Chesapeake Energy was once the second biggest natural gas producer in the country. With a market cap of $36 billion, CHK helped drive the US to the top of the oil heap, becoming the largest oil & gas producer in the world for the first time in decades. Founded in 1989, the company grew rapidly through aggressive wildcatting oil & gas bets that poured money into Oklahoma City, even enabling founder Aubrey McClendon to steal the NBA’s Seattle SuperSonics and install the “Thunder” in a state-of-the-art arena named after his company. Investigators dogged McClendon for years about his questionable tactics, even indicting him in 2016 for rigging bids to purchase oil and gas leases in Oklahoma. That ended months later when McClendon, who had been forced out three years earlier for his shady dealings, drove his speeding Chevy Tahoe into a highway embankment and was killed. The news just got worse for Chesapeake shareholders: the once mighty gas giant declared bankruptcy last night. Chesapeake represents a prime example of the boom and now bust of the US oil and gas revolution of the past ten years. The US fracking industry is now collapsing before our very eyes.
Fracking was a technology developed by drillers in 2008-9 who saw their “easy” conventional reservoirs start to dry up. They drilled ever deeper wells and inserted pipes that could go straight down previously unimaginable distances of 6,000 to 10,000 feet then spread out horizontally to go after shale deposits trapped between layers of rock. Frackers then sprayed tons of water, chemicals and sand to knock loose the oil and gas and suck it up to the surface. The rigs were expensive and the deposits were depleted quickly. Most of the production of a shale well came in the first two years of production – but the amount of oil they pulled out was astounding. Boomtowns sprung up in the Permian and Eagleford basins in Texas as well as the Bakken in North Dakota, the Niobrara in Wyoming and the Marcellus in Appalachia. Texas alone was producing more oil than Iraq. The US shot to the top. In 2019, EIA reported that the US produced 17.9 million barrels per day, versus the 12.4 million produced by the Saudis and 11.4 million by the Russians. But there was a huge problem.
Fracking has never actually made money for its investors. The expensive drilling equipment combined with the fast depletion rates of these wells meant that drillers were constantly spraying money at the next well hoping it will be profitable. Most borrowed frivolously, like a desperate gambler hoping the next hand would bring a flush to pay off his debts and lenders and investors bought it. Some estimate that the during the entire fracking run up, the industry as a whole racked up a massive cash flow deficit as oil profits never overcame drilling capex. According to a recent report by Deloitte: The year 2020 marks the 15-year anniversary of the US shale boom, which heralded an era of US energy independence and more than doubled tight shale oil production over the past five to six years. But beneath this phenomenal growth, the reality is that the shale boom peaked without making money for the industry in aggregate. In fact, the US shale industry registered net negative free cash flows of $300 billion, impaired more than $450 billion of invested capital, and saw more than 190 bankruptcies since 2010.
Shale oil has an average breakeven price of around $50 / barrel. Both Saudi Arabia ($9/barrel) and Russia ($19/barrel) have much lower oil “lifting costs”, giving them an advantage when demand softens or if they initiate a price war. While these countries need much higher prices to support their economies, they can endure longer spells of lower prices to starve out competition. That happened in early March 2020 when the Saudis/OPEC and the Russians would not agree to further production cuts in the face of collapsing demand due to COVID-19. That drove the price of oil from over $50 to below $40/bbl. Within weeks, West Texas Intermediate Crude had collapsed to below $20/bbl, putting the entire shale industry on the brink.
Coming into 2020, shale lenders and investors were already sharply cutting the flow of funds to the industry after a decade of losses. However, these are big companies with a strong lobby in Washington, so President Trump had to repeatedly “ask” the Russians and Saudis to cut production (in exchange for what?). But the Russians and Saudis saw this as an opportunity to buy back market share by holding crude prices low to put the US frackers out of business. In essence, the wobbly US shale industry had become a massive geopolitical liability for our country. The blowback has begun. The biggest producer in the Bakken, Whiting Petroleum, has already gone BK. Chesapeake Energy, facing $9 billion in debt it can’t pay, saw its time run out yesterday. Many more will follow. The obvious answer for America is to permanently cut our consumption of oil and gas and run our homes and cars on renewable energy that is finally cost competitive and does not leave us beholden to any foreign powers. It also doesn’t destroy the planet.
