The Long Term Impact Of The Oil Rig Crash

The North American Baker Hughes Rig Count came out Friday. The decline continues. Baker Hughes gives an oil and gas breakout for every basin and state with five years of historical data.

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Baker Hughes has twenty eight and one half years of historical data for total U.S. rigs but only five years for individual basins. Gas rigs peaked in August 2008 at 1,606 rigs, over six years before the peak in Oil rigs. On February, 26, gas total U.S. gas rig count stood at 102, a decline of over 93 percent.

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A closer look at the total U.S. total rig count.

October 10, 2014 1,609 rigs
February 26, 2016 400 rigs
Percent decline 75 percent

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In figuring the percent decline for each basin I have used October 10 as peak, the week U.S. rigs peaked even though all basins did not peak on that week.

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Bakken

October 10, 2014 198 rigs
February 26, 2016 36 rigs
Percent decline 82 percent

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Eagle Ford

October 10, 2014 202 rigs
February 26, 2016 41 rigs
Percent decline 80 percent

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Permian

October 10, 2014 554 rigs
February 26, 2016 162 rigs
Percent decline 71 percent

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Niobrara

October 10, 2014 50 rigs
February 26, 2016 16 rigs
Percent decline 68 percent

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Total rigs all seven shale basins

October 10, 2014 1,028 rigs
February 26, 2016 257 rigs
Percent decline 75 percent

Note: There are shale (LTO) wells outside the seven shale basins and there are conventional wells inside the shale basins. So the above chart and the one below should in no way be taken to represent shale versus conventional. But they are somewhat of a guide. Wells drilled in the shale basins are, by a wide margin, light tight oil wells, except for the Permian that is. But outside the shale basins it is not so clear. I have no idea what percentage of wells drilled outside the shale basins are LTO wells, but the percentage is not small.

One more point to note. This past week horizontal rigs declined by 19, while vertical rigs increased by 8… whatever that means.

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Total rigs outside shale basins

October 10, 2014 581 rigs
February 26, 2016 143 rigs
Percent decline 75 percent

In the shale plays a drop in the rig count does not mean a drop in well completions. And except for the Bakken, we have only a vague idea of how many wells are being completed each month. We know that the inventory of DUCs, (drilled but uncompleted wells), is quite high. But if so, why are any shale wells being drilled at all? Well here is one reason:

DUCs in a Row for 2016: It’s Anybody’s Guess

Jeb Armstrong, Vice President of Energy Research for the Marwood Group, doesn’t expect most producers to have a large inventory of DUCs. Instead, he sees the backlog as a matter of circumstance rather than a way of loading up on potential volumes. “The only reason why I can see a company willingly drilling DUCs is because they have a rig contract that’s too expensive to cancel,” he said in an email to Oil & Gas 360®. “Might as well keep the rig operating and plow the capital into the ground than pay a penalty to the rig owner.”

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Raymond James analysts shared a similar viewpoint, noting a certain dynamic on the oilservice industry. “Lower returns and crimped cash flow lead operators to slow activity and conserve cash in any way possible,” the note said. “Since many of the land rigs had longer-term contracts and the frack crews didn’t, the quickest way to conserve cash is to drill but not complete.”

But wells are obviously being completed. In fact more wells are being completed than being drilled but we obviously don’t know just how many. And…

DUCs to Prolong Shale Boom Hangover

Many prognosticators of oil and gas markets have found themselves on the wrong side of U.S. production calls throughout the shale era after failing to understand and model the risks associated with operational momentum. Increases in well productivity brought higher potential returns, and every company in the oil patch scrambled to gain the assets, people, and infrastructure to grow production (and hopefully cash) in the future. As supply growth outpaced demand, prices sank, but production hasn’t responded with an equal intensity. Why doesn’t production respond accordingly? The same reason you can’t turn around an aircraft carrier on a dime, momentum.

The momentum of the shale boom can be seen in the large overhang of drilled but uncompleted wells (DUCs) sitting out in the field today, looming over the market and weighing on any potential oil price recovery…

Until the number of DUCs returns to levels more aligned with historical working inventory levels (3-6 months of drilling), we expect their threat to loom large over the market and have a dampening effect on any near-term price recovery. But their longer term impact could loom just as large. If producers steer too much capital away from drilling, and instead harvest DUCs to maintain production and cash flow in 2016, the human capital behind the rig fleet could be lost to other industries, making service cost inflation all but guaranteed when U.S. supply growth is again needed. It looks like this hangover will be felt for years to come.

Conclusion

The decline in the oil rig count cannot, in the near term, be directly linked to a decline in oil production due to so many DUCs. But eventually it must. Steep declines in oil production must eventually follow steep declines in the rig count. And as we see a drop in production we will see a corresponding rise in prices. This, in turn, will cause an increase in well completions, knocking the price back down again.

So don’t expect any quick recovery of either oil prices or production. Yes, it looks like the hangover will be felt for years to come. And in the meantime peak oil will be in the rear view mirror. But no one will notice for years to come.

By Ron Patterson

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