Will U.S. Shale Stage A Comeback As Oil Nears $50?

The casualty list in the oil and gas sector continues to climb.

On Monday, unable to keep up with its mountain of debt, SandRidge Energy filed for Chapter 11 bankruptcy. The Oklahoma City-based shale driller announced a restructuring with creditors for two-thirds of its $4.1 billion in outstanding debt, which it hopes will allow it to continue operations. "The new capital structure will allow the Company to concentrate on oil and gas exploration and development in our active Oklahoma and Colorado project areas," James Bennett, SandRidge President and CEO, said in a statement. "We look forward to completing this next phase of the process quickly with minimal disruption to our business."

SandRidge is the fifth company in five days to file for bankruptcy, joining Breitburn Energy Partners, Linn Energy LLC, Berry Petroleum Co., and Penn Energy. An estimated 77 companies have now declared bankruptcy since early 2015, a figure that is sure to rise in the weeks and months ahead. According to a Deloitte estimate, there are 175 drillers around the world that are in danger of going under, with another 160 companies that face financial distress as well.

The pain has become more acute in 2016 as oil prices dropped to new lows and oil and gas companies burned through any cash they had left. According to Fitch, oil and gas firms defaulted on $26 billion in debt in 2016, which is sharply up from the full-year figures of just $17.5 billion in 2015.

But bankruptcy does not necessarily mean that sharp declines in oil production will be forthcoming. As SandRidge's press release reveals, the company hopes to emerge from bankruptcy without much damage to its production levels. From the perspective of the company's creditors, keeping production elevated makes sense as well - if they are to be paid back at all, oil and gas flows will be necessary. It would be self-defeating if creditors stake out a position that hurt production levels.

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For stronger oil and gas drillers that are not in danger of missing debt payments - which, it should be noted, are companies that represent the bulk of U.S. oil production - the big question is when they will begin to restart drilling.

Many companies have suggested that $50 oil will be enough for them to redeploy rigs. In late April, rig supplier Nabors Industries, oil major BP, and the E&P Pioneer Natural Resources, all said that if oil prices rose to $50 per barrel, drilling activity would increase. According to Wood Mackenzie, the largest 50 publicly-traded oil companies would breakeven at $53 per barrel.

But the industry won't turn on a dime - deploying rigs is not automatic. These are decisions that will be made by individual executives, who must be confident that oil will avoid falling back to the low $40s per barrel or worse. "It's not just about touching $50," Fraser McKay, vice president of corporate analysis at Wood Mackenzie in Houston, told Bloomberg in April. "It's about touching, maintaining and having the perception of future prices above $50 a barrel before you start sanctioning projects that are economic at $50 a barrel."

Bloomberg also quoted Continental Resources COO, Jack Stark, who wasn't going to take the bait of $50 oil immediately. "We won't chase price spikes," Stark said. "We're committed to being patient."

If the rig count is anything to go by, there are few signs that a resurgence in drilling is taking place. As of mid-May, the rig count continues to fall - according to Baker Hughes, the U.S. lost 10 oil rigs last week.

Another factor that will weigh on the oil price rally is the backlog of drilled but uncompleted wells (DUCs). Precise data is hard to come by, but Rystad Energy pegged the backlog of DUCs at somewhere around 4,000 at the end of 2015. There is also a lot of uncertainty about when companies will decide to bring some of that latent output online. The CEO of Whiting Petroleum said in April that $50 per barrel should trigger some completions. "$50/bl is the price where we would move forward on that," CEO Jim Volker said. Again, while there is lots of guesswork here, some analysts think DUCs could add another 500,000 barrels per day in fresh output. The completion of the DUCs will delay and hold back the oil price rally. But $50 oil could just be around the corner.

By Nick Cunningham of Oilprice.com