Thursday, February 12, 2015

Interesting Thoughts On the Oil Glut

A correspondent mentioned this poster on Investor Village who has some good thoughts about the oil glut.


1. The Saudis believe the new equilibrium is ~$80. Even if they're right, they have CLEARLY stated they will let prices go as low as necessary to drive out "bad behavior". They don't really care who cuts - Russia, deepwater, shale, etc. Just be sure of one thing: it won't be OPEC. Expect a bumpy ride.

2. Shale rewarded speed, not efficiency. You got rich by outbidding everyone else for land and rigs then drilling as fast as possible. You couldn't really overpay but you could easily miss out. It was not a cost-conscious environment, to put it mildly. Suppliers made a killing. Newly licensed Eagle Ford truck drivers could make 80k/year, 100k+ with some experience. Wages went so high in North Dakota Wal-Mart had to pay $18/hour. Costs for rigs, supplies and labor will drop. Don't put too much weight on historical break-even prices.

3. CLR and LPI both slashed capex but still forecast production growth for 2015. If this this is legit, and typical, prices may have to go lower before the cowboys yank hard on the reins. COP just cut capex 20% but still expects 3% growth (ex Libya). They seem to be maintaining Eagle Ford and Bakken capex while deferring elsewhere. [...]

5. Despite lots of bad behavior, shale is not an unsustainable Ponzi. 10,000 Eagle Ford wells pumped a billion bbls so far. Even at $60/bbl that's $60b of revenue, which roughly pays back the capex to drill the wells (10k * $6m/well = $60b). The 1m or so bpd still flowing is mostly gravy. It's not much different in the Bakken - 8000 wells have produced about 850m bbls so far. Bakken wells cost more ($8-10m), so perhaps the capex hasn't quite been returned yet, but at 1.2m bpd it won't take long. Both of these fields look pretty profitable at $60/bbl. Especially if drilling costs decline.
There's no question that production for calendar 2015 will be higher than production for calendar 2014. The contributing factors for this are:

1. Momentum from 2014 (despite talk of shale being the new swing producer, it can't start and stop on a dime primarily because of pad drilling),
2. Most companies have really strong hedges in place for 2015 that they can use to bolster their program (can spend more without increasing debt)
3. Capital efficiency will increase, primarily because companies will focus their programs on their best assets. And because costs will come down to rebalance with activity.

By mid-2015 into 2016, #1 and #2 will be gone. And the cost thing should pretty much be done. So you're down to the "best assets" thing, and at a point you've drilled that up as well.

And all of that ignores the changes that will be happening in the plays that aren't shales.

Read an interview with Rich Kinder this week and he says that the world-wide industry can't meet supply growth in the intermediate to long term at $45 or $50. His sense is that an equilibrium price is $65 to $75. I think he's pretty damn close with that opinion, maybe a smidge high on the price, maybe not.
The absolute level of crude oil stocks doesn't really matter, anyway. It's the trend. We see a sharp and unseasonable rise in crude oil stocks. We know steep contango makes hoarding profitable and we know hedgies are doing it. These are not "paper barrels", they are real barrels being pumped out of the ground and not consumed. Clear evidence of a supply/demand imbalance.

What makes this imbalance different than others? Two things. Saudi Arabia stepped away from their role as swing producer. For 25+ years they tweaked output in pursuit of price stability. Sometimes it took more than a tweak, such as the huge demand crash in late 2008 which drove OPEC to cut 3m bpd for a short while. But they always worked to moderate price moves. Until now.
A little over 6 years ago Haynesville had 250 rigs and 4 BCF/day. Today with only 50 rigs they are at 7 BCF/day. And growing.

Haynesville's post-crisis rig count peaked in early 2010, but the decline didn't really hit until July. Production at that time was 7 BCF/day. Production peaked at more than 10 BCF/day in late 2011, more than a year later, after rig count had fallen almost 50%.

Let me repeat: production grew ~45% while rig count plummeted 50%.

Even more shocking - production was still at 10 BCF/day in July/August of 2012 as rig count was bottoming at ~50. So rigs fell over 75% and production was still up over 40%.

Production did finally decline in earnest after mid-2012, but it never really dipped below the mid-2010 level. Oil is not gas and the Big 3 are not Haynesville, but it's still interesting. Also note Marcellus saw a quick 30% drop in rigs from late 2011 through mid-2012. Even with fewer rigs production kept climbing, and it continues to do so to this day.
At the current strip? No. I doubt a $60 forward price will drop rig count to 1000. Even if it does, as W notes the "slow" rigs get dropped first (you can clearly see this on page 3 as rig productivity shot up when rig count fell in 2009). So you only need half the rigs to get 75% of the new flow. Drop new flow to 75% of current levels and Bakken output holds steady (79k bpd depletion each month offset by 78k bpd of new flow). Eagle Ford falls a little each month (+119k - 133k = -14k bpd) but is offset by Permian rising (+81k - 67k = +14k bpd). Niobrara (-4k bpd) and the others are basically rounding errors. But you've got +200k bpd from GOM that's pretty much dialed in this year plus another 200k next year. I just don't foresee this big decline everyone's talking about.
How did we suddenly get to the point where millions of bbls can flow into huge storage tanks without driving spot prices up? Those aren't "paper barrels" sitting in giant tanks at Cushing. The oversupply is real. I know shale grew last year, but it grew several years before that, too. I know Chinese growth slowed, but it's still growth. This isn't 2008 when demand dropped 3m bpd virtually overnight and the oil started piling up. What the heck happened?

Some possibilities:
1. China has REALLY slowed and not told anyone
2. Saudis secretly increased output

3. Oversupply grew gradually but was hidden by Libya shutdown and other factors
4. Growing oversupply during 2014 hidden by supply chain holding bbls back "until OPEC cuts in 10/14"

1 comment:

whydibuy said...

This is nothing but a paralysis by analysis nonsense.
For being a astute oil investor, he seems to miss the elephant in the room. Namely how precise the balance is for supply and demand in oil. Just a few barrels either way make huge swings in pricing.
Whatever this babble says, the longer term view of oil is very bullish. Nobody would be fussing with shale and oil sands if the world was really awash in cheap, easy to get oil. It isn't.
For a really laughable analysis, read the EIA's forecast of the world demand growing to near 100 mmbopd in 2040 AND they surmise that production will match that demand. Where they think the world has hidden 3 or 4 new Saudi Arabias I don't know especially when they also conclude that 75% of OPEC countries have entered permanent declines in their oil production.
The U.S. , through intensive effort pushed its oil production from 5 mmbopd to 10 mmbopd. Take that 5 mmbopd away and see how complacent people would be about oil. And for all the talk about the U.S. becoming another S.A. , the sad truth is that all that shale oil is not materially increasing the estimated reserves of the U.S. The shale move may well be over in 5 years.