The financing model underpinning the US shale oil industry is fundamentally different from that of large companies producing predominantly in conventional oil. Small and medium-size independent producers, which dominate the US shale industry, generally have much higher leverage with high levels of debt and hedging. Since its inception, the industry has been characterised by negative free cash flow as expectations of rising production and cost improvements led to continuous overspending in the sector. Over the last few months, the industry as a whole has seen a notable improvement in financial conditions, though the picture varies markedly by company, and the overall health of the industry remains fragile.
In order to try to assess as precisely as possible the developments of shale industry throughout the decade, we identified four distinct phases that have characterised the shale industry since 2010 up to now.
2010-14: The start-up phase
In the 2010-14 period, technology developments and high and stable oil prices triggered a massive investment wave in the US shale sector. Investment more than quadrupled, leading to an eightfold increase in shale oil production, from 0.44 million barrels per day (mb/d) to over 3.6 mb/d – the fastest growth in oil production in a single country since the development of Saudi Arabia’s super-giant oilfields in the 1960s.
However, the growth came with a huge bill. The sector as a whole generated cumulative negative free cash flow of over USD 200 billion over those five years. Throughout this phase, companies were forced to rely extensively on external sources of financing, predominantly debt and receipts from the sale of non-core assets, in order to finance their operations. In addition to issuing bonds, companies benefited from the reserve base lending structure – a bank-syndicated revolving credit facility secured by the companies’ oil and gas reserves as collateral. This structure was used heavily by small and medium-sized companies with non-investment credit rating that did not have as easy access to the corporate bond market.
2015‑16: The survival phase
The collapse of prices in the second half of 2014 and throughout 2015 and early 2016 had a major impact on the way the shale industry operates. Companies switched to survival mode, focusing on improving efficiency and cutting costs. The number of firms declaring bankruptcy and filling for Chapter 11 protection, a form of bankruptcy involving reorganisation, skyrocketed to almost 100 in 2015-16.
The fall in prices also changed the way the shale industry was financed. Debt finance dried up as banks were unwilling to lend during a period of market turmoil, with bond yield spreads widening to over 1 000 basis points and the credit rating of the majority of companies being downgraded. Asset sales also dropped by 70% in 2015 as owners were unwilling to part with assets at the much lower prices on offer. While the main buyers of the assets were US independent companies, the market turmoil discouraged bank lending, opening up opportunities for financial firms such as private equity firms, which typically have a higher risk profile. Those firms accounted for around 30% of reported asset deals over 2015-16. Available funding from the reserve base lending structure also declined as the value of proved reserves for collateral shrank with lower oil prices. The net result was that companies were obliged to raise equity to finance their operations – a more expensive option.
Despite the slump in revenues throughout this period, the shale industry actually saw an improvement in free cash flow as a result of huge cuts in capital spending and costs. Between 2014 and 2016, investment fell by 70% and costs by around half. Cost reductions helped to offset the impact of less investment, such that shale oil production declined only modestly in 2016.
2017: The consolidation phase
The recovery of oil prices since mid-2016 following the collective decision by the Organization of the Petroleum Exporting Countries (OPEC) and some non-OPEC producers to cut output led to a revival in confidence in the US shale sector. Further advances in technology, huge efficiency gains and cost reductions, and an upward revision of the shale resource base triggered an increase of 60% in investment in 2017. In the meantime, the shale industry proved that its upstream cost structure had been rebased as it was able to offset inflationary pressures coming from overheating of the supply chain, further reducing the overall costs per barrel produced.
Despite the improvements achieved, however, the shale sector continued to slightly over-spend the cash flow generated from its operations, with 2017 cumulative free cash flow remaining overall negative. Asset sales once again became the main source of financing operations, with most transactions occurring between US independent companies. Asset sales involved mainly acreage rather than whole companies, as companies sought to do relatively small deals as a way of making gains in operational efficiency. The confidence in the shale sector, traditionally dominated by private investors and small and medium-sized companies, received a boost from announcements by large US oil companies of their intention to make substantial investments.
