Why US shale and oil producers may struggle to stage a comeback even as crude prices rally

An anticipated rebound by the US fracking industry remains a challenge, leaving Opec+ firmly in control of the markets

Workers at a Colgate Energy site in Texas. Brent and WTI have gained 30% since the beginning of the year, when news of vaccine distribution and a weak dollar moved the needle on prices. Bloomberg

"Drill baby drill is gone forever", Saudi Arabia's energy minister Prince Abdulaziz bin Salman declared after the last meeting of Opec+ when the 23-member alliance decided to rollover its current level of cuts, pushing prices to $70 per barrel.

He was signalling an end of an era for shale, which proved resilient to the vagaries for the oil market and helped crown the US as the biggest producer of oil and gas in the market overtaking Saudi Arabia and Russia.

But the emergence of the Covid-19 pandemic heralded the slow demise of the US shale industry, which had proved nimble to various market conditions prior to the health crisis.

US oil production, which peaked at 13 million barrels per day averaged 10.4m bpd in February, which is down 0.5m bpd from January production, according to the US Energy Information Administration.

EIA forecasts US crude oil production will rise to almost 11m bpd in March. American output will average 11.1m bpd in 2021 and 12m bpd in 2022.

Oil prices are currently trading in the range most conducive for US shale drillers. West Texas Intermediate, the US crude gauge and Brent, the international marker, are nearly 30 per cent higher than at the start of the year. That's even after both Brent and WTI, pulled back some of their gains following the decision by Opec+ and an attack on a major energy installation in Saudi Arabia this week.

Despite the higher oil prices, the shale industry, which operates on low margins, was languishing under $300 billion worth of losses amid a wave of bankruptcies last year has not swung into action as some might expect it to.

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At CeraWeek, a major oil industry-related event which took place online last week due to Covid-19, Vicki Hollub, the chief executive of Occidental Petroleum, a big player in the US shale basins, painted a sombre picture of the industry.

"In my view shale will not get back to where it was in the US," she told a panel discussion, where she was joined by Dr Sultan Al Jaber, the group chief executive at Abu Dhabi National Oil Company.

The decline in US production by 2m bpd over the course of last year would "aid in getting the market supply and demand back into balance", she added.

However, demand is going to remain substantially revised as the US, which has the worst rate of Covid-19 infections globally, will adapt remote working as part of corporate work culture, longer-term. Nearly 42 per cent of workers in the world's largest economy were working from home by the middle of last year, according to Stanford University.

The pandemic, which erased all job gains after the financial crisis of 2007-08 also saw 33 per cent of the labour force "not working". Only 26 per cent, largely essential workers, commuted to their business premises.

"So, by sheer numbers, the US is a working-from-home economy. Almost twice as many employees are working from home as at work," according to Nicholas Bloom, an economist at Stanford.

With US unemployment at 6.2 per cent, according to data from the Bureau of Labour Statistics and a significant portion of the population giving up on searching for new employment, the repercussions on energy demand are bleak.

With more and more workers either not working or working from home, the demand for oil will remain close to stagnant.

Last year, due to the pandemic and ensuing lockdowns, US crude consumption fell to around 18.12m bpd, which was the lowest level since 1995, according to the EIA.

Recovery this year is forecast to remain weak, with liquid fuel consumption set to rise by 1.45 million bpd to 19.51m bpd in 2021.

Tepid domestic demand casts questions about the long-term viability of the shale sector.

"We should not have made these investments," Anders Opedal, chief executive of Norway's Equinor, which made investments in US shale told Bloomberg last month.

Shale's ability to return profits has increasingly come under the spotlight.

Ms Hollub's Occidental posted its sixth quarterly loss in February. "The profitability of shale is much more difficult than people ever realised," she said.

The outages across the US southern belt in February due to an unprecedented winter storm also shut-in production at a time of higher prices.

A rebound in US shale remains challenging, leaving Opec+ firmly in control.

Any growth this year would be "very modest", said Lee Maginniss, a managing director at Alvarez & Marsal, who focuses on energy.

Shale companies who prefer to work with free cash flow may struggle to find adequate capital to fuel their expansion.

The companies will look to maintain a "production mindset" but within an industry that will look to continue to consolidate.

Following the demand crunch and widespread bankruptcies in the US energy industry, oil majors Exxon Mobil and Chevron were said to have discussed the possibility of merging.

The US energy sector will continue to see such activity in the "small and mid-cap market" where companies will look to merge and create scale, said Mr Maginniss.

However for the industry at large, "it's a relatively flat outlook, that the companies are expressing today", he added.