In February 2019, the US rose to the head of the table of oil-producing giants. US exports increased from around 4.5 billion barrels per day in 2018 to 6 billion in 2019, and look set to rival the steady 8-9 billion barrels exported from Saudi Arabia and Russia. To compound such aggressive growth statistics, the US has grasped the title of the world’s largest oil-producer by pumping out a record 12 billion barrels per day. What makes such soaring production truly stand out against its competitors, however, is that it is fuelled by the US shale revolution.
The most recent fracking bust in the oil & gas industry was at the end of 2015; at the time, falling oil prices against a background of soaring debt accumulated by the fracking industry led to the subsequent slashing of operational costs. The number of active oil rigs was cut down substantially – but now, after a few years of recovery, and with the promising discovery of a wealth of oil in the Permian basin of Texas and New Mexico, fracking is the name of the game.
Fracking the Permian basin has been overtaken by oil giants Chevron and Exxon Mobil, with Chevron planning to more than double production out of the basin to 900,000 barrels a day. Its largest growth project since 2016, Chevron has acquired rights to 2.2 million acres in the basin, demonstrating the company’s belief in the future of shale gas. Other large oil companies are also looking to assert dominance in the basin by pushing out or absorbing the smaller players, propelling M&A interest to its highest peak in over a decade. Such streamlining could also serve to make the industry more efficient and perhaps able to turn more profit than ever recorded before which, together with the US topping the production and exporting charts, seems to signal a very promising environment for investors in the US oil & gas industry.
The current buzz around fracking does, however, gloss over deeper concerns lurking within the multi-layered bedrock. Although consolidating the industry through M&A may reduce the costs of fracking, it remains a difficult sector in terms of profitability; fracking companies are only valued as a multiple of acreage owned or level of production, since historically most companies have not been able to turn profit. Currently, even the giants are finding it difficult: despite production levels skyrocketing, Chevron is looking at negative returns for the rest of 2019, and will likely not see positive cash flow until 2020. Part of what makes fracking a difficult business is its fundamentals. Fracking is essentially a last-resort method of extracting oil from parched oil fields where the commodity is harder to access. The means of extraction thereby have negative environmental consequences, such as water reserves becoming contaminated, the increased likelihood of earthquakes and sinkholes, and toxic wastewater polluting natural reserves. Evidently, not only are the financial costs of fracking heavy, but so are the environmental ones. Such concerns beget the question: is fracking the future of the US oil & gas sector, or is it the end?
So, how do investors perceive the US oil & gas industry? Investors in private markets, primarily in natural resources, infrastructure and private equity, will drive the direction of the future of energy. By looking at the aggregate amount of capital that has gone into unlisted natural resources funds targeting the US oil & gas industry, it is possible to gauge investor sentiment and observe how it is changing.
As seen in the chart above, the amount of capital flowing into funds focused on US oil & gas dropped each year between 2015 and 2017, before plateauing in 2018 at $29bn. The number of funds closed has also decreased over the years, suggesting that fund managers are seeing fewer opportunities to raise funds, and have struggled to close due to low investor demand.
Interestingly, the aggregate target size of funds in market in Q1 2019 is relatively high at $52bn, which could suggest that investor appetite is growing once more; however, the simultaneously high number of funds raising may represent many that have been on the road for longer than expected and are having trouble closing. Thus, although fund managers seem to have lofty expectations for the sector, it is still unclear as to whether investors are buying into the oil & gas sector specifically. At surface level, there may be renewed hope in the industry due to amplified M&A activity and even price uncertainty caused by heightened US competition in global production; but go deeper, and the financial and environmental unsustainability of fracking is the driving force behind the sector, and so investors have cause to be wary.
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