Coronavirus may be the straw that breaks the back of oil fracking

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Consumers have some good news at the service station. Prices at the pump for gasoline and diesel are down about 6% since the beginning of the year. For that they can thank the coronavirus (now called Covid-19) outbreak—although it comes at the heavy cost of almost 47,000 people ill and 1,369 dead so far according to the Feb. 14 statistics from the World Health Organization.

At $2.42 regular and $2.91 diesel, these aren’t the lowest prices ever, but they are a big change from the respective $2.90 and $3.17 in the first week of May 2019 and a respectable drop from the $2.58 and $3.08 of the first week in January.

The continuing drop from the 2010s is owed in large part to expanding oil supplies, largely through the controversial method known as hydraulic fracturing, commonly called fracking, a talking point in the 2020 presidential campaign. High-pressure water and chemicals pumped deep underground crack shale rock open, releasing trapped oil for extraction.

“People don’t understand how important the oil shale business has been for the global oil markets,” said Adam Rozencwajg, managing partner of natural resources investment advisor G&R Associates. “In the last ten years, world oil consumption has gone up by about 13 million barrels a day. Close to 75% of that oil came from U.S. shale.”

But the most recent drop in gas prices is a result—at least in big part—of the reduced economic activity in China due to Covid-19. Economic activity and consumption of oil in China are down significantly. The International Energy Agency has cut its demand outlook by 30% in response. Prices are dropping like a stone and have already reached the point where new fracking is barely profitable, if at all.

Environmentalists might applaud, but the cheers could be muted in a few years. The fracking business has already been on shaky legs, and current conditions remind some of what eventually led to triple-digit barrel prices a decade back.

Oil and gas tumble

There’s been a sharp drop of oil prices since the year’s opening. “Brent crude and other oil indicators are down about 20% in the last 30 days, so it’s significant,” said Max Krangle, director of energy market research firm NRGExpert. “Unofficial Chinese government sources have said [national] demand is down about 20%, or 3 million barrels a day, which is a significant decline.”

Although getting reliable data out of China can at times be challenging, Krangle said “it’s not difficult to substantiate these numbers given the quarantine and the panic we’ve seen.”

The graph below shows how West Texas intermediate (WTI) and Brent per-barrel crude oil prices—the major benchmarks for the commodities—have changed since the beginning of 2010.

How much the steep drop at the end of the graph is due to China’s lower consumption because of Covid-19 is hard to say, according to Krangle. As Bill Ebanks, managing director in the energy practice of consulting firm AlixPartners notes, “an unseasonably warm winter” reducing the need for artificial heating is another factor.

According to the most recent figures from the U.S. Energy Information Agency (EIA), China is the second largest consumer of oil after the U.S.

Big reductions in China’s consumption noticeably affect world markets. “We’d say the oil market was pretty much balanced [before] the virus,” said Leigh Goehring, also a managing partner at G&R Associates. “But since the virus has started, you can definitely see the market has shifted into surplus.”

With surplus comes the falling prices that have been evident. U.S. fracking activity feels a major impact from the slide because the production process is inherently expensive.

The costly aspect of fracking is the capital investment needed in the initial drilling. Not only can wells extend downward thousands of feet, but also horizontally out at the bottom similar distances. Companies must cart in water and chemicals to pump into the ground so oil flows up. And there’s been constant new drilling: “These wells decline very quickly in their production,” Ebanks said.

Market prices put a cap on the profit any oil or gas well can make and govern whether exploration and production is economically viable. “After the U.S. attacked Iran, [oil] prices spiked up to about $65,” said Jace Jarboe, a futures and options broker with Daniels Trading. “We’re about $15 off those highs.”

For fracking, “the drop between $65 and $50 is the difference between being profitable and being unprofitable,” Ebanks said. “We’re seeing large write-offs by Shell, Exxon, and others, recognizing that the value of their reserves wasn’t what people thought they were.”

There’s an additional complication. Smaller companies, many of which had borrowed too much and were over leveraged, are getting hit even harder. “Access to capital has been shut off,” Ebanks said. “Banks aren’t lending, and there are no [monetary] infusions to be had.”

If the fracking market had been in good shape before, this might be only a painful interlude. Unfortunately, conditions were already deteriorating.

Goehring and Rozencwajg of G&R Associates said that the fracking oil rig count was down 25% year over year even before the outbreak and that shale growth between 2018 and 2019 had slowed by 55%. This year might see growth near zero.

“We believe that the great shale oil revolution in America is in the process of coming to a close,” said Goehring, who finds the current conditions echoing those of 20 years ago, when a massive shock reduced production and oil prices rose from $11 a barrell to $144 between January 1999 and June 2008.

“For oil investors, you’re probably being given another opportunity,” Goehring said. “The world will want to grow again, and the world will be looking for oil. It was coming from shale, and it won’t be coming from shale in the next upcoming decade.”

And for those whose involvement with oil is more on the consumption end, if oil prices do start racing up again in the next few years, maybe it’s time to start looking at electric vehicles and solar-powered heating.

More must-read stories from Fortune:

—Bernard Arnault was briefly the world’s richest man. Then coronavirus struck
Miracle” cancer treatments could be a blessing for investors too
—BlackRock is donating $589 million to bolster financial inclusion
—Inflation is at historic lows, so why do things seem so expensive?
—WATCH: Biggest investing opportunities and risks for 2020

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