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We Are Witnessing A Fundamental Change In The Oil Sector

We Are Witnessing A Fundamental Change In The Oil Sector

The U.S. oil production decline has begun.

It is not because of decreased rig count. It is because cash flow at current oil prices is too low to complete most wells being drilled.

The implications are profound. Production will decline by several hundred thousand barrels per day before the effect of reduced rig count is fully seen. Unless oil prices rebound above $75 or $85 per barrel, the rig count won’t matter because there will not be enough money to complete more wells than are being completed today.

Tight oil production in the Eagle Ford, Bakken and Permian basin plays declined approximately 111,000 barrels of oil per day in January. These declines are part of a systematic decrease in the number of new producing wells added since oil prices fell below $90 per barrel in October 2014 (Figure 1).

TightOilNewProducingWellsAdded

Figure 1. Eagle Ford, Bakken and Permian basin new producing wells by month. Source: Drilling Info and Labyrinth Consulting Services, Inc

(Click image to enlarge)

Deferred completions (drilled uncompleted wells) are not discretionary for most companies. Producers entered into long-term rig contracts assuming at least $90 oil prices. Lower prices result in substantially reduced cash flows. Capital is only available to fulfill contractual drilling commitments, basic costs of doing business, and to complete the best wells that come closest to breaking even at present oil prices. Related: A Closer Look At The World’s 5 Biggest Oil Companies

Much of the new capital from junk bonds and share offerings is being used to pay overhead and interest expense, and to pay down debt to avoid triggering loan covenant thresholds. Hedges help soften the blow of low oil prices for some companies but not enough to carry on business as usual when it comes to well completions.

The decrease in well completions provides additional evidence that the true break-even price for tight oil plays is between $75 and $85 per barrel. The Eagle Ford Shale is the most attractive play with a break-even price of about $75 per barrel. Well completions averaged 312 per month from January through September 2014 when WTI averaged $100 per barrel (Figure 2). When oil prices dropped below $90 per barrel in October, November well completions fell to 214. As prices fell further, 169 new producing wells were added in December and only 118 in January.

EagleFordNewProducingWells

Figure 2. Eagle Ford new producing wells (2 month moving average) and WTI oil prices. Source: Drilling Info, EIA and Labyrinth Consulting Services, Inc.

(Click image to enlarge)

Bakken break-even prices are higher at about $85 per barrel. Well completions averaged 189 per month from January through September 2014. In November, only 80 new producing wells were added. In December and January, 123 and 114 new wells were added, respectively. Orders for rail cars used to transport oil decreased by 70% in the first quarter of 2015 compared with the fourth quarter of 2014. Related: What Happens To US Shale When The Easy Money Runs Out?

BakkenNewProducingWells

Figure 3. Bakken new producing wells (2 month moving average) and WTI oil prices. Source: Drilling Info, EIA and Labyrinth Consulting Services, Inc.

(Click image to enlarge)

Permian “shale” play break-even prices are also about $85 per barrel based on declining well completion data. Well completions averaged 175 per month from January through September 2014. In January 2015, only 35 new producing wells were added.

PermianShaleNewProducingWells

Figure 4. Permian “shale” new producing wells (2 month moving average) and WTI oil prices. Permian “shale” includes horizontal wells in the Bone Springs, Consolidated, Delaware, Spraberry, Wolfcamp,Trend Area and related combinations of those reservoirs. Source: Drilling Info, EIA and Labyrinth Consulting Services, Inc.

(Click image to enlarge) Related: Oil Prices Won’t Recover Anytime Soon Says Exxon CEO

Much of the commentary about the backlog of deferred completions is exaggerated and irrelevant unless oil prices increase to $75 or $85 per barrel. The assumption underlying most industry chatter these days is that oil prices will return to normal.

The world oil market is undergoing a fundamental structural change in response to expensive oil. Producers are trying to survive by limiting expenditures. While analysts have been focused on rig counts, deferred completions have emerged as the initial path to lower U.S. oil production. This unanticipated outcome suggests that others may follow. While everyone is waiting for higher oil prices and for things to return to normal, what we may be witnessing is the end of normal*.

*James Kenneth Galbraith, The End of Normal–The Great Crisis and the Future of Growth (2014).

By Art Berman for Oilprice.com

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  • John on April 29 2015 said:
    Interesting. The question is, if you stop paying the crew to complete the well, and several months have gone by. When oil prices finally return to $85 or whatever is break even, will the crew be there to complete the well in the scale you need to get a big rebound in the production? We could get a spike back well above $85 by the end of this year :)
  • Siddharth on April 30 2015 said:
    So DUC is a compulsion not a discretion as being projected by these companies' CEOs. If your BEP numbers are correct, crude should shoot to 68-70 without any hurdles as the 'fraclog' will not come into play till then. Also the oil companies can't hedge till 'their' price comes, so a depleted sell side in the futures market.
  • Michael on May 09 2015 said:
    "When oil prices return to normal."
    What is normal? - the price at the pump in the United States.
    In 2005 gasoline at the pump went from @$2.25 to $4.00 per gallon.
    I'll tell you firsthand - that sunk a lot of commuters who lost their homes.
    .
    Here is MY new normal.
    .
    Solar panels - EV's - (not quite yet battery storage), but 800 million U.S. dollars do not lie - even if Tesla only sold them on a pre-order with not a penny down/spent.
    .
    The oil patch must adjust accordingly, and I only hope to live long enough to see it.
  • Gary on May 19 2015 said:
    If the price does not go up, 53% of the rigs will remain offline, and there will surely be a new normal. Shale ouput depletes at a rapid pace. Within a year, they produce 50% of initial output. Shale has been in high gear for several years. Many of those wells are already in a state of decline. Recent Bakken reports prove the point. Actual Bakken production increased in March but production per well declined 4%, and 17% from 2012.

    Looking at the 2008-2009 recovery it appears the Market does not try to punish as much as balance. The last thing Mr. Market wants is a shortage and a price spike equal to the inverse of what we have gone through. If $85 is where drilling can be resumed at a profit then $85 will be the eventual price. Sure, OPEC can produce it cheaper but most of their countries will default on their debt long before the last shale player packs it in.

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