Submitted by Arthur Berman via OilPrice.com,
The U.S. oil production decline has begun.
It is not because of decreased rig count. It is because cash flow at current oil prices is too low to complete most wells being drilled.
The implications are profound. Production will decline by several hundred thousand barrels per day before the effect of reduced rig count is fully seen. Unless oil prices rebound above $75 or $85 per barrel, the rig count won’t matter because there will not be enough money to complete more wells than are being completed today.
Tight oil production in the Eagle Ford, Bakken and Permian basin plays declined approximately 111,000 barrels of oil per day in January. These declines are part of a systematic decrease in the number of new producing wells added since oil prices fell below $90 per barrel in October 2014 (Figure 1).
Figure 1. Eagle Ford, Bakken and Permian basin new producing wells by month. Source: Drilling Info and Labyrinth Consulting Services, Inc
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Deferred completions (drilled uncompleted wells) are not discretionary for most companies. Producers entered into long-term rig contracts assuming at least $90 oil prices. Lower prices result in substantially reduced cash flows. Capital is only available to fulfill contractual drilling commitments, basic costs of doing business, and to complete the best wells that come closest to breaking even at present oil prices.
Much of the new capital from junk bonds and share offerings is being used to pay overhead and interest expense, and to pay down debt to avoid triggering loan covenant thresholds. Hedges help soften the blow of low oil prices for some companies but not enough to carry on business as usual when it comes to well completions.
The decrease in well completions provides additional evidence that the true break-even price for tight oil plays is between $75 and $85 per barrel. The Eagle Ford Shale is the most attractive play with a break-even price of about $75 per barrel. Well completions averaged 312 per month from January through September 2014 when WTI averaged $100 per barrel (Figure 2). When oil prices dropped below $90 per barrel in October, November well completions fell to 214. As prices fell further, 169 new producing wells were added in December and only 118 in January.
Figure 2. Eagle Ford new producing wells (2 month moving average) and WTI oil prices. Source: Drilling Info, EIA and Labyrinth Consulting Services, Inc.
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Bakken break-even prices are higher at about $85 per barrel. Well completions averaged 189 per month from January through September 2014. In November, only 80 new producing wells were added. In December and January, 123 and 114 new wells were added, respectively. Orders for rail cars used to transport oil decreased by 70% in the first quarter of 2015 compared with the fourth quarter of 2014.
Figure 3. Bakken new producing wells (2 month moving average) and WTI oil prices. Source: Drilling Info, EIA and Labyrinth Consulting Services, Inc.
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Permian “shale” play break-even prices are also about $85 per barrel based on declining well completion data. Well completions averaged 175 per month from January through September 2014. In January 2015, only 35 new producing wells were added.
Figure 4. Permian “shale” new producing wells (2 month moving average) and WTI oil prices. Permian “shale” includes horizontal wells in the Bone Springs, Consolidated, Delaware, Spraberry, Wolfcamp,Trend Area and related combinations of those reservoirs. Source: Drilling Info, EIA and Labyrinth Consulting Services, Inc.
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Much of the commentary about the backlog of deferred completions is exaggerated and irrelevant unless oil prices increase to $75 or $85 per barrel. The assumption underlying most industry chatter these days is that oil prices will return to normal.
The world oil market is undergoing a fundamental structural change in response to expensive oil. Producers are trying to survive by limiting expenditures. While analysts have been focused on rig counts, deferred completions have emerged as the initial path to lower U.S. oil production. This unanticipated outcome suggests that others may follow. While everyone is waiting for higher oil prices and for things to return to normal, what we may be witnessing is the end of normal.
How Shale Is Becoming The Dot-Com Bubble Of The 21st Century
Submitted by Leonard Brecken via OilPrice.com,
As I review the financials of one of the largest shale producers in the United States, Whiting Petroleum (WLL), I can’t help but notice the parallels to the .COM era of 1999 which, to some extent, has already returned to the technology and biotech sectors of today. Back then, the faster you burned cash to capture customers regardless of earnings to drive your topline, the higher your valuation. The theory was that after capturing the customers (in energy today, it is the wells) spending would slow and so would customer additions allowing companies to generate cash. By the way, a classic recent case is none other than Netflix (NFLX) which, in the past was exposed for accounting gimmicks that continue even today. It is still following this path of burning cash for the sake of customer additions, while never generating any cash in its entire existence.
Cash was plentiful in 1999 so it could always be raised as the Federal Reserve began its easy money era creating a series of bubbles for the next 15 years. Does this sound familiar to what is occurring now? It will end the same way and that process has already started as currency wars heat up and our economy grinds to a halt proving QE does not, in fact, create wealth (temporary yes for the 1%, short term, until POP) but instead it destroys it by distorting asset prices, misallocating investments, and ultimately creating an equity crash.
We just witnessed this in energy, as all the economic stats that distorted the real underlying economic weakness in the economy led energy producers to overproduce while easy money fueled it and expanded speculation in the futures market. Back in 1999 did the internet companies adapt their business models? Some which still survive today did, but most went bankrupt. The parallels here with energy are simply stunning as most E&P companies need to spend well over their operational cash flow in order to not only grow but to replace the wells that are producing tied to depletion. Money is free right? Well we are witnessing the first stages now and it may not last, as junk bond investors in energy can attest.
Further, US equity markets are beginning to “realize” that the US economy isn’t better off vs. Europe and the US dollar begins to fade as it shows signs of correcting as well. The Fed clearly isn’t as accommodative by instantly launching QE4, for a host of reasons, thus potentially opening the door to a deeper correction vs. prior ones in order to get what the 1% wants again: more QE. Yes the Keynesian feedback loop is real as, in the past, each equity correction was met with more QE.
WLL, in its March quarter, generated over $200M in cash from operations and, with hedges and production expected to be flat sequentially for rest of year in 2015, expects to earn at least $850M in cash from operations, give or take. The problem is though, they need to spend $2B to keep it up because depletion rates are so high. They claim “growth” capital expenditures are discretionary (just like NFLX by the way, in capturing customers), but the realities are that wells in the Bakken deplete 80% in 12 months, so does that really sound discretionary?
What is worse is WLL continues to grow production even though prices have collapsed and cash generation is in decline. In fact, year over year cash generated from operations fell 30% despite production growing some 70% plus percent. Does this sound like a company you want to invest in or like one that is run efficiently? So, let’s review: .com companies did the same and the majority went bankrupt so if WLL and other E&P companies continue to spend cash well above their operation capacity, not because they want to but because they have to, it will lead to the same result as it did in 2000… POP!
Most of these E&P companies who do not adapt will go bankrupt as the money runs dry, unless they spend within their operational CF. As of now, WLL specifically does not seem to be adapting as production rises this year and next. On their EPS call, management did say next year CF would fully cover capital expenditures which is encouraging, assuming current strip. Those companies that do adapt will not only survive but will thrive, as we believe that the ultimate result of all this will be much higher oil prices from here. The shale revolution will see a dramatic period of slow growth/no growth or more likely declining production as marginal players leave and costs to drill overall, outside of most prolific areas (as they run dry), rise. And as a reminder, OPEC does not have the spare capacity in hand to supply the market leading to the next boom in prices longer term. In the short term and as a rule of thumb, do not invest in those companies who spend considerably above the operation cash flow and only consider those that respect their limits.