U.S. Shale Is Living Beyond Its Means

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By Nick Cunningham

Global investment in energy will fall by $400 billion in 2020, the largest single-year decline in history. U.S. shale will be hit particularly hard, with capex set to fall in half, according to a new report from the International Energy Agency (IEA).  After watching hundreds of oil rigs disappear from the field, and after watching U.S. oil production fall by around 2 million barrels per day (mb/d) since March, perhaps that statistic comes as no surprise. “Some of the most dramatic cuts in the oil and gas sector – in many cases above 50% –   have been among highly leveraged shale players in the United States, for whom the outlook is now bleak,” the IEA wrote in its new World Energy Investment 2020 report.

Drilling has come to a standstill and steep decline rates are taking hold. The CEO of Precision Drilling said that the U.S. is set to see a “prolonged downturn” in oil drilling, and the rig count may not begin to rebound for another year.

The pace of bankruptcies is set to accelerate. However, while thousands of workers are sent packing, oil executives seem to be some of the very few people who are not suffering from the historic downturn. CEOs and other top executives continue to see million-dollar paydays.

Reuters pointed out that CEO pay often is linked to the performance of competitors. Since everyone else is doing poorly, compensation for the average CEO remains extraordinarily high. They look good when compared to the next guy.

Reuters cited the example of Clay Williams, CEO of National Oilwell Varco Inc., who received $3.3 million in stock in February, despite presiding over a company that saw its share price plunge by two-thirds since 2017.

There are even more egregious examples. Chesapeake Energy’s management team was awarded $25 million in cash bonuses right around the time the company issued a regulatory filing warning about a potential bankruptcy. Worse, Whiting Petroleum declared bankruptcy on April 1, but company executives made sure they received $14.6 million in cash bonuses.

Energy companies are set to hand out $140 million in executive compensation over the next two years, according to Reuters. “[E]nergy company CEOs have been winning for losing for at least a decade,” Reuters said.

Many of these shale companies won’t survive the next year or two, and Wall Street may not throw them a lifeline this time around. “The fall in the oil price also means that companies that use reserve-based lending face a significant revision in their value of available debt. This will hit small and medium-sized companies particularly hard (not just in shale),” the IEA said in its report. “With the possibility of more constrained access to capital in the future, one consequence of the current crisis may well be a consolidation of the industry towards larger players with deeper pockets.”

But the majors have their own problems. They have been living beyond their means for years. According to a new report from the Institute for Energy Economics and Financial Analysis (IEEFA), four out of the top five oil majors paid more in dividends to investors than they earned from operations in the first quarter of this year.

Chevron, for instance, generated $1.6 billion in positive free cash flow, but paid $4 billion in dividends and share buybacks. Just this week Chevron planned to cut 10 to 15 percent of its global workforce in order to “match projected activity levels,” a spokeswoman told Reuters.

This isn’t just a one-off anomaly because of the pandemic. “For the oil and gas majors, deficits have been the norm over the past decade,” IEEFA analysts wrote in their report. “All told, these five companies generated $340 billion in free cash flows from 2010 through the end of 2019, while rewarding their shareholders with $556 billion in share buybacks and dividends—leaving a $216 billion cash shortfall.”

Again, that time horizon demonstrates that this problem goes beyond the current downturn. It is hard to imagine how borrowing billions of dollars in order to hand the money over to shareholders can be a sustainable business model.

Crude Oil

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