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This Is What Needs To Happen For Oil Prices To Stabilize

This Is What Needs To Happen For Oil Prices To Stabilize

On September 10th the EIA reported a production decline in the Lower 48—essentially shale production—of 208,000 BOPD. That is a staggeringly enormous number, approximately 10 percent of the estimated global over-supply. Additionally, it was a week-over-week number which makes it all the more impressive. Yet it received little attention through the week. Rather, Goldman Sachs was grabbing all the headlines with its $20 call on oil.

This week, I was looking for a possible correction in that number with a zero decline or possibly even a gain (remember, the EIA numbers are estimates). But instead we got another decline of 35,000 BOPD.

Back in June I wrote about the coming decline. Shale oil wells lose a lot of production up front, maybe 70 percent in the first year before tapering off at a 5 to 10 percent annual decline over the next few years until leveling off for the life of the well—maybe 20 years or so out. You can think of it as a slope. Once you crest it, the drop is precipitous and picks up speed before finding a bottom. We are undoubtedly now racing down that slope.

To date, we have lost about 500,000 BOPD in the Lower 48. We will lose that again before the year is out. Pundits will claim otherwise, suggesting that oil in the 50’s or 60‘s will spur activity. But if that activity is in drilling, we won’t see any effect for a half a year or so. If it is in fracking drilled but uncompleted wells (“DUC’s”), that won’t mean much either over time. DUC’s have been the story of 2015 though they have had little effect on stopping the declines being put in.

Back when the onslaught began, which I mark as Thanksgiving Day 2014—when OPEC declined to cut—Wall Street began talking of shale as being a switch; as in you can turn it on and off. Well, in the perspective of a remote offshore project and the 10 years that it takes to bear fruit, then the answer is yes. But shale is not a switch when it comes to controlling commodity prices, which are much more impatient. It took a full 6 to 7 months for the falling rig count to cast a shadow over production declines. And even then the initial declines were shallow, more of a cresting action really. So, going forward, we may have a new metric. That is, a sudden decline in rigs will take 6 to 9 months to show up in production in any meaningful way.

We also still have a somewhat uneducated media that continues to shrug off its homework. We’re about a year into this bear market and oil has been covered to death on the financial news but it is still being misreported. As I mentioned above, the thought that $60 causes a switch to be thrown is wrong. Related: Oil Price Increase Will Not Come Fast Enough To Save Alberta

Operators are battered and bruised. Sensible ones like EOG are holding onto their money. Others like Pioneer are thumping their chests claiming they can drill anywhere any time on their better prospects (but what company is going to claim holding mediocre acreage?). Full disclosure: I own stock in both, but should I stumble upon a few bucks (I run a frack company so these days I’m not counting on it) it would go to EOG.

But, for the most part, very few operators are going to run headlong into a drilling program on a modest recovery. There is also the matter of their banks. They won’t let them. The shine is officially off shale in the debt markets. There are the private equity folks and other bottom feeders that are finding their way into the market but for the most part they are spending money on distressed assets, not new oil and gas wells.

Then there are the service companies. If you imagine your worst enemy, someone that you wanted to see suffer some punishment, then let them run a service company right now.

When the work stops so does the income. All of it. That puts you in the position of watching receivables, which you begin staring at very, very closely, waiting for the cracks to develop. Back in the good old days—2012 or so—a single stage on a shale job was being priced at $125,000 or more. The money being made was giddy. In 2014, that same stage was running around $75,000+ because of heightened competition. As of September 2015, that same stage is now down into the $30,000’s. That’s underwater. Smaller pressure pumper’s are quietly accusing the goliaths of dumping. Wall Street pundits would have you believe that there are new efficiencies being uncovered, but the fact is that those who can are jostling for (a) market share and (b) are using their weight to crush and snuff out the newbies that have come on in recent years with all that private equity money.

When prices come back and operators are chomping at the bit to get back to work, idled service equipment will have to be brought back on-line, which is costly and time consuming. You can’t just turn a key to restart a mothballed blender or frac pump. Idled time always translates into repairs. This is when all the weak points in your equipment are suddenly and unexpectedly exposed. New crews will have to be hired and retrained because the old crews have either moved onto other industries under mass layoffs or will move on once their 6 months of unemployment benefits run out. It is time consuming to hire and re-train. And these are only some of the challenges, the biggest being the cost of ramping up without cash flow to rely on. Related: Oil Price Increase Will Not Come Fast Enough To Save Alberta

Consolidations in service providers are now well underway. We’ve seen Halliburton and Baker Hughes but that was pre-downturn. There’s a few other M&A deals but for the most part it has been a story of closings and consolidations. North American frack camps are being closed at an alarming rate. Equipment that could only be bought new last year is now plentiful at Richie Brother’s auctions. Frack sand trailers are parked in front yards and lots all across American’s oil and gas plays. Service yards that are normally empty in good times are stuffed right up to the chain link fence with trucks, trailers, pickups and assorted equipment.

So much has been made of new efficiencies in the media but there really aren’t any “new” efficiencies other than changes in frack designs, which continue to call for more sand per stage, closer spacing’s between stages (meaning more fracks per well), and some changes in additive chemistry. Sand pricing has come way down as have chemicals, but labor remains where it was. You still need the same number of crew on a well site. No one has come up with robotics to set trucks and hammer in the iron and hoses that connect them. Health insurance is going up. Vehicle, inland marine and general liability insurance are range-bound to up. Taxes don’t go away and then there’s debt. And that’s plentiful and likely increasing. There are some economies these days but the efficiency story should be ignored for the most part.

