The Impact of COVID-19 on the US Shale Oil Industry

By Udhaav Jhunjhunwala (Singapore Management University) and Kyle Stein (Washington University in St. Louis)



2020 has been an extremely volatile year for oil and gas companies with the twin shocks of the COVID-19 pandemic and Russia-Saudi Arabia price war devastating the oil markets with Brent and WTI reaching the lowest levels since 2003. This report will analyze the impact of these twin shocks on the American shale oil industry, focusing the effects on oil demand and supply, bankruptcy and M&A activity, as well as the impact on the communities surrounding oilfields, and how the ongoing energy transition plays into the wider trends.



Trend Overview 


Section 1: Global Demand and Supply Volatility Bearing on the Shale Industry

  • In H1 2020, oil prices faced unprecedented volatility due to the twin shocks caused by the COVID-19 pandemic and Russia-Saudi Arabia price war. 

  • With oil prices falling to multi-year lows, US shale oil producers were thrown into financial stress due to their high Capex requirements and breakeven costs. This has led to a reduction in capital spending and closure of producing wells sharply reducing oil output from the US.


Section 2: Bankruptcy and M&A Activities

  • 18 US shale companies have filed for bankruptcy in Q2 2020 with total debt loads of over $30 billion. It is expected that many more companies will file for bankruptcies in the coming months.

  • Lenders have also been scaling back their exposure to oil companies in the US and this trend is expected to continue in the coming months with banks not willing to roll over debt and credit facilities. 

  • With many companies facing difficulties, the industry is ripe for consolidation. The larger oil supermajors will be able to survive the crisis and can take advantage of the weakness of other players and acquire them at attractive valuations.


Section 3: The Impact on Surrounding Communities and Sectors

  • Oilfield service companies are among the worst hit by the oil price crash with large-scale job losses and shut down of facilities.

  • The local communities near major oil basins have also seen devastating effects. Nearly all businesses from hotels and restaurants to schools and even barbers.


Section 4: The Future of the Industry in the Midst of an Energy Transition

  • The crash in oil prices will lead to lower returns for investors in oil companies, leading to a reallocation of capital towards cleaner sources of energy which can now offer similar returns.

  • The impending shift in the transportation sector with the rise in popularity of electric vehicles and the development of electric trucks will likely significantly dent the demand for oil in the future.



Global Demand and Supply Volatility Bearing on the Shale Industry


The first half of 2020 was probably one of the most volatile periods ever in the oil markets. Entering into 2020, oil demand was at its highest ever at about 100 million barrels per day (mb/d) and the oil prices had stabilized between $60-70/bbl. However, with the onset of the COVID-19 induced lockdowns as well as a price war due to a failure of the OPEC+ alliance to negotiate production cuts, March and April 2020 saw oil prices fall to multi-year lows including the unprecedented event of oil futures trading at negative prices as the storage capacity was overwhelmed globally.


Figure 1: Brent Crude Oil Price Chart - 2 year (Source: TradingView)



We will look at the reasons behind this extreme volatility in oil prices by studying the divergence between demand and supply as well as the impact it had on US shale oil producers.


Global oil demand in 2Q20 fell by a remarkable 16.4 mb/d year-on-year with world oil demand projected to fall by 7.9 mb/d in 2020. The fall in demand can be attributed to the various isolation measures that were introduced globally as the travel and transportation sectors came to a halt and industrial activity bottomed out. While there has been a gradual increase in demand as countries have tried to restart their economies, the short-term demand outlook continues to be bleak.


According to the International Energy Agency, global oil supply fell to a 9-year low of 86.9 mb/d in June 2020 due to output cuts by OPEC+ as well as sharp declines in production in the United States and Canada. The OPEC+ output cuts followed the uncertainty of Saudi Arabia and Russia’s price war that began on 8 March 2020 when Saudi Arabia announced huge discounts for customers on oil. This announcement led to turmoil in the markets as oil benchmarks fell by between 20 and 30% within a matter of hours. This economic downrail was subsequently followed by announcements that Russia and Saudi Arabia would be increasing their daily output. This news sparked a price war that lasted for almost a month, which was fuelled by the increase in supply and the massive decimation in demand due to the coronavirus. The move by Saudi Arabia was an attempt to assert their global dominance as the world's top oil exporter. It was also to possibly take on other higher cost oil producers, such as the shale producers in the US who had flooded the market in the last decade and overtaken Russia and Saudi Arabia as the largest producers of oil.


Largely dominated by shale producers, US oil production fell by 16.6% or 1.99 mb/d in May for the largest monthly decline since 1980. Consequently, the US lost its status as an exporter of petroleum within 8 months of obtaining it. Shale’s high capex requirements as well as relatively high breakeven cost of about $50/bbl has meant that the industry has always been susceptible to an economic downturn. With the oil price crash this year, many companies will see huge impairments and write-downs in their assets. According to Deloitte, 30% and 50% of major listed US shale operators are technically insolvent at oil prices of $35/bbl and $20/bbl respectively. 


