U.S. oil and gas output doesn’t reflect a decrease in drilling rigs
The U.S. energy market has seen a massive downturn over the last 30 months. From 1,900 onshore, active drilling rigs in mid 2014 to a near historic low of 410 onshore drilling rigs in spring 2016. Drilling rigs have declined by over 78%. Less drilling rigs should mean less production output, due to the nature of shale wells declining roughly 65-85% in their first year. Yet, as we follow U.S. crude oil and natural gas production we only see a decline of less than 10%. There are three main reasons for U.S. production to stay strong, even though we have lost many drilling rigs. How will this effect us in 2017 and beyond?
#1 Welcome to the “A” team
Exploration and production companies were forced to layoff drilling crews as oil prices started to decline. Everyone was paying close attention to productivity, speed, and cost of each drilling crew. The most mechanically sharp, efficient, and best equipped drilling rigs and crews were left operating in the downturn. That created the “A” team.
The speed and efficiency of these crews has pushed drilling operations to increase drastically. Based on drilling reports and rig movement, we calculated rigs to drill 2.25 times faster than in 2014. Even though we only have 800 drilling rigs as of today, we are drilling as if we had 1,600.
#2 The power of Engineering
The technology and engineering that takes place on a drilling location is complex, and stunning. For simplifying the drilling process, I’m going to focus on the importance of staying within a specified oil and gas formation “zone”. To get the most oil and gas out of a zone it is important to stay within specific parameters. The more the operator stays within a zone, the more oil and gas can be extracted.
We already know there is a significant decrease in drilling rigs, yet, the U.S. production is remaining strong (see chart above). Each well being drilled is staying in zone longer, which means more exposure to hydrocarbons, and a longer and more accurate lateral drilling leg. In addition, since the wells being drilled are in more proven areas, the engineers completing the wells have direct analogs of prior completions and their results to modify the fracks being deployed.
#3 History is key
Each well that is being drilled is providing engineers and geologists more data to their areas of interest. The more data is being extracted, the clearer the picture of what is below surface.
3-D seismic surveys are the acquisition, processing, and interpretation of data. By cross-referencing historical data, performing additional 3-D seismic shoots, reviewing core samples from wells, and overlapping all data, operators are generating a more transparent picture. In some situations, you will hear oil and gas professionals question how much oil they will extract, rather than if they will hit any.
Hot tips for Investors
Look at drilling companies knowing somewhere down the road that when oil prices decrease, you will see a reduction in drilling rigs, again. This is last in, first out (LIFO) applications.
Watch over-leveraged companies who are drilling because they are protecting their financial backing, by turning proved undeveloped reserves, and minerals into producing reserves. This results in four times increase in book value, and collateral.
Invest in shallow, vertical wells that are providing extremely high economics at recovery costs of lower than $10 per barrel equivalent.
Focus on non-shale, horizontal wells that can be profitable even when oil prices are down.
Oil prices are going to remain sub $55, and hit a low of $40 per barrel. The anticipation is we will see a nice rebound by 2020.
Be on the lookout for service companies within the next five years. A ramp-up in the energy industry will be a driving force for service companies to increase their bandwidth. Infill drilling and completion of thousands of drilled, and uncompleted
wells is going to play a factor.
Steel prices are up 35% in the last 60 days. Deeper drilled wells, will require more steel. This will increase the cost per barrel, and put downward pressure on the economics of a well.
Labor will rise as the industry needs to re-deploy workers. Focus on wells that don’t require a miniature city of people to drill the well.
Stay in areas where infrastructure is in place. Limit processing, transportation, and gathering cost to increase the economics.
Eckard Global and affiliates is going to drill shallow, vertical wells that are in areas that have infrastructure in place. We anticipate finding and drill another dozen wells in 2017, and continue a trend of 12-24 wells per year.
Each industry goes through cycles. We gather, analyze, and pivot according to our findings. The next three years look to have a significant upside in shallow well drilling. These wells can make a profit as oil prices are low. And when the well naturally declines in production, we anticipate oil prices to rebound, and provide an additional bump in the economic performance of a shallow well.
Drilling rigs set the pace of the industry. When we follow them, we can identify trends, and act on them.
Contact us for more details on how to approach the oil and gas industry as a private investor.