Shale Drillers Could Lose Crucial Safety Net

The insurance protecting shale producers’ prices will soon run out.

By Texas StandardJuly 3, 2015 12:58 pm

In recent years, the fate of the Texas economy has been inexorably linked with the highs and lows of the energy business, causing considerable discomfort over the recent fall in oil prices. Despite the undeniable hardships felt by thousands already laid off, the downturn has not been completely catastrophic.

This is partially due to the fact that for the past year, shale drillers have been artificially insulated from the worst of it. An insurance-made financial safety net has kept revenues up, but that buffer will soon expire.

Asjylyn Loder, a reporter with Bloomberg, discusses the situation with Texas Standard’s David Brown.

On what the safety net is, exactly:

“[The shale drillers] have purchased a lot of derivatives, which help them lock in [oil] prices above where we are today. A year ago prices were $107 [a barrel], and now they’re $58. A year ago they bought these derivatives, essentially insurance, guaranteeing them prices- for a lot of them, $90 and above. So they just really haven’t felt the full brunt of the oil crash yet. … When they buy this insurance they typically look out about a year to 18 months ahead and they only buy it for that long. It’s pretty difficult to actually buy it much further out, for a variety of reasons … So a lot of that high priced, high value insurance is starting to run out.”

On what will happen when that insurance expires:

“Even with that insurance, revenue for the companies that we look at is down 37 percent, so that’s pretty tough already. When this insurance runs out and they lose that as well, their banks are going to be looking at [that]. These companies spend more than they make, so they really need those credit lines… If the banks get a little leery of continuing to raise those credit lines, it’s gonna be a liquidity crunch for some of these companies.”

On the hard decisions some companies will have to face:

“For some of them it’s just gonna be a really tough cash crunch. It’s going to leave them basically facing the full brunt of the crash, and it’s going to be tough for a lot of them… I will say, you know, the hedges are rolling off but a lot of companies used the time that that bought them to cut spending, to try to sort of live within their means, and if they’ve been able to do that, if they’ve been able to get spending down enough… some of them might be able to do pretty well.”

On how the oil companies been using these hedges:

“We looked at about 62 different, independent production companies, and for 30 of them the insurance made up 15 percent of their revenue or more. For one company, it was 64 percent. So that gives you a sense of what happens when that insurance just disappears. That’s a pretty big hole to fill.”