Tight Oil Production Will Fade Quickly: The Truth About Rig Counts

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U.S tight oil production from shale plays will fall more quickly than most assume. 

Why?  High decline rates from shale reservoirs is given. The more interesting reasons are the compounding effects of pad drilling on rig count and poorer average well performance with time.  

Rig productivity has increased but average well productivity has decreased. Every rig used in pad drilling has approximately three times the impact on the daily production rate as a rig did before pad drilling.  At the same time, average well productivity has decreased by about one-third. 

This means that production rates will fall at a much higher rate today than during previous periods of falling rig counts.

Most shale wells today are drilled from pads.  One rig drills many wells from the same surface location, as shown in the diagram below.

(click image to enlarge)

The Eagle Ford Shale play in South Texas is one of the major contributors to increased U.S. oil production.  A few charts from the Eagle Ford play will demonstrate why I believe that U.S. production will fall sooner and more sharply than many analysts predict.

The first chart shows that the number of active drilling rigs (left-hand scale) in the Eagle Ford Shale play stabilized at approximately 200 rigs as pad drilling became common. The number of producing wells (lower scale), however, has continued to increase.  This is because a single rig can drill many wells without taking the time to demobilize and remobilize.  In other words, drilling has become more efficient as less time is needed to drill a greater number of wells.

(click image to enlarge)

The next chart below shows Eagle Ford oil production, the number of producing wells and the number of active drilling rigs versus time.

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This chart shows that production growth has not kept pace with the rate of increase in new producing wells since mid-2012.  That is because the performance of newer wells is not as good as earlier wells.

The final chart shows that the rate of daily production is now more dependent on the number of drilling rigs than on the number of producing wells.  Rig productivity--the barrels per day per rig--has increased but average well productivity--the barrels per day per well--has decreased.  In other words, production can only be maintained by drilling an ever-increasing number of wells.

(click image to enlarge)

Average rig productivity has almost tripled since early 2012. Average well productivity has decreased by one-third over the same period. This means that every rig taken out of service today has more than three times the impact on daily production as before pad drilling became common.  

Most experts do not anticipate any significant decrease in U.S. tight oil production in the first half of 2015.  Their analyses may not have accounted for the effect of pad drilling and the decrease in average well productivity.

Using the Eagle Ford Shale is as an example, U.S. oil production should fall sooner and more sharply than many anticipate. This will be a good thing for oil price recovery but maybe not such a good thing for the future profitability of the plays.

One of These Things Is Not Like The Others: IEA's January Report

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Remember the Sesame Street song?

One of these things is not like the others,

One of these things just doesn't belong,

Can you tell which thing is not like the others

By the time I finish my song?

OK. Which curve on this chart is not like the others?

(click image to enlarge)

It's the U.S. and Canada's oil production curve over the past several years.  

That's why oil prices have fallen:  too much oil for the demand in the world. The tight oil from North America is the prime suspect in the production surplus that's pushing down oil prices.

Now that you know the answer, let's talk about IEA's January report that was released today. Here are my main takes from the report:

1. The fourth quarter 2014 supply surplus was 890,000 barrels per day (see the chart below).  That is the difference between supply and demand. We can argue about whether it was mainly supply or mainly demand-I've stated my belief that it's mostly supply-but that's the difference between them.  That is why oil prices are falling.
2. This surplus amount is 170,000 barrels per day greater than in the previous quarter.
3. Demand in the first half of 2015 will be 900,000 barrels per day lower than in the fourth quarter (see the second chart below).  1st half demand is usually lower than 2nd half but that means that prices could fall again.
4. 3rd quarter 2015 demand will increase by 1,530,000 barrels per day and 4th quarter demand will increase another 420,000 barrels per day. That is a lot and would take demand to record highs. This should go a long way towards moving prices higher.