With huge debt loads on many shale companies’ balance sheets and a high breakeven cost which might not be achieved in the near future, the future of these firms look bleak. According to the CEO of Parsley Energy, one of Texas’ bigger producers, the shale output has already peaked and we might never see the output levels seen in early 2020 ever again. With reduced capital spending and closure of producing wells by companies across the country, this might very well be true. On July 9, only 223 horizontal rigs (a proxy for drilling activity) were operating against 853 a year ago. This sharp drop in drilling activity will also lead to an adverse impact on the oilfield services sector, where hundreds of thousands of jobs are dependent on the activities in the shale patch.



Bankruptcy and M&A Activities


Since January 2020, the combination of COVID-19 and the Saudi-Russia price war tanked the US Shale oil industry. Following the end of June, during the second quarter, there have been roughly 18 US shale oil companies that have filed for Chapter 11 bankruptcy, and 25 since January. The sum of debt by every company in the oil industry that filed for bankruptcy since January of 2020 is $30.62 billion, which is nearly a 10.3% increase of the accrued debt during 2019 ($25.77 billion). Almost all of the companies that filed bankruptcy have over $50 million in liabilities. It is expected that many more producers will file bankruptcy in the coming months, despite any improvement in the price of oil. One of the main reasons shale oil companies are struggling to stay afloat is because of highly leveraged balance sheets and high break-even costs. Although the United States puts millions of barrels of oil on the market, barely one-third can break even. On top of that, lenders have been decreasing their exposure to oil producers and are anticipated to continue doing so in the coming months by not rolling over credit facilities while increasing their standards and protections for their current clients who are in the oil business. The borrowing amount for oil and gas companies is based on the value of their reserves, which has taken a hit due to the falling prices, effectively reducing the total amount of money that companies can borrow. In some cases, this reduction can fall below the total outstanding amount, which would lead to an immediate repayment call and add more stress for the borrowers. According to S&P Global Ratings, on average, the borrowing bases were reduced by 23% and credit commitments were reduced by 15%.


Denbury Resources, a huge US oil producer who focuses on enhanced oil recovery (an extraction method using carbon dioxide on exhausted fields), filed for Ch. 11 bankruptcy. The company had a fairly high yield and produced approximately 56,000 barrels of oil per day (BPD) in 2019. However, they were left vulnerable in 2020 when the price tanked due to their greater costs of operations from their unique extraction method. At the end of last year, Denbury Resources had about $2.3 billion in debt, which they are struggling to relieve, and nearly half of which would mature by the mid-fiscal year of 2022. With their plans of filing bankruptcy, the company would eliminate $2.1 billion in debt. If the restructuring of Denbury Resources proved to be effective, the company could perhaps act on the increasing demand to reuse carbon emissions from power generation. This could result in the company thriving and possibly growing their business, especially considering Joe Biden made carbon capture utilization and storage a significant component in his promised energy plan.


At the end of June, Chesapeake Energy - the second-largest producer in natural gas - filed for Ch. 11 bankruptcy. With assets in Texas, Wyoming, Marcellus shale, and Appalachian Basin, the company, in the first quarter, generated around 500,000 barrels of oil. One could foresee their bankruptcy when the company missed their interest payments in June, and with bonds maturing in 2021 that were last traded for merely 5 cents. The bankruptcy plan would rid the company of $7 billion in debt, and to resume operations throughout bankruptcy, Chesapeake Energy obtained $925 million of debtor-in-possession funding. Additionally, investors will finance $2.5 billion on Chesapeake’s way out of bankruptcy. Two days prior to the bankruptcy, Chesapeake Energy had a market capitalization of $116 million. Even as a pioneer in the oil industry with a market value of over $35 billion in 2008, Chesapeake Energy was one of the many companies to find themselves riddled with debt.


Yet, with so many players in this industry left withering away, some formidable companies could take advantage of these rough times. The largest and most profitable companies will most likely overcome these unprecedented times and recover. The smaller and financially weaker producers, however, will succumb to the decline of national output due to the lack of funds stemming from their large debt. This will most likely lead to a surge of consolidations, leaving fewer players in the industry controlled by the biggest firms.* On July 20th, Chevron declared their plans to acquire Noble Energy, a US oil and gas producer, for $5 billion in stock. This purchase is the first significant energy transaction since COVID-19 started. Preceding the deal, Chevron backed out of their offer to purchase Anadarko for $33 billion and concluded the first quarter with earnings of $8.5 billion. Their proposal to purchase Anadarko was an attempt to increase production in the Permian Basin, yet received a break fee of $1 billion. With this acquisition, Chevron will not only increase its US Shale practice, but it will also give them an international foothold with “Noble's flagship Leviathan field off the shore of Israel, the largest natural gas field in the eastern Mediterranean.” This allows Chevron to be the first large oil company to operate in Israel, and enables them to hold a larger position in the Permian Basin and Colorado shale oil regions. From the start of 2020, Noble’s market capitalization went from nearly $12 billion to $4.63 billion just before the deal, and with shares dropping over 60% to $10.18. Meanwhile, Chevron’s stocks only decreased by 2.2% to $85.27. Noble’s valuation increased by 7.5% to $10.38 due to the deal, which is worth approximately $13 billion with debt incorporated. The transaction is scheduled to close in the fourth quarter of 2020 and would give Noble’s shareholders 3% ownership of the joint company. According to Chevron, “The deal will help save about US$300 million on an annual run-rate basis and add to free cash flow and earnings one year after closing, if global oil prices stay at US$40.” The sale would increase the reserves Chevron owns by 18%, combining Chevron’s 11.4 billion barrels of oil and Noble’s 2.05 billion barrels. 


