An oil well in the Permian Basin
An oil well operated by Apache in the Permian Basin in Texas

Don’t mess with Texas? A year ago Saudi Arabia made a surprise decision at the Opec meeting: not cutting its oil production in the wake of softening commodity prices. One explanation was an unwillingness to cede market share. Its $700bn reserve pile meant it could withstand low commodity prices in ways that US shale producers could not. The demise of those American upstarts could then lead to a rally in oil prices and order restored.

Twelve months on, Saudi has moved closer to output cuts (albeit with the big condition that non-Opec producers participate). But the results of its campaign to gut American wildcatters did not quite work as expected.

Simply based on oil production, the US remains formidable. September production of 9.4m barrels per day was off just 259,000 barrels from its peak in April (for reference, the US produced 8m barrels per day in January 2014).

Drilling innovation aside, the key catalyst for US producers in recent years has been readily available financing. And while commodity prices were depressed, for the first half of the year capital markets were open to energy companies.

Much of the energy debt issued in previous years lacked the protection of covenants and with the participation of hedge funds and private equity, producers could find creative financing structures to ride out the bust. Since 2014, the two heaviest months of bond issuance by US oil and gas were February and March of this year.

Finally, however, the reckoning is nigh. As of the end of November, two-thirds of bank loans among the S&P oil and gas index were trading at distressed levels, compared with just 13 per cent in May. Fitch notes that its trailing 12-month default rate of 5 per cent through October is the highest since 1999. With monetary policy set to tighten, and the US debt markets already feeling the effects, Saudi may be feeling some vindication. Cutting its own production, however, would be an strange way to celebrate.

Email the Lex team at lex@ft.com

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