is working now on a comprehensive strategy to tap those substantial resources.
This raises a question, which is hardly leasable in the fog of the far future:
Will financial limits that are currently facing the shale sector in advanced Western countries lead to a shift in the production centers? No one will be able to answer this question until enough time passes to clarify to what extent financial restrain will limit Western shale production.
However, we know from accumulative data the dimensions of the financial difficulties faced by some shale producers. Take, for example, Sanchez Energy Corporation (SEC). The company had gone through a period of significant production increase last year as well as lower capital costs due to Drilled But Uncompleted (DUC) completions, causing the company’s stock to appreciate by 20 percent within six months.
Nevertheless, despite the fact that Sanchez had so many shorter-term positive factors going in its favor, it still failed to sustain the rally. The fact that Sanchez’s stock did not rally even as oil prices gained about 20 percent is an indication that the company may be in trouble in the longer term. Sanchez is not alone in this regard, because other companies, such as Chesapeake, also failed to bounce, in part because of the fact that natural gas prices did not mirror the rise in oil prices during this period, but also because of longer-term worries, which are starting to kick in. The case of Sanchez is worsened by the fact that it also experienced an increase in production volumes last year, as well as increasing proven reserves by a very significant margin, none of which seem to matter.
Sanchez did have to finance the deal to buy another company largely by issuing preferred equity, which now has to be serviced, adding to the longer-term financial burdens that Sanchez must carry going forward. It should be noted that at this point, its preferred equity burden is costing Sanchez about $18-20 million/quarter, which amounts to about 10 percent of its total current revenues. The company would have managed to break even in terms of operating results for the first three quarters of last year, if it were not for this burden, which amounted to about $60 million for the three quarters combined. This is the main reason I did not want to be stuck holding this stock in the long term.
It is amazing to see that shale companies did not really benefit from the increase in oil prices. Sanchez and a number of other shale players are stark examples of this failure. Yet, a number of companies did see a significant rally in their stock prices recently. This should not be seen as a sign of optimism, though, for even within the context of WTI averaging $50/barrel, few shale producers can hope to make ends meet in the longer run in the absence of significantly higher oil prices. Ironically, they are in large part responsible for preventing the price of oil from increasing to a more comfortable price level for themselves.
The question is not just a matter of achieving break-even or a little better at this point. The debt pile that shale drillers accumulated over the past decade or so is quite impressive at somewhere over $200 billion (according to the Economist in March 2017). The amount of drilling opportunities in the sweet spots in the shale field is limited and with every day that passes it shrinks just a bit more. The potentially profitable acreage that is home to the sweet spots within the current oil price context in the Bakken field is about 3,000-4,000 square miles in total, mostly found within four states.
Those four states are home to roughly 10,000 wells drilled since 2008. In other words, the well saturation within the field’s superior acreage is roughly three wells per square mile. By some estimates, that is already enough to cause well interference issues, which leads to lower production per well, and therefore less profitability. Increasingly, we see a situation where debt stays while drilling opportunities decrease, with no new virgin acreage likely to be made available in the future.
Furthermore, one of the key issues that could affect US fracking growth is the size of the reserves in various shale plays. Based on recent information submitted to the SEC by companies with holdings in the Permian, Eagle Ford, and Bakken regions, Berman estimates that the Permian Basin —currently the “hottest” of the plays — may only contain 3.8 billion barrels of oil. Nearby Eagle Ford and the Bakken region in North Dakota might contain about 5 billion barrels each.
This seems like a large amount, but compared to projects that have recently come online in other parts of the world, it is minimal. For example, Kazakhstan’s Kashagan project, which recently started production, is estimated to hold about 35 billion barrels. One of Brazil’s offshore sub-salt areas is estimated to hold between 8 and 12 billion barrels of recoverable oil. The story of Sanchez warns us against using current growth trends to build a scenario into the far future when looking at areas like the Permian, Eagle Ford, and Bakken.
This is why we must consider the question: Will the future of shale shift to countries like Pakistan, Kazakhstan, and Brazil?