Even though U.S. shale oil production continues to reach new record highs, investors might be finally losing faith in the industry that just isn’t profitable. A perfect example of this, legendary oil trader Andy Hall, known as “God” in the industry, is shutting down his main hedge fund. Hall, who is a noted bull in the oil market, saw his hedge fund, Astenbeck Master Commodities Fund II, lose 30% in the first half of 2017.
While Hall’s hedge fund likely lost money betting that oil prices would rise, the entire energy complex took a beating last week, even though oil and prices increased. According to the article, Oil Has A Crisis Of Faith, the situation in the U.S. E&P energy sector took a turn for the worst:
If tumbling and gas prices aren’t the obvious reason for the sell-off in E&P stocks, then what is?
The likeliest culprit is fear that, even if oil prices aren’t falling further, they are low enough to affect E&P firms’ growth plans — as evidenced in guidance given on a number of quarterly earnings calls this week and last.
One of the biggest losers this week has been Pioneer Natural Resources Company (NYSE:), down 16.5 percent since reporting results on Tuesday evening. Part of the reason it was clobbered so badly is that while it merely trimmed its overall growth rate, it sharply cut its guidance for how many more barrels of higher-value oil it will produce this year. Pioneer blamed this on problems it had with what it called “train-wreck” wells suffering from changes in pressure and the amount of water coming up, forcing the company both to delay its drilling schedule and spend more to strengthen wells.
As we can see in the chart above, all types of energy stocks sold off even though the price of oil increased. In addition, Pioneer Resources stock price is now down nearly 17% since their second quarter news release:
Pioneer Resources is one of the larger players in the Permian oil basin in Texas. According to the data put out by Gurufocus.com, Pioneer suffered a negative Free Cash Flow of $155 million Q1 and $252 million in Q2. Actually, Pioneer spent a great deal more on capital expenditures (CAPEX) in the second quarter of 2017, by investing $731 million versus $519 million in the first quarter.
Which means, Pioneer spent $212 million more on CAPEX in the second quarter, only to suffer a larger negative free cash flow of nearly $100 million more versus the previous quarter. Of course, this makes perfect sense in our TOTALLY INSANE business world today to spend $212 million on CAPEX only to lose an additional $100 million in free cash flow.
Another large oil player in the Permian, Occidental Petroleum (NYSE:), lost $300 million in its core upstream U.S. segment. The upstream segment of an oil company’s earnings comes from its oil and gas wells. Downstream is the selling of its petroleum products in retail markets and etc. Not only did Occidental lose $300 million in its domestic U.S. upstream earnings in Q2, it also lost $191 million in the first quarter.
Big 3 U.S. Oil Companies Still Struggling Even With Higher Oil Prices
The Big Three U.S. Oil companies have also suffered losses in their U.S. upstream earnings. Exxon Mobil (NYSE:) lost $201 million and Chevron (NYSE:) lost $22 million in the first half of 2017 in its U.S. upstream earning segment. ConocoPhillips (NYSE:) lost $2.7 billion in its U.S. earnings segment during the first half of 2017, however this was mostly due to a huge impairment write-down.
Regardless, no one is really making money producing oil and gas in the United States. While some of these companies may now be reporting positive free cash flow, this has been mainly due to the huge cutting of their of CAPEX spending. For example, these top three U.S. oil companies were spending a great deal more on CAPEX in 2013 than they will in 2017:
Top 3 CAPEX Spending (Exxonmobil, Chevron & ConnocoPhillips):
2013 = $86.6 billion
2017 Est. = $31 billion
These top three U.S. oil and gas majors will reduce their CAPEX spending by $55.6 billion in 2017 compared to 2013. This is a decline of two-thirds in CAPEX spending in just four years. When a company drastically cuts its CAPEX spending, it becomes easier to make free cash flow. However, by cutting their capital expenditures by two-thirds, these U.S. oil majors will not be adding much in the way of new discoveries or additional oil production in the future.
Moreover, Occidental Petroleum, the largest oil producer in the Permian, enjoyed decent free cash flow during the second quarter of 2017. However, a large percentage of their $1 billion in free cash flow was due to a NOL- Net Operating Loss adjustment of $737 million. Occidental actually suffered a negative free cash flow of $111 million in the first quarter of 2017.
