The rig count will plummet but production will be resilient
I have mentioned this many times, but I think it is an important point that is not being widely emphasized. The cost structure of the major onshore unconventional plays (Bakken, Eagleford, Permian plus all the less significant areas), will drop dramatically over the course of this year. The so called "breakeven" price for all these basins will decrease very substantially if the oil price stays low. Rig productivity has already been improving every month in every basin for the past several years, but this has mainly been due to improvements in technology and the experience level of operators. There will be several new reasons for efficiency improvements.
Operators will focus on their most economic prospects, rather than drilling for exploration, acreage retention or other more speculative activities. Chesapeake Energy, which had become financially overextended due to the aggressive acreage acquisition strategies of then-CEO Aubrey McClendon, pulled back on capex several years ago after a leadership change. They have shown remarkable improvements in efficiency as they cut capex levels, and I think these changes are illustrative of what is likely to happen industry-wide this year. The reasons for the improvements are various but they all are related to making capital spending choices that emphasize making an economic return on a well instead of prioritizing acreage retention, exploration etc. This leads to increases of multi-well pad-drilling in the core areas of a play, rather than testing out the perifery and drilling single-well pads to hold acreage.
From Cheseapeake Energy Investor Presentation:
After a dramatic cut to the capex budget well costs fell substantially in all regions.
The substantial increases in efficiency that Chesapeake made when they reduced capex will likely be seen industry wide in 2015. But the industry as a whole will have a second advantage in reducing costs that Chesapeake didn't have on its own.
Services costs will decrease due to overcapacity: Schlumberger said on their conference call that they would prefer to "stack equipment" than to give up too much on margins. Maybe, but then they should be prepared to give up market share, and that might disadvantage them for when the market comes back. Service costs are highly elastic, and they should fall dramatically. I don't know enough to be able to make any projections about the extent of this effect, but I would expect it to have a substantial impact on the overall economics of tight oil in the USA.
After the 2008 gas crash we saw rig count come down ~75% and production continue to increase. I don't necessarily think this will happen for oil. If the oil rig count falls by 75% I would expect production to plateau or decline modestly. One of the reasons that gas production was able to grow was that the most efficient gas play, the Marcellus, was just coming on at that time. As rigs left the Barnett, Fayetteville, and Haynesville shale drilling was accelerating in the Marcellus. Each rig there produced more gas than in the earlier plays. Secondly, shale gas drilling is much more efficient from a $/BTU standpoint than tight oil drilling. The best shale gas areas are highly profitable if they can sell their gas at $3/mmbtu, the energy equivalent to selling oil at about $18/bbl. The best tight oil areas are currently marginal at about $40/bbl or a bit under, though this number is likely to decrease.
Where is the consensus and how are my views different? I think the price of oil is likely to decline further from here before recovering. We may be in for a long period of serious volatility, in contrast to the relative stability in the market in the several year period leading up to this summer. It is not possible to make long term projections on price with any accuracy, but I think there is a conventional wisdom that a much higher price is necessary to ensure adequate supply. The "correct" long term price, for instance the 5 year average after supply and demand come back to equilibrium, might be only $60-70/bbl in 2015 dollars. $100 was too high- it created too much new production. It is true that much of today's high-cost oil has a higher break-even than that, but we are in the early innings of tight oil though. There are also big low-cost supplies that could come on the market from Iraq and Iran at some point. Either of these countries have the geological resources to increase production by 4 million b/d if the politics go the right way. Though even in an ideal political climate this would likely take half a decade at the least. While it is fun to guess, I must acknowledge that there is a wide range of possible outcomes, and in the end even a much more informed observer than I can only make an educated guess about how prices will behave over the course of this year.
I have mentioned this many times, but I think it is an important point that is not being widely emphasized. The cost structure of the major onshore unconventional plays (Bakken, Eagleford, Permian plus all the less significant areas), will drop dramatically over the course of this year. The so called "breakeven" price for all these basins will decrease very substantially if the oil price stays low. Rig productivity has already been improving every month in every basin for the past several years, but this has mainly been due to improvements in technology and the experience level of operators. There will be several new reasons for efficiency improvements.
Operators will focus on their most economic prospects, rather than drilling for exploration, acreage retention or other more speculative activities. Chesapeake Energy, which had become financially overextended due to the aggressive acreage acquisition strategies of then-CEO Aubrey McClendon, pulled back on capex several years ago after a leadership change. They have shown remarkable improvements in efficiency as they cut capex levels, and I think these changes are illustrative of what is likely to happen industry-wide this year. The reasons for the improvements are various but they all are related to making capital spending choices that emphasize making an economic return on a well instead of prioritizing acreage retention, exploration etc. This leads to increases of multi-well pad-drilling in the core areas of a play, rather than testing out the perifery and drilling single-well pads to hold acreage.
From Cheseapeake Energy Investor Presentation:
After a dramatic cut to the capex budget well costs fell substantially in all regions.
Services costs will decrease due to overcapacity: Schlumberger said on their conference call that they would prefer to "stack equipment" than to give up too much on margins. Maybe, but then they should be prepared to give up market share, and that might disadvantage them for when the market comes back. Service costs are highly elastic, and they should fall dramatically. I don't know enough to be able to make any projections about the extent of this effect, but I would expect it to have a substantial impact on the overall economics of tight oil in the USA.
After the 2008 gas crash we saw rig count come down ~75% and production continue to increase. I don't necessarily think this will happen for oil. If the oil rig count falls by 75% I would expect production to plateau or decline modestly. One of the reasons that gas production was able to grow was that the most efficient gas play, the Marcellus, was just coming on at that time. As rigs left the Barnett, Fayetteville, and Haynesville shale drilling was accelerating in the Marcellus. Each rig there produced more gas than in the earlier plays. Secondly, shale gas drilling is much more efficient from a $/BTU standpoint than tight oil drilling. The best shale gas areas are highly profitable if they can sell their gas at $3/mmbtu, the energy equivalent to selling oil at about $18/bbl. The best tight oil areas are currently marginal at about $40/bbl or a bit under, though this number is likely to decrease.
Where is the consensus and how are my views different? I think the price of oil is likely to decline further from here before recovering. We may be in for a long period of serious volatility, in contrast to the relative stability in the market in the several year period leading up to this summer. It is not possible to make long term projections on price with any accuracy, but I think there is a conventional wisdom that a much higher price is necessary to ensure adequate supply. The "correct" long term price, for instance the 5 year average after supply and demand come back to equilibrium, might be only $60-70/bbl in 2015 dollars. $100 was too high- it created too much new production. It is true that much of today's high-cost oil has a higher break-even than that, but we are in the early innings of tight oil though. There are also big low-cost supplies that could come on the market from Iraq and Iran at some point. Either of these countries have the geological resources to increase production by 4 million b/d if the politics go the right way. Though even in an ideal political climate this would likely take half a decade at the least. While it is fun to guess, I must acknowledge that there is a wide range of possible outcomes, and in the end even a much more informed observer than I can only make an educated guess about how prices will behave over the course of this year.
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