Depletion Depression

Jim Brown
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Energy stocks fell last week for a multitude of reasons but a big one was falling production at the majors. Depletion is outpacing new production.

Exxon, the world's biggest independent oil major, reported a -5.7% decline in production to 3.84 mboepd and the lowest level since 2009 and almost the same production level from 10 years ago. Exxon is spending tens of billions per year on exploration and development and they can't keep up with the decline rate. Exxon has to discover, develop and produce an extra 218,800 mboepd every year just to maintain its existing production rate. Actually boosting production to new levels is nearly impossible.

Chevron said production increases in the Permian Basin and Marcellus Shale were offset by declines in older fields elsewhere. The legacy oil companies like Chevron and Exxon have billions of barrels of reserves but most of their reserves are in older fields that have been producing for decades and the 5-7% annual declines in those fields are very tough to make up elsewhere.

For instance Chevron produced 2.55 mboepd. Using the median decline rate of 6% per year that is a loss of 153,000 boe every day, every year. That means they have to discover, develop and produce another 153,000 boepd every year just to stay even. Since Chevron and Exxon are both reporting production declines the task is proving to be very formidable. For Chevron this is the equivalent of adding the entire production of Continental Resources (CLR @ 152,400 Bpd) every year.

I have reported on this depletion problem dozens of times over the last several years. The legacy fields owned by Exxon, Chevron, Conoco, etc, are mostly vertical wells into very large reservoirs. These fields have been producing for decades and the well characteristics are very well known. These companies are spending billions for enhanced recovery techniques to coax the last few barrels out of these fields. Billions of barrels have already been produced and that is one of the problems.

The pressure in the fields has declined sharply from the days where a new well could produce a gusher. Today it takes pumps to draw the oil to the surface.

These companies inject C02 and or water into the edges of the fields to push the remaining oil towards the pumps. It is very expensive but they have a known formation and they will succeed in pumping every drop possible. The main problem today is that the existing production slows every day. These oil companies are racing to improve their recovery techniques just to stay even and in the case of Exxon and Chevron they are failing.

These companies could move to the shale basins and ramp up drilling on a massive scale since they have the financial resources to do that. However, they are electing to go slow in their development of shale fields because of the high decline rate in shale wells.

I mentioned a -6% decline rate in their legacy fields with vertical wells. In the shale fields it is significantly higher. It is not unusual to have a 50% decline rate in the first year and another 35% in the second year and then slowing to a relative trickle after three years.

The newcomers on the block like Continental, Whiting, Diamondback, etc can boost production substantially from year to year because they had no production to start with. Adding 20,000 bpd is easy if you drill enough wells. However, adding that second 20k, third 20k and fourth 20k becomes a lot more difficult because the first 20K drops to 10k in a year and 5k after another year. These shale drillers have to keep drilling as fast as they can to stay ahead of this decline curve or their stocks will crater.

To do this they leverage every dollar they can raise and sell off noncore assets to keep the rigs running. Eventually this house of cards will collapse because the depletion treadmill never stops but the funding will.

I am not saying there is disaster ahead. These companies can continue drilling new wells with strong production. They just will not be able to keep increasing total production. They are going to plateau and then go into decline as all the premium drilling locations are exhausted and they are forced to move into the second and third tier locations. They will remain strong producers but they will never grow into the next Conoco or Chevron.

Eventually geology will win. Technology is fighting a good battle but geology will win. If you buy a big gulp soda at 7/11 there are only 30 ounces in the biggest version. You can use one straw or a dozen but you will still only get 30 ounces.

Everybody has had a fountain drink that they sucked down on a hot day and left a half cup of ice. You keep going back for that last sip hoping some of the ice has melted and provided some more liquid. You can try as hard as you want but you are never going to get more than 30 ounces and the last 10 ounces are going to come out very slow as that ice melts.

The same is true of EVERY oil field ever discovered. Each only has a certain amount of oil. You can punch 100 wells or a 1,000 wells but you can never get out more oil that there was originally. Every secondary effort or third or fourth effort will pull up a few more barrels but the rate of extraction begins to decline very soon after the last well is drilled in the initial effort. After that initial drilling program all other programs are simply to offset the decline in the original wells.

