In a perfect Goldilocks world there would be a perfect price; not too hot ($80 per bbl), not too cold ($40 per bbl) but just right ($60 per bbl). We all know that forecasting price is a fool’s game and most prognostications become obsolete the moment they are written. Why? Because the production of oil and gas does not operate in an unfettered universe where instantaneous production and demand are in sync. Part of the reason for is because of varying project timelines from long lead times (offshore, oil sands) to short timelines (shale oil). Overriding basic fundamentals, we have other factors in the mix including sovereign objectives (OPEC and now Russia in concert with the Saudi’s), terrorism and geo-political risk (often ignored until supplies are short) and finally financial engineering (hedging) by producers and banks.
Let me begin the discussion by saying that the market is always right and reflects the reality and sentiment of supply and demand today. As we saw in 2014 (remember all those juicy hedges that kept drilling going in 2015) and more recently in the price rise from the high $40’s in July to the low sixties today (those $50 hedges aren’t looking to good now, although it’s too early to tell) the market usually takes us all by surprise.
To say we are at a critical pivot point is an understatement. Since 2014 there have been three era’s. The first of course occurred in 2014 when prices collapsed due to OPEC’s decision to produce flat out to kill US shale and the resultant swelling of oil in storage. The second era, which we are still in, is the OPEC cut era, which by the way is working as prices have risen and storage volumes have dropped precipitously.
The third era is OPEC and Russia’s policies and actions in response to the resurgence of US shale production. Opec and Russia will not adopt future strategies that will result in a repeat of the 2014 debacle as they are sophisticated rationale actors. Why? The economics of constraint are compelling. The first option they have is to turn on 1.8 million bpd and return to $40 oil or second, negotiate a tapering to hold prices around $65 per barrel.
Do the math. thirty-two and half million bbl per day at $65 dollars is $2.1 billion per day, whereas thirty-four point three million bbl per day at $40 is $1.37 billion per day. The net is $740.5 million per day. Russia’s 11 million bbl per day, gives us a huge incentive to work with OPEC, especially given strengthening economic ties between Russia and Saudi Arabia. As much as we would like to believe otherwise and at times despise, Putin (or those that advise him) is shrewdly strategic.
I read recently that the EIA predicted US shale to grow by 1.8 million bpd by the end of 2019. As almost all recent production growth has taken place in the Permian, I looked at two Permian development scenarios using the production and decline data used in the January 2018 drilling productivity report. I ran two un-risked cases, a 410-rig case to drill 49,200 wells over ten years (I also projected out vintage and new wells out to 25 years) and a 500-rig case to drill the same number of wells over 98 months.
The results, as I suspected, indicate that monthly and annual production growth rates slow as the number of older wells grows each month. The “un-risked peak” occurs over a much longer timeframe than “straighlineology” would have us believe and is far smaller than simply growing monthly increases month over month at a constant rate. The reason of course is that the monthly rate of increase gradually diminishes as basin wide aggregate declines grow over time. In lay terms this means that the bigger the production base, the harder you have to work to grow. Eventually as you run out of prime locations eventually all you are doing is drilling to keep production flat. This may be the case in the Eagleford and perhaps the Bakken where the tier 1, tier 2 and tier 3 regions are well established.
In the 410-rig case, production is forecast to grow in month one at a rate of 87,000 bbl per day per month. To illustrate the effect of an aging play, after ten years you are only adding 9,000 bbl per day per month! In this scenario, after the 120-month drilling campaign is completed, production peaks at 5.3 million bbl per day after ten years. Haha you say, it can still grow! Well not so fast. At an increase of 9,000 bbl per day per month it would take another 22 months and 9,100 wells.
Under the 500-rig case, the drilling campaign was completed in 98 months with a peak rate of 5.8 million bbl per day. As was seen in the 410-rig case, monthly increases also diminish over time from an initial growth rate of 114,000 bbl per day per month to 14,000 bbl per day per month after 98 months. In both cases, including vintage Permian production, a total of 27.2 billion barrels of was produced, less wells reaching economic limits.
The EIA drilling productivity reports indicate that US Shale is declining at over 300,000 barrels per day per month. At the current rate of 2,800,000 bbl per day, the Permian needs 225 rigs running each month just to offset declines. I estimate that another 150-175 wells are needed in the other basins just to maintain production.
As I mentioned above, this analysis was based on zero risk. It’s a scientific stretch to assume that the basin has 50,000 remaining locations of similar quality. Of course, there will be some high-quality areas found, but the likelihood is that the play will evolve into a wet gas play with progressively less liquids and higher gas rates as producers reach out from the sweet spots.
As to the EIA estimate of 1.8 million barrels per day of growth, it could very well happen as activity ramps up with higher prices, but I remain somewhat skeptical on Permian growth based on Texas Railroad commission data showing the Permian only grew by 73,376 barrels per day from May 2017 to the end of September 2017 (from 1,559,014 to 1,632,390 barrels per day). Even if you throw in another 250,000 to the end of the year in Texas and another 650,000 from New Mexico, we are probably shy of 2,800,000 bbl per day.
2018 will be an interesting year for all of us. I’m sure OPEC is watching this very carefully and will act accordingly. Only time will tell where peak US shale oil production rates will land and will ultimately be determined by the size of sweet spots. Based on resurgent Permian success peak US shale production could top 7.5 million bpd.
I’ll leave with one final thought, and its that its far harder to grow when you are big.
Randy Evanchuk, P. Eng., has 35 years of experience in the patch. From 2007 until he retired in 2015, Mr. Evanchuk was involved in all phases of of unconventional resource development including;evaluation, economics, production and facilities. As as senior consultant with Murphy’s Holdings, he evaluated their Montney holding as well was as a member of evaluation team. Mr. Evanchuk was the Vice President of new ventures at Daylight Energy where his team was successful in acquiring a substantial Duvernay position. At Seven Generations Energy he was Executive Vice President looking after facilities, marketing, production operations and long range facility and marketing planning