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U.S. Oil Takes A Licking; Production Keeps on Ticking

A plethora of prognosticators is suggesting that the current oil price downturn may stymie U.S. output growth for years, but onshore production is proving even more resilient than the models, Raymond James & Associates Inc. analysts said Monday.

Domestic drilling and completion efficiency gains over the past five years "mean that the U.S. does not need 1,200 rigs to maintain U.S. production; we don't even need 1,000 active U.S. rigs to maintain production," wrote analysts J. Marshall Adkins and John Freeman.

"Moderating decline rates across shale plays from the aging of the average barrel produced and new production increases from stout efficiency gains should lead to sequential U.S. oil production growth throughout most of 2016."

By 2017, drilling activity should double because of "modestly" higher oil prices, averaging about $70/bbl, while surging exploration and production cash flows should also jump by 50%, said the Raymond James team. That would lead to domestic crude oil output growth of almost 1 million b/d in 2017 and 1.8 million b/d in 2018.

U.S. producers have improved well economics enough that Raymond James analysts now predict that the country can increase oil production growth in 2018 by 500,000 b/d "more than 2014 grew with 250 fewer rigs!"

A lot of moving parts make up the global oil equation, noted Adkins and Freeman. Numerous deepwater and international long-lead oil projects have been shelved or canceled at oil prices below $70/bbl.

"Even though we think the U.S. can grow U.S. oil production 1.5-2.0 million b/d in an oil price environment below $70/bbl, the strong growth in global oil demand and the falling non-U.S., non-OPEC supply in 2017-2019 should leave the oil markets undersupplied in 2017-2018.

"Put another way, U.S. Lower 48 oil producers (and related service companies) will be the world's incremental oil producer for at least the next five years, even if oil prices are in the $60 to $70 range."

Raymond James' updated domestic oil production model now shows on a year/year basis that average 2015 production will grow 540,000 b/d, decline 204,000 b/d in 2016, then surge by 911,000 b/d in 2017 and 1.752 million b/d in 2018.

Most industry models don't incorporate type curves for historic production, instead opting for average decline rate assumptions within plays, Adkins noted. Energy Information Administration models, including the Drilling Productivity Report, "lump all producing wells into the same 'bucket,' treating a one-month-old well in its high decline phase like a three-year-old well within major plays."

Raymond James uses a production-by-play model to incorporate "dynamic type curves for each individual play," which means newly drilled versus legacy wells won't decline at equal rates. "By utilizing this approach, we can more clearly see how average field decline rates shift with time as production ages."

Meanwhile, Goldman Sachs analysts last week lowered their oil price outlook on surging output despite the decline in drilling. They cut their West Texas Intermediate six-month outlook to $40/bbl from $54. The one-year target now is $45/bbl versus $60.

Until now, the market focus was on the need for high-yield (HY) U.S. exploration and production (E&P) companies to potentially be forced close to bankruptcy, Goldman analysts said. However, to hit the required magnitude of a domestic production decline, reductions also have to be made by investment grade E&Ps, "whose production is three times larger" than the HY operators.

Goldman analysts "are increasingly convinced that the market needs to see lower oil prices for longer to achieve a production cut," but "the source of this production decline and its forcing mechanism is growing more uncertain, raising the possibility that we may ultimately clear at a sharply lower price, with cash costs around $20/bbl Brent prices, on our estimates."

Societe Generale last week also reduced its outlook for oil prices. Mike Wittner, global head of oil research, said the  oversupply should persist through 2016, with the stage set for a more balanced 2017.

Rebalancing U.S. shale oil production "is not shut-ins, but cuts in spending, drilling and new well completions," he said. "Steep decline rates will do the job." New wells begin to decline quickly within six months. After 12 months, output is down by 75%.

A backlog of roughly 4,000 drilled but uncompleted wells, or DUCs, "could mean faster production declines, but also faster production recoveries, as costs decrease/prices stabilize," said Wittner. "Prices may have overshot. But the decline also shows that the market is pricing in the 'lower for longer' logic...

"E&P companies look one to two years ahead when making investment and hedging plans, and decisions. 2016-2017 prices are key."

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