Shale Oil's "Dirty Little Secret" Has Been Exposed

Tyler Durden's picture

On Friday, on the way to diving into Goldman’s $20 crude call, we recapped our characterization of low crude prices as a battle between the Fed and the Saudis, a battle which is now manifesting itself in budget troubles in Riyadh and a concurrent FX reserve burn. Here’s what we said:

When Saudi Arabia killed the petrodollar late last year in a bid to bankrupt the US shale space and secure a bit of leverage over the Russians, the kingdom may or may not have fully understood the power of ZIRP and the implications that power had for struggling US producers. Thanks to the fact that ultra accommodative Fed policy has left capital markets wide open, the US shale space has managed to stay in business far longer than would otherwise have been possible in the face of slumping crude. That’s bad news for the Saudis who, after burning through tens of billions in FX reserves to help plug a yawning budget gap, have now resorted to tapping the very same accommodative debt markets that are keeping their competition in business as a fiscal deficit on the order of 20% of GDP looms large.

Still, as we went on to point out, it looks like the Saudis have dug in for the long haul here and the strain on non-OPEC production is starting to show as the IEA now says “the latest tumble in the price of oil is expected to cut non-OPEC supply in 2016 by nearly 0.5 million barrels per day (mb/d) – the biggest decline in more than two decades, as lower output in the United States, Russia and North Sea is expected to drop overall non-OPEC production to 57.7 mb/d.” 

“US light tight oil, the driver of US growth, is forecast to shrink by 0.4 mb/d next year,” the agency adds.

Still, the Saudis know that the war is still far from won, which again is why the kingdom is now borrowing to supplement the use of their petrodollar reserves. But as we’ve documented in great detail, the Saudis face a unique set of challenges when it comes to managing fiscal spending. The cost of maintaining the average Saudi’s lifestyle as well as the cost of financing one (and soon two) proxy wars translates to a tremendous amount of budget pressure. Add in defending the riyal peg and you have yourself a problem. So even as the Saudis have ample room to borrow (debt-to-GDP is negligible at present), Riyadh would rather US production fold sooner rather than later and with the next round of revolver raids coming up in October, and with the bond market set to cast a wary eye towards HY going forward, the kingdom just might get its wish. Citi has more on shale’s “dirty little secret”:

Easy access to capital was the essential “fuel” of the shale revolution. But too much capital led to too much oil production, and prices crashed. The growth of North American shale a critical underlying factor in the oil market “regime change” from a $100/bbl world until 2014 to a sub-$50/bbl world today (see Oil and Trouble Ahead in 2015 ). Saudi Arabia’s shift to defending market share rather than price decisively confirmed this new reality. Above $100/bbl, returns to shale investment are so attractive that the kingdom realized it could not sustain its historical strategy of propping up prices or shale would simply erode its market share. As a result, the oil markets returned to competitive economics not seen for decades. And the economics of shale in particular are now set to be a decisive factor in balancing global oil markets and setting global prices.


The shale sector is now being financially stress-tested, exposing shale’s dirty secret: many shale producers depend on capital market injections to fund ongoing activity because they have thus far greatly outspent cash flow. In the aggregate North American crude producers do not generate positive free cash flow (Figure 1), although some stronger producers do.


Capex has consistently exceeded cash flow, causing some prominent critics to argue the business model of shale production is fundamentally unsustainable.



Capital markets plugged shale’s “funding gap” from 2009 through the first half of 2015, but they are now tightening, reducing access to liquidity for some producers and shaping their ability to drill. With eight bankruptcies already announced this year, weaker producers may live or die by the whims of capital providers. The sector is by no means homogenous, but those producers with poor asset quality, high leverage, little hedging protection, and/or dwindling free cash flow look most exposed.



If OPEC traditionally set the marginal supply and served as a coordinated price setting mechanism, capital markets are becoming a new balancing mechanism: a set of highly dynamic, diffuse investment decisions that shape shale production and a large portion of the global marginal supply. Shale oil financing and production is different from what the oil market had become accustomed to over the past few decades. In particular, shale 1) is produced by many smaller, innovative producers who depend on capital markets for financing; 2) is a faster drilling process with smaller, more discrete investment decisions that respond more quickly to market conditions. These factors accelerate the classic commodity cycle of high prices leading to over-investment, which crashes prices, then leading to underinvestment, which raises prices, starting the cycle again. 


