OPEC faces US shale groups resilience

Since taking over as secretary-general of OPEC last year, Mohammad Barkindo has been trying to build contacts with the biggest threat to the oil producers’ cartel: the small and mid-sized US shale companies that have been the most potent new force in the energy industry in the 21st century. “They have a very rich story to tell: how they were able to engineer this revolution. I think they should be commended for doing what they did,” Mr Barkindo told a conference in London in February. “A lot of them have been reduced to tombstones, unfortunately.”

The bad news for OPEC, however, is that many of those fallen companies have refused to stay in their graves. Failures of North American exploration and production companies soared after oil prices started falling about three years ago, with 114 seeking Chapter 11 bankruptcy protection in 2015 and 2016, according to Haynes and Boone, the law firm. But like monsters in a horror movie, these businesses have proved exceptionally hard to kill off. Of the 10 largest US exploration and production companies to have gone into Chapter 11, eight have emerged and are still operating, having shed billions of dollars of debt. As Michael Watford, chief executive of Ultra Petroleum, which emerged from Chapter 11 in April, put it on a call with analysts this month: “In many ways, we are the same, but in other ways we are better.” These corporate survivors have generally been forced to cut output, but many are now planning to grow. They have often kept their pre-bankruptcy management teams, retained with generous incentives. The tenacity of shale companies is a testament to the leniency of US bankruptcy laws, and the exuberance of the capital markets. New bond finance for US E&P companies slowed for a while in 2016, but has subsequently rebounded, while equity capital raising was at a record high last year.

When Saudi Arabia, OPEC’s de facto leader, decided to allow oil prices to fall in the autumn of 2014 by not curbing production, it was a deliberate attempt to squeeze higher-cost producers including US shale companies out of the market. OPEC anticipated these producers would run up heavy losses, which in turn would cut off their access to capital. But as it has turned out, US shale companies have been able to cut costs and increase productivity dramatically. Their losses, while substantial, were not large enough to scare investors away. The wave of bankruptcies has made the industry stronger, by wiping out onerous debt burdens, and by leading to assets being transferred to companies that have capital to invest. Oklahoma City-based SandRidge Energy, for example, filed for Chapter 11 last May, at the lowest point of the industry’s activity. It emerged in October with $3.7bn of debt eliminated, and relisted on the New York Stock Exchange. Last week it reported net income of $51m for the first quarter of 2017, compared with a loss of $324m during the same period in 2016. Over the past year, it cut its production costs per barrel by about 27%, and wiped out its debt interest payments, which had been $81m in the first quarter of 2016. Production has fallen, but James Bennett, SandRidge’s chief executive, told analysts last week he expected oil output to start growing in the second half of 2017. It had just one rig running for most of the first quarter, added a second towards the end of the period, and expects to start up another around the middle of the year. Another company enjoying a second life is Halcon Resources, which like SandRidge went into a “prepackaged” bankruptcy last July, emerging in September. Halcon similarly posted a rebound in profitability: it swung from a net loss of $567m for the predecessor company in the first quarter of 2016 to a profit of $189m for the successor group during the same period of this year. Halcon, too, has been pursuing growth. It recently added a second rig running in the Williston basin of North Dakota, and announced in January that it was spending about $840m to buy assets in the Permian region of Texas, currently the hottest part of the US for shale oil development.

The companies that emerge from bankruptcy are likely to be under greater pressure to grow rapidly, because of the change in the composition of their investors, according to Charles Beckham of Haynes and Boone. Many have held debt-for-equity swaps, which means that bond investors have become shareholders. Biggest risk for sector is increased output causing new crude price crash “The new owners are not going to be nearly as patient with managements as the old shareholders were,” says Mr Beckham. “They are going to want performance to be turned around quickly.” Not every company that comes out of Chapter 11 is determined to grow. Samson Resources, which went into bankruptcy in September 2015, sold off many of its assets before emerging as Samson Resources II in March, and said last week it was also looking to dispose of its drilling rights in east Texas and northern Louisiana. But these deals still strengthen the industry, because the oil and gas reserves end up with companies that have the financial muscle to develop them.

OPEC has already been unsettled in recent weeks by the stubbornly high level of oil inventories. The revenant shale companies, evidence of the relentless vitality of the US industry, are a reason for the cartel and all other oil producers to be nervous.