U.S. shale drilling has fallen off a cliff since it became apparent that oil prices weren't going to recover quickly near the end of 2014. As you can see below, the number of active drilling rigs has been falling rapidly in 2015, and it doesn't appear that the pain is over for drilling companies.
This week, there was a slight recovery in oil markets, and oil prices are now hovering around $57 per barrel for WTI crude oil. But that may not be enough to save U.S. shale, and a strong voice in the industry sounded the alarm bells for investors this week.
Could half of fracking companies go bankrupt?
There have been a lot of bad signs for U.S. fracking during the past six months, but Weatherford International's (NYSE:WFT) first-quarter results and comments related to the industry may have told us just how bad things are going to get.
The fracking services company said it would increase layoffs by 2,000 to 10,000 workers in an effort to cut costs to match this market. An executive also said that half of the 41 fracking companies left in the market would either be bankrupt or consolidated as a result of the industry's struggles.
We've already seen plenty of evidence that consolidation will take place. There were 61 fracking companies to start 2014, and the two biggest -- Halliburton (NYSE:HAL) and Baker Hughes (NYSE:BHI) -- are planning to merge forces. But there hasn't been a surge in bankruptcies. That may be the case after the biggest players pick off the high-quality assets they want to buy, leaving scraps for the smaller players that are left.
This is what happens when a market like fracking sees a rapid decline in demand. Companies come under financial distress and are forced to either go out of business, or combine with competitors to ride out the wave.
Is fracking in the U.S. dead?
There's no question that $50 oil has killed the economics of shale oil. If it continued, the industry would be in real trouble. But $100 oil isn't needed to bring fracking back to life.
A report from Bloomberg Intelligence out this week suggests that $65 oil would bring 500,000 barrels of oil per day into the market by the end of 2016. This is pent up supply from wells that could come online quickly and just need the right economics to start providing a ray of hope for the market.
But there's a problem with this backlog of supply. It will act as a cap on oil prices because supply will go up as prices do, creating a suppressive effect on prices. So there's upside -- but it isn't nearly what it was a year or two ago.
No bullish signs for U.S. fracking
When you combine the rough financials for fracking companies with Saudi Arabia's increasing supply of oil and the pent-up supply in existing wells, there's no reason to think a boom of fracking in the U.S. is on the horizon.
From an investment standpoint, I would stay away from fracking plays until we see a meaningful and sustained improvement in oil prices. Low oil prices may not kill fracking in the U.S., but it's going to shrink the market dramatically. If Weatherford is right, and a lot of fracking companies go out of business in the next year, there's just too much risk to bet on which company might emerge as a winner if the fracking market returns to growth years from now.