Production Rising

Jim Brown
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Despite a -42% drop in active rigs the production in the U.S. continues to rise. The U.S. produced 9.366 million barrels per day in the week ended on March 6th. This came despite a drop of -806 rigs since September.

The EIA data showed that production per rig from new wells rose +24% in the Eagle Ford, +29% in the Bakken and +30% in the Permian. Drillers are finding new ways to increase production and drill wells faster. This is allowing them to continue to increase production despite operating fewer rigs.

Last October research group IHS found the breakeven price for a new shale well was $57 per barrel. With costs for well equipment and services now down -10% to as much as -40% that breakeven cost has declined significantly. It may still be over today's WTI price but it is falling.

While each well is different companies have figured out how to standardize designs, equipment and techniques so that inventories of equipment and spare parts are held to a minimum and well times are reduced. There were 37,500 wells drilled in 2014 and many of them are just now being put on production. The process after a well is drilled requires fracking, installation of pumping equipment and connection to a gathering system and then to a pipeline. All of that takes time. This is why production is still rising while rig counts are falling.

As drillers become more efficient it requires fewer rigs. For instance there were 1,606 active gas rigs in the summer of 2008. That has declined to only 257 last week but gas production is still increasing. A lot of that gas is coming as a byproduct of oil wells but the gas wells now being drilled are very productive.

The storage problem is still growing. Cushing is approaching a record high and will probably set a new high this week. Part of the problem is the type of oil we produce. The U.S. produces various grades of light sweet crude and production is now over 9.3 mbpd. Some of our crude is so light it can be used as gasoline with hardly any processing. Unfortunately U.S. refiners have a capacity of just under 18 mbpd. More than 12 mbpd is setup to process sour crude from places like Venezuela, Saudi Arabia, etc. Heavy sour crude produces more products per barrel than light sweet crude. WTI is best suited for refining into gasoline. Very little byproducts like diesel, heating oil and jet fuel come from WTI.

With 6 mbpd of light sweet crude refining capacity and 9.3 mbpd of production there is a clear bottleneck. Refiners setup for sour crude can refine some WTI but they prefer not to because of their setup. If U.S. producers could export WTI there would be an immediate plunge in inventories. There are plenty of refineries around the world that would love to have our WTI because it produces less emissions when it is refined.

Because of the glut of WTI the shale oil sells at a significant discount in the Midwest. Harold Hamm, CEO of Continental Resources, said last week that Bakken crude was selling for $32 a barrel or $15 below WTI at the time.

In the chart below from Continental is shows the surge in shale production from just the three main producing areas. In 2008 barely 250,000 bpd were produced and today we are producing more than 3.5 mbpd. The inability to produce, ship and process that much of an increase in only a few years has thrown pricing into a tailspin. The price for Bakken crude is discounted to allow for the cost of shipping by rail across the country to coastal refineries because there is not enough pipeline capacity from the Bakken.

The Eagle Ford had virtually no production five years ago and produced 1.7 mbpd today. That is nearly as much as the Canadian oil sands and it took Canada nearly two decades to get to that point.

In the Texas oil fields it has been five years of boom but that is quickly turning to bust. Motels are now advertising vacancies. Manufacturing facilities that turn out oil field supplies, pipe and tools, have cut back from three shifts to two. The rig count in Texas is expected to fall -70% by the end of June. More than 50,000 job cuts have been announced. Eagle Ford production is expected to decline in April.

Marathon is cutting the number of active rigs in the Eagle Ford from 18 to 10 and reduce the number of wells drilled in 2015 to 220 from 350 in 2014. The company still expects total production to rise 5-7%.

The biggest change in the drilling process to save money is to not complete the wells. For instance EOG is drilling wells but then capping them and not fracking or connecting them to production. They currently have more than 200 drilled but not completed wells. It costs about $4 million to drill the well and then another $4-$5 million to frack and complete it. This way they can get the hard work out of the way and have an inventory of wells ready to complete when oil prices rebound.

