The Great American Shale Boom is at risk of hitting a wall. Falling oil prices and rising interest rates are crushing the profitability of these energy production projects.
In recent years, technological advances in hydraulic fracturing has fuelled a shale boom. Oil and natural gas extracted from shale basins has left the US flush with energy.
However, it’s not cheap to tap these so-called unconventional plays.
In other words, crashing oil prices will soon make many of these energy sources money-losing projects. Morgan Stanley estimates the average breakeven oil price for these US plays to be around $US76-$US77 per barrel. Goldman Sachs puts that number at closer to $US75.
To make matters more complicated, many of these energy companies are financing their operations by borrowing in the junk bond market.
“As oil prices have fallen recently, so have prices of high-yield bonds,” Charles Schwab’s Collin Martin wrote in October.
“Oil prices can have a broad impact on the high-yield bond market because energy corporations have been increasing their share of the high-yield bond market. Today, energy companies make up more than 15% of the Barclays U.S. Corporate High-Yield Bond Index. That’s up from less than 5% of the index at the end of 2005 — and the chart below shows that the share has been steadily increasing over the past decade.”
If the price of oil can’t cover production expenses and/or force these companies to idle their operations, then you could expect a rise in delinquencies and defaults.
Even worse, this comes as interest rates are broadly expected to go higher from here.