Brent Hits High, WTI Lags

Jim Brown
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Multiple problems overseas continued to support Brent prices as the contract rose to slightly more than $110. However, while WTI rose it failed to set a new high.

I won't go into all the details about the actual and potential production problems in the Middle East and Northern Africa because I have covered it multiple times in recent newsletters. Suffice to say that the explosion of violence in Egypt has continued to create worries over Egyptian production outages and possible delays for shipments through the Suez Canal. Neither event is likely to happen.

At the same time Libyan production has been cut significantly as well as Nigeria and Sudan. See prior newsletters for the details.

Iraq took on a new focus last week as day after day of bombings took their toll. More than 1,000 Iraqis were killed in July from a resurgence of bombings and Al Qaeda attacks. It was the deadliest month since 2008.

On Friday Iraqi Foreign Minister said he has sought help from the USA and the assistance package could include a limited number of advisors, intelligence analysis, surveillance assets and lethal drones.

"There is a greater realization in the Iraq government that we should not shy away from asking for help and assistance," Zebari told reporters in Washington. He said the U.S. seems to be more interested since the resurgence of Al Qaeda in Iraq. The growing threat has become a serious threat for the U.S. and its allies.

The U.S. wants to ensure the Iraqi Shiite led government includes Sunni Muslims. The U.S. also wants to make sure Iraq remains independent from the Shiite government in Iran and stays out fo the war in Syria where Sunni Muslim rebels are trying to overthrow Syrian president Bashar Assad, an Alawite, which is an offshoot of Shiite Islam.

The U.S. has repeatedly chastised Iraq for allowing Iranian planes to fly weapons over Iraq to Syrian bases.

A new wave of violence is engulfing Iraq and it is slowing the revitalization of the Iraqi oil fields. Production has slowed and new production has been delayed by the increasing deadly security issues.

The multiple risks to waterborne crude has provided support for Brent prices. WTI is not exported so any exported crude around the world is indexed to Brent prices.

Barclays released a note on Friday saying the oil price risk remains to the upside in the short term. The long term outlook is for softness in crude prices due to record high net speculation, tepid demand growth due to refinery maintenance in September and October, growing production in the U.S. and better Canadian supply as maintenance issues have been resolved. On the upside there is a temporary increase in global demand due to prestocking of new refineries and new refinery capacity. Refineries store millions of barrels onsite so new refineries or expansions of existing refineries require the inventorying of millions of barrels. This temporary increase in demand is removing surplus oil from the waterborne market.

USA and Peak Oil

With the global economic slowdown since 2008 the global production has had a chance to move ahead of demand and gain some breathing room. This does not mean Peak Oil has gone away but only been postponed.

While the U.S. is thought to have enough natural gas for decades of additional development the same is not true for oil. This is probably a surprise for everyone that believes the Bakken, Permian, Mississippi Lime, Eagle Ford etc will continue to produce ever growing volumes of oil for decades to come. That is not the case as multiple surveys and reports are now predicting.

U.S. oil production is expected to peak in 2017. At that point we will not be able to drill new wells fast enough to offset the rapid decline rates in the shale wells. New wells come on very strong but decline very fast. They may continue producing for decades but as a fraction of their original production rates.

Wells that come on at 3,000 bpd can decline to 300 bpd within 24-36 months and continue declining at a slower rate thereafter.

David Hughes, a geoscientist having spent 32 years with the Geological Survey of Canada, has published a report called "Drill Baby Drill" where he claims U.S. shale production is on an "exploration treadmill" that is rapidly increasing just to maintain current production. Click HERE for the report.

He said more than 1,542 new wells at a cost of $14 billion annually are required to maintain current production in the Bakken. More than 6,000 new wells per year at a cost of $35 billion annually are required to maintain the current U.S. production rate of 7.5 mbpd. If you combine oil, NGLS and gas it will require 8,600 new wells per yeat at a cost of $48 billion to offset declines. Shale production is expected to peak in 2017 at 2.3 mbpd. The Bakken and Eagle Ford are expected to decline back to 2012 levels by 2019 and only 700,000 bpd by 2025.

Shale Production Chart

The typical Bakken well declines 69% in year one, 39% in year two, 26%, 27%, and 33% in succeeding years. It is very tough to overcome that kind of decline and that is a good well. The weaker wells not in the main fairway will come on slower and decline faster.

More than 75% of Bakken wells produce less than 500 bpd after the first 30 days. Median 30 day production is 341 bpd.

