By: Bryan Gruley, Kevin Crowley, Rachel Adams-Heard, and David Wethe – Bloomberg – Twenty years ago, before the U.S. oil industry became a global energy power that strikes fear into Saudi Arabia, brothers Dan and Farris Wilks started Frac Tech Services LLC in tiny Cisco, Texas. The company provided equipment for hydraulic fracturing, aka fracking, the breaking up of tight sedimentary rock by blasting water, sand, and assorted chemicals through horizontal bores at fantastically high pressure.
Frac Tech grew into one of the most successful pressure pumpers as the U.S. experienced a boom first in shale gas, then in shale oil. The Wilks brothers became billionaires when they sold Frac Tech in 2011, just as shale oil was transforming the U.S. into one of the world’s biggest producers of crude. Last September the country became a net exporter of crude and petroleum products for the first full month in at least 70 years.
The big oil explorers and producers are household names: Chevron and BP, Exxon Mobil and Royal Dutch Shell. But the U.S. oil renaissance has ridden heavily on the backs of little-known pressure pumpers that figured out how to extract oil from the stubborn shale of Colorado, New Mexico, North Dakota, Texas, and Wyoming. The companies that perform this grimy work are also central to the potent political notion that Americans shouldn’t have to rely on the Saudis, Russians, and other oil producers for petroleum.
Today the Wilks brothers’ former company, now publicly traded and named FTS International Inc., is fighting to stay alive. Since early March, Frac Tech Services has slashed executive pay, idled almost its entire fleet of pumping gear, and laid off two-thirds of its employees. It has more debt than cash. Its stock fell to about 30¢ a share before a 20-for-1 reverse stock split in May. Other pressure pumpers are suffering, too, with thousands of workers laid off. Research firm IHS Markit Ltd. recently pondered whether current conditions could “create a scenario in which a wave of bankruptcies in service companies leaves North American shale without enough pumpers to do the work at today’s standards.”
With pressure to move away from fossil fuels rising, the bigger question may be whether the shale phenomenon itself can endure. Already this year, more than three dozen North American explorers, fracking service companies, and pipeline operators—including shale pioneer Chesapeake Energy Corp.—have sought bankruptcy protection. Production is down about 2 million barrels a day from a peak of almost 13 million early this year, and Morgan Stanley says prices must go higher than the current $40 a barrel to prevent further production declines in 2021. Futures prices need to settle in the $55-to-$65-a-barrel range for an extended period before new drilling picks up significantly, says research firm Enverus. Even then, many companies are so highly leveraged that much of their cash could go to reducing debt rather than extracting oil.
Shale’s woes are connected to pandemic shutdowns eviscerating demand and the Saudi-Russia price war that briefly pushed oil prices below zero. But the shale industry’s own shortcomings had gotten it into trouble before Covid-19, as a look at FTS’s winding journey through twin booms and busts makes clear. Now a crucial link in the U.S. oil supply chain is facing mass extinction.
In December 2010, Frac Tech filed with the U.S. Securities and Exchange Commission for an initial public offering. The prospectus described a vertically integrated company that not only dispatched crews to fracture horizontal wells for oil and gas producers, but also manufactured its own equipment, mined fracking sand, and managed a logistics business with more than 1,000 rail cars. This new method of fossil fuel extraction was going full blast in natural gas and gaining momentum in oil as producers feasted on cheap postrecession capital to spend on drilling.
Frac Tech noted in its prospectus that it benefited from a “tight supply” of competitors and ample demand. In some drilling locations, Frac Tech operated around-the-clock, using twin day and night crews. The late Aubrey McClendon, chief executive officer of Chesapeake, which owned 26% of Frac Tech and was a regular customer, called the company “the best in the business.”
The following spring, Frac Tech canceled the IPO. It then closed a leveraged buyout that delivered the company to a group of investors led by Temasek Holdings Pte, a Singapore state investment company, and RRJ Capital. Chesapeake increased its stake to 30%, and the Wilkses pocketed more than $3 billion, some of which they’ve used to acquire vast tracts of land in Montana and Idaho and to support anti-abortion and other conservative causes.
Frac Tech’s annual revenue had risen sixfold in four years, to $1.3 billion, and its net income had quadrupled, to $369 million. Crude prices had hit $100 a barrel, and shale was a happy business. Blue-collar workers looking to earn $100,000 a year flooded into West Texas. RVs and “man camps” housing out-of-towners stacked up around the little towns. Monahans, with a population of 7,000, saw that “probably double,” says Todd Hunt, CEO of Tejas Bank there. “License plates from all over the United States.”
