In late 2009 I started to invest heavily into North American oil producers with large land positions in unconventional tight and shale oil plays. I felt these companies had potential to turn these unappreciated tight oil resources into significant reserves and cash flow.
It is hard to believe today, but as recently as 2009 the unconventional oil boom was still pretty much unknown to many people outside of the North American energy industry. I was actually pretty early to the party.
That unconventional boom is a secret no more!
It is no secret because you just can't hide the almost 2 million barrels a day of production that the Bakken in North Dakota and the Eagle Ford in Texas have brought to North America.
This growth in oil production is great for the American economy. What people need to understand though is that these growth rates just can't continue for long.
I've been invested almost exclusively in these unconventional producers for four years and I feel like I've got a pretty good grasp on what we can expect going forward from these plays.
I'm not saying that production from the Bakken and Eagle Ford is going to roll over tomorrow and start declining. No, I believe that we can keep growing unconventional oil production in the United States through at least 2020.
What I believe though is that the rate of growth is going to slow significantly in the next couple of years and continue to slow thereafter.
I think the analysts predicting US oil independence and a glut of oil need to sit down and crunch some numbers.
What I think the overly optimistic projections are missing is the nature of an unconventional tight or shale oil well. After these unconventional wells come on production they produce at very high initial rates but then have their production rates decline very, very quickly.
The chart below shows a typical production profile for an unconventional oil well:
That big initial burst of flush production is what makes the well economic for the producer. The capital invested in the better tight oil wells is typically recovered in 12 to 18 months.
But the huge decline rates are what will make production growth from these tight oil plays slow down markedly in the next couple of years.
We have received an initial surge as each year we have drilled considerably more wells than the prior year.
But the surge in production we have experienced relates more to the increase in oil-directed drilling rigs (number of wells) than anything else. As the rig count flattens (as it has to) so does the number of new wells, which will mean that the rate of growth in oil production is going to decrease rapidly.
Production will keep growing, but at a much lower rate.
The fact is that production growth has to slow unless we can massively increase the number of wells drilled each and every year.
Let me provide a very simple example where we have only one drilling rig drilling wells in an unconventional oil resource play. We will assume that the rig drills only one well per year.
This example translates very well to what is going on now in the North Dakota Bakken where the number of new wells each year is leveling off.
Year One - We go from production of zero to an average of 100 barrels per day (the first year average production from an unconventional well. Production growth in year one is 100 barrels per day
Year Two - We have production from the second well drilled (100 barrels per day) plus production from the well, which was drilled in year one (which averages 50 barrels per day in year two) for a total of 150 barrels per day of production in year two. Production growth in year two is 50 barrels a day (150 barrels per day in year two vs. 100 barrels per day in year three).
Year Three - In year three we have another new well (100 barrels per day), plus the second year for the second well (50 barrels per day) and the third year for the first well (which is down to 35 barrels per day). Production growth in year three is 35 barrels per day (185 barrels per day in year three vs 150 barrels per day in year two).
Production keeps growing every year as we add wells, but the rate of production drops pretty dramatically. If the rig count and number of wells does not increase, the amount that production increases each year will drop rather dramatically pretty quickly.
Don't believe me? I don't blame you.
David Demshur - Chairman, President, Chief Executive Officer
Yeah, as we will see over the next couple of quarters, we will need every drop to maintain production levels of where we're at. If you just do a little bit of work in the Bakken, we added in the year 2011 196,000 barrels a day to production, and then we added another 234,000 barrels of production in 2012. If we are to keep pace with that level of production in the Bakken increase, we would need to add somewhere near 4,000 producing wells in the year 2013. The most we've ever added was 1,722 wells last year. Through April of this year, we've added 570 producers in the Bakken and they've added 22,703 barrels of oil, so you can see there that the decline curve never sleeps and the decline curve always wins. So it becomes more difficult, and that's just really an example of what we will see happen in the Eagle Ford and Niobrara as well.
Across the globe we have always been fighting the decline rates of conventional oil fields. In order to grow production we need to first offset the natural declines in production and then on top of that add incremental production.
That fight grows almost exponentially harder with unconventional wells that lose 70% of their production after one year.
The unconventional boom in oil production happened because we went from virtually no capital being directed at these plays and no wells being drilled to billions of dollars of capital and thousands of wells.
That initial surge can't be repeated unless we can somehow drill twice as many wells each and every year. And that is just physically and financially impossible.
The unconventional boom is a real, but we must realize that the rate of growth is about to slow very quickly in the near future. I expect that slowing of growth to appear first in the Bakken over the next 18 months and then in the Eagle Ford.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.