Production Decline Imminent

Jim Brown
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Various reporting agencies and production prognosticators claim a U.S. production decline is imminent. Production has declined in three of the last four weeks and we are already down -86,000 bpd from the 9.422 mbpd high in the week ended on March 22nd. Could that be the peak production in the U.S. for years to come?

Multiple companies and agencies are predicting a sharp decline in production beginning in June. Bakken production has already declined -50,000 bpd and accelerating. The Bakken requires 115 new well completions per month to avoid production declines and there were only 42 completions in February. In 2014 the monthly completion average was over 160.

The CEO of Core Labs (CLB), a reservoir analysis firm, said the sharp decline in drilling coupled with the sharp decline rate of shale wells would push U.S> production below 9.0 mbpd by year end. "With 70% decline curves and the rig count cut in half it does not take long to see a fall in U.S. production." He also predicted $70 WTI by year end in constant dollars. That means as long as the dollar stays where it is today the oil prices should be $70. If the dollar declines significantly oil prices will surge. More than $30 of the decline in prices since July were due to the surge in the dollar.

The EIA has been predicting that production increases in the Permian would offset declines in the Bakken. That prediction appears to be wrong and now they are expecting total U.S. production to decline in May by -57,000 bpd. You may remember the EIA was predicting U.S. oil production would rise 500,000-700,000 bpd in 2015 before this rig collapse began. To put that in perspective for the week ended on January 2nd the U.S. produced 9.132 million bpd. An increase of 600,000 bpd (the midpoint of their prior forecast) would have pushed that up to 9.732 mbpd. Instead it now appears that production could decline by year end to 8.9 mbpd or nearly -800,000 bpd below their prior estimates. Given that the low price for fuel is expected to boost global demand by 1.15 mbpd in 2015 we are quickly headed for a sharp rise in prices. The EIA had previously said global production would be 1.0 mbpd higher than demand in 2015. That situation appears to be changing rather quickly. On April 7th they revised their forecast to project demand will be higher than production in 2016.

In Texas the amount of oil shipped over rail from the Texas fields has dropped -25% despite EIA predictions for a continued increase in production. It would appear that the rapid decline in active rigs plus the rising fraclog of uncompleted wells could put a serious dent in production in the coming months.

Bloomberg reported last week that the fraclog has risen to 4,731 wells. Halliburton said last week they thought the total was over 4,000. Those have been drilled but not fracked. That number has more than tripled over the last 9 months with oil wells making up 80% of the total. The Permian has 1,540 waiting to be completed, Eagle Ford 1,250 and the Bakken 632. Analysts said companies are completing less than 20% of wells drilled, down from 60% in February.

Continental Resources, Whiting Petroleum and others have documented the serious decline rates of shale wells. I have reported on it in these pages many times. In Continental's latest presentation they show a 20% decline in 30 days and 60% decline in 120 days. That tracks with published numbers showing a 70-75% decline in the first year. A well coming online at 1,750 bpd initially will be pumping less than 500 barrels or less 12 months later. Without a constant stream of new wells coming online that means every one of the wells drilled 12-18 months ago when the average was 9,150 wells per quarter, will be pumping only 20-25% of its initial rate. You can do the math but that is a huge decline and one I don't think the EIA has fully grasped yet.

Another factor is the hedged production for 2015. Pioneer Resources (PXD) hedged 90% of their 2015 production. That means they can keep producing like crazy and they are still getting $90-$95 for their oil. Not every company hedged that much or hedged that far out but there is a significant amount of hedged production still in progress. As those hedges roll off and companies are forced to accept $50 instead of $90 for their oil there will be another significant decline in production. Most companies believe the price of oil will rise long term. Oil in the ground is a savings account for the future. If their production is not hedged they will not be in any rush to produce it. They will produce enough to pay the bills and transit into maintain mode until prices rise. You can bet they will be a lot more conservative in their future expenses and use of leverage and that will slow production growth for years to come.

Producers are currently focused on drilling the most productive regions in their leases. They will run out of these locations in the next 12-18 months and be forced to move to less productive locations and without a significant increase in oil prices a lot of those wells won't be drilled.

If prices were to spike as the result of some conflict in the Middle East there would be a race to frac those 4,000+ wells and put them into production. That could depress prices BUT it would not happen over 30-60 days. Because of the quantity of wells to be completed it could take a year or more to erase the fraclog because new wells are still being drilled. Some analysts seem to think producers can just snap their fingers and those wells will get completed. Unfortunately this is not the case. Even with the current surplus of frac teams and equipment it still requires scheduling and the delivery of that equipment and supplies including massive amounts of sand, water, equipment, etc. The latest fracking techniques require as much as 8,000 tons of sand to be pumped into a well along with a 5-9 million gallons of water. That equates to about 80 railroad cars of sand per well (Source) and 100-200 truckloads of incoming liquids per well and quadruple that number of outgoing wastewater trucks. Source

There are already articles beginning to pop up claiming Peak Oil has been reached in the USA. The idea behind it is that once the bubble burst it may be impossible for producers to reach the same level of effort as they were at last July. Production is going to decline significantly. Producer financial capability is going to decline significantly as banks and investors shy away from the same debt levels. Producers are not going to leverage themselves up to the same extent as before. They will be content to operate a normal business and slowly increase production but remain profitable with lower expenses and levels of activity. While I am not ready to claim Peak Oil yet, I can definitely do the math once we see how far production declines and how fast rigs are put back to work. The rig activity six months from now will be the indicator for future production. Stay tuned.

Active Rigs

Active drilling rigs declined -22 to 932 for the week ended on Friday. Oil rigs declined -31 for the week to 703. Active gas rigs rose +8 to 225. Active rigs have now declined -999 since the high of 1,931 in September. That is a -51.7% drop. Active offshore rigs gained +1 to 34 and well off their January high of 60.

Oil Inventories

Crude inventories rose another 5.3 million barrels to 489.0 million and the highest level for April since 1931. Crude inventories have risen +106.5 million barrels over just the last 15 weeks. Inventories are 23% over year ago levels.

Refinery utilization declined to 91.2% last week from 92.3%. Imports rose from 7.15 mbpd to 7.77 mbpd. U.S. production declined -18,000 barrels to 9.336 mbpd.

Cushing inventories rose +700,000 barrels to 62.2 million and a new high. Cushing is now over 87.6% of capacity and well over the level where inflows are normally curtailed in order to maintain operational capability. Cushing has about 71 million barrels of capacity according to the EIA. The highest utilization on record was 91% set in March 2011.

EIA Crude Inventory Chart

Gasoline inventories fell -2.1 million barrels to 225.7 million. Gasoline demand rose +171,000 bpd and imports rose +192,000 bpd.

Distillate inventories rose +.4 million barrels to 129.3 million. Demand rose +48,000 bpd. Imports rose +36,000 bpd.

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


The Nasdaq closed at a new high thanks to gains in only four stocks. The Dow closed positive by 21 points thanks to a sharp gain by Microsoft that added +35 points. Without Microsoft the Dow would have been negative. The odds are good the market will show some weakness in the coming days with the FOMC meeting on Wednesday.

Jim Brown

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