After a decade of the American fracking industry burning through hundreds of billions of dollars more than it earned, this industry previously dominated by shale drilling specialists is entering a new phase. The oil majors — a group of multinational companies that typically have divisions throughout the oil supply chain — now are investing heavily in fracked oil and gas operations.
The latest development is Chevron acquiring shale oil and gas company Anadarko for $33 billion. One of Chevron’s current “human energy” ads uses the catchphrase “We do difficult.” Which is good for Chevron if the oil major hopes to profit off this investment, because making money on U.S. shale oil has proven very difficult for the current players.
At Chevron, we know nothing extraordinary was ever easy. Everything bold or monumental is always difficult. Easy doesn’t make us better at anything. Difficult is an invitation to be great, and we do difficult. pic.twitter.com/ZGBnVN0RA3— Chevron (@Chevron) April 16, 2019
Why would major oil companies choose to invest in an industry that has failed to turn profits in the past decade? It helps to consider the state of the broader oil and gas industry.
In the U.S., natural gas prices are so low that in areas flush with it like the Permian Shale in Texas, gas is selling for negative amounts — meaning gas producers have to pay someone to take it. Norway’s state-owned investment fund — an international leader with approximately a trillion dollars under management — recently announced its divestment from U.S. shale oil and Canadian tar sands oil companies.
Chevron CEO Mike Wirth recently told investors of the shale decision, “There’s nothing we can invest in that delivers higher rates of return.”
To put that in perspective, Reuters recently concluded, “U.S. shale producers last year again spent more money than they collected.” Chevron's top executive says the company's best investment option is a business model that consistently has delivered negative returns.
Not to be outdone, ExxonMobil is also making a big move into U.S. shale, with plans focused on the Permian Basin in Texas and New Mexico. As DeSmog reported, Exxon is selling the idea that a partnership with Microsoft and the use of cloud computing will help it unlock the secret to profits in the Permian. Reuters reported that Exxon CEO Darren Woods “said on March 6 that Exxon would change ‘the way that game is played’ in shale.”
The way the game is played now involves spending more money to produce shale oil than companies have been making selling that oil.
Without a doubt, the Permian Shale produces a lot of oil via horizontal drilling and fracking. And oil companies are in the business of producing oil, even if that means losing money doing it. This business has no guarantee of profits but has very strong evidence that oil is present in shale basins and can be produced by fracking. However, the steeply declining production rates of fracked oil wells raises the question of how long U.S. shale basins will continue producing record amounts of oil.
Chevron's CEO says fracking is the best option right now for delivering higher rates of returns. Chevron also has stated it doesn’t expect to make money on shale oil production in 2019 but that should change in 2020. The refrain of “we’ll make money next year” is one constant in the shale oil industry.
Betting That Bigger Is Better
This week the Permian region hosted an annual conference where the unconventional oil and gas industry gathers to talk shop. (Horizontal drilling and fracking for oil and gas is considered “unconventional” by traditional standards for accessing these fossil fuels.) And the message coming from the conference supports the latest approach the oil majors are embracing: scale.
Scale, scale, scale is the new mantra in the oil business. Consolidation is here & will continue, say the panelists. #DUGPermian— Hart Energy Events (@HartEnergyConf) April 16, 2019
The promise to investors is that the oil majors will use economies of scale plus technologies like artificial intelligence and cloud computing to finally make a profit — at some point in the future. There are a few obvious flaws with the idea that bigger is better in shale oil.
The first is a limited supply of what the industry calls “sweet spots,” or “good rock,” the areas with highly productive, and even profitable, wells. The oil majors have acquired the rights to large amounts of land in shale basins to frack but how much of that area holds sweet spots? History indicates the answer to that question comes on a well-by-well basis and a company can't know for sure until it drills.
Scott Sheffield has a long history in the shale oil business and was the founder of Pioneer Resources — a company working in the Permian for decades. Sheffield recently returned from retirement to take the helm again at Pioneer.
Reuters recently reported that in Sheffield’s opinion, the majors “are eventually going to run out of inventory.” Buying more inventory could be an option, but what is the quality of that inventory, that rock? There are plenty of signs that the shale industry has already tapped out many of the known shale sweet spots in shale plays like the Eagle Ford and the Bakken.
