With crude oil prices falling to $40.80 Wednesday on the EIA report of higher crude stocks, the chorus questioning how long this downturn can last is rising in volume. At BTU Analytics we’ve done a significant amount of analysis on the economic sensitivity of the major plays, and we know that cash flow from current crude oil prices is insufficient to maintain current production levels, assuming that the cost of drilling the well factors into the decision. Good news, right? If prices aren’t at levels that support new drilling, drilling should stop and US oil production should finally roll over, the way everyone in the industry (and OPEC!) hopes it will. Unfortunately, it’s not quite that simple.
Prices are too low for producers to earn consistent, sustainable economic returns on new wells, but the hangover from 2014 drilling activity is only just beginning to be felt. We have been highlighting the anticipated impact of the large inventory of drilled but uncompleted (DUC) wells to our clients and in our energy market commentary for over six months now, including over 5,000 horizontal DUCs in the major oil producing basins alone. The fact that our bottoms-up production forecast of 90+ producing areas accounts for these DUCs has been one significant factor behind our calls on production and price we’ve steadfastly repeated throughout 2015. Our most recent production forecast featured in our August Upstream Outlook calls for US lower 48 production to decline by a modest 115 mb/d from the peak by the end of the 2015. What would it take for US lower 48 oil production to fall much more substantially, like 500 Mb/d by the end of the year?
Let’s just wish away that inventory of DUC wells to begin with. While this might seem completely obtuse, one could make the argument that a large number of producers might gamble on higher prices a few months from now, and hold off completions in hopes of prices significantly higher than today. (And at this point, $50/bbl crude is significantly higher, unfortunately). Using our production forecasting tool, we’ve ignored the impact of DUC inventory and forced the number of wells turned to sales for every month through the end of the year to the current drilling pace. Doing this, we lose an additional 115 mb/d of crude oil production by the end of the year, bringing the decline from peak to approximately 230 mb/d. But that decline is short-lived, as production reverses course in the first half of 2016 and ends the year flat to where the year began, all without factoring in any increase in activity.
And what about a scenario for those in the industry still predicting a V-shaped recovery? Well, let’s start by ignoring DUCs once again, and then factoring in another 25% decline in activity from today’s levels. Now we’ve found a way to decline production by 537 mb/d by the end of the year, and that decline is sustainable.
What’s the takeaway from the exercise of these scenarios? That counting on significant production declines in US crude oil production is a loser's bet. But a pause in US production growth should be enough to bring the global market back into balance in 2016.
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