The WSJ reports, "between 2006 and 2012, U.S. exploration and production companies clocked almost $1 trillion in capital expenditure, far above operating cash flow of $670 billion, according to Raymond James. Companies have proven adept at filling that funding gap, not least by raising debt.
The E&P sector in 2007 was carrying $28.84 of net debt per barrel of oil equivalent produced, according to data from IHS, roughly equal to operating cash flow. By last year, net debt per barrel had jumped 36% to more than $39, while cash flow was essentially flat.
That should provide fuel for those who doubt the shale boom's longevity, as rising debt levels choke off returns and the capacity to invest in new wells to keep production growth going.
Moreover, as the Federal Reserve moves closer toward the day it will eventually raise rock-bottom interest rates, that should compound the squeeze on E&P spending power. Interest costs have been minimal in the grand scheme of things, according to Sanford C. Bernstein. Looking at E&P sector cash flow from the start of 2011 through the first quarter of this year, it found that out of average revenue of $56 per barrel of oil equivalent, cash interest charges ate up only $2.
Don't count on rising rates to swamp shale drilling, though.
For one thing, a lot of the sector's existing debt carries fixed interest rates, perhaps 90% of the amount outstanding, according to Brian Gibbons at CreditSights. The industry also isn't facing imminent demands to pay back or roll over a lot of this debt. Roughly 60% of the amount outstanding, or $346 billion, doesn't mature until after 2020, according to data from Mr. Gibbons.
High-yield issuers, typically with weaker credit profiles, have especially pushed maturities out in the near term. Whereas 27%, or $129 billion, of investment-grade E&P debt matures by the end of 2018, only 13%, or $17 billion, of the sector's high-yield debt falls due by then.
All this offers some structural protection against rate increases. Still, new borrowing by E&P companies, especially high-yield issuers, may well face constraints as time goes on and debt-servicing costs rise.
Yet investors in the sector, and lenders to it, must also consider how the money is being spent. Since 2012, output per rig in U.S. shale oil and liquids projects has been growing by around 30% to 40% a year, and at percentages in the low teens for natural gas, according to Citigroup. Such productivity gains mean every dollar of investment goes further. Moreover, a big chunk of the investment of the past decade was to secure land, rather than drilling per se, so again, that should reduce the pressure to spend to a degree.
U.S. E&P companies also benefit from their location. Tightening sanctions on Russia and continued turmoil in the Middle East should push more energy-targeted capital toward the relative stability of North America, while also offering geopolitical support to global energy prices.
A true demand shock—a sharp slowdown in Chinese energy demand, for example—could hit E&P activity by undercutting oil prices. Or the sector could finally hit a wall on productivity growth. But when it comes to funding, at least, even the mighty Fed is unlikely to derail shale".
