Oil price, overleveraging and shakeout in the shale energy sector - Game changers in the oil industry

•The plunge in oil price triggered a prolonged bust in the energy sector•Large-cap companies are less dependent on the fluctuation in oil price than are mid- and small-cap firms•Extreme levels of overleveraging of small- and mid - cap companies that are engaged in the shale oil production

In recent years, we have observed significant growth in unconventional energy, shale energy, in particular in the United States. There was a boom, followed by a bust. The plunge in oil price triggered a prolonged bust in the energy sector. Which firms will benefit, and which will be squeezed out due to this persistent oil price decline? A new equilibrium is about to evolve under these conditions. In this paper, we develop a theoretical model that accounts for recent features in the energy sector. In particular, we focus on the shale energy companies and illustrate a trend toward a boom in external borrowing, overleveraging, and, now, a high risk of insolvency. With the use of a new method, called nonlinear model predictive control (NMPC), we show dynamic paths toward two equilibria: either a tight oligopoly or extensive competition, with the shakeout of some firms. This is also tracked by studying leveraging and overleveraging by groups of firms. We further undertake an empirical analysis using a vector error correction model (VECM), which helps identify the short- and long-term effects of those new challenges on the stock performance of the energy companies. The main finding is that large-cap companies are less dependent on the fluctuation in oil price than are mid- and small-cap firms and are more likely to survive the shakeout.