Tuesday, April 5, 2016

Oil: The Shale Bankruptcy Rout Looms

There was no fundamental reason for the shale companies to run when WTI made the big move off the ~$26 lows, the E&P's were (are) still losing money.
Here's the proxy we use for the group, the SPDR S&P Oil & Gas Exploration & Production ETF:

$22.97 on Feb. 24 to $31.68 on March 18; 38% in 23 days.
As the retail guys say: "And Mr. Bigg, if you annualize that!!!"

One quick note on philosophy: There is no need to call the bottom, it is better to be right than early.
Here's the headline story from OilPrice:

Bankruptcy Rout Looms Despite Impressive Productivity Gains In U.S. Shale
Horizontal fracturing of tight hydrocarbon-bearing formations was responsible for a phenomenal resurgence in U.S. oil production, which rose more than 4 million barrels per day from 2010 levels before peaking in April of last year.
Monthly U.S. field production of crude oil in thousands of barrels per day, Jan 1973 to Dec 2015. 
Data source: Monthly Energy Review.
Only 1/4 of the drilling rigs that were active in the U.S. shale oil producing counties in November 2014 were still on the job this February. Despite this massive cutback in capital spending, total U.S. crude oil production had fallen only 400,000 barrels a day (a 4.5 percent drop) as of December.
Number of active oil rigs in counties associated with the Permian, Eagle Ford, Bakken, and Niobrara plays, monthly Jan 2007 to Feb 2016. Data source: EIA Drilling Productivity Report.

The reason that U.S. oil production has not fallen more is remarkable efficiency gains. Occidental Petroleum described a series of measures they have taken that have reduced the time it takes to complete a well by up to 50 percent, which could enable it to drill the same number of wells each month using half the number of rigs. Other innovations are allowing much more oil to be produced from each completed well. Decker, Flaaen, and Tito (2016) note that the average new well in the Bakken produced 200 barrels/day in 2007. Last year the number was 400 b/d. However, it remains true as ever that production from an average new well will have fallen off by half within a year of operation.

Average Bakken well decline rates by year (production from the well n months after completion).  
Drillers have also been able to get deep cost discounts from the companies that sell to them as a result of the market bust. These along with the productivity gains have significantly lowered the price of oil at which the producers would be able to cover their costs (including capital costs). A survey by the Federal Reserve Bank of Kansas City asked operators (primarily working in the Niobrara Shale) what oil price would be needed in order for drilling to be profitable in their area. The median response was $60 a barrel, down significantly from the $79 estimate of a year earlier, but still far above current prices. Many analysts expect a third to a half of U.S. oil companies to file for bankruptcy in 2016.
Median response (red line) and range of responses (blue rectangles) to price needed for profitability.
The table below reports operating income for five of the most important companies in the shale oil boom, which, between them, produced almost a million barrels a day in 2014. Between them they lost $32 billion in 2015, a year when the average price of WTI was $49/barrel. So far in 2016 we’ve averaged $33/barrel....MORE