Banking Crisis Adds To Shale Industry Pessimism

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by Forbes

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Banking Crisis Adds To Shale Industry Pessimism

The banking crisis is adding to mounting pessimism among U.S. shale producers about the direction of oil prices as the first quarter draws to a close.

After a stellar 2022 that saw the sector generate record cash flow and reward shareholders with huge returns, persistent cost inflation, oil-field labor shortages, low natural gas prices, and rising fears of a recession are casting a pall over the shale patch. The banking crisis is the cherry on top, sparking concerns about capital availability.

While the impact of the banking crisis is likely to be confined to smaller, under-capitalized independent producers, of more significant concern is the potential impact that a broader tightening of bank credit could have on personal household finances, particularly as it relates to consumption, construction, and other segments that would curb oil demand and drive down oil prices.

Recent optimism that oil would soon top $100 a barrel led many operators to ditch hedges for fear of leaving money on the table. Now, based on the Dallas Fed's recent survey of industry sentiment, energy executives reckon oil will end the year just shy of $80 a barrel - robust enough to earn strong returns but not the boom many expected.

The recent OPEC decision to cut output by 1 million barrels was a reaction to demand and sentiment concerns arising from the banking crisis, which was weighing on prices.

Even if the banking crisis continues to spread, it shouldn't be a major issue for the larger companies that produce most of the domestic petroleum output. Many top exploration and production (E&P) companies now rely on cash reserves instead of capital markets to fund development due to the shale industry's new era of capital discipline. Even the balance sheets of small producers are strong than in the past.

So strong are balance sheets that consultant Deloitte said last year that the E&P sector could use cash reserves and expected future free cash flow to pay off debt as early as 2024, if desired, assuming high commodity prices and capital discipline continued.

Of course, the risks increase if oil prices tank or U.S. natural gas prices drop even lower than current paltry levels of just over $2 per million Btu.

The underappreciated risk of the banking crisis may be that it spreads to more banks, tightens credit, and hammers oil demand.

So far, that doesn't seem to be happening. Global oil demand should gain momentum as the year progresses and hit record levels as China's economy ramps back up after years of Covid-related restrictions. China's reopening is taking longer than expected, but Beijing can't afford to put it off much longer.

The International Energy Agency (IEA) predicts global demand will rise by 3.2 million barrels per day between the first and fourth quarters of this year, which would be the largest gain in a single calendar year since 2010.

The IEA expects demand to grow to an annual record 102 million barrels per day this year, including a peak of 103.5 million barrels per day in the fourth quarter. Even the OPEC cartel is bullish, expecting demand to rise on average by 2.32 million barrels daily.

Still, it's early, and history has shown that skeletons could fall out of the closet of more banks, deepening the financial crisis.

While nobody expects a repeat of the 2008-2009 financial crisis, which saw global oil demand drop by about 1 million barrels per day each year, the potential that it could worsen and spur a severe recession remains a concern. Other recessions, including 1990-1991 and 2001, saw demand growth weaken but not contract, which is the likely scenario this time around.

Veteran oil economist Phil Verleger thinks the outlook for oil is getting quite grim as more information from banks spills out. "Governments and central banks will save the financial system, as they often have. No one, though, will throw a life vest to the oil industry," he said in his latest Notes at the Margin.

The industry is betting that it doesn't come down to that. However, a combination of lower prices and tighter lending could squeeze some E&P companies and make life uncomfortable. Such pressures would prompt further consolidation in the industry, driving smaller, under-capitalized companies into the hands of bigger players.

For now, investors should expect some bumps in the road for oil and gas companies but no full-scale roadblocks.

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