2018: Profitability at last?
Current trends suggest that the shale industry as a whole may finally turn a profit in 2018, although downside risks remain. Thanks to a 60% increase in investment in 2017 and, based on company plans, an estimated 20% increase in 2018, production is projected to grow by a record 1.3 mb/d to over 5.7 mb/d this year. Several companies expect positive free cash flow based on an assumed oil price well below the levels seen so far in 2018 and there are clear indications that bond markets and banks are taking a more positive attitude to the sector, following encouraging financial results for the first quarter. On this basis, this we estimate that the shale sector as a whole is on track to achieve, for the first time in its history, positive free cash flow in 2018. This result is all the more impressive given the context of rising investment.
Structural changes also augur well for the sector. Recent consolidation, such as the recent USD 9.5 billion Concho-RSP Permian merger, and the increased participation of the majors and other international companies could bring significant economies of scale and accelerate technology developments, including through digitalization. Larger companies generally have a more robust financial structure and rely less on external sources of financing, so their shale investment will be less vulnerable to future downswings in oil prices and financial conditions.
The potential risks for shale independent from rising interest rates are currently attracting a lot of attention. The impact of rising interest rates on independent oil and gas companies in the US shale industry may also be small. Most companies are highly leveraged, benefiting from the ample availability of low-cost bond finance. However, given the high depletion rate, the time horizon of shale projects is so low that the discount rate has only a minor impact on the net present value of a given project. Rising interest rates often coincide with tighter lending conditions, which may make it harder for companies to service their debts and refinance their operations. But this risk can be managed through asset sales to less-capital-constrained companies, such as the majors, and increased reliance on equity raising through IPOs and private equity.
A lot of attention has been focused on interest expenses – the cost of repaying debt. The development of shale production has been accompanied by constantly rising interest expenses, which has impeded companies from generating profits sustainably. For the first time, the overall amount of interest expenses paid by shale companies declined in 2017. While US shale companies remain far more leveraged (measured by the net debt/equity ratio) than traditional operators, leverage is falling from its peak in 2015 and the average interest rate paid by shale companies – currently around 6% – has been broadly stable in recent years despite rising interest rates generally since the end of 2015, though they still pay more than conventional oil producers. Improving financial conditions mean that shale companies are able to borrow more cheaply than before.
The US shale industry seems to have reached a turning point with the recent significant improvement in its financial sustainability. But major uncertainties and important downside risks to the future of the shale industry remain:
Above-ground constraints: With production rising very rapidly in certain basins, such as the Permian, timely investment in takeaway capacity and pipeline infrastructure will be vital to the further expansion of the industry. At present, several producers in the Permian Basin are forced to discount their crude oil by more than USD 15 per barrel compared with the price on the Gulf Coast due to a lack of pipeline capacity. No significant pipeline capacity expansion is expected before 2019. The importance of infrastructure applies not only to oil but also to associated gas production, wastewater and other products. In the absence of new pipeline capacity, companies might be forced to curb drilling or ship their production using trucks or rail, which are usually much more expensive.
Further productivity gains: The continued ability of the companies to offset inflationary pressures with improved productivity stemming from technology or improved project execution remains very uncertain. In most active basins, especially the Permian, there are clear signs of overheating and bottlenecks in skilled labour, materials and equipment. In addition to the potential for further technological advances, there may be scope for more efficiency gains, for instance by expanding operations in continuous acreages, improved understanding of the resource base and more accurate spacing of wells.
Grabbing the fruits of the “digital revolution”: Companies are putting more effort into developing and adopting innovative digital technologies and big-data analytics in order to reduce costs, by optimising operations, improving reservoir modelling and enhancing processes.
Competition from other sources of oil: The US shale sector has not been alone in reducing its costs and will need to continue to do so to remain competitive in international markets. Most onshore resources, especially in OPEC countries, cost less to produce than shale oil, while the bulk of new deepwater projects are competitive with the cheapest shale basins. Consequently, the US shale industry is required to keep improving.
