In search of the marginal producer...

Based on the massive capex cuts we are seeing and the tight oil ("shale") decline rates, it is likely to be the US onshore production that peaks and starts to decline later this year.  There are big cuts to offshore producer's capex budgets as well, but because of the long timeframe for offshore, this won't effect short-term supply.   Tullow, an E&P speciallizing in Africa and offshore drilling, recently cut their capex from $1b in 2014 to $200mm for 2015.  The capex budgets from the majors should be interesting.  So far the large-cap E&Ps haven't anounced huge cuts.  Conoco cut only 20% vs last year when they announced in mid december.  Smaller companies have had much bigger cuts, for example Oasis (Bakken) cut 50% when they announced in December.  Denbury (CO2 flooding projects) cut 50% in November.  Continental (Bakken and mid-continent) cut 40% in December.  As I have said before though, I wouldn't be surprised to see production flattish even after huge capex cuts, since the least efficient operators and regions will bear the brunt, just as we saw with shale gas in 2008-2009.

I had always heard that oil sands needed $30 + oil to survive.  I can’t say precisely where I heard that, but it was the number in my mind when I went to look a few months ago at.  But the oil sands producers have held up remarkably well, and this Bloomberg article says they can keep going at as low as $10/bbl in some cases!  I had thought they had relatively modest capex cost per bbl (partly due to their very long production life) but then higher OPEX, which would make them prime candidates for shut ins.  This does not seem to be happening so far.  Very low natural gas prices might be helping too, since processing oil sands takes  plenty of energy.  The other thing is that the huge discount to WTI that the benchmark Western Canada Select (WCS) grade sees has closed from as much as $40 in 2013 down to close to $10 currently.  I don’t have access to great data here so I’ll have to apologize for the approximations.

One thing to think about: Consider that widespread use of horizontal drilling and hydraulic fracturing to extract tight oil has only commenced at-scale about 5 years ago.  Deepwater and ultradeepwater drilling has been around since the 1970s.  Efficiency in both is improving, but unconventional-onshore oil production is just in its infancy.  Recovery rates are still incredibly low, in the neighborhood of 5%, vs 50% or so for conventional oil projects (depending on a number of considerations).   As I’ve said many times before, I think it is very unreliable to make long term projections about so called break-even economics of unconventional oil.  People were saying $5.50 was a breakeven for shale gas back in ’08, yet here we are after 6 years of gas prices below $5 and production has consistently grown.  We have even heard of 100% irrs in the Marcellus with $3 gas (check out company presentations from Cabot or Range).

Could unconventional onshore improvements make ultra-deepwater offshore drilling obsolete?  This is not a prediction, but rather a question.  I don’t think it is inconceivable that further improvements in unconventional onshore, and its application to resource basins in other countries, permanently constrains the price of oil over the long term.  Deepwater started in developed countries in areas like the Gulf of Mexico (North Sea is mostly shallow), but has since moved to developing regions like Brazil and West Africa.  After many years, deepwater, and especially "ultra deepwater" is still at the high end of the cost curve.  Consider that 5 years after the first deepwater discovery, around 1975, deepwater was still in its infancy.  5 years after EOG first discovered the Bakken in 2006, tight-oil was in the midst of a massive industry-changing boom, attracting over $100b of capex annually in the USA alone (including lease acquisition, exploration, development etc).  Even this past year, we would occasionally see claims by E&P companies that they had improved recoveries by as much as 60% by changing their completion design.  These improvements would be due to changes like cementing their liners, increasing the amount of propant, increasing the number of frac stages, using plug and perf or coiled tubing fracs instead of sliding sleeve frac designs etc.   No one knows how cheap it will get, but like the oil sands or shale gas drilling, what starts on the very high end of the cost curve, is likely to become more economical over time.  Also, deepwater may always have BP-Horizon incident looming over it.  No one has ever gone out to drill an on-shore well only to end up with $50b in liabilities.