Many prognosticators of oil and gas markets have found themselves on the wrong side of U.S. production calls throughout the shale era after failing to understand and model the risks associated with operational momentum. Increases in well productivity brought higher potential returns, and every company in the oil patch scrambled to gain the assets, people, and infrastructure to grow production (and hopefully cash) in the future. As supply growth outpaced demand, prices sank, but production hasn't responded with an equal intensity. Why doesn't production respond accordingly? The same reason you can't turn around an aircraft carrier on a dime, momentum.
The momentum of the shale boom can be seen in the large overhang of drilled but uncompleted wells (DUCs) sitting out in the field today, looming over the market and weighing on any potential oil price recovery.
We've been talking about DUCs for quite some time. (You can find our previous coverage here: "Will Oil Price Contango Defer Well Completions," "Eagle Ford Completions Standoff," and "Producers Bagging DUCs, Bearish for Pricing.") But today's question is this: How will these DUCs impact production and pricing in 2016, and when will their influence wane? Let's examine a single region and try to quantify what DUCs mean to the market.
The map below shows the location of DUCs in the Eagle Ford. One of the first questions we are often asked regarding DUCs is where they are located. Are they in the heart of the play or in acreage that never should have been developed? For this analysis, we mapped the location of the DUCs against our grid of wellhead breakevens across the entire play. While the breakevens are technically based on the costs to drill and complete a well, and don't tell us the crude price at which it makes sense to complete the well given the drilling cost is already sunk, they do help us answer the question -- is this real development or an investment that is likely to be abandoned?
Next, we aggregated the data by operator. The chart below shows the ten operators with the most DUCs as of the latest reported data. Not surprisingly, BHP (NYSE:BHP) and EOG Resources (NYSE:EOG) have the greatest percentage of DUCs in the most economic areas of the Eagle Ford. Some areas within the counties that we've designated as the Eagle Ford footprint didn't have adequate data for estimating breakevens, so DUCs in those areas are designated as 'unknown'. It's also interesting to note that there isn't a large percentage of wells in the $70+ areas among the top 10. Across the entire data set, the number of DUCs that falls into the $70+ and unknown categories is approximately 18%. The 10a operators listed account for approximately 45% of the DUCs in the Eagle Ford area.
Based on the exercise above, it seems reasonable to expect that most of the DUCs within the Eagle Ford footprint will eventually find their way to market. BTU Analytics expects a significant amount of DUCs to be completed throughout the year as producers look to maximize the efficiency of their investment dollars in a depressed commodity price environment.
Until the number of DUCs returns to levels more aligned with historical working inventory levels (three to six months of drilling), we expect their threat to loom large over the market and have a dampening effect on any near-term price recovery. But their longer term impact could loom just as large. If producers steer too much capital away from drilling, and instead harvest DUCs to maintain production and cash flow in 2016, the human capital behind the rig fleet could be lost to other industries, making service cost inflation all but guaranteed when U.S. supply growth is again needed. It looks like this hangover will be felt for years to come.
Disclosure: I/we 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. I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.