The EIA projects the current production from shale fields to peak by 2017 and then decline. New, smaller fields are just now beginning production but their production will only offset the declining production from the earlier shale plays by 2017. People who say the U.S. will become energy independent are either bad at math or they don't understand the problem. We still import more than 7 mbpd and even if the EIA's best projections are accurate we will only be able to reduce that to 5 mbpd by 2017 and then it will begin to rise again.

If you want to prove this theory for yourself go buy a big gulp and pretend it is the Bakken or the Permian. Grab a bunch of straws and invite your friends to have a sip. The end result is the same.

Crude oil prices declined last week for multiple reasons. The rising dollar had a big impact because a stronger dollar means less are required to buy a barrel of oil or an ounce of gold. The dollar hit a ten month high last week. A rising dollar makes investing in commodities like oil less desirable so traders who would be long reverse their positions to shorts.

There was a fire at the CVR Coffeyville refinery in Kansas. This 115,000 bpd plant uses WTI straight from the storage facility at Cushing Oklahoma. The refinery could be offline for six weeks or more and that suggests a drop in demand of roughly 805,000 barrels per week. Since there is a glut of WTI in the Midwest already the prices declined.

Lastly the rise in gasoline inventories for the last four weeks and the depression in the gasoline prices has reduced the crack spread for refiners. This means it is less profitable to refine crude and some refiners will reduce their throughput to put upward pressure on gasoline prices. The reduced throughput will reduce the demand for crude and that forces prices down.

Oil Inventories

Crude inventories declined by -3.7 million barrels and the fifth major consecutive decline. Normally this would be a reason for crude prices to rise but the factors above overruled the falling inventories. Inventories decline despite a sharp spike in imports of +337,000 bpd. Crude production in the U.S. fell -122,000 bpd to offset some of those import gains.

Refinery demand has been high but demand declined by -47,000 bpd to 16.551 mbpd. That is only 110,000 bpd off the high for the year from two weeks ago so demand is still strong. Refinery utilization declined slightly from 93.8% to 93.5% but also at the highs for the year. Refiners are getting ready for their final surge into the Labor Day demand cycle and will begin shutting down for maintenance after Labor Day.

Gasoline inventories rose +365,000 barrels to 218.2 million. This was the fourth consecutive weekly gain. Imports declined -23,000 bpd and production declined slightly by -20,000 bpd. Gasoline demand rose by 214,000 bpd to 9.006 bpd.

Distillate inventories rose by 789,000 barrels for the 10th consecutive weekly gain. Imports increased by 33,000 bpd but production fell by -184,000 bpd and demand declined by -84,000 bpd.

Crude inventories at Cushing declined to 17.9 million barrels. This is a multiyear low and well below the assumed minimum operating level of 20 million barrels. Apparently the analyst assumptions were wrong.

In the graphic below green represents a recent high and yellow a recent low.

Natural gas inventories rose +88 Bcf last week to 2,307 Bcf. Stocks are still -530 Bcf below year ago levels and -641 Bcf below the 5-year average. There are only 13 weeks left in the gas injection season before the demand season begins on November 1st.

The mild summer weather has kept utility companies from drawing down gas supplies for electric generation. If this were to continue we could actually end the injection season with more gas than in 2013. While this is unlikely it is possible and this has driven gas prices back to levels we have not seen since last November at $3.75.

Inventories of gas in storage rose more than 1 Tcf since mid-April for the fastest gain in more than 11 years.


The equity markets declined an average of -3% last week and oil stocks fell -3.3% while oil service stocks fell -4.23%. The equity markets in general reached some decent support with the S&P falling to 1920 intraday and closing at 1925. The Dow closed at roughly 16,500 and the Nasdaq 4350.

The S&P futures are up +6 points late Sunday night so we could start the week off with a bounce but I would not count on it lasting. August is the worst month of the year and August has been negative four of the last five years.

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Jim Brown

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