Menu Close

These Are the Three Reasons Why U.S. Oil Production Hasn’t Declined… Yet

This is a syndicated repost published with the permission of Money Morning - We Make Investing Profitable. To view original, click here. Opinions herein are not those of the Wall Street Examiner or Lee Adler. Reposting does not imply endorsement. The information presented is for educational or entertainment purposes and is not individual investment advice.

As we approach the end of what has been a miserable year for theprice of crude oil, analysts are now directing attention toward indications of a floor forming.

Over 2015, a persistent surplus in oil production has offset significant cuts in forward capital commitments and a decrease in drilling – the number of drills in the field is now less than one-third of what it was when the slide began last year.

But U.S. oil production has remained high, despite a clear contraction in operations. This is perhaps the least understood event of the past year.

There were essentially three reasons why this occurred… and they explain the next phase in oil markets…

Front-Loaded Wells Make Pumping Oil Worthwhile at Almost Any Price

oil wellFirst, as the brunt of American output moved from traditional drilling to emphasize unconventional shale and tight oil, drilling became deeper, horizontal, fracked, and much more expensive.

Yes, future projects in this class were the initial ones shelved. With prices diving below $50 a barrel and then below $40, wells requiring $70+ oil prices became untenable – especially once the price collapse gave notice that it was hanging around for a while.

Nonetheless, there was a double early premium from the more expensive drilling. For one thing, these deeper horizontal drillings produce more volume on average than standard vertical wells. For another, most of that volume comes out up front, usually within the first 18 months.

Since over 80% of project expenses are front-loaded, with costs expended before anything comes out of the ground, operators will maintain initial runs at wells once open regardless of wellhead price (what they receive when the oil is sold to a distributor, usually at least 15% below what the market charges).

That is the only way to recover sunk costs.

In higher-priced scenarios, a producer will use secondary or enhanced oil recovery (SOR/EOR) techniques to lessen the normal production decline. These include water flooding, natural gas reinjection, and chemical treatments.

The problem here is that for already expensive shale/tight oil drilling projects, these SOR/EOR techniques drive costs up even further. In the current environment, most companies will forego these ways of increasing volume and rely on “creaming” initial production and then allowing the well to decline naturally. That downward curve can be rather steep.

Therefore, the initial pop in production from shale/tight wells is unsustainable when the same number of new wells are not being spudded to replace old ones.

In other words, we are in the initial stages of a U.S. production decline now expected by both domestic and OPEC analysts. There will be a short-term increase in prices as a result, until a balance is struck and new projects are undertaken.

But there’s another reason why U.S. oil production remained high throughout the year…

New Techniques Have Increased Drilling Efficiency

The second factor leading to higher production despite the decline in both capital commitment and rigs involves improvements in drilling efficiency.

Simply put, the last year has witnessed some refinements in both technique and operations that have reduced per-well costs appreciably. This allows drilling to continue in marginally profitable locations, even though the longer-term prospects show little marked improvement.

Still, most companies have been staying above water (or one step ahead of the sheriff) by hedging prices forward. Unfortunately, that approach is no longer viable: Spreads are not sufficient to allow cash-poor operators sufficient leverage, and the debt crunch is hitting.

Simply put, even with lower per-well costs, companies cannot roll debt over at rates allowing them to stay in business.

These considerations are accentuated by the realization that the vast majority of producers have been cash poor for more than a decade. This means that they have been spending more on ongoing and new projects than they’ve obtained from sales from existing production.

Normally, when prices are higher, this is of little consequence. Cash on hand can be used for dividends, stock buybacks, or asset replacement, while the expected oil market price provides debt at affordable rates. The interest merely becomes a cost of doing business.

Today, however, it is combining with other factors to bring about a wave of corporate bankruptcies, insolvencies, mergers, and acquisitions.

