Shale Oil Bust Reveals Inflated Inventories

Oil drilling operations in West Texas|Getty Images

Oil drilling operations in West Texas|Getty Images

Companies across the American shale patch are in trouble. Back in 2009 fracking companies lobbied the Securities and Exchange Commission (SEC) for rules that allowed them to claim the potential of their wells. This greatly inflated inventories and drove an investment boom in shale oil, but the new rules had one catch. Undrilled wells had to be drilled within five years and profitable at a barrel price set by the SEC. The price was the average of the prices on the first day of each month during the calendar year. In 2014, this price was $95 per barrel but for 2015, the price comes at $51 per barrel. This price already includes the barrel price on Dec 1st. “They got such a break with the price for last year, but it sure as hell isn’t going to happen this year,” said Ed Hirs, a managing director at Houston-based Hillhouse Resources, an independent energy company.

Bill Barrett Corp. stands to lose as much as 40 percent, and Oasis Petroleum Inc. will have to erase 33 percent according to filings. Chesapeake Energy will see its inventory cut by 45 percent, and this will only be partially offset by more recent discoveries and expansions. All shale oil companies will see a reduction of their inventories because while a lot of the wells owned could be drilled when oil was selling for over $90 per barrel, this cannot be done at today’s prices.

The shale oil revolution has effectively stalled. Especially since the SEC rule allowed for more undeveloped reserves than used to be the case. Since 2008, the year before the new rule went into effect, undeveloped resources of oil and natural gas have tripled to 6.1 billion barrels based on Bloomberg data. The same data indicates that undrilled wells account for 45 percent of proven reserves, a rise of 30 percent since 2008. Some of these wells are likely never to be drilled while others may return to inventories when barrel prices rise in the future.

“The question is, how are these reserves going to come back? Because if you have to spend within cash flow, those reserves aren’t coming back. Not unless we get a spike in prices, or we return to levered growth,” said Subash Chandra, an energy analyst at Guggenheim Securities in New York.

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