The argument to be a buyer of the Saudi Aramco IPO
John Dizard looks at the role of US shale producers in the global oil and gas sector
Like cats transfixed by a pigeon, the world’s bankers are quivering in anticipation of next year’s initial public offering by Saudi Aramco, the state oil group. Once-strict regulators are finding exceptions to rules, lawyers are straining to magic away litigation risk, and giant real-money investors are being cajoled into orderly queues.
Many problems can be waved away for the opportunity to participate in “The IPO” as it is referred to on Wall Street. The fees on a ticket of maybe $75bn . . . no wonder they are focused. There is just one question from investors, though: what about shale? Do the US producers continue to depress oil and gas prices?
Let me answer the question with another question. Is the shale industry still competitive thanks to technology, or thanks to quantitative easing? Americans tend to say that rising “unconventional” hydrocarbon production is all about superior science and engineering. International oil people believe the shale people are the spoiled children of the Federal Reserve, the US central bank, and overindulgent investors.
I believe the US exploration and production industry for oil and gas has developed great technology, but it has required continuous transfusions of cheap outside money to keep going. The tide of cheap shale oil and gas will recede only when the capital markets stop wiring funds to the producers.
You could even compare the cost of the capital market’s subsidy of the shale industry to other US strategic assets. A new aircraft carrier comparable to the Gerald R Ford, along with the aircraft and other ships of its strike group, has been estimated to cost $25bn-$30bn.
So if you were playing geopolitics as a simplistic board game, the post-2014 capital markets’ support of the shale industry might be considered the equivalent of three new aircraft carriers. It significantly cut the US dependency on eastern-hemisphere oil.
When the price cuts by Opec, the cartel of oil exporters, hit the shale industry in November of 2014, I thought that the crunch moment for the industry would come sometime in early 2015. Historical experience indicated that was when banks would “redetermine” the borrowing base of the companies and reduce their allowable debt levels.
However, history has not turned out to be a reliable guide in the QE era. It may have been winter in the E&P patch after the halving of the oil price, but there has been a seemingly eternal spring in the private equity and junk-debt world. Many expected a flood of outright bankruptcies and a liquidation of capacity.
There were some bankruptcies, but most management teams emerged from those with newly struck stock options and recharged drilling and completion budgets. Private equity and junk-debt refinancing took the place of operating cash flow modestly leveraged with secured bank lines.
As one Oklahoma oil and gas man I know says: “There is still unlimited capital, and as long as that is true, you can grow anything. If the companies had been forced to live within their cash flow, then their production would go down. Then they would have run into a death spiral where nobody would want to invest in them.”
The shale companies struggling with sub-$40 or sub-$50 oil prices were also able to live off the excess inventory of drilled-but-uncompleted (DUC) wells that had built up during the boom years.
As our Oklahoman says: “There were thousands of DUCs that had not been taken account of. The companies could just complete and connect those to offset the declines in production from older wells.”
Along with the sunk-cost inventory and cheap refinancing, the US E&P companies made real advances in the use of geoscience to find new oil in already-known fields.
They also drilled longer lateral holes, and made more effective use of fracking techniques. So productivity went way up in places such as the Permian Basin in Texas.
As one international oil analyst says, though: “The Permian is preventing high prices today, but ensuring high oil prices tomorrow. The low prices are holding back investment in most of the world, and that is storing up a significant problem in meeting demand in the future.”
That is the argument to be a buyer of the Saudi Aramco IPO.
There are two bets involved in the listing. Can Saudi Arabia contain the social and strategic pressures caused by cheap oil? And will the capital markets eventually stop subsidising shale producers?