That being said, Occidental, was able to enjoy free cash flow because it cut its overall CAPEX spending from $8.4 billion in 2013, down to an estimated $3.3 billion in 2017. So, by cutting its CAPEX spending by $5 billion, it’s much easy to make positive free cash flow:
Not only has Occidental CAPEX spending declined since 2014, so has its cash from operations. Hence, the reason for the huge cut in CAPEX spending. Occidental reported a healthy $11 billion in operating cash in 2014. However, this fell to $3.4 billion last year as the price of oil dropped to an annual low not seen since 2004.
As U.S. oil companies continue to sacrifice exploration and capital expenditures to become profitable or at least break-even, this will cause big problems for oil supplies in the future. That being said, the oil industry has another negative factor to deal with that could spell additional trouble for the fracking oil industry in the future.
Fracking Oil Wells In The Permian Basin Consumes A Staggering Amount Of Fresh Water
One little factor that seems to be overlooked in the media is the staggering amount of water consumed in the production of shale oil and gas in the United States. According to a study reported by Scientific America back in 2015, stated:
Oil and natural gas fracking, on average, uses more than 28 times the water it did 15 years ago, gulping up to 9.6 million gallons of water per well and putting farming and drinking sources at risk in arid states, especially during drought.
Though fracking is used to produce natural gas in less-arid regions such as Pennsylvania, many of the nation’s fracking operations occur in places where water may become scarcer in a warming world, including Texas, the Rocky Mountains and the Great Plains—regions that have been devastated by drought over the last five years.
As the USGS study indicates, a lot of the oil and gas fracking is taking place in more arid climates. One such arid climate is the Permian Basin in West Texas. According to another article titled, As The Oil Patch Demands More Water, West Texas Fights Over Scarce Resource:
“The Permian Basin is basically a desert, and that immediately presents challenges in finding adequate water,” French said. “You can do without a lot of things. But you can’t do without water.”
At least three other companies in the region are selling or planning projects to sell water to energy companies that use it by the billions of gallons to crack shale rock and release oil and gas. Water use in the Permian has risen six-fold since the start of the shale oil boom, from more than 5 billion gallons in 2011 to almost 30 billion last year. Energy research firm IHS Markit predicts demand will double by the end of this year, to 60 billion gallons, and more than triple by 2020, to almost 100 billion.
As we can see in the chart above, oil and gas companies in the Permian are estimated to consume a staggering 60 billion gallons of water in 2017, double from the 29.6 billion gallons last year. And if these energy companies get enough silly investor money, they will need nearly 100 billion gallons of water by 2020 to produce oil in gas in the Permian.
Unfortunately, water is a scare resource in West Texas as farmers, ranchers, environmentalists and residents are worried that the tapping into billions of gallons of water in underground aquifers will impact the local cattle industry, agricultural crops and possibly dry up natural springs in the area.
The race for the U.S. to produce more oil than we have in more than four decades is costing an arm, leg and a foot, as well as consuming one heck of a lot of fresh water. I believe we are going to look back at this point in history and wonder… WHAT IN THE HELL WERE WE THINKING???
As I have mentioned in several articles and interviews, the wonderful U.S. Shale Oil & Gas Industry really hasn’t made any money for nearly a decade. However, they have added a great deal of debt. Let me present this chart one more time because nothing has changed since the last time I posted it:
Over the next three years, the debt (low investment grade energy bonds) that these energy companies will have to pay back jumps from $67 billion in 2017 to over $230 billion in 2020… just at the time the Permian Basin is forecasted to peak in oil production. However, I have my reservations on that prediction.
While the U.S. continues to produce oil that isn’t really profitable, the overall debt level in the energy sector will likely increase. The only way for this FACADE to continue is under the Fed Policy of low or zero interest rates. If the Fed continues to raise rates, this will certainly put a real KIBOSH on the U.S. Shale Oil and Gas Industry’s ability to finance their ever increasing amount of debt.
Lastly…. oil production in the U.S. will likely continue to rise for a while. The Mainstream media will point to American ingenuity and the push for energy independence as the reasons for all this wonderful new oil production. Unfortunately, someone along the way forgot to mention that most this oil was produced at a loss. The POOR SLOBS that are really going to feel the pain are the investors who went after HIGH YIELD returns as they couldn’t find it in the market today.
Even though the U.S. shale oil and gas companies continue to pay their interest expense (yield to these investors), that has an expiration date. Once that expiration date arrives, and these investors ask for the original funds back….. is when they wish they had purchased gold and silver instead.
But….. sometimes it really takes getting beat up financial to wake up to the fundamentals of owning physical precious metals.