This analysis was written by IEA Senior Programme Officer Alessandro Blasi and IEA Energy Investment Analyst Yoko Nobuoka, and was adapted from World Energy Investment 2018. Source: IEA
Solar powering sustainable development in Asia and the Pacific
The way energy is produced, distributed and used causes environmental damage – most visibly air pollution – that in turn harms people’s health. It is also one of the major drivers of climate change. Recognising this, countries are urgently looking to shift to more sustainable energy, but the transition has so far been slow. Put simply, our future depends on our ability to decarbonize our economies by the end of the century. This was recognised by the Paris climate agreement in 2015 and is central to the United Nations 2030 Agenda for Sustainable Development. Sustainable Development Goal 7 (SDG 7) sets countries the twin challenge of meeting new benchmarks in renewable energy and energy efficiency, while ensuring universal access to modern energy.
In Asia and the Pacific, progress towards SDG 7 needs to be accelerated. While 99 percent of the population is expected to have access to electricity by 2030, access to clean cooking fuels will reach only 70 percent of our region’s population, leaving far too many people exposed to the deadly impacts of indoor air pollution. Energy intensity – a measure of our economies’ energy efficiency – is set to decrease but will fall short of 2030 Agenda targets if no further action is taken. At the same time, the share of renewable energy in total energy consumption is only expected to reach 14 percent, well under the 22 percent share required.
Solar energy has a major part to play in closing these gaps. It is an opportunity we must seize for low carbon development, energy security and poverty alleviation. Because solar power can bring clean, emissions-free and evenly distributed energy. This is particularly relevant to Asia and the Pacific, where developing countries have abundant solar energy resources. Solar energy technology increasingly offers a cost-effective alternative to extending networks to outlying and often challenging geographical locations. A potential which has been captured by the Indian leadership’s ambition for “one world, one sun, one grid”.
Governments, the private sector and investors are now thinking over the horizon, planning for a more sustainable and low carbon future. The cost of renewable technologies, very much including solar power has dropped rapidly, bringing these solutions within reach. India now has the newest and cheapest solar technology of anywhere in the world. Mini-grids or standalone solar home systems can be deployed quickly and help reduce greenhouse gas emissions. Due in part to unsustainable subsidies and in part to inertia, coal fired electricity is set to continue to grow in the short to medium term, but wind and solar must play a much more substantial role sooner rather than later for us to have a chance of meeting the SDGs or achieving the aspirations of the Paris Agreement.
India is supporting this solar revolution. By founding and hosting the International Solar Alliance, it has moved decisively to increasing access to solar finance, lowering the cost of technology and building the solar skills needed among engineers, planners and administrators. But it has also set an unparalleled deployment target for solar power generation. The National Solar Mission aims to reach 100 GW of solar power generation by 2022 and has spurred intense activity in solar development across India which has captured the imagination of the region.
At the Economic and Social Commission for Asia and the Pacific, the development arm of the United Nations in the region, we are clear solar energy can boost renewables’ share in our power mix, increase energy efficiency and bring electricity to remote parts of the region. Our research is focused on overcoming the challenges of achieving these three elements of SDG7. Upon request, we support countries maximize the potential to adopt sustainable energy through technical support and capacity building, including through the development of energy transition roadmaps. Work is also underway to develop a develop a regional masterplan on sustainable energy connectivity, vital to make the most of solar power by supporting the growth of cross border power systems.
A core purpose of sustainable development is to ensure we leave future generations a world which affords them the same opportunities we have enjoyed. This is within our grasp if we work across borders to promote solar energy throughout Asia and the Pacific. India has a major role to play. Its experience gives us a historical opportunity to shape best practices in solar energy for our region and reduce carbon emissions. This is experience we cannot afford to waste.