In North Dakota the number of uncompleted wells jumped from 75 to 825 in January. The catch is that the capped wells can only be inventoried for 12 months. If prices remain low the production in the Bakken is expected to decline from the current 1.2 mbpd to 1.0 million by July, 875,000 by July 2016 and 720,000 by July 2017. The State of North Dakota said producers in the state need $75 per barrel to sustain production.

Simmons & Co, an energy analyst and consulting firm, said cash flows for service companies will decline by more than 40% in 2015 and there will be bankruptcies and consolidations.

Carbo Ceramics (CRR) said last week they are mothballing a proppant production facility in Mcintyre Georgia due to lack of demand. With very few wells being completed the demand for ceramic proppants has died. The company said "We have not seen any improvement in demand for ceramic proppant, nor do we anticipate any change in the near term." They are also reducing the output of their other facilities in order to manage the buildup of excess inventories and manage cash flow. "We will slow down or idle additional facilities as necessary."

To compound the situation the EIA upgraded their estimate of global liquids supply for 2015 by +820,000 bpd to 93.76 mbpd. This is just under the same upwardly revised estimate from the IEA at 94.0 mbpd. The EIA expects global demand to be 93.0 mbpd and the IEA is expecting 93.5 mbpd.

Clearly, U.S. production is eventually going to fall off a cliff but it may be the end of 2015 before it happens. There are a lot of moving parts to this picture and it all depends on the price of oil. If the price does not rebound a lot of these money saving plans are going to self destruct. Cash balances and credit lines are going to deplete and a new level of reduced activity is going to appear.

We can see from the details above that shale drillers are poised to restart activity at a very rapid pace once oil prices rebound but there is a limit to the amount of time they can remain in "standby" mode.

Active Rigs

Active drilling rigs declined -67 to 1,125 for the week ended on Friday. Oil rigs declined -56 for the week to 866. Active gas rigs fell -11 to 257 and a new 18 year low. Active rigs have now declined -806 since the high of 1,931 in September. That is a -41.7% drop.

Other than during the financial crisis the number of active rigs has been above 1,700 since the beginning of 2006. We are poised for a significant decline, possibly to less than 1,000 in total.

Baker Hughes warned that in those previous oil declines of 50% or more the active rig counts declined by 40% to 60%. So far we are only down -42% so we still have a ways to go. A 50% decline in oil rigs would be -805 from the 1,609 peak on October 10th. So far we have declined -743 oil rigs so we could lose another 100 or more before it is over.

Oil Inventories

Crude inventories rose another 4.5 million barrels to 448.9 million and the highest level for February since 1930. Crude inventories have risen +66.5 million barrels over just the last 9 weeks. Inventories are 21.3% over year ago levels and 25.2% above the five-year average.

Refinery utilization rose to 87.8% last week from 86.6%. Imports fell from 7.4 mbpd to 6.8 mbpd. U.S. production rose +42,000 barrels to 9.366 mbpd and the highest level since 1972.

Cushing inventories rose +2.3 million barrels to 51.5 million and a 6-year high.

Gasoline inventories declined -200,000 barrels to 239.9 million. Gasoline demand fell -295,000 bpd and imports declined -104,000 bpd. Demand was probably still down due to the severe weather.

Distillate inventories rose +2.5 million barrels to 125.5 million. Demand fell -229,000 bpd. Imports increased +157,000 bpd. The drop in distillate demand was expected given the number of airline flights that have been cancelled over the prior week.

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

Propane inventories declined by -1.33 million barrels to 53.74 million. Demand declined to 1.32 mbpd.

Natural gas inventories declined -198 Bcf to 1,512 bcf. Inventories are now -13.0% below the five year average of 1,737 Bcf and +46.9% above year ago levels at 1,029 Bcf.

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


The market lost ground last week but could rebound if the outlook for the Fed meeting is for no change. Wednesday's Fed meeting will be the key for the market. The S&P futures on Sunday night declined as much as -6 before rebounding into positive territory at 10:PM.

Jim Brown

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