In the meantime, another technological advance in oil drilling has proven to be more of a double-edged sword…

Cheaper Wells Have Propped Up Oil Production… for Now

Third, the present state of oil in the United States is emphasizing what I call VSF projects – vertical, shallow, formula drilling. These are wells that provide major cost advantages over unconventional, deep, horizontal, fracked drilling.

For example, while a deep well in the Eagle Basin or Bakken can easily cost $5 million to $6 million or more, a VSF well can cost no more than a few hundred thousand dollars.

The comparative expense advantage is obvious. But these wells also produce less. Therefore, VSF may be a life preserver for some companies, but it is not going to make up the slack lost in aggregate production levels.

The bottom line is this. All three of these factors are leading to a plateauing of U.S. production registered by fewer companies… and some pressure for rising prices.

And that brings us to the next phase in oil markets…

U.S Oil Producers Are Well-Positioned for Next Year

Remember, while the talking heads have been fixated on supply levels acting as a suppressing element on the price of oil, the other side of the equation is not declining. Instead, overall demand continues to increase, with the primary spikes occurring globally in regions providing higher prices.

This is another tailor-made support for Congress at last allowing exports of U.S. crude. The lifting of the export ban remains the best mid-term protection for domestic jobs and local tax bases.

On a related note, WTI (West Texas Intermediate, the New York benchmark oil rate) is now trading at parity to London-set Dated Brent. That is reversing a five-year trend and provides for a marginally higher WTI market price.

Now, don’t get me wrong here. We are not moving back toward $80 or $90 a barrel. The recovery will be slow and stochastic. Yet it is shortly to be underway.

[Editor’s note: Just in case you missed it, click here for Kent’s detailed oil price forecast for 2016.]

This remains all about balance. Given the largess in extractable American resources, over-production can still occur quickly.

But recent events dictate that remaining oil companies will be better able to prevent shooting themselves in the foot.

To get full access to all Money Morning content, click here

About Money Morning: Money Morning gives you access to a team of ten market experts with more than 250 years of combined investing experience – for free. Our experts – who have appeared on FOXBusiness, CNBC, NPR, and BloombergTV – deliver daily investing tips and stock picks, provide analysis with actions to take, and answer your biggest market questions. Our goal is to help our millions of e-newsletter subscribers and Moneymorning.com visitors become smarter, more confident investors.

Disclaimer: © 2015 Money Morning and Money Map Press. All Rights Reserved. Protected by copyright of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including the world wide web), of content from this webpage, in whole or in part, is strictly prohibited without the express written permission of Money Morning. 16 W. Madison St. Baltimore, MD, 21201.

The post These Are the Three Reasons Why U.S. Oil Production Hasn’t Declined… Yet appeared first on Money Morning

Join the conversation and have a little fun at Capitalstool.com. If you are a new visitor to the Stool, please register and join in! To post your observations and charts, and snide, but good-natured, comments, click here to register. Be sure to respond to the confirmation email which is sent instantly. If not in your inbox, check your spam filter.

3 Comments

  1. DanielJackson2

    A great article, but a pity its not correct. U.S. oil production has already dropped 600,000barrels of oil per day, and imports of crude are rising again

  2. DanielJackson2

    It also displays complete ignorance of oil shale production, and the effect of legacy production as opposed to the Initial Production.

    For shales the decline rate is in the region of 70%+ in the first year, so the idea that companies can continue pumping is simply wrong, because the legacy oil loss has to be replaced by new wells.

    For example you start with a field of 100 wells, for simplicity you might bring 50 in the first six months into production, but you have to run to stand still because those 50 wells even after six months have lost 50% of their initial production.

    50 x 1000bbls per well = peak 50,000bbls a day at 30 day peaks, they decline daily, but even not accounting for compound decline, after 60 months they are down to 50 x 500bbls per well or 25,000bbls a day, so you haver to drill another 25 wells just to catch up with lost legacy production. Then you carry on with the other 50 to make the 100 wells, but it gets worse and worse and worse.