(click image to enlarge)

(click image to enlarge)

Now, these are only estimates and IEA is notoriously wrong in their forecasts but that's what we have to work with. They don't estimate production which is too bad but the report says that 2015 production is now revised down 350,000 barrels per day from previous estimates.  IEA expects that most of that will happen in the 2nd half of 2015 after North American tight oil production starts falling.

So, where does that leave us?  The problem is mostly about supply but demand has to increase if we're going to fix the surplus problem in 2015 because supply is not expected to fall that much.

I think this means that prices will increase in 2015 but not a lot unless something else happens.  That something else will probably be an OPEC and Russia production cut in June after the next OPEC meeting.  

Remember, the supply surplus in the 4th quarter of 2014 was less than 1 million barrels per day.  OPEC can easily accommodate this and has made bigger cuts as recently as 2009.

Some geopolitical crisis could also happen in the coming year and that might add $20/barrel or so.  Negative things for a price increase could also happen like demand not growing as much as IEA forecasts or production not falling enough.

When do oil prices stop falling?  No one knows and this data doesn't have enough resolution much less reliability to help answer the question.  

EIA, however, may offer some help here.  EIA publishes monthly world data and, in the chart below, they show supply and demand in approximate balance for November and December of 2014.

(click image to enlarge)

That may signal that prices will find a bottom as soon as this balancing is felt by the market.  Or not.

Dumb and Dumber: U.S. Crude Oil Export

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Exporting crude oil and natural gas from the United States are among the dumbest energy ideas of all time.  

Exporting gas is dumb.  

Exporting oil is dumber.

The U.S. imports almost half of the crude oil that we use. We import 7.5 million barrels per day.  The chart below shows the EIA prediction that production will slowly fall and imports will rise (AEO 2014) after 2016. 

(click image to enlarge)

This means that the U.S. will never be self-sufficient in oil. Not even close.

What about the tight oil that is produced from shale?  That's included in the chart and is the whole reason that U.S. production has been growing.  But there's not enough of it to keep production growing for long.  

Here is a chart showing the proven tight oil reserves just published last month by the EIA.

(click image to enlarge)

Total tight oil reserves are 10 billion barrels (including condensate).  The U.S. consumes about 5.5 billion barrels per year, so that's less than 2 years of supply.  Almost all of it is from two plays--the Bakken and Eagle Ford shales. We hear a lot of hype from companies and analysts about the Permian basin but its reserves are only 7% of the Bakken and 8% of the Eagle Ford.

Tight oil comprises about one-third of total U.S. crude oil and condensate reserves. The U.S. is only the 11th largest holder of crude oil reserves (33.4 billion barrels) in the world with only 19% of Canada's reserves and 12% of Saudi Arabia's reserves.  

(click image to enlarge)

In other words, the U.S. is a fairly minor player among the family of major oil-producing nations.  For all the fanfare about the U.S. surpassing Saudi Arabia in production of crude oil, we are not even players in reserves.  What that means is that we may temporarily pass Saudi Arabia in production because it chooses to restrict full capacity, and U.S. production will fade decades before Saudi Arabia's production begins to decline.

Let's put all of this together.  

• The U.S. will never be oil self-sufficient and will never import less than about 6 million barrels of oil per day. 
• U.S. total production will peak in a few years and imports will increase.  
• The U.S. is a relatively minor reserve holder in the world.

How does this picture fit with calls for the U.S. to become an exporter of oil? Very badly.  For tight oil producers to become the swing producers of the world? Give me a break.

Perhaps we should send congressional proponents of oil export like Joe Barton (R-TX), Ted Cruz (R-TX) and Lisa Murkowski (R-AK) to "The Shark Tank" TV show to try to sell their great idea to the investors and judges.

I'm out.

**See my previous blog "U.S. Advises Oil Companies How to Break The Law" for discussion of the light oil and condensate refining issues, and The Energy Policy and Conservation Act that bans crude oil export.

The Oil Price Fall: An Explanation in Two Charts

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Don't worry.  It's not complicated. 