It didn’t matter much in places like Monahans, but fracking was a hot political issue. Environmentalists raised concerns about air and groundwater pollution linked to fracking chemicals. Natural gas generated as a byproduct of fracking often goes to waste as oil producers burn it off through a process called flaring. Last year enough gas was flared in West Texas’ Permian Basin alone to power 5 million U.S. homes. Sharon Wilson, senior field advocate for the nonprofit Earthworks, argues that shale has worked against U.S. energy independence. “Rather than having a managed decline of oil and gas as we build out renewable energy, now we’ve got chaos,” she says. “We’re probably less independent now than if we had used this time to transition to renewable energy built in the USA. People would be better off healthwise, and we wouldn’t be dealing with this awful bust.”
In the early days, shale oil producers seemed like miracle workers. They could get wells flowing in mere weeks, while offshore projects took years. Shale wells delivered big initial bursts of oil, helping producers grow at copious rates. Wall Street had almost endless patience. Instead of earnings and cash flow, investors focused on whether you hit your production estimates. “It was all about, Let’s grow this as fast as possible,” says analyst George O’Leary of Tudor, Pickering, Holt & Co. “I’ve got to drill like crazy for five years, and if prices are at $100, I’m going to make a mint.”
By late 2011, Frac Tech was running 33 pumping fleets of flat-bed trailers, high-powered pumps, water trucks, diesel engines, sand trucks, gauges, pipes, hoses, and crew. More than half its business was with so-called dedicated customers like Chesapeake—those that prebooked Frac Tech crews for use on the bulk of their projects. In September, Frac Tech’s new owners filed for an IPO and announced the name change to FTS.
The IPO never happened, and this time it wasn’t because there was a better deal elsewhere. The leveraged buyout had loaded more than $1 billion in debt on FTS, and the company wasn’t making enough money to service it. Not long after the buyout, a natural gas glut sent prices into a free fall, and FTS’s customers began cutting capital outlays. The costs of running the business were rising, too, especially that of guar, a bean used to thicken fracking fluid. As producers shifted to oil, new pressure pumpers piled in, giving producers leverage to reduce what they were willing to pay for pumping. Dedicated customers became less dedicated. In retrospect, the Wilks brothers couldn’t have timed their deal much better. They bid farewell to their baby as just about everything that made pumping so lucrative was about to change.
Within 18 months of the buyout, Standard & Poor’s cut FTS’s credit ratings, investors pitched in money to keep the company from violating debt agreements, and the CEO, a former McClendon underling, was replaced. The LBO borrowing wasn’t intended to be permanent, rather a sort of bridge loan to sustain the company until it could execute a proper offering. But the acquirer’s expectations for growth, reflecting the industry’s mood, turned out to be too exuberant.
With oil prices slipping in late 2014, the world’s oil-producing nations looked to the Saudis to cut production and keep prices up. The Saudis declined, having given up all the market share they were willing to. Crude prices bottomed out at about $30 in 2016. Producers cut back on drilling, and some pressure pumpers went out of business. FTS, after refinancing $1.1 billion in debt in 2014, managed to hang on. Company executives declined to be interviewed for this story.
By late 2017 crude was in the $60-a-barrel range and the shale oil boom was officially back on, with the Permian Basin the favored place to drill. FTS had survived the bust, rebounded under another new CEO, Michael Doss, and was preparing yet again for an IPO. Across the shale world, a sort of amnesia set in.
The archetype of the American oil driller is the flag-waving, hell-raising Texas wildcatter looking high and low for his next gusher. Shale supposedly made the caricature obsolete: Who needs a wildcatter when everyone already knows where to find the oil?
Pressure-pumping fleets are essentially mobile factories, and like any other factory they make money only when they’re active. Generally they’re paid by the stage—a length of a horizontal bore, usually about 200 feet long, through which a pumping crew blasts water and sand. The bores themselves can extend laterally for 2 miles.
With oil prices healthy again, drillers cranked up rigs, private equity money poured in, and pressure pumpers and related oil-services firms went public. FTS went into its February 2018 IPO after tripling revenue in 2017, to $1.5 billion, reactivating a bunch of fleets, and generating positive operating income for the first time since 2014. The company had raised its pumping prices by 56% on average in 2017. However, in a conference call with industry analysts in March 2018, Doss said pricing was getting competitive again, noting, “There are new [pumping] fleets coming into the market.”
Despite a winnowing during the bust, Frac Tech Services was still vying with about 40 rivals. As they started redeploying, the supply glut forced pumpers to make price concessions, contributing to drops in FTS’s revenue and earnings later in 2018. Producers by then were paying about $50,000 a stage, less than half what they paid in 2011, says Daniel Cruise, founder of Coras Research.
As prices fell, another threat arose: Wall Street was running out of patience with shale. The economics of shale oil and conventional oil are as different as the drilling methods themselves. After their early surge of output, shale wells trickle out more rapidly than conventional vertical wells in what’s known as the decline curve. Flows from conventional wells tend to fall 5% to 10% a year, while a shale well can lose as much as 65% of its production by the end of its first year.
To keep production numbers high, shale companies keep drilling wells. It’s an expensive treadmill. Seeking to make the most of their acreage, producers started bunching wells closer and closer together, the kind of idea that can look better on a spreadsheet than in the Texas dust. Those additional bores, known as child wells, can interfere with output from the parent well, leading to diminished profits and wasted acreage.
