(Mar 13): On the morning of March 2, 2016, a large SUV smashed against the side of a bridge overpass in Oklahoma City. The driver was 56-year-old Aubrey McClendon, one of the of most aggressive CEOs in the US and the founder of Chesapeake Energy, who helped triggered the shale oil boom, single-handedly transforming the global oil and gas industry and making America the world’s top oil producer. The US now produces 13.6 million barrels a day ahead of Saudi Arabia’s 12 million barrels and Russia’s nine million barrels. America’s once massive petroleum deficit — US$436 billion ($610 billion) in 2008 — is now a surplus.

Though McClendon was driving very fast, he was not intoxicated. There were no brake marks on the road leaving the police puzzled over whether it was an accident or suicide. Just a day earlier, however, the shale pioneer had been indicted by US federal court for allegedly “orchestrating a conspiring to rig the price of oil and natural gas leases in Oklahoma.”

McClendon was a larger-than-life former billionaire who had lived through several boomand-bust cycles in the oil business. At the peak Chesapeake had a market capitalisation of US$35 billion and McClendon was America’s most highly paid CEO taking US$100 million a year boasting of the world’s largest wine collection and biggest known collection of antique maps.

Four years after McClendon’s tragic death, the loss-making US shale industry is in turmoil, oil prices are in free fall and a huge debt crisis is looming as the US stocks are in bear market territory for the first time since 2009 financial crisis. Meanwhile, the world is trying to grapple with the Covid-19 pandemic that threatens to trigger a global slump.

Last week, as a battle raged between Saudi Arabia and Russia over production volumes after the Saudis cut prices and boosted production, oil prices plummeted. At one point earlier in the week, the benchmark WTI crude plummeted to around US$28 a barrel from a high of US$68 early last year. On the face of it, the oil war of 2020 looks like a childish power feud between Crown Prince Mohammad Bin Sal-

man (MBS) and Russian strongman Vladimir Putin.Yet the real target of both men is the US’ shale business, which has left the Saudis and Russians as smaller players in a global industry that faces structural issues like the rise of electric cars and increasing concerns about the impact of fossil fuels on climate change.If Putin and his enemy MBS can bankrupt the US shale sector, it will substantially boost oil prices, and the money the Saudis lost in SoftBank’s Vision Fund as well as its investments in dodgy startups like co-working outfit WeWork would look like chump change.

But what is shale and how did it become so big? In the aftermath of the global financial crisis as cost of capital plunged and financiers looked around for new businesses to fund, they stumbled upon Shale, hydraulic fracturing — or fracking, a new technology to extract gas from shale rocks or parts of earth that had never been drilled before. Money poured into Montana and North Dakota’s Bakken formation, Southern Texas’ Eagle Ford, western Texas’ Permian basin and West-central Oklahoma’s Anadarko-Woodford. As time went on, drillers were able to extract oil from the same rocks triggering a shale oil boom.

US oil production burgeoned nearly 10-fold in ten years catapulting to top place ahead in Saudi Arabia, and hence the moniker “SaudiAmerica”. The shale revolution has had profound effects on the US, creating jobs and cutting energy costs. Nearly 6.5 million people are employed by US oil and gas industry, mostly in the shale sector. Add in the oil services sector and ancillary industries, nearly 20 million jobs depend on the US oil and gas sector.

US Geological Survey estimates that up to six trillion barrels of crude can now be extracted from shale formations in the country. Little wonder, then, that Wall Street investment bankers and cash-flushed private equity firms have poured over US$430 billion into Shale companies hoping to benefit from rising global demand for oil. The shale business model was simple: Anyone could just buy wheat fields or barren land and just drill for oil in the resource-rich regions of Texas, Montana or North Dakota. If you had land and were a willing driller, there was no shortage of banks or investors willing to lend you as much as it took to get oil off the ground. The mantra was “Drill, Baby, Drill” and more often than not, if you just kept drilling, you were bound to eventually strike black gold.

As shale oil came on stream, oil prices plunged from US$110 a barrel to under US$90 a barrel. Russia and Saudi Arabia did not like the declining prices, so they flooded the world with oil to drive over-leveraged, small US shale producers out of business. But instead of folding, shale firms just went back to Wall Street, which issued new bonds at low interest rates.

