Biggest Weekly Rig Count Decline Since 2000

BHI Rig Count_02-13-201598 rigs were idled last week, the biggest weekly drop in the Baker Hughes Rig Count since 2000, with nearly half of that decline coming out of Texas alone!

And take a look at this interesting picture below from NAPE.  It shows the number of wells earning their cost of capital at $100 (upper left), $80, $60 and $40 per barrel (lower right).  You can see the amount of ‘color’ (i.e., wells) that fall by the wayside as prices fall.

Bakken Economics @ $40-100/bbl Oil (Courtesy Moyes @ NAPE)
Bakken Economics @ $40-100/bbl Oil (Courtesy Moyes @ NAPE)

Oil Prices: Is the Tide Turning?

In prior posts, we highlighted some of the reasons oil prices collapsed and, more importantly, opined on when we might begin to turn the corner.

Based on some of the most recent Baker Hughes Rig Count data, it looks like the process has begun.

Change in North America Land Rig Count (courtesy Baker Hughes)
Change in North America Land Rig Count (courtesy Baker Hughes)

Looking at the chart above, we see a dramatic fall off in the North American rig count over the last 10+ weeks.  We noted previously that many North American shale plays become uneconomic at prices below $60 per barrel and suggested that rig rates – and production rates – would rapidly decline in this price environment.  That’s just what we’re seeing, with North America having lost 526 rigs (23%) since the near-term peak (at 2,309 rigs) just before the fateful Thanksgiving Week OPEC meeting; in the last two weeks alone, 225 have been idled!

Source: Baker Hughes
Source: Baker Hughes

Baker Hughes also provides a series of nice cuts on the data, including how many rigs are drilling for oil (and gas) on a play-by-play basis.  If we take a look at six major oil basins – in which most rigs are drilling unconventional plays – the rig count is down by 286 (26%) since late November.  If we take 1,000 barrels per day as the average IP (initial production) rate for the average well in one of these plays and assume each rig can drill roughly one well per month, well that means we’ve already removed several hundred thousand barrels per day from the market (that would have otherwise been there).  Furthermore, not every well that is drilled is necessarily completed (frac’d) and brought on line, so this estimate of ‘lost oil’ to the market may be conservative.

I was curious about the international data too, shown below for our readers:

Source: Baker Hughes
Source: Baker Hughes

We’re looking over a longer time frame with the international data (going back to the start of 2014). In general, the rig count is fairly stable, except over the past few months where we’ve seen the onshore rigs especially begin to nosedive.

Since the July 2014 peak, onshore rig counts are down by nearly 10%. While the falloff isn’t as dramatic as it is in North America, we’re still seeing declines, albeit at a slower pace as many of these rigs are dedicated to larger, multi-well field development projects in which it’s much harder to scale back the drilling program once the field development plan is sanctioned.

Net-net, it looks like the market is behaving in a fairly rationale way.

Investors also seem to be thinking we might be reaching a bottom.  After falling by nearly 25% since late November, the oilfield services ETF (OIH, whose top 3 components – Schlumberger, Halliburton and National Oilwell Varco – account for nearly 40% of its value) is up nearly 10% from its bottom of just a couple of weeks ago.  As goes the rig count, so too goes OIH.

For those wondering about it’s peak – well, OIH traded around $58 in July 2014 and around $70 in 2008-09 before the global financial crisis.  If you have a value investing mindset similar to Warren Buffet and seek to buy when everyone else is selling, now might be an interesting time to bottom-fish and buy in!  Good luck…

OIH

Oil Bust – Why Did It Start, When Might It End?

OPEC Market Share

A geoscientist from the Middle East recently shared the two charts in this post . I think they are both pretty intriguing and thought some Sweet Spots readers might as well.

The chart above shows the degradation in OPEC market share as a result of the shale boom. From a recent peak market share of 44% following the 2008-09 global financial crisis, OPEC’s share of global liquids production has fallen by 5% in the last five years as various shale plays – including the Bakken, Eagle Ford and those in West Texas’ Permian Basin – experienced a boom in development drilling activity and production.

Now market share isn’t something one commonly hears in the world of the global oil and gas business (share gains and losses are more commonly associated with smart phone wars and soft drink battles), but it is really interesting in this case, especially if one tries to value this share loss.

Global production is around 90 million barrels per day. If we assume production was roughly constant from 2009-2014 (it actually grew, which makes OPEC’s loss even larger in absolute barrel terms) and that prices were roughly constant at $100 in this same period, this 5% share loss equates to $165 billion in lost revenue to the OPEC producing countries every year. That’s a big number, and something several OPEC members – Saudi Arabia in particular – felt was worth defending.

So that explains some of how we got into this mess. The next question is, when might we get out of it? For some insight, let’s look at the chart below.

OilPrice-PeakToTrough

It shows how long prior downcycles took to unfold from the price peak to the price trough. Though it feels like the collapse in prices was more sudden this time, the black ‘Dec 2014’ line actually shows a less precipitous decline than we experienced in some other downturns (e.g., 1986). Moreover, we are now in the longest ‘peak to trough’ downcycle of any price bust in the last 30 years.

Does that mean we’re nearing the end? Hopefully! We now need to add another 30 days to this chart (for January), during which time oil prices have further declined to 42% of the peak. If the past holds any guide to the present, it looks like we’re close to hitting the metrics that signaled the bottom in prior busts. Let’s hope that’s the case!

