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Higher Oil Price Unlikely to Deplete Onshore DUC Backlog, Says Barclays

Even if U.S. oil prices were to strengthen this year and producers were compelled to work on their backlog of uncompleted onshore wells, it’s unlikely new production would overcome depleted inventories, based on an analysis by Barclays Capital.

Producers might be able to bring online 2,000-3,000 drilled but uncompleted wells, or DUCs, at an oil price of $40/bbl, according to a review by Barclays led by analyst Michael Cohen. But there are big reasons that likely won’t matter, he said.

“In addition to inventory levels and demand concerns, the market perceives that the U.S. well backlog will pose additional headwinds. We disagree that these wells will add substantial volumes of oil,” mostly because of worsening producer financial situations, cost inflation and labor constraints.

Up to 200 wells a month may be moved to sales under a $40 price scenario, which would have the ability to increase output by 600,000-650,000 b/d by the end of the year, according to data supplied by Rystad Energy that Cohen’s team used in its analysis.

However, the new domestic oil output would not be enough to “fill the entire production void that’s opening up from all this other supply that’s coming online,” Cohen said. “The market will be surprised that those incremental volumes are not as big as expected.”

Many may have forgotten that “U.S. shale is less than 5% of the entire market. Oil is declining in Canada, Russia and Brazil.”

Given that declining production already is underway in Western Siberia, Colombia’s heavy oil, Alberta and Saskatchewan, Brazil’s Campos Basin, and US conventional supply, “it should come as no surprise that shale, which represents just 5% of the global supply stack, will likely be called upon to grow strongly later this year.”

On its own, the excess well backlog “will not save U.S. oil production,” Cohen wrote. “Drilling activity must also increase. Roughly three months separates the end of drilling and the completion date, but excess DUC wells build up as drilling activity exceeds completion activity in a play.”

In the first half of 2015, rig contracts forced many producers to suspend completions, which grew the DUC backlog. In the second half of last year, even with an uptick in the rate of completions, which exceeded the rate of newly drilled wells, Lower 48 onshore production still fell 540,000 b/d from its April 2015 peak by the end of the year, he said.

If oil prices were to rise, Barclays is only forecasting about half of Rystad’s forecast 600,000 b/d would be able to ramp up in the U.S. onshore because of a dearth of completion crews. Industry layoffs have reduced capacity to bring online oil sales as quickly as producers might want even if prices were higher..

Besides, completing the DUCs because of higher prices actually would boomerang, snapping any price strength, and “until that perception is proven wrong, it’s going to cap rallies,” he said.

“There are other reasons rallies could be capped, like demand concerns and the overhang in inventories, but not DUCs,” he said. “It was a lumpy adjustment for shale production on the way down, and it’s going to be just as lumpy on the way back up.”

Barclays is forecasting oil prices to be capped “below $45/bbl” in the first half of 2016 “until more acute supply adjustments take place…”

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