Well productivity in the Lower 48 jumped in 2018, but output last year appeared to slide, implying the decline curve may be steepening relative to years’ past, according to Raymond James & Associates Inc.
The analyst team held its 18th annual dinner in Houston last week at NAPE, the North American Prospects Expo, and anonymously surveyed nearly 200 oil and gas executives about prices, production and drilling trends.
NAPE draws exploration and production (E&P), oilfield services, midstream and alternative technology executives, as well as institutional investors, to network and make deals. Most of the Raymond James dinner guests were from E&Ps or E&P-related private equity firms.
“When it comes to E&P, our survey results suggest that sentiment among private E&Ps and private equity investors is shifting increasingly negative on well productivity gains after a tough 2019,” the analysts led by John Freeman said.
Following a 15% surge in 2018 in initial production (IP) rates over 30 days (IP-30), most participants in the NAPE survey conducted last year “expected another banner year in 2019, with 70% of respondents expecting at least a 5% gain, including a third which expected over a 10% increase,” analysts said.
However, through 11 months of 2019, the data suggests the average new well in 2019 produced 3% more oil on an IP-30 basis, but slightly less oil on an IP-90 basis.
“Chasing higher and higher IP-30s is meaningless if by the end of 90 days you've actually produced less oil...In fact, this actually implies that the decline curve is steepening relative to years’ past.”
Many factors affect well productivity and declines, including the quality of the rocks and lateral lengths. The Raymond James team said the lower IP-90 profiles may be indicative of horizontal well spacing that is too narrow and an increase in parent-child interference, which lowers expected production as a well matures.
“Put another way, the average decline curve is becoming steeper than we thought because the wells are interfering more than previously thought,” analysts said.
Several E&Ps last year were adjusting their spacing to minimize interference, which has become something of a “foregone conclusion” as the industry shifts into development mode. Around one-half of all Permian Basin activity now uses pads with five wells or more.
“When we asked participants the primary driver for well productivity declines, as anticipated parent/child interference was the most important, garnering 35% of the vote (up from 28% that cited it last year),” analysts said.
“Interestingly, worse rock quality saw the biggest delta between the two years, moving from last place a year ago with 6% in 2019 all the way to second with 20%. This result reflects concerns that the United States is running out of top tier well locations in the premier basins/zones, given operators naturally have focused on tier-one inventory since the downturn” from late 2014-2016.
The industry's cost structure has dropped on the shift to development mode, so even with flat-to-declining productivity, the industry remains “wildly more profitable than before, as evidenced by the fact that the industry generated free cash flow last year for the first time since the shale revolution began.”
Still, the emphasis on returns and free cash flow has created a “pessimistic (or optimistic depending on your perspective) outlook for service costs, with activity unlikely to return absent a sustained rally in crude,” according to the survey.
Also on the radar for E&Ps is the environmental, social and governance, or ESG, movement, which has become of increasing importance to the industry, with 90% of respondents noting it has impacted their businesses.
Energy executives are somewhat bullish on global oil and the futures markets, but they expect the natural gas market to get no love this year, the annual survey found.
“The mood throughout the room appeared cautiously upbeat, but the coronavirus has many thinking they may need to wait until 2021 for the group to gain momentum. In sum, the industry seems to be more bullish on oil than the futures markets, although not nearly as bullish as we are over the next year.
“On the other hand, the respondents (like us and the futures market) do not expect to see U.S. natural gas prices greater than $2.50/MMBtu this year.”
In the survey results, “the $1.50-2.00/MMBtu range received the most votes” as to where gas prices may exit 2020, with the median near the upper end of that range. “Interestingly, this is even lower than today's futures strip, which is averaging about $2.05/MMBtu for this year.”
For oil, about half of those surveyed expect crude to exit 2020 in a range of $50/bbl to $60, with the median forecast in the upper $50s. This would be above the current futures market at $50/bbl, but well below the Raymond James estimate of $73.
At the annual Raymond James dinner at NAPE last year, participants said they expected oil prices would exit 2019 around $62/bbl, which was “extremely close” to the actual $61.
“Overall, despite all the near-term uncertainties, we continue to see a rapidly increasing number of energy participants shifting their business models toward sustainable free cash flow and creating businesses that can thrive even during periods of weaker commodity prices.”
Even with the growth in renewables, the survey participants said they believe peak global crude demand is still decades away.
“One of the most important concerns we hear from investors relates to the uncertainty regarding when global oil demand will peak,” the Raymond James team said. “Our view is that peak oil demand is still a ways off, and...most of the survey participants seem to agree.”
Trends like electric vehicles (EV) are having an impact on oil demand, but consumer appetite remains limited, only accounting for 2.5% of global auto sales and less than 1% of vehicles now on the road.
“As we move further into the 2020s, those numbers are likely to grow, but even if we assume 35%-plus annual growth in EV sales until 2025 we still believe that demand can grow as much as 1 million b/d that year, driven by continuing economic growth in Asia and Africa.”