In 2020, oil demand plummeted to historic lows. Producers struggled to find storage for the unwanted barrels. While Saudi Arabia and Russia kept flooding the world with excess oil, companies in the US were in dire straits. They were dealing with a double black swan. Will they be able to recover?
The Worst Year for Crude?
When oil prices fall below a certain level, producers make a loss. This is particularly true for shale oil production. Oil is extracted from tighter layers, which makes the process more expensive by definition. In 2020, for the first time since 1983, US crude for May delivery turned negative. This was the worst day the oil market had ever had.
The devastating pandemic caused demand to fall by 30% globally. According to Artem Abramov, head of shale research at Rystad Energy, “$30 is already quite bad, but once you get to $20 or even $10, it’s a complete nightmare”. While the prices have since recovered to over $40, they are hardly impressive compared to the highs of previous years.
Too Much Debt
The problem with unlucky producers is their optimism. They were too reckless with borrowing during the good times. Then, companies with too much debt had to close down. This was the survival of the fittest. Nobody knows what the future holds. The following estimates from Rystad Energy should help you understand the prospects:
- When Oil Costs $20 per Barrel
If such a low price persisted, 500+ American companies would go under by the end of 2021. This concerns both exploration and production.
- When Oil Costs $10 per Barrel
At this price, the number of bankruptcies would double, surpassing 1,000. Very few US E&P companies with debt can survive in such conditions. The majority would end up filing Chapter 11 or considering strategic opportunities.
As you can see, impending bankruptcy is a reality for many US producers. The problems are particularly acute for those who have been borrowing heavily. The shale industry has been hit the hardest because of the nature of oil extraction.
String of Closures
2020 became the biggest year of oil bankruptcies since 2016 when the crisis was caused by a shale downturn. Back then, 70 companies ceased to exist. The latest string of restructurings includes names like Oasis Petroleum Inc and Lonestar Resources US Inc.
According to Haynes and Boone, by September, 36 debt-laden companies owing 51 billion dollars collectively went bankrupt. In comparison with the events of 2016, each of them was more heavily in debt. Five years ago, almost twice as many firms owed $56 billion in total. In addition to producers, 37 oilfield service providers have now gone out of business.
Drawbacks of Shale
Shale companies have been the driver of explosive growth for US oil production. Their output accounts for the majority of the 13-million-barrel daily output. However, to stay afloat and continue growing, producers have to continue drilling more and more wells.
In this industry, wells start to decline more quickly. This explains why so many companies have borrowed capital to support their operations. Such is the nature of the business — drilling never stops. According to the bankruptcy report by Haynes and Boone, a considerable number of oil producers are expected to file for bankruptcy protection throughout 2021.
A Broader Perspective
But what about non-crisis years, you may ask? In 2019, 33 bankruptcies were registered in the first three quarters. In comparison with 2018, this showed a 50% growth. Still, the second quarter of 2020 saw more cases than in any period since 2016. According to Chris Duncan, a research analyst at Brandes Investment Partners, this wave will continue unless a sustained recovery of the prices is observed.
The Grim Reality
The coronavirus pandemic has caused a slew of bankruptcies in the US oil production sector. In comparison with the previous crises, each of the vanishing companies was more heavily in debt. As wells decline more rapidly, producers need to invest in drilling all the time. This explains why so many US-based companies are on the verge of disappearing.