A backlog of oil wells that have been sitting idle could put renewed pressure on oil prices once the oil starts flowing.
Oil prices dipped just below $50 per barrel this week on several pieces of bad news, including comments from Iraqi officials that cast doubt on the chances of an OPEC deal in November and the rising output from Nigeria.
OPEC successfully sparked an oil price rally last month when it reached a tentative deal Algiers to cut output, but without a solid and meaningful deal in Vienna in November, the group could disappoint the markets. "OPEC appears to be approaching the limits of its ability to jawbone oil higher without something concrete to put on the table," Jeffrey Halley, a senior market analyst at the brokerage firm OANDA, told Reuters in an interview.
Without OPEC rumors to push up crude, oil traders will turn their focus back to the fundamentals, which remain frustratingly stuck in a sort of limbo. The global supply surplus is not enormous, but big enough to cap oil prices. Inventories are starting to come down, which is evidence of a market moving towards balance, but it is still only proceeding at a snail’s pace. Meanwhile, demand in China continues to slow, a variable that could upend even the most cautious estimates about when the oil market will come into balance.
But another uncertainty is the vast backlog of drilled but uncompleted wells (DUCs) located across the U.S. shale patch. Over the past two years the oil and gas industry drilled thousands of wells that they ultimately decided not to complete, leaving a large pool of oil that is sitting on the sidelines waiting to get into the game. Deferring completion made sense when oil prices were plunging to lows not seen in years – why not wait until oil prices rebound to extract your oil and put it on the market?
For much of the past two years during the oil price downturn, the DUCS began building up, but data was scarce. In September, the EIA began publishing figures on DUCs. All told, there are an estimated 5,069 DUCs in the seven major shale regions tracked by the EIA. The Permian and the Eagle Ford have the most, with 1,378 and 1,276 DUCs, respectively.
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The backlog represents a large volume of new supply that has yet to come online, but could begin doing so in the near future. It is typical to have some level of DUCs for a variety of reasons that do not pertain to the collapse in oil prices, but there are currently about 2,000 more than what is normal, according to Wood Mackenzie. If the industry completes all of those wells, they could add roughly 250,000 barrels per day, the consultancy estimates.
And there is every reason to think that those wells will begin to come online in the near future. Much of the cost of extracting a barrel of oil is concentrated in the drilling process, while completion costs are minor by comparison. As such, whether or not a company made a smart decision to drill a well in a world of $50 oil, the drilling expenses at this point are sunk costs. So completing them is a no brainer. “You’re at a point where pretty much every DUC that’s sitting out there is in the money,” Ryan Duman, a senior analyst at WoodMac, told the Wall Street Journal in an interview. Duman expects the backlog to come down to more normal levels over the next 18 months.
The total DUC tally has basically been climbing since 2013, reaching a peak in January 2016 at 5,576 wells. The backlog hovered around that level for the entire first quarter – a time when oil prices bounced around in the $20s and $30s per barrel. Only in April when oil prices started to tick up, largely due to major supply outages in Nigeria and Canada, did the DUC backlog start to come down a bit. The industry completed a net of 506 wells between April and September, bringing the total down to 5,069. With oil prices back up to $50 per barrel, surely that figure came down further in October, although data won’t be released from the EIA until mid-November.
The U.S. lost more than 1 million barrels per day between April 2015 and this past summer. However, the EIA’s weekly estimates between July and October show output remaining largely flat, holding steady between 8.4 and 8.5 mb/d. There are many reasons for that, including companies beginning fresh drilling. But the uptick in completed wells from the DUC backlog is playing a role in halting the declines in U.S. oil production in recent months.
By Nick Cunningham of Oilprice.com
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