The money pipeline is running dry for large portions of the U.S. shale oil sector, tipping drillers into bankruptcy and threatening the industry’s breathtaking growth in oil production.

Spooked by lower oil prices, equity and bond investors are now shunning the smaller, independent shale explorers that lifted the U.S. to the top rank of global oil producers. Meanwhile, say analysts, banks have pulled in their horns, and are likely to further restrict companies’ capacity to borrow when they begin their twice-annual reviews of loans secured by oil and gas reserves.

Market-watchers expect this financing squeeze to trigger a wave of mergers among smaller companies in the Permian Basin and other shale-oil regions.

Public investors believe the sector has “five to 10 too many” companies and want to see a consolidated industry with greater scale, less debt and better control of capital spending, said Matt Portillo, managing director for upstream research at investment bank Tudor, Pickering, Holt & Co.

The financial reckoning has been a long time coming. In the aftermath of the 2014-15 oil price crash, U.S. oil and gas producers managed to raise $56.6 billion from equity and debt capital markets in 2016, according to Dealogic. This year they have raised just $19.4billion, even though U.S. oil production has grown by more than a third in the past three years.

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As funding becomes scarce, bankruptcy filings are on the rise this year. Haynes and Boone, a law firm, counted 33 by the end of September, 27 of them since May, which is almost as many as in the whole of 2018. This month EP Energy Corp. filed for bankruptcy with $4.6 billion in debt, citing “challenging dynamics as a result of depressed commodity prices.”

Bankruptcies have turned off fund managers. Among 240 high-yield mutual funds tracked by data provider Morningstar, about three-quarters have less than 10% of their assets invested in energy—much less than a neutral weighting of 14%.

“It feels like the beginnings of high-yield throwing in the towel on energy companies,” said John McClain, a portfolio manager at Diamond Hill Capital Management in Columbus, Ohio.

Banks are currently reappraising the value of oil and gas reserves underpinning loans to producers. As the twice-annual review gets under way, they are using more conservative assumptions for future oil and gas prices.

Portillo at Tudor, Pickering, Holt estimates this shift will lead to a 10%-25% reduction in loan facilities extended to weaker producers in 2020.

“You have to be so aggressive in looking at each deal and each operator. We’re much more thoughtful now about looking more carefully at drilling plans,” Keith Cargill, CEO of lender Texas Capital Bancshares, said on an earnings call last week. The value of Texas Capital’s non-accruing energy loans has more than doubled in the past year, the bank said.

On Oct. 23 shares of Houston-based Cadence Bancorp sank 12.4% after it disclosed big charge-offs including $5.3 million related to an energy borrower. “With respect to any new energy loans, we are highly cautious,” CEO Paul Murphy told analysts.

In its latest survey of 200 oil and gas companies, the Federal Reserve Bank of Dallas reported that banks had cut leverage limits for their borrowers to 2.5-3 times a company’s EBITDA, down from 3.5-4 times. “It seems no one has any money for oil and gas projects. Lack of Wall Street participation in oil is very apparent,” a respondent said.

With companies more dependent on their own cash flows to fund drilling, some are falling short in developing new reserves that form the collateral for bank lending, said Michael Rose, a banking analyst at Raymond James. “If you can’t raise more money you just run out of steam,” Rose said.

The tougher financing outlook, along with fading productivity at wells, is translating into lower expectations for U.S. crude oil production growth. Most analysts expect an increase of less than 1 million barrels per day (bbl/d) next year, compared to 1.6 million bbl/d in 2018.

Lower U.S. output would not automatically spark a recovery in oil prices as a slowing world economy has cut expectations for demand.

Consolidation is under way. Takeovers this year have included Occidental Petroleum Corp.’s $55 billion purchase of Anadarko Petroleum Corp. after it outbid Chevron Corp. for the company. Occidental’s shares have fallen about 25% since the companies agreed the merger.

“The market has not given the [deals] we’ve seen today a really great reception,” said Steve Hendrickson of Opportune, a consultancy and investment bank based in Houston. “In fact, it’s kind of been the opposite.”

Still, bankers predict more deals among smaller producers, paid for in stock at modest takeover premiums. One example was Parsley Energy Inc.’s $2.3 billion deal last week to acquire Jagged Peak Energy Inc. at a price 1.5% above the target company’s 30-day average share price before the deal. Parsley predicted an immediate boost to its free cash flows from the acquisition.

Wil VanLoh, Jagged Peak’s controlling shareholder, set the tone in his statement. “The inevitable consolidation in the Permian has started.”

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