So what's the endgame, you ask? According to Citi, "two things become clear in an analysis of the financial health of US hydrocarbon production: 1) the sector is not at all homogenous, exhibiting a range of financial health; 2) some of the sector indeed looks exposed to distress [and] lifelines for distressed producers could include public equity markets, asset sales, private equity, or consolidation. If all else fails, Chapter 11 may be necessary." 

Got it. So essentially, with HY all but closed, banks re-evaluating credit lines, and the cost of funding set to rise, there are essentially only three options: liquidation of assets, tap the dumbest of the dumb money by selling more shares, or else throw in the towel. 

Of course there's another possibility: oil prices rise sharply. And while everyone seems to think that's highly unlikely, the irony of ironies here is that if Saudi Arabia continues to beat the war drums in Yemen and Syria, Riyadh could end up being shale's savior.

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trader1's picture

that shale oil is "dirty" is no "little secret".

Mr. Ed's picture

The only "little secret" I'm converned about is the collection of 3 charts that I cannot click on to get a larger and readable size!

C'mon Tylers... please.

The Merovingian's picture

what a shock .. U.S. Oil companies using leverage to expand and grow. Oh wait ...

kaiserhoff's picture

Yes.  It's called investment,

  everywhere but here.

sun tzu's picture

In some places they call it a ponzi scheme when you keep issuing more shares and borrowing money to pay dividends because your cash flow is negative. Look at Kinder Morgan

Vlad the Inhaler's picture

I have an idea, let's build a pipeline from Alberta to Texas.

general ambivalent's picture

Why not to the moon? There's no point in waiting.

sun tzu's picture

We need an energy crisis first so we can spend 10 years debating if we need an oil pipeline. For now, we'll just have the oil shipped by diesel trains through populated areas because that's much safer and environmentally friendly and Warren Buffett can make more money since he bought most of the railroad companies. 

post turtle saver's picture

we already have that, the problem is that there isn't one that runs through Baker, Montana... the point being, to add light shale oil to syncrude and dilbit coming out of Alberta _and_ to bypass Valero's refinery grip on the current Keystone routes... but then we'd only need that if the US were going to export crude oil, would we? so much for that idea...

arbwhore's picture

I thought this was common knowledge.

James_Cole's picture

I guess for people who haven't read bloomberg, FT, NYT, WSJ, or... basically any news organization in the past decade + have managed to be on zh whilst avoiding weekly retreads of this topic, it is still surprising to hear.

Main_Sequence's picture
Main_Sequence (not verified) Sep 12, 2015 11:13 AM

The Saudi Arabians bottomed-out their oil prices to undercut Iran/Russia who are selling progressively more oil to China, and in tandem, China is slowly weaning themselves off Saudi oil.

Of course, for Saudi Arabia to try and win back their biggest customer China, they drop the price to make their product more appealing.

When one exporter has a 50% off sale, all other exporters have to follow suit to stay competitive, and thus accelerates a race to the bottom.

It's good to see that Saudi Arabia's plan has backfired.  What goes around, comes around.

Looks like Qatar, US-NATO-Israel, Jordan, and Turkey will have to pick up more of the slack in their funding for ISIS, AKA the Syrian Gas Pipeline Clearance Team.

NoPension's picture

It that the same thing that happens when an ILLEAGAL invader sneaks into the country and offers to work for $12.00 an hour, under the table?

All the other employers have to do the same to stay competitive?

Am I learning?

Vlad the Inhaler's picture

Sounds like the employer who hires the illegal invader needs a talking to.

James_Cole's picture

I like that attitude on illegals: government needs to step out (i.e. never crack down on employers who actually FREELY HIRE these people) on the demand end and instead get extremely involved on the supploy, i.e. build very expensive police state mesaures (+ walls) to keep people out and harrass people within.

MSimon's picture

Hire robots at $6 an hour. There is no minimum wage for robots.

cossack55's picture

You need to come up with a better acronym.....SGPCT tho accurate is a little long and does not "sing".

sun tzu's picture

Russians can build pipelines straight to China and India. The Saudis have a problem with Iran in between. 

chinoslims's picture

Which comes first, the Fed raising rates or the Saudis cutting production?

Ms No's picture

I don't see any reason to believe that any of these operations are financially healthy and I wouldn't be surprised to find out down the road that the numbers we are currently looking at to be falsified.  The whole operation was just off from the get go, it started with NeoCons screaming that Obama and the Feds were going to kill the boom with regulation but the exact opposite happened and everything seemed to magically give way for the shale miracle including of course the MSM, environmental law, SCC regulations of reserve calculations, long hidden decline rates etc.