That’s just the United States. Then there’s the rest of the world. Truthfully, I don’t know what the hell is going on in the Saudi oilfields, but I’m assuming Ed Morse at Citibank does. Morse was the analyst who called the top. A few weeks ago he stated that Saudi production could go no higher. That was big and in my mind it likely also marked the bottom. The Saudis chose not to cut last November, restated their 30mm BOPD OPEC objective, then began pumping like hell. They did announce that a 200,000 BOPD increase would be coming and maybe it has, but if they can go no higher, then global production has plateaued. Factor in the States, and other areas in decline, and I can’t see many traders and speculators lining up on the short side when the IEA is seeing oil demand going above 96 MBPD next year and the EIA is throwing out staggering week-over-week declines. Related: Aussie PM Ousted As Commodities Pressure Proves Too Much

But I’ve been wrong on this count before. I didn’t see the second leg down this summer and Goldman did. But this $20 bearish position is over-baked. It’s also too reliant on inventory numbers.

Inventories will remain high in some parts of the world and will be drawn down in others. But overall, rising global demand and shrinking U.S. production (and other areas as well) will begin to eat away at inventory. It just requires some patience. And markets won’t wait to adjust pricing until we hit a balance. There will be some foreshadowing in oil prices here.

Each of the 3 stages needed to move to a sustainable price have to be given time to play out. The rig count story has been told with a brutally fast 60 percent drop. Meaningful production declines are on. Next will be inventory draw downs; in that order. As to the latter, we’re just beginning to see the effects of the rig count. Cushing was down 2 million bbls this week, so no tank topping there. And non-strategic U.S. storage is off 30 million bbls from its high. That’s not even 10 percent but just wait. Large drawdowns will be here sooner than predicted.

By Dan Doyle for Oilprice.com

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  • Ricky on September 17 2015 said:
    Dan,

    That was an AWESOME article! I also really think that production is set to accelerate its decline in a big way.

    Just wait until the borrowing base redeterminations play out for the E&P companies and watch the credit dry up for the weaker producers. I think we're going to see some bankruptcies for the weaker shale patchers. But this brutal pain is what is needed in order to have the market rebalance. I look forward to the impressive recovery within the next 2 years!

    Ricky
  • Graham on September 18 2015 said:
    Great Article Dan!
  • Adam on September 18 2015 said:
    Dan, production has indeed dropped and is now just below where it was at the beginning of the year. The problem is that inventories are MUCH higher than they were at the beginning of the year. It looks like there was a production ramp into the summer, I think, because most of the oil in storage was sold via futures contracts for delivery months out. So most of the oil in storage wasn't available for immediate processing. The production ramp created the immediate supply needed for refinery demand. Now that driving season is over we have seen the production decline to where it was at the beginning of the year. I honestly don't think we will see much more of a decline in production below 9M bpd. If that is the case, given the still high inventories, it won't take long to begin challenging the record inventory levels. The question is how many rigs does it take to sustain current production levels, that is the key, is it not?
  • Jerry Rukavina on September 19 2015 said:
    Interesting insights Dan. Lots of uncertainty which bodes well for oil traders. I hope the side ways channel/flag breaks up and jobs are saved.
    -Jerry
  • Mel F. - retired hand. on September 20 2015 said:
    Very well thought out...enjoyed reading some reality - in place of "peak oil crash" stuff.

    I have worked "thru" 3 busts in my life - never one with the decline curves of shale oil in the mix. But, some items here got my attention... ie:

    First is that IEA figure, 96 MMbopd demand next year -- interesting, last I paid attention I think it was like 72-74 MMbopd...must mean that India and China have woke up the 900 lb tiger, eh?.. 20 MMbopd increase! Yet, OPEC is straining to make 30 MMbopd of that. We both know that Russia is in this mix as well, as well as some crashing So Amer sources.

    The rig count "needed" to stabilize bopd production is so wide open, due to different fields/problems/methods, etc.. Just think, 10 rigs running in Saudi/Iraq with 30 day drilling/completion windows could "add" 120 wells flowing 50k bopd each...that's 6 MMbopd new production! (old data used, OK?).. Or, 10 rigs running in our oil shale areas...with an added 2 week completion window to haul sand and pound iron on each... once the slack was out of the system, once again you could have 120 wells flowing per year of work...but, it would only yield +/- 2.5 times the equivalent standard SINGLE well in the middle east/SA areas. No big gain, eh?.. Lot's of other variables in here that can change many outcomes...just loose returns or take a kick...all them "atta' boys" are out the window, eh?...

    However, the "reduced production rates/totals" will have to be reflected in prices - unless there is intentional manipulation of this commodity market too, just like it is over in the Gold/Silver PM markets! Over the years, SA has NOT taken any "noted/reported" steps to continue building more "excess/swing capacity" - they have been more focused on building vertical product capacity for higher over all margins. Hence, I do NOT expect SA or any other single producer to be able to add more production/day to the world's supply -- I think/feel they have topped out and will play the "word game" of jaw-boning for bigger market splash/effect.

    This push for "export of USA crude" authority will really be a fly in the soup if it passes and is signed... Wonder if those "double bottoms" will be part of that bill, or, will those US jobs be exported as well..

    Keep turning to the right, 'ya hear?...

    PS.. How about you try some :packaged deals with multi small operators in such oil shale basins... do a true "cost plus +12%" contract with full disclosure - in return for a small over-ridding royalty per well...?... Might help you keep a crew or more busy and together during these thin times... Maybe put those crews on the same basis...ie: pay while working only, but a share in the pool of royalties individually...pass thru, eh?... Kind of like the old days where people were considered as family, not just hands.

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