Shale Oil Becomes Shale Fail (and A Nice Subsidy For Consumers)

I’m tempted to say the following to the writers of two recent pieces (here and here) outlining the continuing negative free cash flow of companies fracking for oil in America: “Tell me something I don’t already know.”

But apparently their message (which has been true for years) needs to be repeated. This is because investors can’t seem to understand the significance of what those two pieces make abundantly clear: The shale oil industry in the United States is using investor money to subsidize oil consumers and to line the pockets of top management with no long-term plan to build value.

There is no other conclusion to draw from the fact that free cash flow continues to be wildly negative for those companies most deeply dependent on U.S. shale oil deposits. For those to whom “free cash flow” is a new term, let me explain: It is operating cash flow (that is, cash generated from operations meaning the sale of oil and related products) minus capital expenditures. If this number remains negative for too long for a company or an industry, it’s an indication that something is very wrong.

Only nine of 33 shale oil exploration and production companies reviewed in the report cited above had positive free cash flow for the first half of 2018. This iseven though prices had risen all the way from a low of around $30 in 2016 to the mid-$70 range by the middle of this year.

To get an idea of just how bad it has been even through periods when the price of oil averaged above $100 in 2011, 2012, 2013 and most of 2014, here are the annual free cash flows in dollars of those 33 companies combined since 2010 and they are all negative: -14 billion (2010), -21.9 billion (2011), -37.8 billion (2012), -16.8 billion (2013), -33 billion (2014), -34.4 billion (2015), -18.3 billion (2016), -15.5 billion (2017).

Capital expenditures are what companies invest in future production—in this case, theacquisition of new oil deposits and the drilling and completion of new wells and associated infrastructure. Because operating cash flow has not been sufficient to cover the drilling of new wells, companies must either issue new debt or new shares to raise money to do so. The former makes companies more likely to go bankrupt if oil prices turn down and the latter dilutes the value of the company for existing shareholders. Either way, it’s not good news for investors.