Table 1: Notable Bankruptcies in US Shale Sector (Source: Saudi Gazette)



The Impact on Surrounding Communities and Sectors


The most recent fall in the oil industry accompanied by the latest wave of bankruptcies has often grabbed the headlines while masking the tragic effect that the downturn has had on related sectors and local communities. 


According to a Simmons analyst, oil and gas producers are “having to right-size considerably… not only due to the implosion inactivity but their belief that, effectively, the size of the industry and the rate of growth going forward in the United States is going to be considerably slower.” With companies restructuring and filing for chapter 11 bankruptcy, cutbacks and layoffs have been widespread. Since the beginning of the crash, over 115,000 oil workers have been laid off in the United States, with the biggest impact felt by the oilfield service companies (OFS) that provide the entire suite of services that allows oil companies to flourish from drilling wells to laying pipes and providing software. Workers in this sector are typically the first to go when there’s a downturn due to it being largely equipment focused and the need for a large labor force relative to their clients. One of the largest OFS companies, Schlumberger, shut down 150 facilities in North America and laid off a quarter of its global workforce, eliminating almost 21,000 jobs. Halliburton, another OFS company, closed down 100 facilities and laid off thousands of employees across the USA.


The total spending on oilfield services is set to fall by 25% this year, highlighting the impact that the cyclical nature of oil and gas has on the fate of companies and workers in the background, according to Rystad Energy. The collapse of oil companies will also leave many of the service companies with irrecoverable unpaid debts, leading to a double whammy as future business will decrease along with many small service companies left unpaid for work already rendered. While OFS companies are the hardest hit, the entire oil business has been laying off workers with supermajors like Exxon Mobil laying off engineers, Chevron cutting between 4,500 to 6,750 jobs and even energy-focused private equity firms and asset managers reducing the number of portfolio managers they employ as the value of their investments dwindled.


Figure 2: Major Oilfield Service Companies Revenue Growth Forecasts (Source: Financial Times)



In Texas, the heart of the US shale industry, the local communities are just as affected by the oil and gas industry and have been left withering away as they are trying to survive. Unlike previous oil price crashes, this one was combined with a public health crisis which meant people could not relocate or find other jobs to sustain themselves. The unemployment rate in the Permian Basin went from 2.1% last year to 13.4% in May 2020. In 2019, the West Texas Food Bank gave out roughly 550,000 pounds of food each month, which is almost 40% less than this year’s 900,000 pounds of food since May. In April, of those collecting food, 74% of the families claimed they had never stepped foot in a food bank before, highlighting just how deeply the entire community was affected. The impact was felt across nearly every industry in the region from restaurants and hotels to schools as well as barbers. A local RV park lost nearly 80% of its occupants and had to drop monthly rent by almost 20% from $580 to $480. Pody’s BBQ, a local restaurant located in Pecos, Texas, which is a favourite among oil workers has been progressively losing more and more business. The restaurant’s sales dropped 30% and in order to continue operations and attract customers, they were forced to change their menu to incorporate cheaper items which could be afforded by the customers. Before the bust, barbers could make up to $180,000 by cutting hair near drilling sites serving more than a 100 customers a day. Now, the team of 4-5 barbers in shops has been reduced to one and the number of customers has gone down by 80%, with just 20 customers coming on average daily. In Pecos, more than a dozen new hotels opened in the last decade, with peak rates mirroring those of New York CIty. In April this year, hotel occupancy rates in the Permian basin crashed to a record-low of 32% from 62% in February. The local school in Fort Stockton hasn’t heard back from 10% of its students as compared to under 1% for the entire district, as many families moved away permanently following job losses in the oilfields.


Figure 3: Hotel Occupancy Rates in the Permian Basin (Source: Wall Street Journal)




The Future of the Industry in the Midst of an Energy Transition


Climate change and the impending shift from fossil fuels to renewable energy sources has probably been one of the factors that oil and gas companies have been preparing for in the last few years. In the face of the pandemic and the ensuing crash in oil demand, many oil companies will not be able to deliver the double-digit returns that have kept companies incentivized to keep exploring and extracting oil as well as provided investors with justifications for continued investments into fossil fuels. This will likely lead to an acceleration of the energy transition as resources and funds are re-allocated towards more sustainable and cleaner sources of energy, which will now be able to provide comparable returns. 


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