Deloitte Study: The Great Compression: Implications of COVID-19 for the US Shale Industry

Second quarter earnings to bring a surge of asset impairments, which could accelerate insolvencies and spur deep industry consolidation in 2020

NEW YORK, June 22, 2020 /PRNewswire/ —

Key takeaways:

  • Fifteen-year U.S. shale boom entering period of “great compression.”
  • Vulnerable shale operators hit hard by COVID-19, and heightening oil price volatility.
  • Looming $300 billion of impairments could spark bankruptcies and deep consolidation.
  • Buyers beware, only 27% of major operators make attractive acquisition or merger targets.

Why it matters
Prior to the pandemic, the U.S. shale industry in aggregate was losing money. Now simultaneously faced with a new normal of lower oil prices, reduced demand, capital constraints, heavy debt loads and COVID-led economic uncertainty, the industry is entering a period of “great compression.” Deloitte’s new study, “The Great Compression: Implications of COVID-19 for the US Shale Industry,” explains how present circumstances could trigger a deep consolidation in the U.S. shale industry and offers recommendations for operators to navigate the road ahead.

A $300 billion correction could be looming, 2Q inflection expected
According to the study, challenging oil market and economic conditions could prompt the shale industry in aggregate to impair or write-down the value of their assets by as much as $300 billion — with significant impairments expected in the second quarter of 2020. As a result, the leverage ratio of the industry could increase from 40% to 54%, potentially setting off a chain reaction of insolvencies and restructuring.

Approximately 30% of shale operators are technically insolvent at $35 per barrel
The study found nearly a third of today’s operators are technically insolvent with oil prices at $35 per barrel, and 50% at $20 per barrel. As asset impairments and write-downs increase debt ratios, an even greater number of companies could become at risk for bankruptcy.

The great compression could have lasting and domino effects
New telecommuting norms, regionalized trade and supply chains, a new fuel order, and stable business profile of new energies have fast-forwarded the specter of peak demand to the present. While a combination of global production cuts, easing of lockdowns worldwide, capex reductions and accelerated field decline rates have helped oil prices to recover from sub-zero levels, it remains to be seen if oil prices will return to $50 to $60 per barrel in 2020. As shale operators face these new realities, the reverberations could extend beyond the U.S. shale industry and have a domino effect across the oil and gas value chain.

Buyers beware, only 27% of major E&Ps identified as attractive acquisition targets
The study analyzed the operational and financial health of top U.S. shale operators and found that only 27% were “augmentors,” representing value-accretive targets for supermajors or large independents. Conversely, approximately 50% of major E&Ps were identified as “superfluous” or risky bets for potential buyers. The study found that any large acquisition or merger should be considered only if one plus one is greater than two, on both operational and financial fronts. A key question is what to buy and, more importantly, what not to buy.   

Key quotes
“The history of oil and gas is filled with periods of extensive consolidation. Following a 15-year boom, the U.S. shale segment appears to be next. As COVID-19 impacts amplify pressures on shale companies through 2020, a wave of impairments may prompt the deepest consolidation the industry has ever seen over the next six to 12 months.”    

Duane Dickson, vice chairman and U.S. oil, gas and chemicals leader, Deloitte LLP

“The short-term outlook for U.S. shale is undeniably challenging, but E&Ps should regard the great compression as a unique opportunity for reinvention. Selective consolidation among producers in the short-term can help revitalize the industry and better position it for the future. Especially as the energy transition moves forward, investment in big data, advanced digitalization and sustainability measures can be of paramount importance to long-term survival and success.”

Scott Sanderson, principal, oil and gas strategy and operations practice, Deloitte Consulting LLP

Challenges come with opportunity
The U.S. shale industry appears to be facing a test of historic proportions as they enter a period of “great compression.” However, these difficulties also present an opportunity for revitalization through rigorous operational diagnosis and experimentation. Beyond M&A, companies that effectively integrate meta-data analytics, sustainability measures and digital technologies into their business models might be the likeliest to successfully respond, recover and thrive.

Connect with us on Twitter at @Deloitte4Energy or on LinkedIn at Duane Dickson and Scott Sanderson.

About Deloitte
Deloitte provides industry-leading audit, consulting, tax and advisory services to many of the world’s most admired brands, including nearly 90% of the Fortune 500® and more than 7,000 private companies. Our people work across the industry sectors that drive and shape today’s marketplace — delivering measurable and lasting results that help reinforce public trust in our capital markets, inspire clients to see challenges as opportunities to transform and thrive, and help lead the way toward a stronger economy and a healthy society. Deloitte is proud to be part of the largest global professional services network serving our clients in the markets that are most important to them. Now celebrating 175 years of service, our network of member firms spans more than 150 countries and territories. Learn how Deloitte’s more than 312,000 people worldwide make an impact that matters at www.deloitte.com.

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