White House’s Crude Oil Top-Up Plans Won’t Fix Shale Industry’s Debt Problems

As America’s heavily indebted shale oil and gas firms reel beneath collapsing crude oil prices, word gradually trickled out that the Trump administration was considering tossing them a lifeline. Options included low-interest loans to shale firms, slashing a 12.5% levy on oil and gas extracted from federal land, and mopping up some crude supply by buying fresh reserves for the US’ Strategic Petroleum Reserve, the world’s largest emergency stockpile of crude. 

By Friday afternoon, during a press conference at the White House that capped a tumultuous week in markets, the shale industry had its answer. The government will plow more oil into a series of artificial caverns inside salt domes along the US Gulf Coast: the Strategic Petroleum Reserve (SPR). 

Crude prices immediately jumped around $2 per barrel, while the stock prices of shale oil drillers shot up. Shares of Diamondback, Pioneer Natural Resources and Devon Energy, three of America’s top shale companies, all rose around 10%. A key exchange-traded fund that tracks oil and gas companies — the SPDR S&P Oil & Gas Equipment & Services ETF — rose 9%. 

Yet a top-up of the SPR, helpful as it may be for a US government perennially concerned with energy independence, will likely do little to prop up shale companies. 

The SPR needs an additional 78 million barrels to reach its capacity of 713.5 million barrels. If the government indeed buys enough to fill it to capacity, and spaces its purchases out over a year, that would effectively remove around 214,000 barrels of oil per day. That is equivalent to not even half the size of the cuts which OPEC+ had been considering before recent talks fell apart. 

Likewise, while the shale industry doubtless welcomed the rebound in oil and share prices, they fall well short of what it needed. The price of WTI crude is down 48% since January, closing at $32.85 this afternoon. Stock prices of many shale companies are down even further. Some, such as Apache Oil, have lost nearly three-quarters of their value since January. 

Hollowed out to the bone, these companies could now be in for a reckoning. Investors have warned for years that the industry’s voracious appetite for debt was unsustainable. Pressed by shareholders, many firms began reigning in spending and increasing payouts to shareholders in the form of buybacks and dividends. But then came a 40% crude price crash in late 2018, and, now, a 50% price crash since mid-January. Dealt two crushing blows by a Saudi-Russia price war and the demand-deadening covid-19 pandemic, many observers expect a lasting oil supply glut that will keep prices firmly depressed. 

That means there will be no escape from a looming cash crunch. Even before this week’s mayhem in oil markets, around two-thirds of high-yield exploration and production companies were trading at distressed levels, according to analysts at Deutsche Bank, news portal MarketWatch reported. “There is a certain subset of energy companies like Chesapeake that will not survive,” said Diamond Hill Capital Management’s Bill Zox. 

Some firms have been talking up their books. Devon Energy today called its financial position “exceptionally strong,” saying it had $1.8 billion in cash and an untapped $3 billion credit facility. In comments to the Washington Post earlier this week, Pioneer Natural Resources CEO Scott Sheffield said that his firm had a “great” balance sheet. 

But they are also hunkering down for what could be a long and painful rethink of their business models. Devon Energy said it was cutting its 2020 capital expenditure by $500 million, or 28%. And in his comments to the Washington Post, Sheffield said Pioneer Natural Resources would “make the necessary adjustments.” 

Sheffield himself is proof of those preparations: he became CEO only at the end of last month after predecessor Tim Dove stepped down.