It Don’t Come Easy – Low Crude Prices, Producer Breakevens and Drilling Economics – Part 2

There was no open outcry trading on the CME NYMEX yesterday because of the MLK holiday but after rallying on Friday U.S. crude prices resumed their descent here in electronic trading and the London ICE Brent contract lost $1.40/Bbl to close at $48.77/Bbl. Unsurprisingly the Baker Hughes oil drilling rig count is down by 209 (13%) since December 2014 as producers take a hard look at their production budgets. Yet production is still expected to increase in the short term – in part because the rigs that are left will focus on “sweet spots”. In today’s blog “It Don’t Come Easy – Low Crude Prices, Producer Breakevens and Drilling Economics – Part 2” Sandy Fielden looks at the assumptions behind RBN’s IRR and breakeven scenario analysis.

In Episode 1 of this series we reviewed recent price carnage in crude, natural gas and natural gas liquids (NGL) markets. We noted that existing wells that are currently flowing will continue to produce – there is no value to shutting in output because of falling prices.  That is  because even at today’s prices, the per-unit revenues of existing wells are significantly above operating costs. In fact, production is likely to increase in the near term for at least four reasons: (a) Producers are cutting back drilling, but the rigs that are left are focused on their highest yield “sweet spots”, the best, largest producing opportunities.  The producer’s goal is to maximize revenue, and that means maximizing production volume.  (b) In recent years a number of leases signed by producers have HBP (held by production) clauses, requiring drilling and production to hold leases that were acquired at significant costs.  Some wells will be drilled and produced to hold these leases, regardless of short-term economics.  (c) Some producers were wise enough to hedge their prices, and will continue to drill and produce against those higher priced forward sales, and (d) producer economics will be improved by lower drilling services costs, which are coming down fast in response to lower drilling activity.

We also noted last time that for most producers – cash is king and the key metric they need to concentrate on when making new drilling investment decisions is the internal rate of return (IRR) for each well in different price scenarios. We ran that analysis across major U.S. shale basins to help you understand how producer breakevens and drilling economics have changed dramatically in the last six months. In this episode we explain the model inputs and outputs as well as the major assumptions behind our analysis.

To perform the analysis we used the RBN Production Economics model first introduced in the fall of 2013 as part of our blog series  “The Truth is Out There - Unconventional Production Economics”. Our internal rate of return (IRR) and breakeven analysis involves running the RBN model for about 200 well cases using input variables from a variety of company and analyst reports at different crude and natural gas price levels. We summarized results from these cases to arrive at typical IRR values for wells in each of the major U.S. shale basins in a range of pricing scenarios. We also calculated breakeven crude prices for both typical and sweet spot wells in each basin.