Phasing Out Coal and Other Transitions: Lessons From Europe
Climate change reports are seldom sanguine. Carbon dioxide, the principal culprit, is at record levels, about twice the preindustrial value and a third higher than even 1950. Without abatement it could rise to a thousand parts per million in a self-reinforcing loop spiraling into an irredeemable ecological disaster. The UN IPCC report warns of a 12-year window for action.
Contrasting President Trump’s boast of US energy independence based on coal and other fossil fuels in his SOTU address on Tuesday, two Democrats, Senator Ed Markey and Rep. Alexandria Ocasio Cortez, have introduced a 10-page Green New Deal resolution to achieve carbon neutrality within ten years. While this target may not be technically feasible, it is an admirable start to the discussion. At the same time, the Germans are attacking the problem forcefully as demonstrated by their new coal commission report issued last week.
In November 2016, the German Federal Government adopted its Climate Action Plan 2050. It outlined CO2 reduction targets in energy, industry, buildings, transport and agriculture. Energy is the most polluting; its emissions total the sum of all the others except industry and energiewende (energy change) was a key aspect of the plan.
So even as our atavistic president is promoting coal, Germany, the EU economic powerhouse, announced it is planning to phase out all coal-fired power stations by 2038. As outlined in the November 2016 plan, a commission comprising delegates from industry, trade unions, civil society including environmental NGOs and policy makers was appointed in 2018 to examine the issue and prescribe an equitable solution. After eight months of negotiations and discussions, concluding with a final 21-hour marathon session, it has produced a dense 336-page document. Only one member out of 28 cast an opposing vote, and Greenpeace added a dissenting option as it wants the process to begin immediately.
Such an objective was a special challenge because of Germany’s long industrial history coupled with coal mining. The plan shuts down the last coal-burning power station by 2038 as the final step in the pathway outlined — an ambitious alternative is to exit by 2035 if conditions permit. Total capacity of coal-using stations in Germany is about 45 gigawatts, and the report sets out a four-year initial goal of 12.5 gigawatts to be switched-off i.e. about two dozen of the larger 500+ megawatt units by 2022. Progressively, eight years later (by 2030) another 24 gigawatts will have been phased out leaving just 9 gigawatts to be eliminated by 2035 if possible but definitely by 2038 at the latest.
It is a demanding plan for coal has been deeply embedded with German industry. To ease the pain for tens of thousands of workers and their families, the plan allocates federal funding to deal with its broad ramifications i.e. job loss and displacement. An adjustment fund will be used for those aged 58 and over to compensate pension deficits. Funds are also directed towards retraining for younger workers and for education programs designed to broaden skills.
It includes 40 billion euros to develop alternative industry in coal mining states plus money not directly project-related. In addition further investments in infrastructure and a special funding program for transport adding up to 1.5 billion euros per year are allocated in the federal budget until 2021.
The change-over will raise electricity prices, so a 2 billion euro per year compensation program for users, both private individuals and industrial, will continue until 2030. This is designed to relieve the burden on families, and to maintain industrial competitiveness.
Germany is not alone. The EU has issued an analysis of accelerated coal phase-out by 2030. The Netherlands has its own energiesprong (energy leap) focused on energy transition and energy neutral buildings, meaning that the buildings generate enough energy through solar panels or other means to pay for the energy deficit from their construction and use. It can now clad entire apartment blocks in insulation and solar panels, and is reputed to be so efficient that some buildings are producing more renewable energy than consumed. This expertise is also being utilized in the UK.
Given the forests, the Norwegians have tried something different. They have built the world’s tallest wooden skyscraper, the Mjøs Tower, 85 meters high in Brumunddal. Its wood sourced from forests within a 50 km radius uses one-sixth the energy of steel and of course much less, if at all, emission of greenhouse gases.
By the end of Germany’s enormous sector-wide endeavor, it expects to reduce CO2 emissions to roughly half through 2030 and 80-95 percent by 2050. The comprehensive and complete nature of the program
could serve as a blueprint here in the US. Thus the obvious question: If Germany with a far larger proportion of its workforce associated with coal can do it, why can’t the US?