I offer a simple explanation for the recent fall in oil prices in just two charts.  

Oil prices move up and down in response to changes in supply and demand.   If the world consumes more oil than it produces, the price goes up.  If more oil is produced than the world consumes, the price goes down. 

That's where we are right now.  The world is producing more oil than it is consuming. The price of oil goes down.  It's that simple.  

The chart below shows when the world has been in a production surplus and a production deficit since 2008. Right now, we are in a production surplus so the price of oil is going down.

(Click image to enlarge)

The important thing to take away from this chart is that the production surplus is smaller so far than the last time this happened between March 2012 and March 2013.  Then, oil prices fell quickly but recovered in about a year.  The difference between these two events, however, is that monthly average oil prices have fallen 27% so far but only fell 18% in 2012-2013.  

The difference is found in quantitative easing (QE), the Federal Reserve Board's policy of pumping huge amounts of money into the U.S. economy.  

QE ended in July 2014, the exact month that oil prices started falling.  What a coincidence!  This is shown in the chart below.

(Click image to enlarge)

What is the connection between QE and oil prices?  World oil prices are denominated in U.S. dollars so the more the dollar is worth, the lower the price of oil and vice versa. That's a well-known fact.

When the Fed started printing money like crazy after the Crash in 2008, the value of the dollar was kept artificially low compared with other currencies.  The ever-weakening U.S. dollar dampened the impact of production surpluses and deficits on the price of oil.  

When QE ended in July 2014, the dollar got stronger and the price of oil went down as it always does when this happens. The coincidence of the end of QE with the onset of a production surplus created a perfect storm for oil prices.

There is nothing especially different about this latest oil-price fall compared to any of the others except the end of QE.  It's not really about shale or the Saudi decision not to cut production.  It's about a relatively ordinary oil-production surplus that happened at the same time that QE ended.  And, there are few geopolitical fear factors now to mask the production-consumption balance as there have been in recent years (that will change, I am certain).

What's the message?  Oil prices will recover and I doubt that we will see years of low prices as many have predicted.

(Click image to enlarge)

The Real Cause Of Low Oil Prices: OilPrice.Com Interview With Arthur Berman

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See the full interview at OilPrice.com

In a third exclusive interview with James Stafford of Oilprice.com, energy expert Arthur Berman explores:

• How the oil price situation came about and what was really behind OPEC’s decision.

• What the future really holds in store for U.S. shale.

• Why the U.S. oil exports debate is nonsensical for many reasons.

• What lessons can be learnt from the U.S. shale boom.

• Why technology doesn’t have as much of an influence on oil prices as you might think.

• How the global energy mix is likely to change but not in the way many might have hoped.

OP: The Current Oil Situation - What is your assessment?

Arthur Berman: The current situation with oil price is really very simple. Demand is down because of a high price for too long. Supply is up because of U.S. shale oil and the return of Libya’s production. Decreased demand and increased supply equals low price.

As far as Saudi Arabia and its motives, that is very simple also. The Saudis are good at money and arithmetic. Faced with the painful choice of losing money maintaining current production at $60/barrel or taking 2 million barrels per day off the market and losing much more money—it’s an easy choice: take the path that is less painful. If there are secondary reasons like hurting U.S. tight oil producers or hurting Iran and Russia, that’s great, but it’s really just about the money.

Saudi Arabia met with Russia before the November OPEC meeting and proposed that if Russia cut production, Saudi Arabia would also cut and get Kuwait and the Emirates at least to cut with it. Russia said, “No,” so Saudi Arabia said, “Fine, maybe you will change your mind in six months.” I think that Russia and maybe Iran, Venezuela, Nigeria and Angola will change their minds by the next OPEC meeting in June.