Consider Permian driller Concho Resources Inc. To juice production, the company last year crammed 23 wells onto a single drilling location dubbed “Dominator,” with bores spreading out underground like octopus tentacles. Concho produced just a fraction of what it promised from those wells, forcing it to dial back its 2019 production forecast. Its shares fell 22% in a single day. Diamondback Energy Inc. encountered a similar problem when a neighboring producer’s wells interfered with its output, meaning the company wouldn’t meet its forecast. Its stock plunged, too. Both companies’ shares recovered some before the pandemic began.
It was yet another reason for investor exasperation. “How companies still, after all these years we have wailed and gnashed our teeth, manage to overpromise and underdeliver remains an infuriating mystery,” analyst Paul Sankey, now of Sankey Research, said in a note to clients. Since 2010, U.S. producers have spent about $340 billion more than they generated in revenue, according to Deloitte LLP. “In 2014 it would have been better for investors to take their money, burn half of it, and put the other half under their mattress,” says Clark Williams-Derry, an analyst for the nonprofit Institute for Energy Economics & Financial Analysis. “It’s not just bad performance, it’s been epically horrible performance.”
The cheap capital that fueled shale’s rise dried up. IPOs and follow-up offerings dropped to their lowest points in at least a decade. Texas shale activity as measured by rig counts, drilling permits, and well completions declined through much of 2019, says economist Karr Ingham of the Texas Alliance of Energy Producers. Producers kept squeezing pressure pumpers for lower prices. By the end of 2019, at least two pumping companies were exiting the business, and others, like FTS, were laying off workers and seeking other ways to cut costs. Then came the coronavirus.
Almost a quarter of Texas’ 242,000 oil and gas jobs have disappeared. The state’s unemployment rate leaped to 13% in May, from 3.5% at the end of last year. Houston alone has lost at least 10,000 industry jobs and will probably see an additional 15,000 vanish by the end of the year, says Bill Gilmer, director of the Institute for Regional Forecasting at the University of Houston’s Bauer College of Business.
The pain is acute in West Texas, where pressure pumpers and other service companies are the economic lifeblood of towns such as Monahans, Kermit, and Pecos. “We have 200 cars wrapped around our buildings every day of the week,” says Libby Campbell, executive director of the West Texas Food Bank. The bank distributed more than a million pounds of food in June, twice the amount of a year earlier. Many clients have never sought public assistance before, Campbell says: “The fear on their faces, it’s heartbreaking.” Hunt, the Monahans banker, says: “Honestly, I haven’t seen anybody stop paying me yet. I know the train’s coming, I just can’t see how big it is.”
Texas oil people who’ve lived through past busts remain resolute. This spring the Railroad Commission of Texas, which regulates the oil industry, considered limiting crude production in the hope of bolstering prices amid the Saudi-Russia price war. Some Texans reacted with disdain. “Texas, out of all states, represents a humble, steadfast resolve that refuses to sacrifice its principles due to foreign influence,” David Dale, a Houston-area land manager for oil and gas producer Ovintiv Inc., wrote to the commission. Troy Eckard of Eckard Enterprises LLC in Allen, Texas, told regulators that Russia and Saudi Arabia are “terrorists” whose “game of supply hostage is not the time to bow down and sell out. Let the weak go broke. Let the overpaid, poorly run private equity-back[ed] companies fall by the wayside. Leave us to our own free-market solutions.” The commission stood pat.
As oil historian Daniel Yergin has observed, companies go bankrupt, rocks don’t. Assuming prices slowly recover, producers will begin to turn wells back on—a process that’s never been tried at this large a scale—and maybe drill some new ones. Whether they start paying pumpers better remains to be seen. Opportune LLP, a Houston energy advisory firm, says pumpers and other service companies face “a test of survivability, not profitability.” Consolidation seems likely, with producers themselves possibly acquiring the smaller service companies on the cheap.
The Wilks brothers started a new frac service company, ProFrac Services LLC, four years ago. The brothers also have invested millions of dollars in shale drillers, four of which have filed for bankruptcy.
On a Feb. 13 conference call, three analysts congratulated Doss on FTS’s fourth quarter. Never mind that revenue and earnings were way down from the previous year or that the company’s market value was one-seventh what it was 12 months earlier. Things were better than expected in terms of daily pumping hours and stages fracked per fleet. Plus, the company had finally whittled the old LBO debt to a somewhat manageable level. “The last 18 months have been challenging,” Doss said, “but current indications are that we are beginning to turn the corner.”
His tone was bleaker on his next quarterly call, on April 30. By then, FTS had only four fleets in the field. “Even at our low point in 2016, we still had 11 frac fleets operating,” Doss lamented. Asked about the future, he said: “We definitely want to come out of this. However long this downturn is—9 months, 12 months, maybe beyond—we want to come out of this.”