Production Updates

Jim Brown
 
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There is a dirty little secret in the recent earnings reports from several exploration and production companies. Apparently having unlimited amounts of money does not guarantee increased production.

Exxon posted a -4.9% decline in production in Q3 and Chevron posted a -1% decline. Between those two companies they are spending more than $71 billion in capex to support drilling in 2014. Even with that seemingly unlimited flow of cash they could not find enough new oil to offset the decline in their oil fields.

Peak Oil has been ignored since the financial crisis because demand fell off significantly for a couple years and allowed global production to catch up. Today we have an excess of oil by about 2-3 million barrels per day depending on who you listen to. This will not last forever.

Shale oil production in the U.S. is expected to peak by 2017 despite all the new wells being drilled. Baker Hughes said there were 9,566 new wells drilled in Q3 in addition to the 9,000+ wells drilled in Q1 and Q2. U.S. production on January 1st was 8.145 mbpd. Production last week was 8.97 mbpd. We drilled roughly 28,000 new wells from January 1st through Sept 30th and production increased only 825,000 bpd. That means each new well only gives us a net increase of roughly 29.5 barrels per day. That is because for every new well there are dozens older wells that are in decline.

The problem is the more than 1.1 million active oil wells in the USA. If every well only declined one barrel per year that would be a huge drop. Unfortunately a lot of those decline a lot more than one barrel per year. The average shale well declines -65% in the first year alone. Active Wells by State

The average new well in the Permian Basin produces about 350 bpd according to the EIA. There are about 560 rigs operating in the Permian today. The EIA claims every new well provided a net production increase of 172 bpd in October. Production in the Permian rose +42,000 bpd in October. EIA Permian Report

The numbers are better for the Bakken. There are about 220 rigs working in the Bakken and each rig was responsible for a net increase in Bakken production of +530 bpd according to the EIA. In October the production from the Bakken rose +29,000 bpd. EIA Bakken Report

While all these numbers are comforting we are still faced with the problem of what happens when all the fairway wells have been drilled. Exploration companies drill the easy and most productive wells first. Once they are forced to move out of the fairway and into the rough the barrels per new well will begin to decline and along with that statistic we will see a drop in production from the overall field.

If they can't keep the initial well production at current levels they have no chance of keeping ahead of the 65% decline rate in the first year of a well's life. E&P companies are on a treadmill to nowhere. They have to keep drilling faster and faster to keep ahead of the declines and eventually the treadmill will win. It is not mathematically possible for producers to win the race. There is not enough fairway and they are running out of prime locations to drill.

I am not preaching doom and gloom here, just the facts. Crude production in the U.S. will exceed 9.0 mbpd, a 30+ year high before the end of 2014. Total production will probably rise to somewhere in the 11.0 mbpd range by 2017 but then the depletion monster will finally overtake production and the numbers will begin to decline.

People say everyone just needs to find new fields. Unfortunately that is not as easy as it sounds. The vast majority of the U.S. has already been drilled. For the last 100+ years enterprising drillers have been punching holes everywhere possible looking for oil. The map below from www.fractracker.org shows the existing oil reserves in the USA. We know where the oil is and we know where it is not.


Everyone needs to enjoy gasoline below $3 for as long as it lasts because it will go higher eventually. The cost of wells, workers, technology, transportation, pipe, sand, etc is not going to get any cheaper. Oil prices have to go up in order to maintain existing production. If oil prices go down and drilling is no longer profitable the amount of drilling will decline. Oil production will decline and oil prices will rise. It is a basic business fact. The oil in the ground will wait until it becomes profitable for somebody to drill it. There is plenty of oil that costs more than $100 in the ground now. Nobody is drilling it because it is not profitable. When oil returns to $150 those reserves will be the new black gold that everyone will race to drill.

Oil Inventories

The spike in crude inventories moderated somewhat to a gain of +2.1 million barrels. That is significantly lower than the +7.0 barrel average gain over the last three weeks. This is the time of year when inventories rise but +23 million barrels in only four weeks is ridiculous.

Crude imports declined -376,000 bpd and demand for crude by refineries declined -79,000 bpd. U.S. production rose +36,000 bpd to 8.97 mbpd and another 30+ year high.

Refinery utilization declined only slightly from 86.7% to 86.6% and barely worth noting. This is maintenance season but utilization has barely faded from the 90+% level of just six weeks ago. The refiners are making a lot of money with the low oil prices as we saw from the Exxon and Chevron earnings reports. Were it not for the refinery profits they would have missed earnings. While demand in the U.S. is not strong they are still able to make money by refining the oil and exporting the fuel, which is a thriving business today.

Cushing inventories rose from 20.6 to 21.4 million barrels suggesting the downstream demand may have lessened temporarily. Cushing has plenty of room to beef up inventories but the incoming pipeline capacity is now less than outgoing capacity. We should see inventories rise in December once refiners start reducing inventory to avoid the yearend tax bill on inventory.

Gasoline inventories declined -1.2 million barrels to 203.1 million and the lowest level in several months. Refiners and distributors are trying to push the last of the summer blend gasoline out of the system and reload with the winter blends required as of November 1st. Gasoline demand at 8.87 mbpd was only slightly below the high-water mark of 9.04 mbpd just two weeks ago. With more people going to work that gasoline demand number is going to remain high.

Distillate inventories declined by a whopping -5.3 million barrels to 120.4 million and also a multi-month low. Demand declined by -83,000 bpd and imports fell by -49,000 bpd.

In another accounting anomaly the total of refined products supplied to the market rose to 20.06 mbpd and also a multi-month high. So how did distillate and gasoline inventories fall so much with record refining output? Enquiring minds want to know.

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


Propane inventories declined -1.34 million barrels to 80.27 million. Inventories were at the highest level since October 1998 and this is the first week of winter weather. Demand increased from 1.18 mbpd to 1.52 mbpd. The prior week was the peak inventory level for the season.


Natural gas inventories rose +87 Bcf to 3,480 bcf. Inventories are still -8.2% below the five year average at 3,790 Bcf. This was the last week in the injection season. We did not reach the projected total of 3,500 Bcf. We are still about 400 Bcf below where we need to be as we begin the heating season.

With below freezing temperatures all across the U.S. this week the heating season has begun. Gas prices should begin to rise and now it is a watch and wait to see if we have enough gas in storage to get through the winter.

The blue line in the chart below shows the current inventory relative to the five year average.


Market

The market ended the week at its highs and the Nasdaq and Russell 2000 charts were left with some very bearish candlesticks. The odds are very good the market will give back some gains early in the week and consolidate before moving higher.

Jim Brown

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