We’ve seen several announcements by U.S. companies that they will spend less money drilling tight oil in the Bakken and Eagle Ford Shale Plays and in the Permian Basin in 2015. That’s great but it will take a while before we see decreased production. In fact, it is more likely that production will increase before it decreases. That’s because it takes time to finish the drilling that’s started, do less drilling in 2015 and finally see a drop in production. Eventually though, U.S. tight oil production will decrease. About that time—perhaps near the end of 2015—world oil prices will recover somewhat due to OPEC and Russian cuts after June and increased demand because of lower oil price. Then, U.S. companies will drill more in 2016.

OP: How do you see the shale landscape changing in the U.S. given the current oil price slump?

Arthur Berman: We’ve read a lot of silly articles since oil prices started falling about how U.S. shale plays can break-even at whatever the latest, lowest price of oil happens to be. Doesn’t anyone realize that the investment banks that do the research behind these articles have a vested interest in making people believe that the companies they’ve put billions of dollars into won’t go broke because prices have fallen? This is total propaganda.

We’ve done real work to determine the EUR (estimated ultimate recovery) of all the wells in the core of the Bakken Shale play, for example. It’s about 450,000 barrels of oil equivalent per well counting gas. When we take the costs and realized oil and gas prices that the companies involved provide to the Securities and Exchange Commission in their 10-Qs, we get a break-even WTI price of $80-85/barrel. Bakken economics are at least as good or better than the Eagle Ford and Permian so this is a fairly representative price range for break-even oil prices.

But smart people don’t invest in things that break-even. I mean, why should I take a risk to make no money on an energy company when I can invest in a variable annuity or a REIT that has almost no risk that will pay me a reasonable margin?

Oil prices need to be around $90 to attract investment capital. So, are companies OK at current oil prices? Hell no! They are dying at these prices. That’s the truth based on real data. The crap that we read that companies are fine at $60/barrel is just that. They get to those prices by excluding important costs like everything except drilling and completion. Why does anyone believe this stuff?

If you somehow don’t believe or understand EURs and 10-Qs, just get on Google Finance and look at third quarter financial data for the companies that say they are doing fine at low oil prices.

Continental Resources is the biggest player in the Bakken. Their free cash flow—cash from operating activities minus capital expenditures—was -$1.1 billion in the third- quarter of 2014. That means that they spent more than $1 billion more than they made. Their debt was 120% of equity. That means that if they sold everything they own, they couldn’t pay off all their debt. That was at $93 oil prices.

And they say that they will be fine at $60 oil prices? Are you kidding? People need to wake up and click on Google Finance to see that I am right. Capital costs, by the way, don’t begin to reflect all of their costs like overhead, debt service, taxes, or operating costs so the true situation is really a lot worse.

So, how do I see the shale landscape changing in the U.S. given the current oil price slump? It was pretty awful before the price slump so it can only get worse. The real question is “when will people stop giving these companies money?” When the drilling slows down and production drops—which won’t happen until at least mid-2016—we will see the truth about the U.S. shale plays. They only work at high oil prices. Period.

U.S. Advises Oil Companies How to Break The Law, Approves LNG Despite Fracking Fallacy Debate

In the waning hours of 2014, the U.S. government slipped a few things past us:

• It advised oil companies how to get around the law prohibiting crude oil export by "self-classifying" crude oil as "not crude oil", and 
• Approved an LNG export facility despite the Fracking Fallacy debate that suggests that the U.S. may not have enough natural gas to meet our own demand in a few years much less send gas to the rest of the world.

On December 30, 2014, Reuters reported that the U.S. Commerce Department's Bureau of Industry and Security advised oil companies that they could self-classify their light tight oil and condensate as "processed condensate" and legally evade the ban on exporting crude oil.  Crude oil export has been illegal since 1975 when President Ford signed the Energy Policy and Conservation Act (EPCA). The idea behind the legislation was to keep domestic oil in the U.S. as a strategic buffer against the global oil price fluctuations created by the embargoes of 1967 and 1973.

