Fall in the oil price has not curbed fracking nearly as much as expected

WHEN the oil price crashed last year, many assumed that the earliest casualties would be the small, nimble American companies that specialise in getting “unconventional” oil out of shale, tar-coated sand and the like. After all, with their high production costs and heavy debts, these firms were inherently more vulnerable to price shocks than big oil companies, the thinking went. Indeed, Saudi Arabian officials even suggested that they were refusing to cut their output precisely in order to put such firms out of business.

Six months later, though, there is little sign of a bust in America’s shale basins, where horizontal drilling and hydraulic fracturing (fracking) have led to a boom in oil and gas production in the past five years. Scott Nyquist of McKinsey, a consultancy, says the price drop has not caused the “immediate distress” that was originally assumed. An analysis of 300 independent American oil and gas companies in the first quarter of this year showed that more than two-thirds had healthy balance-sheets, with at least as much equity as debt. By the same token, the debt of two-thirds of the midsized firms in the survey was trading at 80% or more of its face value, suggesting that investors are not too worried about their health. The firms that have been in trouble are those with dud leases, or which had embarked on big takeovers last year, just before the price began falling.

Figures compiled by investment bankers at Barclays tell a similar story. Although yields on the “junk bonds” issued by American energy firms spiked from a low of 5% in the summer to more than 10.5% in December, they have since fallen back to 8% (roughly the same as in mid-2012). It has become a little more expensive for frackers to borrow, in other words, but there is no sign of a crippling squeeze.

The number of rigs drilling for oil in America has fallen by half since October, from some 1,600 to 800; that will eventually sap output. For now, though, American oil production is still growing: in March it rose by 120,000 barrels a day (b/d).

One reason is that frackers have been able to cut costs, along with the rest of the oil industry, as the price of labour, steel and other inputs has fallen. That gives a one-off boost to their finances. They are also benefiting from continuing improvements in productivity. These include better seismic data, which means more fracks are successful, the ability to drill ever more wells from a single spot and, on the horizon, polymers and other fluids that cut water use or replace it altogether.

It is not all plain sailing. Oil reserves are valued in October, notes Michael Cohen of Barclays. Those priced last year, with oil around $100 a barrel, will be worth a lot less this time round. But even troubled firms do not necessarily cut production. New owners can purchase their assets cheaply and keep pumping.

The main lesson is that although the price drop has been bad for producers in such places as the North Sea, it has not derailed America’s oil boom. Indeed, America is replacing Saudi Arabia as the world’s swing producer. Frackers have drilled lots of wells and then plugged them, waiting for the price to rise again. If it does, Mr Cohen expects between 300,000 and 800,000 b/d of production to start up.

Nor is there any sign of a shift away from unconventional oil in terms of capital investment. Unconventional oil has been gaining an increasing share of the pie in recent years (see chart). Investment of all kinds will dip this year but Rystad Energy, a research firm, sees it rising strongly again thereafter. A new forecast from America’s Energy Information Administration reckons rising production and greater efficiency mean that the country will stop importing energy between 2020 and 2030, depending on the price.

This contributes to a picture in which oil prices—barring big geopolitical upsets—look unlikely to rise sharply. True, global demand for oil is set to rise, and old oilfields are depleting, meaning that much of the industry needs to run in order to stand still. But the message from America is that finance and technology combined are more than a match for geology.