US Shale Winners And Losers
This column starts my series on $80 oil and US shale winners and losers.
My working thesis is that although oil’s drop into the $80’s might be temporary, it won’t be short-lived. That puts marginal producers here in the US at risk, as much of their current production and certainly future planned production is predicated on higher oil price expectations.
I’m beginning this series by outlining the Bakken and Three Forks region first, as I believe that oil companies there are at the most risk to see slashed capex, production and therefore dropping share prices. But before I begin, I must thank Michael Falloon of shaletrader.com for his excellent help, almost certainly the most informed independent analyst of the Bakken and the companies invested there of anyone I have ever read. His service is a worthy addition for anyone deeply invested in that play, or indeed many of the other major US shale plays.
The reason I focus on the Bakken first is not because of the potential oil supply there or the quality of the play, quite the opposite. The diverse area involved and the relative maturity of fracking programs in the Bakken have led to a breakneck pace of production that have delivered tens of thousands of new jobs, dozens of new successful oil companies and a fresh housing boom. It has also led to an increasing lack of sufficient infrastructure in pipelines and storage, an incredible natural gas flaring problem and, perhaps most importantly for the producers there, a discounted price for Bakken oil despite the fact that it is of perhaps the best quality of any being currently produced here in the US. That discount has run up to $15 or more below the benchmark that most people refer when talking about oil on CNBC or elsewhere – West Texas Intermediate crude (WTI) – which itself has labored under a $5 to $15 discount to global crude for the last several years.
So that’s the first point to keep in mind when discussing Bakken players – they are under a financial pressure of a $20 to even $30 less return per barrel than, for example, what’s coming out of the North Sea – and their production possibilities and growth will be measured by that discount. In short, a sustained drop in oil prices will be far more challenging for them going forward than virtually any other oil producer anywhere.
Every company is obviously going to be different and it will be hard to generalize about the players in the Bakken in any completely revealing way: There are lease costs, the drilling companies being used, efficiencies, wells per acre, production rates, growth plans, debt and other balance sheet liabilities, depletion rates, hedging programs in place and their costs and several dozen more factors to consider for each.
In general, if you’ve entered the Bakken early, retained favorable leases in the most productive areas and not expanded much outside those regions or promised superhero growth that’s reflected in your share price, you’re more than likely to survive the coming Bakken $80 winter (or more like $65 basis winter). Continental Resources (CLR) is one of those companies that springs to mind, although even they have many projects that will need serious rethinking should oil stay near $80 long enough.
One way to get an initial sense of who will be under the most and least pressure is to look at a map of the Bakken with its most productive areas in highlight:
The central play in the Williston Basin is revealed in red, the Nesson Anticline. With fantastic production profiles allowing upwards of 40 wells per acre, this is the prime real estate of the Bakken. This area and the players in it will interest us less as the production rates and costs in the Nesson and other adjacent areas are fantastically profitable. It is dominated by some of the behemoth US oil companies in little danger of complete failure, no matter how long oil stays low – names like Conoco-Philips (COP), Occidental (OXY) and Marathon (MRO) are deeply involved as are EOG Resources (EOG) and the aforementioned Continental Resources. While we will have to discuss the growth profiles of all of these companies, should oil stay at $80 for a year or more, we’re much more interested in those marginal producers who will struggle to maintain capex budgets and production growth if oil is low for as little as 6 months.
These companies will generally be working in the relatively less productive areas of the Bakken, with completion rates a third of those in the center of the play, tougher lease conditions, faster depletion and more difficult credit. It is these ‘weakies’ we want to isolate and learn about as they will give us not just ideas on where to invest and not to invest, but also how long it might be before these marginal players cause a flattening and even a decline in production growth in the Bakken and therefore in the United States.
That is the ultimate goal of this series as it is the correct prediction of that event that will ultimately be the most important to our portfolios. A dropping production profile will imply a consolidation and supply shortage to come – and long-term positively tremendous investment opportunities in the survivors.
But first, find the weak ones. That will be the focus of my next several columns but as a taster, both Michael and I agree on Emerald Oil (EOX) as one under severe pressure and to be avoided.