I do not support the ban on exporting crude oil but it is the law.  Congress should debate the law and vote whether to keep or repeal the law. The Department of Commerce has given the oil companies a "wink" letting them know it would be OK to export their light oil if they just call it something else. Isn't it is illegal to advise people how to get away with breaking the law?

Oil companies have been calling for reversal of the EPCA since early in 2014 arguing that surging U.S. production from shale has fundamentally changed the conditions that lead to the ban on exporting crude oil.  When the EPCA was signed, the U.S. was producing 8.3 million barrels of oil per day (Mmbopd) and production was falling.  Today, production is 9.0 Mmbopd and increasing.

The real issue, however, is that most U.S. refineries are not designed to process the light tight oil produced from the Bakken and Eagle Ford shale plays.  It has a lower specific gravity than ordinary crude oil (WTI--West Texas Intermediate is the standard for the U.S.) and must be blended with heavier oil from Canada, Mexico or Venezuela so it can be refined into diesel, gasoline, jet fuel and other products which may be legally exported.

This, by the way, is the real reason for the Keystone XL pipeline from Canada. It would bring super-heavy crude oil from the tar sands in Alberta that would be perfect for blending with light tight oil.  President Obama is right when he says that little of this Canadian oil would be used in the U.S.  He is dead wrong, however, when he says it would not benefit the U.S. because it would increase refining jobs and U.S. exports, and lower U.S. gasoline prices--all good for the economy.  

Diesel is the cash cow among refined products because it is in high demand in overseas markets.  Gasoline is a more-or-less unwanted by-product of producing diesel and that is why the price of gasoline has been going down in the U.S. since the rise of light tight oil production.  A surplus of gasoline forces its price down.

So, the ban on crude oil exports is good for American consumers because it maintains and creates refining jobs, helps with our balance of trade and lowers the cost of gasoline.  Allowing oil exports would streamline the process for oil companies since they would not have to bother with the refining step but would mean that most of the refining of U.S. light oil would be overseas which would not be as good for the U.S. consumer.

If President Obama is against the Keystone XL pipeline, it makes sense that he is for exporting crude oil but he won't say that because that would put him in the same camp as the oil companies.  He has, therefore, cast the Keystone XL as an environmental issue saying that the U.S. should not promote the "dirty" process of tar sand mining and extraction in Canada.  I'm going to stay out of that discussion but I doubt the Canadians are going to abandon the tar sands because their neighbor does not approve a pipeline.

Obama clearly favors taking a regulatory approach to complex problems instead of the more cumbersome process of passing or repealing laws.  It is wrong to offer oil companies a regulatory solution that borders on illegality when it would be right to debate the Energy Policy and Conservation Act and reach a clear course of action.

Also in the last minutes of 2014, FERC (Federal Energy Regulatory Commission) approved Cheniere Energy's request to build its Corpus Christi LNG (liquefied natural gas) Terminal in southern Texas.  Other LNG export facilities were previously approved but this is the first green-field facility to be authorized.  Its cost will be approximately $12 billion.

The timing of this approval is wrong because of the Fracking Fallacy debate that casts doubt on future supply of natural gas in the United States.  The government should postpone decisions on new export licenses until the present debate on supply is resolved or at least better defined than it is today.

Ironically, Oklahoma billionaire George Kaiser's company Excelerate Energy announced that it will postpone its floating LNG terminal planned near Cheniere's Corpus Christi project.  The main reason appears to be questionable economics now that oil prices have fallen--most overseas LNG contracts are linked to oil prices. The difference between Excelerate's decision and Cheniere's decision seems to be about George Kaiser spending his own money versus Cheniere spending other people's money.

I do not support banning LNG export although I think it is a profoundly bad idea based on economics and likely higher natural gas prices in the U.S. once shale gas supply peaks near the end of this decade.  It is inappropriate, however, for the government to move forward with approvals while the Fracking Fallacy debate about future gas supply is high on the national energy agenda.