Investment banks were able to sell those bonds to high- net-worth individuals or insurance companies hungry for yields. Because shale firms kept getting funded despite the fact that they did not have the ability to pay back their loans, oil prices kept going down until early 2016 when they plunged to US$26 a barrel, or less than a quarter of where they were just three years earlier. The Arabs and Russians had underestimated the resilience of the shale firms and the ability of Wall Street or private equity firms to keep throwing good money after bad.

To be sure, the shale industry had taken a page out of Silicon Valley Tech start-ups. While they sucked in a lot of cheap capital they also promised a huge payday to their investors down the road. And oh, shale also a sexy story to tell.

Unlike the old offshore drillers and onshore oil well owners which relied on decade-old technology, shale was constantly improving efficiencies deploying new technology to bring costs down. The well-worn narrative of the old oil — represented by Arabs and Russians — just couldn’t compete with that storyline.

Here is the dirty secret about shale. Although you can get a lot of oil from a horizontally drilled shale well in the first year of operation compared to vertically drilled conventional one, production in the shake well starts decline pretty rapidly in subsequent years. Many wells only produce less than half of the oil in second year as they did in the first year of operation.

Some actually produce just 30% as much oil in second year. That means shale producers need to drill more wells every year just to match the previous year’s output. That requires more cash which means they need to go back their private equity investors for equity or debts or Wall Street banks for new bond issuance or commercial banks new lines of credit.

The good news is that over the years, shale guys have operationally become very efficient.

They have also been able to squeeze costs down to barest minimum. Yet cost savings and dramatic improvements in efficiencies hasn’t made Shale guys the lowest cost producers even as cost-perbarrel of production on average have declined from US$70 some years ago to between US$40 and US$50 a barrel. The cost of conventional oil varies— Saudi Arabia can produce at under US$10 per barrel in some of its fields, while elsewhere costs range from US$20 to US$40 a barrel. There are only a handful of US shale firms with production costs below US$33 a barrel.

Even those shale firms don’t make money because US$33 a barrel is just the cost of extraction and doesn’t include financing costs.

Having raised US$430 billion over the past decade, shale firms have yet to produce anything in terms of profits. The debt keeps mounting. As interest rates fall, shale companies borrow more to retire earlier higher yielding debts which helps enable them to raise more money to pay for additional capital expenditure for new wells. Ratings agency Moody’s Investors Service says US oil-and-gas companies have more than more than $40 billion of debt maturing in 2020 and US$200 billion of debt maturing over the next four years according to. Late last year with oil hovering around US$50 a barrel over 60% of the shale debt was rated junk. The shale industry has yet to prove that it can produce enough free cash flow to fund itself without resorting to more capital raising. Shale companies have yet to show that they can outrun the required reinvestment. They seem to need so much money that in effect they are running like Ponzi schemes since they always need more capital from outside just to keep going.

McClendon’s Chesapeake — still a shale player — has seen its stock dive 99% from its peak and now has a market capitalization of just US$297 million. Billionaire Harold Hamm’s Continental Resources — another big shale player — has seen its stock decline 89% from its peak.

Most listed shale plays are down 80 to 90% from their recent highs.

So, what’s next for shale? Banks that helped fuel the fracking boom have begun to tighten requirements on revolving lines of credit and are finally questioning the industry’s fundamentals. They are also insisting that companies stop new drilling as well as their relentless pursuit of growth and start focusing on cash flow and profits.That is easier said than done because every year, shale wells are diminishing in resources and frackers need to drill more just to remain in business.Whether oil prices stay at current levels, retest the US$26-a-barrel lows they touched in 2016 or soar to US$100 a barrel, the shale industry has peaked. Even as US interest rates slide to near zero in the coming weeks and months, bankers, private equity players and hedge fund managers that propped up shale for over a decade are no longer willing to keep throwing money at them. Expect more bankruptcies and consolidation in the months ahead.

<i>Assif Shameen is a business and technology writer based in North America</i>

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