By Nick Cunningham
Despite years of burning through cash, and the deep sense of anxiety within the shale industry itself, Goldman Sachs says the current down market represents a buying opportunity.
Through August of this year, more than 190 shale companies have declared bankruptcy since 2015, according to Haynes and Boone, LLP. In fact, the rate of bankruptcies has ticked up this year as low prices and restricted access to capital makes it increasingly difficult for indebted shale companies to roll over their obligations.
But a mountain of debt looms just over the horizon. According to the Wall Street Journal, between July 2019 and the end of the year, roughly $9 billion in debt was set to mature. However, between 2020 and 2022, a whopping $137 billion in shale debt matures. The fracking industry “does not have a viable business model,” according to analysts at the Institute for Energy Economics and Financial Analysis.”
Still, some investment banks hold out hope. Goldman Sachs argues that the market for shale equities could be bottoming out, offering a chance for investors to scoop buy in while everything is cheap.
After meeting with several oil executives in Houston this week, Goldman recommended Buy ratings on EOG Resources and Murphy Oil, while keeping Neutral ratings on a handful of others. One of the interesting takeaways that the bank had was that oil executives “view shale maturity as an industry issue primarily vs. adversely impacting their own company,” Goldman Sachs said in a note.
In other words, oil executives think that the financial trouble afflicting the industry is the other guy’s problem. Cash-strapped companies are in trouble because they are poorly run, or have bad acreage, etc. The collective lack of positive cash flow is not an indictment of the entire industry, shale management thinks.
Goldman also said that “managements see costs continuing to fall and remain optimistic on efficiency gains.” Again, it may be true that some companies are cutting costs and becoming more efficient, but in the aggregate, there is evidence that this is not the case. For instance, in the Permian, input costs rose in the third quarter even as drilling activity fell, according to the Dallas Fed.
Anonymous shale executives themselves laid into the industry in the Dallas Fed survey. “[M]any oil shale projects are failing to meet production projections… Further cost declines will not be forthcoming,” one executive said. “You cannot make money drilling at this price structure. An ongoing drilling program consumes all your returns and continues to require new money,” another added.
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Meanwhile, a recent report from Raymond James concluded that analysts are overestimating productivity gains. Parent-child well problems continue to mount, which adds evidence to the notion that there is a limit to efficiency gains. The “bigger hammer” approach – more sand, more water, longer laterals, more wells packed together – might not have a lot of room left to run.
Goldman Sachs is more optimistic. Or, at least, they like a few companies relative to the rest of the pack. The bank says that EOG Resources, in particular, will grow production and cut costs. “Management believes it has turned the corner on well productivity in the Permian following last year’s spacing/depletion challenges, which will allow it to remain differentiated with respect to well productivity vs. industry,” Goldman said of EOG.
The investment bank made the case that a handful of companies like EOG are attractive. But it was not a ringing endorsement of the industry on the whole. Instead, it’s just that these companies might perform better relative to the rest of the beaten down pack.
Nevertheless, the investment bank acknowledged that U.S. oil production growth might disappoint. “We believe there remains downside risk to our US oil growth forecasts as managements on the margin are looking to spend less, grow less and deliver more [free cash flow], while the rig count continues to fall,” Goldman said.
With access to capital cut off for embattled shale drillers, and pressure from shareholders to cut spending, U.S. oil production growth is slowing down.