Fracklog is Building

Jim Brown
 
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The "fracklog" is a new term coined to represent the backlog of wells that have already been drilled but not yet fractured and completed for production. The recent admissions by numerous E&P companies that they were only drilling and not fracking in order to cut costs has created a new problem for future production.

In the Bakken and Eagle Ford alone there are now more than 1,000 wells that have been drilled and not fracked. The cost to drill is around $4 million on average and the cost to fracture, hook up the production equipment and connect to the gathering systems is roughly $5 million on average.

By not completing the wells they are saving about $5 million a well. This allows the E&P company to trim costs and continue drilling at a rapid rate.

The problem we are going to see in the future is a flood of fracking orders all at once. If oil prices were to rebound to $65 in May all of these producers could pickup the phone and place the orders to complete those wells. Imagine this across all the shale fields.

You may remember a couple years ago when there was not enough fracking equipment. Wells sometimes went 3-4 months before being completed because there was simply not enough men and equipment and supplies to handle the rising demand. Over the last several years that problem was resolved and companies like Halliburton added thousands of workers and bought billions in equipment to fracture these wells.

The way things normally work in the oil industry it is either feast or famine. There is either too much capacity or too little capacity. You may have heard that Halliburton and Baker Hughes are laying off roughly 15,000 workers due to lack of demand. Those workers will end up finding other jobs in a different industry that is not prone to the severe cycles like the oil industry.

Oil prices have declined more than 50% five times since 1980. Every time it declines an entire generation of oil field workers are terminated and they move on to other industries. You may remember back early in the last decade when workers were at a premium. The drop to $10 a barrel in 1998 had decimated the sector and active rigs declined to only 488, down from 4,530 in 1981.

In the mid 2000s anyone with two arms, two legs and a pulse could get a job making $100,000 a year in the oil field and they would train you. We have gone full circle again. Most E&P companies have projected active rig cuts through July. That means the -45% drop from September through last week will continue for several more months.

This has caused the sand and proppant companies to shutter plants and mothball sand mines because of the lack of demand. There are thousands of railroad cars sidelined because of the drop in demand for sand, well pipe, etc.

Fast forward to whenever oil prices rebound to $65-$75 per barrel. When those frac orders begin to fly there will not be enough experienced workers to run the equipment. Orders for sand will begin to stack up and the mines will have to be reopened, workers rehired, etc. Steel plants will have to ramp back up to three shifts to produce well pipe. Railroads will have to track down all the sidelined cars and put them back into service.

Since all of the completion orders will probably go out about the same time there will be massive confusion and delays as the entire fracking industry restarts. So far the entire industry has not completely shutdown. There are still wells being completed but far less than in the past. When the restart comes it will compete with the new wells still being drilled for men, equipment and supplies.

Analysts have been saying that the rising fracklog means producers can turn on production almost immediately once prices rebound. This is simply not the truth. It will probably take a year or more to return to "normal" production. The key here is that normal will not be the normal from 2012. It will be a new normal where E&P companies are going to be less aggressive in their drilling programs and once the restart boom passes we will probably drill fewer wells in future years.

BHI said there were 9,544 onshore wells drilled in Q4, down -22 from Q3. Compared to Q4-2013 the number rose +461 wells or 5%.

The average onshore rig count for Q4 was 1,856, up +14 rigs from Q3 and +159 rigs over Q4-2013. On average the onshore rigs drilled 5.14 wells each in Q4. Slower drilling rates in the Eagle Ford, Marcellus and Haynesville weighed on the average.

It will be interesting to see how many wells were drilled in Q1. Those numbers will be out in the next couple weeks and it will show us how the -45% decline in active rigs has impacted the well count.

Active rigs are down -862 from September. At the 5.14 well per quarter average that would mean a loss of -4,430 wells IF those rigs had been down all quarter, which they were not. This suggests we could see a decline of -2,000 wells or more in Q1. However, we already know that Q2 will see a decline of at least -4,430 wells because of the active rig decline. Since the rig count is expected to decline through July we could expect well over 5,000 wells to not be drilled.

This means crude production at the end of 2015 could be significantly lower than it is today. When you factor in the -65% first year depletion rate of a typical shale well and somewhere in the range of 12,500 fewer wells drilled in 2015 it would appear that Saudi Arabia may have won the production war.

There was another major development last week. Offshore rigs for the week ended March 20th, declined -11 to 37. That is down from 54 for the week ended February 20th and a -31% decline in just a month. This is a major event and another piece of evidence demonstrating the severe impact on the industry from $45 oil.

Active Rigs

Active drilling rigs declined -56 to 1,069 for the week ended on Friday. Oil rigs declined -41 for the week to 825. Active gas rigs fell -11 to 246 and a new 18 year low. Active rigs have now declined -862 since the high of 1,931 in September. That is a -44.6% drop. Active offshore rigs declined -11 to 37 and well off their February high of 54.

Baker Hughes warned that in those previous oil declines of 50% or more the active rig counts declined by 40% to 60%. As of last week we are down -49% so we still have a ways to go. That 60% worst case is looking more likely every day.


Oil Inventories

Crude inventories rose another 9.5 million barrels to 458.5 million and the highest level for March since 1931. Crude inventories have risen +76 million barrels over just the last 10 weeks. Inventories are 22% over year ago levels and 26.2% above the five-year average.

Refinery utilization rose to 88.1% last week from 87.8%. Imports rose from 6.79 mbpd to 7.4 mbpd. U.S. production rose +43,000 barrels to 9.419 mbpd and the highest level since 1972.

Cushing inventories rose +2.9 million barrels to 54.4 million and a 6-year high. Cushing is nearing 80% of capacity at 56 million barrels and the level where inflows are curtailed in order to maintain operational capability.

EIA Crude Inventory Chart

Gasoline inventories declined -4.5 million barrels to 235.4 million. Gasoline demand rose +745,000 bpd and imports rose +128,000 bpd. Demand probably rebounded as the severe weather ended.

Distillate inventories rose +400,000 barrels to 125.0 million. Demand rose +16,000 bpd. Imports declined -298,000 bpd.

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


Propane inventories rose by 540,000 barrels to 54.28 million. Demand declined to 1.08 mbpd.

Natural gas inventories declined -45 Bcf to 1,467 bcf. Inventories are now -13.3% below the five year average of 1,692 Bcf and +52.8% above year ago levels at 960 Bcf.

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


Market

The market recovered last week thanks to the Fed's dovish comments and the Nasdaq broke over the 5,000 mark once again. Small caps are leading the charge because of their lack of exposure to the strong dollar. However, beware the last week of March. On 17 of the last 25 years the S&P has declined an average of -1.6% as fund managers restructure their portfolios ahead of the summer doldrums and investors take money out of the market to pay their tax bills. There is no guarantee the market will be weak but everyone should keep their eyes open.

Jim Brown

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