The Money Spring

All,

Mike Shellman at Oily Stuff, pens the best blog on the oil business. He often writes regarding the unsustainability of the shale drilling business model.  In his most recent post, he commented on a recent report that Haynes & Boone released on what sources companies are using to raise capital to fund their 2018 exploration and production efforts. The report indicates that 58% of the capital deployed in 2018 will be from the raising of debt. Berlin argues that this number is actually higher as the report notes that "Joint Ventures with Private Equity firms such as farmouts, drillcos, etc" will account for 12% of the capital deployed in 2018, but those arrangements are going to be partially funded with debt also. Regardless, there is a lot of borrowed money at play. 

  Sheikhs v Shale  from The Economist

Sheikhs v Shale from The Economist

Is this sustainable? Mike argues that it is not and his fact based writing often explains why. Berlin argues that it is sustainable. There are many reasons why it is sustainable and listed below are a few of them:

  1. We have an expanding money supply that keeps interest rates artificially low and drives yield hungry investors to riskier margins....and
  2. Incentives are skewed in most public corporations and management teams often enrich themselves at the expense of the majority of the owners. This can be observed when companies take on new debt to improve short term metrics at the expense of the company's long term financial health and stability....and most importantly
  3. The longer something has occurred, the more likely it is to continue to occur. While 15 years is not a long time in the span of world history, capital markets have been funding marginally profitable shale wells for 15 years. You might say "it does not make sense, why are these companies being funded?" Berlin would argue that it is your mental model that does not make sense and needs to be updated. It hurts her head too, after all, wouldn't the equity stake holders want to profit on their investment? But, since the market has funded the exploration efforts, it makes sense.

Please comment below or contact Berlin with any more questions about the suitability of debt financing and the continued sustainability of the shale drilling business model. Or if you would like to sell your Oklahoma mineral rights under any unconventional (and conventional) oil and gas well.

More to follow,

Berlin