2015 was a year marked by a dramatic reversal of fortune in the oil industry.
Crude oil prices dropped down to a third of their 2014 highs, effectively pouring ice water on America’s shale revolution.
Our Inside Energy reporter Dan Boyce takes a look back.
To understand what many oil companies have been going through in the last year we need to enter a dark forest filled with hedges, zombies and strippers.
To explain, I visit Steve Trammel.
TRAMMEL: “Hi dan. Steve Trammel.”
He analyzes North American oil and gas for IHS. And he starts the tale of a hypothetical business.
“So, we’re willing to sign a contract with you as Dan Oil Company…”
Yes, Dan Oil Company--the name alone should worry my made up investors. Trammel’s playing their part.
It’s late 2014 and he’s going to pay me $55 dollars for every barrel of oil I drill for the next year. Oil is selling for more than $60 dollars a barrel at this point, so it’s a pretty good deal for Trammel.
“Think about gambling, really, that’s what it is.”
He’s gambling that prices are going to go up, so he’ll make even more money selling the barrels he’s buying from me at that fixed $55 dollar rate.
The fixed rate is called a hedge, and it was happening a ton at the beginning of 2015 because investors didn’t think oil prices would actually keep falling.
BUT….they did...down to $45 dollars, $40, even $35.
Initially, this is good for Dan Oil, right? Because Trammel Investors still has to pay me $55 dollars. Still, Trammel’s not happy about it.
“Wow, we sorta missed our bet on this one so we’re not gonna do this again in 2016.”
When Dan Oil’s hedge contract runs out toward the end of 2015, all of a sudden I have to sell oil at the real price and that’s a problem. The wells I drilled are really expensive.
“These wells are 2 to 8 million.”
and, like many small and medium sized oil companies, Dan Oil doesn’t have that just sitting around. So to finance my drilling, I took on a ton of debt, and that’s normal. The financial times reports US oil and gas company debt more than doubled from the end of 2010 to June 2015. But, now the money my oil is bringing in with these low prices is only enough to pay off the interest on that debt.
These wells, just paying off interest and slowly cannibalizing my resources--an actual term used for a well like this is a zombie.
Let’s bring in another analyst, Bernadette Johnson.
“I’m managing partner at Ponderosa Advisers.”
She helps oil and gas companies decide what their next business move should be. So in advising me, she sees the zombie wells stumbling around my balance sheet, of course she doesn’t like that. Especially because, as the price keeps dropping, I’m not able to pay the interest on my debt, I start sinking deeper and deeper every single month.
“...every single day, really, So that’s a situation where Dan Oil Company is in trouble.”
Then, the final blow comes when she sees my assets include not just zombies, but strippers.
“Stripper wells.”
Stripper wells are really old.
“they’ve been producing for maybe 40 years.”
They still cost money to run, but not much oil is coming out of them any more.
“if you’re a company that has a lot of those and you’re in the red, you’re going to have to abandon them, you’ll have to file for bankruptcy.”
Granted, this is a doomsday scenario. But, this kind of thing happened to more and more companies as 2015 went on. Law firm Haynes and Boone tracks this and they count 37 oil and gas bankruptcies from January to the beginning of December. and both analysts Bernadette Johnson and Steve Trammel expect that trend to increase in the New Year.
That means more layoffs, firesales and mergers.
Trammel believes a barrel of oil will be cheap through at least the first half of the year.
Why?
“The big thing that we’re really gonna watch and the whole world is watching is those Iranian barrels coming back onto the market.”
Iran being able to export its oil was part of the nuclear deal signed with the US and other world powers in 2015.
And Trammel says Iran, they’ll be able to move their barrels fast.
“I’ve heard that they have oil on ships just sitting there waiting.”
So, in order to survive, Dan Oil may just have to resort to piracy.
Just kidding, Iran, remember I don’t actually have an oil company.