The mysterious case of disappearing electricity demand
Authors: Stéphanie Bouckaert and Timothy Goodson*
Electricity is at the heart of modern life, and so it’s easy to assume that our reliance on electricity will increase or even accelerate. However, in many advanced economies the data reveals a surprisingly different story.
Electricity demand has increased by around 70% since 2000, and in 2017, global electricity demand increased by a further 3%. This increase was more than any other major fuel, pushing total demand to 22 200 terawatt-hours (TWh). Electricity now accounts for 19% of total final consumption, compared to just over 15% in 2000.
Yet while global demand growth has been strong, there are major disparities across regions. In particular, in recent years electricity demand in advanced economies has begun to flatten or in some cases decline – in fact electricity demand fell in 18 out of 30 IEA member countries over the period 2010-2017. Several factors can account for this slowing of growth, but the key reason is energy efficiency.
There have been a range of new sources of electricity demand growth in advanced economies, including digitalization and the electrification of heat and mobility. However savings from energy efficiency have outpaced this growth. Energy efficiency measures adopted since 2000 saved almost 1 800 TWh in 2017, or around 20% of overall current electricity use.
Over 40% of the slowdown in electricity demand was attributable to energy efficiency in industry, largely a result of strict, broadly applied, minimum energy performance standards for electric motors. In residential buildings, total energy use by certain classes of appliances has already peaked. For example, energy use for refrigerators (98% of which are covered by performance standards) is well below the high point reached in 2009, and energy use for lighting has also declined. In the absence of energy efficiency improvements, electricity demand in advanced economies would have grown at 1.6% per year since 2010, instead of 0.3%.
Changes in economic structure in advanced economies have also contributed to lower demand growth. In 2000, around 53% of electricity demand in the industrial sector came from heavy industry, but by 2017 this figure had fallen to less than 45%. Advanced economies now account for 30% of global steel production, for example, down from 60% in 2000, and for 25% of aluminium production, also down from around 60% in 2000.
Finally, electricity demand for heat and mobility increased by only 350 TWh between 2000 and 2017. Today, electric cars represent only 1.2% of all passenger vehicle sales in advanced economies and account for less than 0.5% of the passenger vehicle stock. Since 2000, only around 7% of households in advanced economies have switched from fossil fuels (mainly gas) to electricity for space and water heating purposes, and use of electricity for meeting heat demand in the industrial sector remains marginal. In many regions, the price of electricity relative to fossil fuels limits its competitiveness for heating end-uses.
When we look to the future, the pace of electrification is set to pick-up somewhat in advanced economies. Nonetheless, electricity demand growth is projected to remain sluggish in the IEA’s New Policies Scenario (NPS), as improvements in energy efficiency continue to act as a brake on increasing demand for many end-uses. In addition, fewer purchases of household appliances (most households in advanced economies today own at least one of each major household appliance such as refrigerators, washing machines and televisions), and a shift from industry to the less electricity-intensive services sector, all contribute to lower electricity demand growth.
On average, electricity demand in advanced economies is projected to grow at just 0.7% per year to 2040 in the NPS, with the increase largely due to digitalization and policies that incentivise the use of electric vehicles and electric heating. Without those policies, electricity demand would continue to flatten or even decline in many advanced economies.
There are other factors at play. For example, population growth in many advanced economies is barely exceeded by electricity demand growth, meaning that further growth in GDP per capita does not lead to an increase in electricity demand per capita (as an exception, the industry sector in Korea accounts for a large share of electricity demand, and so it is one of the few advanced economies that sees industry contribute to overall electricity demand growth on a per capita basis).
Ultimately, despite moderate growth in electricity demand, fuel-switching to electricity and energy efficiency improvements in the use of other fuels mean the share of electricity in final consumption is projected to increase to 27% in advanced economies by 2040, up from 22% today.
*Timothy Goodson, WEO Energy Analyst
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