Bakken Decline Curve Chart

The major problem with the exploration treadmill is that we run out of drilling locations in the Bakken in 2017 with an estimated 11,725 operating wells. As of Jan 2010 the EIA estimated there were 9,767 remaining locations and the current drilling rate is 1,500 per year. Bakken production is expected to peak at 973,000 bpd in 2017. Production will decline at 40% annually after 2017. New wells are closing in on 2,000 per year and that will move the peak to 2015 at 1.1 mbpd if the rate of drilling continues. That is not likely since the choice locations are drilled first and the marginal wells will be drilled at a slower pace.

Eagle Ford wells decline at an even faster pace of 60% in year one, 64% year two, 72% year three and 46% year four as the wells decline to an average of 10 bpd from initial production of 375 bpd.

Eagle Ford production is expected to peak at 891,000 bpd in 2016 with 11,406 operating wells.

David Hughes is not the only scientist projecting the imminent decline in Bakken production. The North Dakota Dept of Mineral Resources is also projecting a peak in the 2015-2017 timeframe. They are predicting a slower decline because they believe oil prices will rise and make the marginal wells more economic and keep the pace of drilling higher for a longer period. If oil prices don't remain high the decline accelerates.

North Dakota Production Expectations

The Energy Watch Group (EWG) posted an article earlier this year suggesting that global OIL production peaked in 2012. Most of the numbers being published today include all "liquids" and as we know NGLs are not oil. You can't make gasoline and diesel from NGLs. Most projections for 2014 demand of roughly 91 mbpd include things like biodiesel so it is not a "clean" projection of oil supply or demand.

The Fossil and Nuclear Fuels, Supply Outlook report can be read HERE.

Who Wins?

The production race is going to heat up over the next several years because public companies like Continental Resources, Whiting Petroleum, Noble Energy, etc, have shareholders demanding ever higher production. They will continue to increase capital budgets to drill more wells faster and try and get ahead of the production curve. Unfortunately the decline factor will eventually catch them and production will decline as they run out of new locations to drill.

The winners over the next several years are going to be Schlumberger, Halliburton and Baker Hughes. The well servicing group are seeing their drilled base expand by roughly 6,000 wells per year and service fees are going to climb.

The same metrics I outlined for shale oil wells works exactly the same for gas wells. As the 12-24-36 month decline rates kick in the race is going to heat up to drill gas wells. The country is gearing up to consume more gas because they have been sold the headline that we have a 100-year supply of gas. That may be true but we don't have a 100 year supply of economical gas. Prices will have to rise to justify the rapid decline rates and the faster consumption rates.

There are multiple LNG facilities already licensed and more than 20 others in the permit process. While I doubt all will be approved we are going to see LNG exports of multiple Bcfs per day in the near future and growing.

The well servicing companies are going to be the eventual winners. Baker Hughes said active rigs rose by +13 to 1,791 last week. Oil rigs gained +12 to 1397. Gas rigs rose +2 to 388. Six were listed as miscellaneous. The 18 year low of 349 was set on June 14th. The peak was 936 in 2011. The total rig count for the same period in 2012 was 1,914.

Exploration and production companies will prosper over the next several years but once they run out of "profitable" drilling locations it could be a long road down.

This suggests oil and gas prices will have to continue rising in order to justify the tens of billions in annual capex commitments to keep production from sliding at a faster rate.

I did not start out this commentary to rehash the peak oil scenario. There are other oil production stories including Brazil, Iraq, etc. I don't think anyone is willing to pick a new global peak just yet but it is still out there in the relatively near future.

Tropical Storm Erin

Tropical storm Erin formed last week off the coast of Africa and lasted for about two days. It has been downgraded to a tropical depression and may be stripped of her name at any time. The storm track is north through the Atlantic and not expected to make landfall in the U.S. even if she does return to her former self.

The localized disturbance that moves across Venezuela dissipated to rain and wind only and has only a 10% chance of turning into a tropical storm.

Only four named storms have appeared so far in 2013. The 30-year average is 12 storms and the outlook for this season is 13-19 storms with five major hurricanes. The two red areas in the map below have a 70% chance of becoming named storms.


The Dow closed at a six week low on Friday and I expect the decline to continue. In addition to the normal seasonal declines we are facing a debt ceiling battle and the mid September FOMC meeting where they may decide to taper QE. I continue to believe we will see weaker markets over the next six weeks and we will have a buying opportunity in September. Be patient!

Crude prices typically decline in August-September and then rebound in the fall as winter heating oil demand increases. The events in the Middle East are preventing that normal end of summer decline but once inventory levels begin to rise I think we will see a significant dip in prices.

Jim Brown

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