Watching the whole thing go down it just reeked of a government operation as opposed to strictly a capitalist venture and now it is clear why.  Being that this shale boom involved a combination of spend crazy banks + the US government (possibly under a national security charge) +  oil companies (don't see much of the majors) I would be damn careful trying to predict what is going to happen with this "shale miracle".  There is what should have happened a long time ago (if it should have ever happened at all) and then there is what will happen as it is clear that the whole thing is riding on banking puppet strings.

kaiserhoff's picture


Do you know of any governments, at any level that are financially healthy?

How about just one with honest books?

Ms No's picture

Nope I do not know of one, but this oil boom had multiple purposes one of which was geostrategy pertaining to Russia and possibly some other things that are not entirely clear as of yet.  It definitely helped the economy appear to be healthier.   

sun tzu's picture

I think 0bama and his EPA stepped out of the way because the economy was in the shitter and he needed something to stop the economy from completely collapsing. He could claim credit for all those jobs HE created. O&G was one of the few industries that was booming after the 2008 collapse.

MSimon's picture

it is clear that the whole thing is riding on banking puppet strings.


It is riding on the price of oil. Supply/demand.

Chuck Knoblauch's picture

Another bedtime story about the evils of debt?

viator's picture

I'm sure, given the direction of events in the middle east, oil prices will drop indefinitely.

sun tzu's picture

When has the ME been stable in the past 60 years? What will the collapse of China and Japan do to the price of oil?

starman's picture

But imagine this you were profiting off $144 a barrel vs $45  barrel!

Oh and I've heard Rolls Royce is laying off workers. 

Spiritof42's picture
Spiritof42 (not verified) Sep 12, 2015 12:06 PM

Old saying "low tide exposes naked bodies."

Chad_the_short_seller's picture
Chad_the_short_seller (not verified) Sep 12, 2015 12:20 PM

CLR has no cash left and 7 Billion in debt. They supposedly break even with oil at $50. How in the hell do they survive this? 

sun tzu's picture

Union Bank and their vendors have pretty much given them an unlimited line of credit with no collateral and 2% interest rate. That unsecured debt is being packaged and sold as investment grade. This should end well. 

Chad_the_short_seller's picture
Chad_the_short_seller (not verified) sun tzu Sep 12, 2015 8:19 PM

Then one should buy puts on Union bank because CLR is going to default on any loan they get. 

Element's picture



The shale sector is now being financially stress-tested, exposing shale’s dirty secret: many shale producers depend on capital market injections to fund ongoing activity because they have thus far greatly outspent cash flow.


eh? That was a 'secret'? You're kidding right? That's how every commodities boom-bust cycle operated and ended since Adam was a boy. It's the 'bust' part of the boom-bust cycle.

Gusher's picture

"Easy access to capital was the essential “fuel” of the shale revolution. But too much capital led to too much oil production, and prices crashed".

  Oh give me a freaking break!  Same thing happens in farming. High corn prices bring higher production which causes lower prices. it's called the free market.  Our country needs energy security.  Oil royalties in ND go to farmers!    Oil profits in Venezuela, Nigeria, the middle East, those oil profits often go to dictators and terrorists.  As for a world oversupply, few saw that coming. The adequate supply isn't as surprising as the slack demand. But demand will return eventually.

sun tzu's picture

Nobody saw it coming....just like the dotcom bubble and RE bubble. LOL


US oil production increased 100% from 2006-2014 while demand dropped 10%. Nobody saw the oversupply coming. 

Gusher's picture

Hey moron, oil is a global commidity.  So the U.S. was suppose to not increase production?  Just keep buying oil from Osama's cousins? You are an idiot.

morongobill's picture

Maybe. But it is almost a done deal that it won't return quick enough to save the companies involved now.

Grandad Grumps's picture

How is shale oil any different than public DOTCOM 2.0 stocks? They cannot run the company on their cash flows either.

Look at a company such as LinkedIn. If it was a shale oil company it would have been dead long ago.

Publicly fund the shale oils as LinkedIn was done, with them going back and back and back again to the well, and they would be the same as LinkedIn, with an uncalculable PE... but lots a laundered cash from so called investors.

The banks just changed the game on the shales and not LNKD.

sun tzu's picture

The difference is the capex for frackers is much higher while revenues are collapsing and they are facing global competition. 

