If it really darkest before the dawn, it is getting pretty darn dark in America’s oil fields. But the many have predicted all along that this downturn will need to hit a hard bottom before there is any chance of a lasting upturn.
A new analysis published by Bloomberg indicates that we may be just about there. It looks at the decline in rig counts over the last five years. Take a look at the full report here. It is a moving image that compresses five years of rig counts into a few seconds. It shows very graphically how fast the drop has been, but it also shows that we still haven’t seen a comparable drop in production.
What does this mean? First, a disclaimer – This is by no means an expert analysis of the economics of oil and gas. However, there are a couple of things that jump out from these two graphs.
First, production may be looking over the edge of the cliff. Production always follows drilling more slowly on a drop than on a rise. Increased drilling equals high production relatively quickly, as soon as the new wells go on line. However, there is a time delay for production to follow a drop in drilling because the well output has to decline before it shows up as a production decrease. How much of a delay? By some estimates, annual average decline rates for the three top producing land plays in the U.S. are between 22% and 55%. However, first year decline rates are much steeper; a well in the Bakken may decline more than 70% in the first year. So, if the big drop in rig count hit in at the end of the first quarter of 2015, we may see some very steep declines in production from some regions within the next few months.
There are a few caveats to this however:
- Rigs are becoming more efficient, meaning a drop in rig count doesn’t equal a one-to-one decrease in new wells.
- The Bloomberg analysis appears to include offshore production, which skews the result. For example, Gulf production is actually expected to increase in the near term.
- This does not include drilled but uncompleted (DUC) wells. There were an estimated 4700 DUCs a year ago and the number has climbed. They could go on line relatively quickly if prices go up, bumping production.
Second, a decline in production could move the pain from the collapse of oil to some new sectors. Transportation may be punished by the decline. Right now rail, pipeline and trucking are seeing some shifting of routes for oil. A general production decline means less oil to move from every reservoir area. Some production services are still in demand as production stays high. A drop in production could be punishing to those companies.
The other key to this is what is happening around the world. We don’t know much about how different oil companies in different countries are managing their reserves. The race is on to produce as much as possible in an effort to keep the company solvent, but at what cost? Without proper management, a lot of the oil and gas may be unrecoverable, especially at low prices. That further exacerbates the drops in production for years to come.
Will a production decline re-balance the world supply and demand? We may not have to wait more than a few months to see some indications.