US Biggest Oil Producer

Jim Brown
 
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That title is what everyone expects in a few short years but as I have written several times in recent months we should not count our barrels until they are in the tank.

Bloomberg's Business Week article this week is on the rapid decline in shale wells. The article starts off by profiling Chesapeake's (CHK) Serenity 2-3H well near Oklahoma City. When first drilled in 2009 it produced at 1,200 barrels per day. Now that well produces less than 100 bpd. Shale wells start fast and fade fast.

Companies have to race to get the next well into the ground before the older ones drop to a trickle. This is called the Red Queen race after the character in "Through the Looking Glass" who tells Alice, "It takes all the running you can do to keep in the same place." That is very true in the shale oil business. The faster you drill new wells the faster you have to keep drilling new wells or the rapid depletion will cause the production numbers to slip. For companies that live and die from quarter to quarter on posting higher production numbers that means the Red Queen syndrome forces you to drill faster every month than you did in the prior month.

The U.S. produced the most oil in 24 years for the week ended on September 13th at 7.83 million barrels per day. Saudia Arabia produces an average of 10.0 mbpd and claims to have the capacity to pump 12.5 mbpd as long as you don't care what kind of oil they pump. Most of their oil is the heavy sour crude that only certain refineries can process. We are a very long way from catching Saudi Arabia in the production race.

Shale well production declines an average of 65% in the first year. For a well like the Robert Heuer 1-17R in the Bakken that produced 2,358 bpd when it began in 2004 that means it declined to 731 bpd after one year. The second year -39%, 3rd -26%, 4th -27%, 5th -33%, etc. In year five production has declined to only 161 bpd. The initial pop of drilling 100 new wells a month is great but you have to keep it up otherwise your production will drop like a rock.


Baker Hughes said the U.S. drilled 9,175 onshore wells in Q3, up +164 from the 9,011 drilled in Q2. A simple math exercise will illustrate my point. If every one of those wells averaged only 200 bpd, not the 2,358 bpd in the Robert Heuer 1-17R, that would be an increase in U.S. production of 1,835,000 bpd every quarter. Since that is not happening we know that existing well declines are sapping all that new well strength.

The table below is the number of wells drilled in each of the major U.S. basins. The Bakken is in the Williston Basin.


U.S. production has only risen from 6.598 mbpd from Oct 1st, 2012 to 7.809 mbpd last week. That is a gain of 811,000 bpd over an entire year. With producers drilling an average of 9,000 wells a quarter or 36,000 since Oct 1st, 2012 that would imply all the new wells only produced 22 bpd. Obviously that is not correct since the average new well comes in at more than 1,000 bpd. Granted a lot of those are gas wells since 25% of the active rigs are drilling for gas.

Using simple reasoning that suggests 2293 were gas wells and 6881 were oil wells. Even using that greatly reduced number we should be seeing new oil production rise by 1,376,200 bpd every quarter if every well produced only 200 bpd. Instead the actual production gain is only 202,750 bpd every quarter because of the decline in older wells.

The following chart illustrates the predicament. The Eagle Ford is expected to see peak production in January 2016 at 1.21 mbpd with 9,000 operating wells. However, production will begin to fall despite the continued increase of new wells. When the field is totally drilled out in 2014 at 25,000 wells the total production is expected to be only 300,000 bpd. That is an increase of 16,000 additional wells but a drop in production of -900,000 bpd. The same scenario is also true of the Bakken.



Eventually these shale fields are going to be drilled out and without the discovery of replacement fields we will see production decline rather sharply. The press has started predicting the U.S. will become energy independent in the next several years. Unfortunately the facts don't support that projection.

The U.S. may have a lot of natural gas and we have a lot of oil but we will never be energy independent. We currently import over 8.0 million barrels per day of oil. That would require the addition of 8 more Bakken or Eagle Ford fields to eliminate our dependence on foreign oil.

The next time you hear some talking head on TV predict U.S. energy independence just mark them down on your mental notepad as either an idiot or really bad at math.

Even OPEC understands these facts. Abdalla Salem el-Badri, the OPEC secretary general, said last week at a conference in Kuwait that U.S. shale producers are "running out of sweet spots" and that output will peak by 2018.

Iran

The P5+1 talks with Iran begin again on Tuesday and already Iran is refusing to discuss certain parts of a possible nuclear solution. The P5+1 nations are the five permanent members of the UN Security Council plus Germany. The new Iranian negotiating team has expressed willingness to expand the talks and seek an acceptable solution to the nuclear enrichment problem. However, the 6 nations know from previous talks that Iran is long on words and short on action.

Numerous times in the last ten years the 6 nations have proposed shipping Iran's enriched uranium out of the country into safe storage. This would prove Iran's claims that it was not trying to build a bomb. The uranium would be reprocessed for Iran and supplied as fuel for their only reactor whenever they needed it at no cost to Iran. If you were not trying to build a bomb that would seem like a rational option to rid your country of crippling sanctions that cost the economy more than $100 billion over the last year and pushed inflation to 25%. Iranian representatives flatly refused to even consider this option at the meeting this week.

Another option was to ship the uranium to Russia where Russia would refine it and enrich it for Iran and deliver it as needed for reactor fuel. Since Russia is their strongest ally this was thought to be a workable solution. Iran refused this option as well.

Another option mentioned in the past was for Iran to simply stop enriching and open their facilities to the IAEA for monitoring. No uranium would leave Iran but none would be enriched in Iran. The 6 nations would then provide enriched uranium to Iran at no cost for use in their reactor. That option was also rejected by Iran.

The key point here is that Iran refuses to halt enrichment, refuses to allow inspections but continues to extend talks that have lasted for years with no progress. As long as they can keep talking they will keep enriching.

Analysts now believe Iran has enough uranium for 15 bombs. They are currently constructing a plutonium reactor at Arak that is widely seen as a parallel route to a nuclear weapon. In a plutonium reactor the fissionable uranium 235 bombards non-fissionable uranium 238 with neutrons and eventually converts it into plutonium 239. The process actually creates more fuel than it uses and the plutonium can be used in nuclear weapons. South Korea restarted a plutonium reactor in recent weeks in an effort to create more fuel for their weapons development.

For Iran to claim they only want to use the uranium for peaceful purposes while they are building a plutonium breeder reactor that generates nuclear weapon fuel is an example of their "watch what I say not what I do" bargaining tactics.

Market

The market was very volatile last week with the Dow trading in a 500 point range. The decline we were expecting finally accelerated on Wednesday but failed to break significant support. Rumors on Wednesday afternoon of a potential thawing of the deadlock in Washington sent futures soaring and the Dow gapped up +190 points on Thursday.

The markets extended their rebound on Friday as lawmakers scurried around Washington with a flock of reporters in hot pursuit. As of late Saturday it was all for naught with three major proposals turned down by President Obama and Harry Reid. News out of the House is that Obama has gone back into "I will not negotiate" mode. That does not bode well for Monday since the debt ceiling deadline is Thursday and it takes the Senate three days to act on any bill.

While Monday could see a material meltdown in the markets the bottom line is that a deal of some sort must be done by Thursday to avoid a major problem in the credit markets. I would be looking to buy any early week dip on expectations for a late week rally. S&P futures are down -15 on Sunday night.

Jim Brown

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