Oil Price Bust #4: Impact on 2015 USA Production

WTI

 

Since the start of July, oil prices have fallen from nearly $110 per barrel (WTI) to $45. While drops of this magnitude have happened before (60% in this case; more than 100% in the global financial crisis of 2008-09), the pace of this decline has taken many by surprise. There are lots of articles out there as to why it’s happened – Saudi’s flexing their muscles in a bid to maintain market share; slowing demand in Europe and Asia; collusion between the USA and the Saudis to ‘pressure up’ the Russians and the Iranians – among others.

For me and many others in the Baby Boomer oil patch cohort, this is Bust #4. The first occurred when many of us were in college or just about to graduate (1985-86) – prices dropped into the single digits; job offers were withdrawn; and massive layoffs hit the industry (Exxon, my employer out of college, laid off 30% of its technical staff in Exxon USA the Friday before I started my first day with the company).

Prices imploded again during the Asian financial crisis of 1997-98. The impacts were similar, with bankruptcies soon to hit the geophysical industry (recall PGS). Then we had Bust #3 during the global financial crisis. And now we’re onto Bust #4.

Without wanting to be so bold as to put forth an argument that “it’s different this time” (though I think it is), let’s simply take a look at what the impact of this price decline is likely to be on USA production in 2015.

First, a few bits of numerical context.  The world produces and consumes around 80 million barrels of oil every day. The top three producers – each of which produces around 10 million barrels per day – are Russia, Saudi Arabia and the United States (this was the order in 1Q2014).  During 2014, the U.S. vaulted to the #1 spot, with production exceeding 11 million barrels per day.  Various financial analysts projected the U.S. would be producing 13 million barrels per day by the end of the decade.

This surge in U.S. production – driven by the shale  boom – upset the Saudis and other OPEC producers as it displaced the need for their products in the U.S. and other importing nations around the world.  So, as they have before, the Saudis opened up the taps to keep the market oversupplied and force out the high-cost producers.  The best guess estimates of the level of this oversupply range from 1-3 million barrels per day.

So the question is, how fast does this supply overhang come off the market?  To get a sense of this, let’s look at Continental Resources and the Bakken for a little back-of-the-envelope estimate.  As many know, the Bakken (along with the Eagle Ford) has become the epicenter of the USA shale boom.  The Bakken produces about 1 million barrels per day (from a diminimus level a decade ago).  Continental and Whiting are the Bakken’s largest producers, each pumping roughly 100,000 barrels per day.  Others in the Top Five in the Bakken are HESS, EOG and Statoil who all produce in excess of 50,000 BOPD.

With prices falling, capital budgets are soon to follow.  In December, Continental cut its CapEx targeting the Bakken by $1 billion.  Given the economics Continental has in it’s investor presentation, it’s easy to see why. With $45 oil, Continental’s Bakken wells generate ‘only’ a 10% return.

Continental Bakken

The average Bakken well costs roughly $8 million to drill, complete and frac. So if Continental cuts $1 billion from its Bakken budget (almost all of which would be targeted at drilling wells), then that’s 125 fewer Bakken wells that Continental will drill in 2015. Let’s say Whiting makes similar cuts, as do all other Bakken players. That implies to me that somewhere around 1,000 Bakken wells that would have otherwise been drilled in 2015 no longer will be. What does the average Bakken well produce? The type curves in Continental’s and Whiting’s investor presentations state that IP’s are somewhere around 850 barrels per day. So calculating it out, that implies 850,000 barrels of oil that would have come into the market in 2015 from the Bakken no longer will.

While the D&C economics of all shale plays are different, they are also fairly similar in many regards. Thus, it wouldn’t be too hard to assume that the Eagle Ford, Permian, Niobrara and other oil-rich shale plays will suffer similar declines. So with budget cuts alone, it’s pretty easy to see how the amount of supply entering the market in 2015 from USA shale plays will be dramatically reduced compared to what everyone thought just 3 months ago.

But those are new wells you say…what about wells already in production? Well, this is where the current shale bust is somewhat unique (at least compared to other oil busts of the past). When the market was heavily supplied by conventional fields, the base decline rates of the ‘swing production base’ were in the 4% per year range. But shales are different. Look at the curve below.

Whiting Bakken

You’re seeing the type curve for a typical Bakken well drilled by Whiting. You’ll note the 850 BOPD initial production rate. But after just one year, that same well is only producing 275 BOPD; and after two years, production has dropped to around 150 BOPD. So if the industry dramatically cuts back on the drilling of Bakken wells, not only will we remove upwards of 1 million BOPD that would have come into the market, we’ll also be facing a situation where – depending on the age of the well – we’re probably removing 20% of the legacy production base every year. That’s going to amount to several hundred thousand barrels per day in each major shale basin.

As this process repeats in other shale basins across the U.S. (not to mention other development projects in conventional fields around the world), we’ll remove a significant amount of supply from the market and, I would assert, the market should come back into balance pretty quickly. With USA shales now serving as the world’s ‘swing producer,’ I would argue that this time, it really is different.  Unfortunately, like all these rides down have been in the past, it’s probably going to be a pretty bumpy ride with some white-knuckle moments along the way.