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Is This The Next Big Headache For Oil Prices?

Drilled Well

When oil analysts look at the markets to try to get a sense of where oil prices are heading, one of the great unknowns, at least in the U.S. shale industry, is the large volume of drilled but uncompleted wells (DUCs). As oil prices began collapsing two years ago, shale drillers increasingly decided to defer the completion of their drilled wells, hoping to wait out the downturn and bring production online at a later point when prices rebounded.

But with oil prices suffering from a prolonged downturn, the DUCS began to mount, leaving a huge backlog of potential production that was yet to come online. From the point of view of the nascent and fragile oil price recovery (or more accurately, several cycles of recovery in the past year or so), the DUCs threatened to kill off the price rally, as they would bring a flood of new production online right when prices rose high enough.

However, it appears that the “fracklog” is already getting worked through. According to Bloomberg Intelligence, the number of DUCs stopped rising in the first quarter of this year.

Data as of April 1 shows that the backlog of DUCs stood at 4,230 wells, which is largely the same since the start of the year. Moreover, by the end of 2017, Bloomberg Intelligence predicts that the DUCs could be completely worked through in the Permian Basin, and 70 percent of the DUCs could be finished in the Eagle Ford. That could occur even if prices remain in the $40 to $50 range.

There are two reasons that the DUC backlog stopped rising: Oil companies stopped drilling new wells to begin with following severe spending cuts, and they also began to complete some of those older wells.

“We think that by the end of the third quarter, beginning of the fourth quarter, the bullish catalyst of falling U.S. production will be all but gone,” Bloomberg Intelligence analyst Andrew Cosgrove said. “You’ll start to see U.S. production flat lining.”

The rush of new output will stop U.S. oil production from falling any further, stabilizing output at some point later this year. But there is another way of looking at such a scenario: The fracklog will no longer loom over the market, a bearish variable that could always trigger another price downturn. With the DUCs completed, the onus will be on oil companies to find and drill new wells, a much taller task than simply completing already-drilled wells. In other words, while the completion of the DUCs could bring new production online, it is also a sort of one-off, with production increases having fleeting effects. Related: Oil Continues To Plunge As Markets Turn Bearish

That means the industry will need to drill new wells in order to prevent U.S. oil production from falling. And of course, there are early signs that some drillers are deploying new rigs – the oil rig count is up by 41 rigs as of July 15 from the low point hit in May.

Weekly EIA estimates put U.S. oil production at 8.494 million barrels per day in mid-July, or down about 1.2 mb/d from a peak hit in April 2015. Production is expected to continue to slide as companies – aside from some exceptions – remain on the sidelines.

But Bloomberg Intelligence is not alone in predicting that DUCs present a threat to an oil price rally. Citigroup estimates that DUCs could add as much as 1 million barrels per day of new production in the second half of 2016, which would surely prevent oil prices from rising in any substantial way. “DUCs represent the low hanging fruit for U.S. oil producers,” Citi said in June.

Other forecasters are more skeptical. Oslo-based Rystad Energy believes that about 90 percent of the DUCs are profitable at $50 per barrel, so for all intents and purposes, that can be used as a rough rule of thumb for when DUCs start to be worked through in earnest. But it sees completions proceeding only at an incremental rate of a few hundred per month, which could add 300,000 barrels per day by the end of the year. Wood Mackenzie more or less agrees, arguing that it is unlikely that the entire industry moves at once, especially since it takes time to activate fracking crews and equipment. The consultancy sees new production of about 250,000 barrels per day by the end of the year.

If that is the case, DUCs could slow declines but not necessarily spark a revival in U.S. oil production.

By Nick Cunningham of Oilprice.com

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  • Robbins Mitchell on July 25 2016 said:
    So telling someone to "Go frack a DUC" is actually sort of encouraging

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