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Falling Oil Prices Squeezing Onshore E&P Operators

It's only a "matter of weeks" before onshore operators begin laying down rigs in some U.S. oilfields, one industry observer told NGI on Tuesday. Onshore exploration and production (E&P) companies also are seeking price relief from oilfield service operators, according to one energy analyst.

Analysts with Tudor, Pickering, Holt & Co. (TPH), who have been keeping a close eye on the U.S. onshore, earlier this month estimated that as many as 160 horizontal and 30 vertical rigs could be drilling in marginally economic plays and would be among the first "rigs at risk" (see Shale DailyOct. 22). They identified the most vulnerable plays as the Tuscaloosa Marine Shale, the Permian Basin's Cleveland, Tonkawa and Marmaton formations; the Mississippian Lime, and fringe targets in the Eagle Ford and Bakken shales.

On Tuesday, they recited their macro model for 2015 oil growth model in the United States at 850,000-900,000 b/d. However, based on the 190 rigs that could be at risk, production impacted next year could total 215,000 b/d of oil, 500 MMcfe/d of natural gas and 52,000 b/d of liquids associated production.

Those are just numbers, but there is anecdotal evidence from the front lines. A native Oklahoma City cab driver who drives a few execs regularly who work downtown for E&Ps, said they tell him it's a "matter of weeks" before onshore oil companies start dropping rigs because of low prices. They say it's similar to 2008 when gas prices crashed but this time it's worse and they expect to see big layoffs at some companies.

It's going to impact the entire onshore industry, according to a few of his regulars. High debt load is worrying more than a few companies. There's not a lot of leeway for some of the smaller operators. His passengers are worrying the pullback could roil not only the Midcontinent, but it could also domino across the entire country.

The cab driver with his ear to the ground has taken his own measurements. He said he already could feel the impact of slower business in the energy town. He's been keeping track of flights and estimated that there were more than 120 flights a week coming into Oklahoma City in 2007 and into 2008 when gas prices were high. As gas prices plunged, flights into town fell to around 60 a week. Over the past three weeks or so, flights into town have fallen to about 70 a week from about 100 at the start of summer.

In public, some onshore E&Ps have discussed the higher costs of producing "better" wells -- that is, more fracture stimulation, more proppant, longer laterals all cost more money. Continental Resources Inc. executives in September disclosed that drilling and completions to enhance production in the Bakken Shale were costing a lot more to produce around 25% more oil per well (see Shale DailySept. 19).

TPH analysts have heard of some E&Ps beginning to ask for price relief from oilfield service companies, i.e., to share the pain of falling oil prices. Analysts on Tuesday cited letters from E&Ps and questioned whether they would be successful in pushing their pricing lower.

"For well supplied oil service product/service lines, ‘probably,’ is the answer," said the TPH analysts. "For tighter service lines, it's a function of customer buying power," such as how big a company is and whether the oil service company has a lot of exposure. It's also a question of the "duration of the oil price decline (the longer at this level, the better the success) and whether oil service companies feel the real threat of lower demand, which would in turn create the lower pricing environment anyway."

On Monday, Goldman Sachs cut price forecasts through 2015 for West Texas Intermediate (WTI) and Brent crudes (see Shale Daily, Oct. 27). Until now, a tight global oil market had required strong OPEC production and growth in the U.S. onshore, analysts said. However, they "now have higher confidence that a structural transition has been reached and that U.S. production growth needs to slow." Core OPEC producers also have lost their pricing power, moving toward the "marginal cost of U.S. shale oil production."

WTI was cut to $75/bbl for 1Q2015 and for the second half of 2015 from $90. Brent for the same periods was cut to $85/bbl from $100. For the second quarter of 2015, when global oversupply is expected to be the largest and prices the weakest, WTI is forecast to be $70, with Brent at $80.

Prices need to be low enough by early 2015 to force U.S. E&P companies to slow capital expenditures (capex), which they believe will occur at around $75/bbl WTI.

"Given our expectation that Saudis will not cut production meaningfully until they see evidence of a strong capex cut from the U.S. E&Ps, and given that such capex cut would not materialize in slower production growth for another six months, we estimate that global inventories will rise in the first half of 2015..." By the second half of next year, they expect domestic shale production to slow and core OPEC also to cut output.

"This would allow for global crude inventories to stabilize with the market back in balance in 2016 on the back of stronger demand and slower U.S. production growth," said the Goldman analysts. "As a result, we forecast that oil prices will stabilize at $90/bbl Brent prices (and $80/bbl WTI) in 2016."

Barclays Research analysts said in a note they are more optimistic about a more rapid recovery in oil prices in 2015. They revised their price forecasts downward on Tuesday for the first six months of 2015 by around $6.00/bbl, but they kept their original forecasts in place for the second half of next year the same on the expectation that lower prices would boost demand and OPEC would cut supplies lower than current levels.

For 1Q2015/2Q2015, Barclays cut WTI to $78/80 from $87/86; Brent to $88/92 from $95/92.

Barclays analysts said they believe prices have bottomed and should recover "modestly" in the final three months of 2014. They also think "U.S. tight oil producers will likely take a long-term view. Although lower WTI prices may dent production in the second half of next year, cost and efficiency improvements, company variability and producing basin infrastructure buildout mean the real effect is unlikely to be as uniform as a simple breakeven cost curve."

Following a "brief recovery" in prices in early 2015, the analysts expect oil prices to fall and then they anticipate a strong recovery.

"Given that long-term marginal costs in oil production are well over $100/bbl and that the weak prices of the past four months have already resulted in several project cancellations/postponements, it seems extremely unlikely that oil prices will remain below $100 for very long, especially as we expect to see a combination of several factors contributing to an improvement in global oil balances by the second half of 2015."

Meanwhile, Wood Mackenzie called the oil price decline "more a reaction to possible future weakness in oil demand rather than a sudden change in supply and demand fundamentals.” Short-term demand is lower than expected, but the longer-term outlook "remains positive," their latest analysis indicates.

"Current production in most areas of the world, including U.S. tight oil, is economic well below current oil prices and not likely to be shut in, except for a few unusual cases such as U.S. extra-heavy and stripper well production," said Wood Mackenzie's Ann-Louise Hittle, head of macro oil analysis.

At $70/bbl for WTI, consultants estimated that the U.S. tight oil sector would lose around $15 billion in cash flow for 2015, equal to a "relatively minor 150,000 b/d in lost production growth in 2015, if fully cut from drilling budgets." If prices were to fall below that threshold and remain there for most of the year, around 0.6 million b/d of tight oil supply growth would be under "serious threat" by the end of 2015.

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