Producer rates of return are far below where they were a few months back, and the Baker Hughes crude rig count is down 553 since November. A third of pre-crash crude rigs are now idled. That means that crude oil production will be falling soon, right? Not necessarily. There are a number of factors working to keep production up, not the least of which is the rapidly declining cost for drilling and completion services. Today we examine the impact of these factors, review RBN’s crude oil production scenarios and consider what it all means for the long-term relationships between prices, returns and production volumes.
This blog builds on our analysis of production economics, productivity improvement and factors influencing producer behavior in several postings over the past few weeks. In It Don’t Come Easy Part 1, Part 2 and Part 3, we showed that with prices in the $50/bbl range, rates of return for most crude oil plays are breakeven at best. We made the point that there are a lot of assumptions imbedded in that analysis, including no change in current producer productivity and no change in drilling/completion costs from last year. We’ll get back to that one a little later. In Getting Better all the Time – Productivity Improvements, Crude Production and Moore’s Law we showed how much drilling productivity has improved over the past few years, and speculated that new rounds of improvement could be driven by producers doing what it takes to survive in a world with lower oil prices.
Impact of Lower Drilling and Completion Costs
Let’s now consider what lower drilling and completion costs mean for producer returns. In It Don’t Come Easy, we looked at what happened to rates of return as a result of the crash. In that posting we showed that back in the fall of 2014 when crude prices were in the $90/bbl range, most of the high-growth crude basins showed internal rates of return (IRRs) in the 40% range, but by January 2015 with crude oil at $45/bbl, those numbers were at low single digit or breakeven (0%) levels. As prices came up slightly in February 2015, the numbers got a bit better. Figure #1 below shows February numbers in the same format as the graphics we used in It Don’t Come Easy.
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About the song
All About That Base was written by Meghan Trainor and Kevin Kadish and released on June 30, 2014, on Trainor’s album titled Title (yes, that's confusing). The song received Grammy nominations for Record of the Year and Song of the Year. It topped the national charts of 58 countries internationally and as of December 2014, the song had sold over 6 million copies worldwide.
Comments
In reply to Production Forecast by Anne Keller
Producers are becoming much more efficient, deploying new technologies that increase IP and EUR while holding costs the same - thus reducing the per unit cost of production. So when today's good stuff is drilled up, there will be another wave of good stuff right behind it. That could go on for a very long time.
Rusty,
Your logic for the Base Oil Theory is intriguing. It occurs to me that if your scenario plays out, we will unwittingly replace Saudi Arabia as the world's swing producer. Considering our production rate is privately-controlled & price-driven (per your assertion) vs S.A.'s governmental control, it's inevitable that we would descend into the swing producer role. The Saudis seemingly grasped this fact when they declined to reduce production volume. Smart Guys!
Jvmiller68
Volumes have been written about OPEC's (read: Saudi's) decision for keeping production steady at the recent Nov 27th meeting...........speculation and conspiricy theories run the gamut from a desire to punish the US shale oil industry to the desire to punish Russia for their actions in Syria. I would suggest it's much more simple. Saudi does not want to be the world's swing producer anymore, they simply want to be baseload production.
In this scenario, US Shale becomes the world's swing producer. As you mention in your article, "If such a market dynamic has developed, the significance to world energy markets will be profound." One would expect that the world's New swing producer (US Shale) would react to market forces of supply/demand more quickly than OPEC has historically (no regularly scheduled meetings or emergency meeting required) and without political criterion as part of the decision making process.
This definitely could lead to the historical supply inelasticity of crude oil markets to be a thing of the past....at least for a while, as you have mentioned. Less supply inelasticity would lead to less overall price volitility and that would be beneficial to consumers, both in developed economies and certainly emerging economies.
If this sceanrio is correct, then the questions in my mind is are as follows:
1)What is the marginal cost of production of the ~ 94 million'th dialy bbl of crude produced if it originates from US Shale? This will be close to where we see prices stabilize.
2)How long will it take the mrkt to rebalance production and inventory and allow OPEC to convert from swing producer to baseload producer (ie. the first 30mm bbl/day producer)?
Answers:
1)Certainly it's higher than ~ $50/bbl WTI. That said, seasonality of demand will hurt inventories and prices near term and help in H2/2015. I think the term structure of the curve will simply steepen and we have probably seen the lows in the Dec 2015 contract. (Unfortunately, that won't necessarily mean that there will be outsized profits to be made from storing crude - as the cost of storage will jump as we become more full.)
2)At least the first half of 2015 and probably longer. Recall that during past extreme dislocations to the commodity price (whether supply led or demand led), budgets, permits and rig counts drop precipitously and quickly but production drops marginally and slowly. E&P companies do all they can to avoid severe production cuts as they know shareholders will punish them most severely for production-per-share declines and, their cost of capital will go up.
All-in-all, in a "crude oil manufacturing era" and the less volitile commodity price environment of the future (post the current rejigging of baseload and swing producers), and one in which we're less concerned about finding bbls and more concerned about engineering bbls out of the ground most effectively.......the low cost producer wins. The current share price declines and uncertainty in the commodity price environment have led to many investors being severely underweight the energy sector. Herein lies the opportunity.