    You then have 75wells at six months to produce the peak rate of 100,000bbls, you then drill the other 50 wells, but after six months you have lost 50% production on those 50 wells also, plus the further decline in the other 75!

    The ONLY thing that has kept shale going is Zero Interest Rates Policy.

    The idea that new technology is enhancing production is simply wrong, as those advances have already taken place, and the biggest advance was not technological as such, it was geographical, i.e. PAD DRILLING, allowing 8 wells to be sunk from the same platform

    Sadly as attempts have been made to enhance initial production it has all been at the expense of subsequent years, making them a one hit wonder.

    Only 4% of shale well have EVER hit their EUR (estimated ultimate recovery), as companies like to gloss up how well they are doing, in order to survive but accounts show they are all making losses, at the same time as claiming they can make profits on $30 oil….but they don’t!

    Even harsher is the fact many of the companies expouse a 20=25 year life on wells, which is complete rubbish.

    With the year on decline rates being massive and 70% in the first year, within 28 months most wells are down to just stripper well status, and that is not economically viable to continue, but they sometimes keep them going because they do not want to plug and abandon wells which costs a lot of money.

    Eventually within 36-40 months these wells are doing 30bopd, and are not even economical to produce from in this stripper status and with the high amount of infrastructure needed to process and transport it.

    Then we have the fact that shale oil and condensates are the most dangerous of the hydrocarbons produced in over 86 different oilwell locations in the world.

    That’s why rail delivery was forced upon operators as some pipelines would not carry the hydrocarbons because they are not stabilised.

    You have no doubt seen stories of the explosions that have ripped towns and rail carriages apart when carrying this unstable ‘oil’, so the idea that somehow the U.S. will be able to fill up a 2,000,000bbl super tanker is nuts, because first the oil will have to be stabilised which costs even more.

    As an example vapor rates on conventional oil are about 3-4%, on shales they are up to 300% more causing them to be extremely unstable, almost on par with the false positives on how cheap it is to produce.

    People should remember that fraccing is not new its been around decades, and the idea that a horizontal well designed as such to increase net pay zones can ever be cheaper than conventional wells is simply ridiculous because most horizontal wells start off as a vertical welll and then require laterals to be added, and fraccing, so if they are cheaper, so are the verticals, but the conventional oil has a much lower decline rate.

  3. DanielJackson2

    So Dr Kent Moors, with respect you need to do more work and add more facts rather than surmising, which is always dangerous in science.

    The SEC allowed oil companies to exaggerate claims which has caused billions of dollars to be tied up where overall oil extraction costs on shale are greater than the sale of the product at oil prices under $50.

    Its hedging that has kept some going and again the SEC rules that have allowed these companies to continue glossing up their company reports to obtain more and more funding, but where it will go bang.

    This proxy war which is what it really is in the ultra low oil price environment, is not sustainable, as world oil use next year is forecast to be greater, but what very few of your so called experts comment on is DECLINE RATES.

    The Saudi oil fields are very mature and Ghawar in particular is in terminal decline, already the subject of enhanced oil recovery techniques such as waterflooding, and you only do this to eek out the last drops in a terminally declining field.

    Why do you think there was a deal to bring Iran back into oil production…nothing to do with nuclear questions, but about OIL.

    The Iranian fields are even more mature, so a hiding to nothing there before long.

    This year some of the claimed production from Middle Eastern fields such as Saudi, has been nothing short of fiction. No one audits their output, their export or their reserves, so they can effectively say whatever figures they like and this is what they are doing.

    The U.S. seems to be doing a similar job in trying to make out there is no loss of production, when the EIA’s own figures show that is not true.

Leave a Comment

This site uses Akismet to reduce spam. Learn how your comment data is processed.

RSS
Follow by Email
LinkedIn
Share

Discover more from The Wall Street Examiner

Subscribe now to keep reading and get access to the full archive.

Continue reading