Shale Output Is Falling Faster Than Expected
Shale drillers will see production drop sooner than expected under a U.S. government forecast, a momentum change that hints at an eventual price rally.
Just five months after Saudi Arabia put the market into a tailspin by refusing to cut supply despite a global glut, the shale oil industry will record its first monthly dip since U.S. officials began weighing output in 2013.
The projected production drop is small, just 1 percent. Yet investors took note, pushing oilfield stocks to the top five spots in the Standard & Poor’s 500 Index on Tuesday, led by rig operators Ensco Plc and Diamond Offshore Drilling Inc. The decline lags the idling of rigs because of a backlog of already-drilled wells that have gradually been coming online.
“OPEC’s plan is playing out and price is correcting the oversupply,” said Michael Scialla, an analyst at Stifel Nicolaus & Co. in Denver, in a telephone interview.
West Texas Intermediate crude, the U.S. benchmark, climbed 3 percent to $53.47 a barrel at 2:03 p.m. in New York, extending the rising streak to a fourth trading session.
Shale fields make up about half of total U.S. production, which will continue growing this year and next, rising to 10.3 million barrels a day in 2025, according to a new longterm forecast by the Energy Department Tuesday.
Crude lost almost 60 percent of its value since late June, making some shale fields unprofitable to develop and forcing companies to cut back exploration prospects. Oil explorers were forced to shut down more than half the rigs drilling for crude in the U.S. since the Saudi statement in November, and canceled expansion plans to conserve cash.
“The question on everyone’s mind was would we see it in the second or third quarter, and I’m not surprised it’s happening in the earlier part of that range,” said David Pitts, chief financial officer at Houston-based producer Carrizo Oil & Gas Inc.
Wells extracting oil from dense shale rock experience “hyperbolic decline rates,” Pitts said by telephone.
Comstock Resources Inc. halted all crude drilling at the start of the year and expects the oil production decline to begin in its third-and fourth-quarter results, said Gary Guyton, the Frisco, Texas-based company’s director of planning.
“Shale is a treadmill, so if you’re not drilling, you’re not producing,” Guyton said in a telephone interview. Overall, the production decline “might not be hugely significant but at least it won’t be growing.”
The flexibility to ramp operations up and down quickly makes shale fields especially attractive to oil companies coping with volatile fluctuations in world oil markets, said ConocoPhillips CEO Ryan Lance last week in an interview at Bloomberg headquarters in New York.
“We think we’re going into a world that’s going to be characterized by lower, gradually rising prices, but a lot of volatility,” Lance said. “When you have that volatility, what you want is the ability to be flexible and resilient and be able to flex your programs up and down.”
Shale producers such as EOG Resources Inc. have been predicting U.S. output would decline by the end of the year. In February, the Houston-based company said its own production would reach a nadir during the second and third quarters.
Lance said he expected U.S. output to fall in the second half of the year, helping prices to recover to as high as $80 a barrel in the next three years.
“There is a supply response happening. You don’t see it in the first half of the year because of the investments that we made over the last two years,” he said. “The reductions in capital that the industry has made are substantial. That’s going to start to materialize in the back half of this year.”
Saudi Arabia, the dominant member of the Organization of Petroleum Exporting Countries, squelched efforts by some in the cartel to curb output in November, accelerating a fall in oil prices prompted by oversupplies. Saudi crude has been displaced from some U.S. markets as the flood of domestic shale oil offered refiners a cheaper alternative.
The five major U.S. shale oil regions will pump an average of 5.561 million barrels a day in May, down from this month’s estimated 5.618 million, the Energy Department said in a report released Monday.
The Niobrara formation northeast of Denver will lead the decline with a 3.3 percent drop, according to the Energy Department in Washington.
In the Niobrara formation, which lies beneath northeast Colorado and the edges of Kansas and Wyoming, the production fall-off will be sharper than in other regions because explorers were quicker to idle rigs, said Andrew Cosgrove, an analyst at Bloomberg Intelligence. Compared to other shale-oil areas, individual wells in the Niobrara don’t produce as much crude, reducing profitability, he said.
The two biggest operators in the Niobrara — Anadarko Petroleum Corp. and Noble Energy Inc. — have been slowing activity and deferring work, according to Scialla, the Stifel Nicolaus analyst.
Only one of the primary producers in the formation — Denver-based PDC Energy Inc. — hasn’t slowed down, and that’s because they locked in cash flow prior to the oil market’s crash with financial instruments called hedges, Scialla said in a telephone interview.
“The Niobrara wells are cheaper and shallower than in the other shale plays but they’re not as prolific either,” he said. “They cost about half as much as a typical well in the Eagle Ford or the Bakken but they also only produce about half as much.”
After the Niobrara, the Eagle Ford shale in Texas and the Bakken formation in North Dakota will register the next biggest month-over-month production declines in May, with 1.9 percent and 1.7 percent, respectively.
In the other two major U.S. shale oil regions — the Permian in Texas and the Utica in Ohio — output is expected to rise in May, the Energy Department said.
Explorers will be cautious about resuming their old pace of drilling out of fear that rising production would deflate prices again, Carrizo’s Pitts said.
“There would have to be a pretty significant bump up in prices for people to start picking up rigs again,” Pitts said.
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