This week the industry publication Natural Gas Intelligence reported on a new analysis by the financial services firm Raymond James & Associates Inc., which warned that not only might the rapid ramp-up in U.S. shale oil production be slowing — it may be ending:
“….it is important to note that there is a very high likelihood that well productivities turn negative in the next few years as parent-child, and core acreage issues overwhelm the industries ability to complete longer laterals with more sand.”
DeSmog covered the issue of parent-child wells in August 2018 (a “parent well” is the primary test well and “child wells” are drilled around it). We also have noted that the shale industry is running up against the limits of fracking and horizontal drilling technology and the way these issues contribute to industry losses.
However, this latest prediction by Raymond James & Associates is a first. The fracking industry has proven it can produce large amounts of oil and gas but, overall, has lost money doing that. This new warning questions the industry's ability to produce ever-increasing amounts of oil from shale.
Raymond James summed up the issue, saying, “To simplify, as each play/basin's sweet spot is drilled out, it's reasonable to assume that well productivity will eventually be hampered by a shift to tier two acreage.”
Raymond James: increase in 2018 Permian well productivity b/c majors benefited from EOG, PXD, CXO, PE completion learning curve.— Art Berman (@aeberman12) April 17, 2019
Unlikely repeatable & will probably turn negative in next few yrs.#OOTT #oilandgas #oil #WTI #CrudeOil #fintwit #OPEC pic.twitter.com/EOANlNXZF4
Author Bethany McLean wrote about a similar sentiment in her book Saudi America about the failed finances of the fracking industry.
In the book, McLean quotes one industry investor, whose words presaged the warning from Raymond James.
“Our view is that there’s only five years of drilling inventory left in the core,” one prominent investor told McLean, whose book was published in September 2018. “If I’m OPEC, I would be laughing at shale. In five years, who cares?”
The major oil companies are making big predictions about how much oil they will be producing in five years, even though right now, Chevron admits it won’t make any money on shale this year.
The mantra of the shale industry to investors has been one asking for patience because payoff is still coming. But payoff, after a decade, has yet to arrive. Now major oil companies are making the same claim.
Will Hickey, the co-CEO of Permian oil producer Colgate Energy LLC, this week explained to Reuters the reality of producing shale oil: “You’re at the mercy of what your acreage produces.”
Do the oil majors own enough sweet spots and will those areas produce prolifically for the next five to 10 years? Unlikely, based on history, but as Chevron’s CEO has explained, right now this is their best bet.
Alta Mesa: A Cautionary Tale
Anadarko is not only in the news this week because of the Chevron deal. Another reason tells a cautionary tale for the industry.
Jim Hackett was the CEO of Anadarko before he retired in 2013. However, in 2017 he was lured back to the shale patch with a billion dollars of investor money, which he used to form the company Alta Mesa Resources. Who better to start a new oil fracking company than a former shale company CEO?
Hackett spent the billion dollars, but it was not on “good rock.” His move led the Wall Street Journal to now call this “one of the more spectacular failures met chasing the next big thing in the American shale boom.”
In 2017 Alta Mesa told investors “its average well would produce nearly 250,000 barrels of oil over its life.” In 2018 the new number was 120,000 barrels, and now Alta Mesa is in the midst of investor lawsuits, layoffs, and financial reporting issues. In about two years, a billion dollars is gone and Hackett is borrowing more to try to keep the company afloat.
“Don’t ever run out of cash. It’s not fun,” says Armstrong. You might miss some opportunities but you can then plan long term. #DUGPermian “You have to build a cushion to allow some failures without going off a cliff.”— Hart Energy Events (@HartEnergyConf) April 16, 2019
The Wall Street Journal calls this “[a] cautionary tale for investors chasing wealth in the U.S. energy boom,” but this is just the latest high-profile example of how shale oil is a capital destruction machine and how sweet spots can make or break a business.
However, Chevron, Exxon, and other oil majors are ignoring these cautionary tales and believe that this time, with them, it will be different because as Chevron puts it, “We do difficult.”
That may be true, but so far, trying to make money on shale oil production suggests requiring, “They do the impossible.”