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Good for one, but bad for all. The rich get richer. The critical few. The old 80-20 rule. These are just some of the gems that have crossed our desks lately to describe what is happening in drilling activity.
Based on its finely honed expertise for drilling only the best acreage and for the lowest possible cost, the oil industry is set¬ting itself up for a slower recovery, unless we get some kind of October surprise. Many of the second-quarter conference calls indicated we are not yet done seeing higher-flowing wells that can be produced with lower LOE (lease operating expense).
Therefore, as we look forward to 2017, the odds of a reset in the supply-demand balance are skewed by the increased effec¬tiveness of U.S. drilling and the fact that so many E&Ps now claim they will grow production while remaining within cash flow at $45 or $50 oil. This is the stunning progress that’s been made during the severe downturn.
At press time the future oil price was anybody’s guess; predictions ranged widely. Raymond James & Associates said it fore¬sees $80/bbl sometime in 2017. BNP Pari¬bas said $49 next year. Macquarie said $70. Simmons & Co. said it believes the industry needs to see the upper $50s for any sustain¬able North American recovery in growth, and it doesn’t see that happening until sec¬ond-half 2017. As of right now, it expects oil prices to correlate with the U.S. dollar for the next few quarters. Seaport Global Hunter’s call is $55.
But in light of the progress that has been made, Evan Calio and team at Morgan Stanley Research said maybe the mid-cen¬tury point isn’t that bad after all. In a report titled “Make $50 Great Again,” they noted that many E&Ps beat production guidance in the second quarter and continue to guide toward production growth through the year, even while drilling fewer wells than two years ago.
Of course this is the 80-20 rule in motion, true for E&Ps lucky enough to hold Tier 1 acreage. “The resiliency of core U.S. shale remains clear, yet against a backdrop of steep declines, making it more tolerable,” said Calio, citing the “unrelenting ability to do more with the same (or less) and signif¬icant LOE savings.” Add up all the positive comments from E&Ps that can differentiate themselves with solid acreage in the core and lower costs, and you get a looming rise in oil supply—offsetting any drawdown of above-average inventories.
This is a dilemma for the entire universe of companies and investors, but it bodes well for a select few. “As results aggregate, the similar concern of ‘good for the micro and bad for the macro’ envelopes [the industry],” Morgan Stanley said.
Let’s look then at supply. Lower 48 onshore production peaked at 7.68 million bbl/d in March 2015, just a few months after the late-2014 onset of the oil price crisis. Since then, domestic onshore vol¬ume has fallen about 1.1 MMbbl/d to 6.67 MMbbl/d. Some 40% of this decline occurred in Texas alone, with another 20% coming in the Bakken Shale in North Dakota. RBC Capital Markets analyst Scott Hanold estimated in a report that the base output decline onshore is about 33%. That’s a substantial chunk to replace each year just to stay even.
Morgan Stanley said it expects U.S. pro¬duction to have fallen by 693,000 bbl/d by the fourth quarter, versus its prior estimate of a decline of 708 Mbbl/d. Jefferies’ research team estimated a decline of 725 Mbbl/d, which would be an 8% drop-off. However, most guidance by companies seems to under¬state productivity enhancement and gains in drilling efficiency. This is a moving target that is being rewritten by the week, and the old saw of “Under promise and over deliver” also plays into every scenario.
Some experts now foresee a rise in U.S. production next year. Jefferies noted that among its coverage group of 25 E&Ps, 10 have announced budget increases for this year, and that in the aggregate, their 2016 capex will have gone up a modest 4%—but that is $1.1 billion. It cautioned that for the most part, increased oil rig activity will impact production in early 2017.
RBC concurs. “Our model indicates that onshore U.S. production declines should continue in second-half 2016,” it said. “We estimate U.S. oil production will decline 600 Mbbl/d in 2016, grow 60 Mbbl/d in 2017, and grow 600 to 800 Mbbl/d in 2018, using our $45/$59/$65 [WTI] oil price forecasts in 2016, 2017 and 2018,” Hanold said.
An FBR & Co. report said, “A key piece of our ‘critical few’ analysis is that the remaining inventory of high-grading locations is more than sufficient to support development for several years, especially in the expansive Permian Basin.”
What’s more, analysts made their obser¬vations before Apache Corp. unveiled its eye-popping discovery in Reeves County, Texas—the Alpine High—in early September.
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