The U.S. shale industry really took off in 2009. Thanks to the United States’ extensive shale formations, it has benefited hugely from the shale revolution. The combined technologies of hydraulic fracturing and horizontal drilling vastly increased the productivity of shale wells, and overall U.S. oil production has increased apace. In 2018, the U.S. produced an average of nearly 11 million barrels per day of crude oil, almost 60 percent of which came from shale. It’s helped the U.S. surpass Russia and Saudi Arabia in the production of hydrocarbons and is pushing the U.S. toward becoming a net energy exporter, a benchmark it’s expected to reach next year.
Financing: The Catalyst
Financing was, in many ways, the engine that drove the rise of shale oil, but the industry’s reliance on debt has also threatened to bring it down. In the wake of the 2008 financial crisis, interest rates fell, making debt cheaper and borrowing easier. In the low-interest rate environment, investors were looking everywhere for yield. Shale looked particularly appealing for debt investors since reserves could be used as collateral – if companies failed to pay their debts, the banks could simply take control of the reserves. This created the appearance of added security.
The availability of cheap, accessible debt coincided with two other important moments that created a turning point: skyrocketing oil prices and technological developments that had made the economics of shale drilling viable (though still expensive). Shale production took off, reversing a decadeslong decline in U.S. oil production that had begun in the 1970s.
Debt, however, is a double-edged sword. In exchange for immediate access to capital, firms assume higher operating costs down the road. This can lead to firms becoming over-leveraged as they assume so much debt that they cannot afford to both pay off the debt and pay regular operating expenses. So when oil prices tanked in 2015-16, many over-leveraged companies went out of business, causing U.S. oil production to drop from about 9.4 million bpd in 2015 to 8.8 million bpd in 2016. Notably, this was not an accident. Global oil supply had been climbing thanks to shale production. When supply is too high, OPEC typically cuts production to drive prices back up. But in 2015-16, OPEC chose not to cut supply, hoping that low prices would drive shale producers out of business and thus allow OPEC countries to reclaim market share they had lost to shale.
This downturn threatened to prove right concerns that, without high oil prices and access to cheap, plentiful debt, shale is not an economically viable industry. Companies had taken on unsustainable amounts of debt to fuel growth. When interest rates began to climb, the need to service that debt was a further incentive for shale companies to continue production – even if operations were barely or not at all profitable. These firms’ lending used to set up new wells created debt service expenses, which led to total operating expenses exceeding cash coming in from operations for too long; if interest rates had continued to rise, the entire industry would be, if not sunk, at least forced to slow production. This was not lost on debt investors, who of course feared that bankruptcies would wipe out most of their investment. As oil prices fell, access to debt capital decreased, forcing cash-strapped shale companies to turn instead to equity financing (that is, to issue more stock).
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