InsanityIsWinning's picture

Ah, but ZIRP will continue as will funding high risk shale.  Remember, Insannity is winning . . .

sun tzu's picture

ZIRP is for Wall St and a few politically connected companies. The frackers are not in that group and the last round of financing was 4-6% for the stronger companies and up to 12% for the junk bonds.

falak pema's picture

free money and freer Oil subsidies.

Nobody realises to what extent the US government has subsidized the Oil lobby since 50 years; as the key industry that needs to be nurtured : the oil/automobile/petrochemicals oligarchy machine that never stops taking from the public.

All that spiel about Obama subsidizing renewables PALES in comparison with big financial capital's and big state's JOINT collusion to help Big OIL.

Lies, damn lies and State subsidies  to the TBFT !!!

MSimon's picture

Compare the subsidies per BTU of oil vs "renewables". You might learn something.

And until we get solar that can collect dark energy or batteries that cost near $0 per BTU of storage solar and all the rest of AE are not going far.

Magooo's picture

"When Saudi Arabia killed the petrodollar late last year in a bid to bankrupt the US shale space and secure a bit of leverage over the Russians"


Are you fucking RETARDED?????


Do you seriously thing that the Saudi's would be allowed to do such a thing?  


Duh - remember Saddam --- remember Gaddafi?  Have a look at what is happening to Assad....


America may be fucked - but it is still the most powerful nation on the planet -- and a minnow like Saudi Arabia KISSES THE RING --- or they get a new leader who WILL KISS THE RING (and the ASS)


China and Russia are refusing to kiss the ring - hence the petrodollar is fucked --- but the Saudi's --- they are on their knees kissing the ring, licking the balls and ass, deep throating the dick....  and getting jack hammered from behind...


Because they know that if they don't that's the end of the shopping... the yachts... the hookers and blow....  the House of Saud would NEVER fuck with the US ...


They are pumping like mad for the same reason everyone else is pumping like mad --- they need the cash flow.



Basilian's picture

Magooo -- you are an Artist weaving Truth and Comedy

Hahaha -- your description reminds of the scene in that James Franco movie "The Interview" where he is acting out a porn scene.


Barnaby's picture

Shale oil is a ponzi.

Inject valuable goo into the earth, using energy from other valuable goo, in order to extract watered-down other valuable goo?

How does this make sense unless frackers are fleecing their VC?

Basilian's picture

The wells do not last long enough to achieve the ROI to be profitable--- everyone knows this. The capital investment to open a well is the mechanism or liquidity making vehicle rather as that money deposited in a bank to open a well still possesses the fractional reserve multiplier effect --- the bank can make/print 30x or more that amount of liquidity to then lend out.  How do you think we achieve GDP growth to keep everyone thinking that their retirements are still alive ( the only thing that keeps the population silent and calm).

When the market crushes the frackers eventually the assetts are sold dime on the dollar altering the ROI to profitable for the new owners and the tax payer gets stuck with the Bill which is probably a repacked loan to pay off a loan --- the financial industry was paid up front day #1 on a known Bad deal. Welcome to your world of a debt based economy. The governement role is to approve and allow the frack well to be funded as if the wells reserve were the collateral yet the reserves are not enought to ever achieve ROI---once this ball leaves the governement gate the banks blow it up printing money and lending money to their friends while you and I are looking at the fracking and you should be looking where the 30x (or more) money went that the well allowed to legally come into existence. Squirrel!

big rock's picture

I live on the Bakken and I will explain it to you: it still costs $7 1/2 million to drill and complete a well. The best place in the Bakken is McKenize County where a 150,000 barrel first year production, 30,000 second year and 12,000 third year production is considered terrific.

The State takes 11% of revenue in production and extraction taxes, the royalty holders 16% or basically, the operator gets 73% of well head price; Bakken well head price is usually $10 less than, and often times much less, of West Texas with a 3 year production of 192,000 barrels, divided in to $7 1/2million you get a well head cost per barrell of $39. Not including any sort of production and maintenance costs (usually around $9 barrel) the break even cost for Bakken crude requires a WTI of ($64 -$10=$54;  $54 x .73= $39+)....WTI of $64. And that's just to break even and excludes the $9 operational costs.
The true cost to just break even in the Bakken is WTI@ $ make any return at all on your investment (maybe 10%) you literally need $85 WTI.....and that my friends is not anywhere in the future.....for years.