Shale Permits Fall As Low Oil Prices Start To Bite

Will plunging oil prices result in a drastic decline in U.S. shale oil production? Will the Saudis, who have stuck to their guns in refusing to scale back OPEC oil production, be the first to make their American shale-oil adversaries blink?

Investors and oil market analysts, not to mention financial media, would like an easy answer to these questions, but the time lag between lower prices and anticipated lower production from shale oil-producing regions in the United States makes prognostication quite inexact.

Yesterday, however, new data was released showing that the slowdown may have already arrived.

According to DrillingInfo, an industry data firm, permits for new wells dropped 15 percent across 12 major shale formations in October, after doubling in the period since last November.

Related: Which Oil Producing Region Loses the Most From Low Prices?

Permit issues are an early indication of drilling activity, and as such, can be seen as a talisman of future production. Visualized as a lineup of falling dominoes, the oil price falls first, followed by drilling permits, oil rig counts, and finally, production levels.

DrillingInfo says the slowdown is most pronounced in Texas, where new permits in the Eagle Ford and Permian Basin shale deposits dropped a respective 13 and 22 percent. In contrast, permits rose slightly in the Barnett shale in Texas and the Bakken in North Dakota, according to numbers quoted on Monday by Reuters.

"This is a pull back from the acceleration. People are being careful," Allen Gilmer, chief executive officer of DrillingInfo, told the news organization - with the acceleration referring to the breakneck pace of drilling activity in U.S. shale regions over the past two years. Texas, for example, issued a record number of drill permits - 934 - before they fell to 885 in October, which is still more than double the same month in 2010 when shale production in the U.S. was just starting to take off.

While some might see the high permit numbers compared to four years ago as no reason for alarm, especially considering that permits have fallen before without an appreciable decrease in production, there are indications that the next domino, falling rig counts, is teetering dangerously, if not already falling.

Oilfield services giant Baker Hughes said for the week ending November 26 there were 1,917 active oil and gas rigs in the United States. That rig total is 12 less than the previous week and is the fourth rig count decrease in the past nine weeks. In other words, falling rig counts are becoming a trend.

In the Permian Basin of Texas and New Mexico, the country's largest oil play, the number of rigs fell by four in November to 558, according to Baker Hughes. In the Williston Basin of North Dakota, where drillers are working the Bakken shale formation, the rig count dropped to the lowest level since August.

How long before lower rig counts translates into lower production? Analysts say it could be six months. That's because money has already been invested into producing wells that will continue to pump oil even if it drops under $65 a barrel. Some companies have hedged their 2015 production at prices well above international benchmarks.

"Don't hold your breath for a production response, since there will be a six-month lag between a drop in rigs and a slowdown in production," wrote Manuj Nikhanj, head of energy research at Investment Technology Group, as quoted by Bloomberg.

Related: Early Signs Of A Pullback In Drilling Activity

Leo Mariani, an analyst at RBC Capital Markets LLC, told the Wall Street Journal that "no one's going to shut in existing production wells," but he thinks lower prices will really start to bite in 2015, when he forecasts a roughly 15 percent decline in capital spending on U.S. onshore drilling.

Analyst Jeff Tillery was more pessimistic, saying if oil prices hover around $70 a barrel, rig counts and capital expenditures could drop by 25 percent next year. However, Tillery sounds an optimistic note, believing that production growth will pick up in 2016 as prices and demand recovers, according to WSJ.

The bottom line? It's going to get worse before it gets better. Like a tap that can't easily be shut off, U.S. shale producers will continue pumping out oil even with crude prices at four-year lows, at least for the next few months. That could drive the price even lower. But with 19 shale regions no longer profitable at $75 oil, according to data compiled by Bloomberg, it's only a matter of time before those regions succumb to lower prices, and oil production slows. The cure for low prices? You guessed it, low prices.

By Andrew Topf of Oilprice.com

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