Shale Oil Outlook: Fundamentals And Permian Growth

Oct.23.13 | About: Pioneer Natural (PXD)

U.S. oil production is not going to vaporize any time soon as many depletion theorists argue. Could this be another faction of the peak oil theorists? Admittedly, there are many energy policy questions posed by the U.S. shale oil boom. From an economy and investor point of view, the outlook has many opportunities. Importantly, innovation in drilling technologies and efficiencies have played a key role in this unconventional energy play.

Acknowledging the unquenchable thirst for shale resources data, the U.S. Energy Information Agency (EIA) developed a new report called the Drilling Productivity Report (DPR). This is its attempt to capture more drilling productivity information over simpler rig count measures; misinformation about well depletion and the sustainability of shale resources abounds. A few highlights are offered:

  • Increases in drilling efficiency and new well productivity, over an increase in the number of active rigs, have been the main drivers of recent growth in U.S. oil and gas production.
  • The Bakken and Eagle Ford regions together account for about 75% of current monthly oil production growth across the six regions tracked in the DPR. Over the past year, production in these two regions increased by nearly 700,000 barrels per day. The Permian region, which remains the biggest absolute oil producer, grew by about 93,000 barrels per day from last year's production level.
  • The Marcellus alone accounted for about 75% of natural gas production growth in the six regions.

While this information confirms what many energy investors know - that the Bakken and Eagle Ford areas have been and are the main growth engines for U.S. oil production - it understates what is happening in the Permian Basin.

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The other nuance is at the firm level. The EIA's monthly additions are from "one average rig." In the Permian, for example, there is a lot of variation in the production coming from rigs, and therefore wells, based on location and the firm's acreage. All shales are not created equally. The other factor in the Permian is that a good deal of appraising, testing and "de-risking" acreage is very much occurring and production is yet to come online.

Notice the Permian Spraberry (bottom brown), Wolfcamp (dark brown) and Bonespring (blue) shale plays. Estimates for the Spraberry/Wolfcamp are that it is producing 450,000 boe per day, growing to 2.5 million in 20 years (See Pioneer (NYSE:PXD) earnings call transcript 5/02/13, referencing slide 10). That's the entirety of what is depicted here below. However, at a future date, the Eagle Ford and the Bakken will be at their more natural production rates, as opposed to the earlier ramp up stages as shown here.

Prices Matter

One can talk about production curves and depletion, but prices are the great moderator. Incentives are high to produce at $100 oil. What will make that price change, and therefore change the firms' production choices? There are several forces that can impact these trends. One is a reduction to oil demand, largely from expected higher growth areas like non-OECD (non-advanced) countries. India recently announced blending its gasoline with biofuels to cut down on oil imports. China is seeking to curtail its overheated and unsustainable growth rates. World economic slumps, like our post-crisis one, could reduce overall demand, and therefore price. This option appears the least likely in the immediate future. The other risk is oversupply. If oil producers believe it is in their best interests to leverage $100 oil, they may produce more. IHS calculates the impact of lower prices on production and still derives a 4.5 m/b/d forecast in 2035. In world markets, the truly able force in this scenario is OPEC.

From an earlier article on "How U.S. Oil Matters":

"Of OPEC producers, heavyweight Saudi Arabia controls the majority of the surplus capacity, which is expected to average 2.3 bbl/d in the second quarter of 2013. The group's fourth quarter capacity is expected to average 3.6 bbl/d, growing to 4.6 million in 2014. In 2004-2008-the reduced spare capacity of OPEC from a lack of timely capacity investment - was a major part of the story when prices rose to around $140, but Asia's demand growth also contributed to the tight-supply, high-demand picture. The supply-demand dynamics are more favorable than in earlier periods.

OPEC's secretary general Abdalla Salem el-Badri believes U.S. shale producers are "running out of sweet spots" and that production will peak in 2018. That is just four years away. These projections lack the impact of price, continued drilling efficiencies, innovation and proper Permian projections. The other factor is peak demand for oil. Fuel efficiency standards in both advanced and emerging countries will continue to rebalance the demand growth from non-advanced economies. Even China has new standards in effect in 2015.

Bigger Picture

The EIA data illustrate a clearer picture of U.S. oil production and trends. This table from the drilling report indicates that the Bakken leads in terms of new-well oil production, followed by the Eagle Ford and Niobrara. The Marcellus shale is the mega producer of natural gas to date.

Oil production in the U.S. appears on track for a reasonably steady multi-decade run. The risks to reduced production include an economic shock, too much production leading to reduced prices, an unknowable black swan event, or innovation. For example, in 2005, the peak of U.S. import dependence, the U.S. imported 12.549 million net petroleum imports per day (m/b/d), about 60% of the 20.8 m/b/d of U.S. demand. Current counts indicate U.S. oil production of 9.7 m/b/d, with the application of horizontal drilling driving a 34% increase in production. In the first half of 2013, demand was 18.655 m/b/d, a 12% drop from 2005 levels, and U.S. imports were approximately 36%, notes the Economist Intelligence Unit. This is oil and gas industry innovation.

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(See a larger Permian producer article, Apache (NYSE:APA). See article about small cap firm in the Permian, Concho Resources (CXO).)

Disclosure: I am long CXO. 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.