The 'Lower For Longer' Oil Price Horizon Has Just Receded

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Includes: OIL, USO
by: Stephen Rhodes

Summary

The EIA revised its estimates of legacy decline rates in the February edition of its Drilling Productivity Report.

The 15% lower decline rates yield higher levels of production in the Permian, Eagle Ford, Niobrara and Bakken basins, and by implication in other shale plays in the lower 48.

These higher production rates push balanced crude oil inventories out to the Spring of 2017.

Significant storage issues well develop over the next few months unless production levels are substantially reduced.

Two headlines attracted the attention of (NYSEARCA:USO) holders this week, contributing to another fall in oil prices: the IEA revelation that the worldwide production surplus estimated last month at 1.5 million Bpd is more likely 1.75 Bpd, and delivery problems in Cushing. That crude blending has been impaired by a lack of available tank capacity in Cushing means that working storage capacity is actually lower than previously assumed, prompting Goldman Sachs to resurrect a $20 WTI scenario. A third issue has attracted less notice, namely a change in estimated legacy decline rates in the EIA's February Drilling Productivity Report. Here is the note included with the report regarding the change:

NOTE:
The procedure for estimating legacy production changes has been revised, beginning with this February 2016 release of the DPR, to enable earlier detection of inflection points. In the past, a trend line was used to project changes in legacy production. Because a trend line will detect inflection points relatively late, we have adopted changes that will show the inflection points several months earlier. These changes will be described in the methodology document next month.

EIA does not say what the changes in methodology are, saving that for the next report. We can measure the impact of the changes, though, by comparing legacy decline rates for January with those in the February report. Here is what we find for the four major oil producing basins (Bakken, Niobrara, Eagle Ford, and Permian):

Revised Legacy Decline Rates, Bpd

 

4 Basin

4 Basin

 

Month

January

February

Delta

Sep-15

(329,770)

(321,201)

8,569

Oct-15

(331,449)

(317,411)

14,038

Nov-15

(332,804)

(312,921)

19,882

Dec-15

(333,614)

(304,670)

28,944

Jan-16

(333,891)

(298,582)

35,308

Feb-16

(333,617)

(292,419)

41,197

Click to enlarge

Table by Author, Data from EIA

The EIA made adjustments to the months prior to September 15, but those only averaged 800 Bpd per month going back to January 07. Another oddity found in comparing the two reports is the revision to production for the combined basins. Here is what we find:

Revised Daily Production, BPD

 

4 Basin

4 Basin

 

Month

January

February

Delta

Sep-15

5,112,782

5,126,847

14,065

Oct-15

5,045,137

5,098,590

53,453

Nov-15

4,966,488

5,042,787

76,299

Dec-15

4,871,273

4,978,541

107,267

Jan-16

4,767,320

4,911,525

144,204

Feb-16

4,653,536

4,840,325

186,789

Click to enlarge

Table by Author, Data from EIA

As with the legacy decline rates, data back to January 07 was revised, which is normal with each report. The revisions prior to September, however, averaged only 700 Bpd. Further, although rig counts were the same and rig productivity changes were negligible, production increases far exceed those that can be attributed to legacy decline changes alone. Clearly something went awry with the methodology changes the EIA undertook in September that resulted in significant under reporting of production in the 4 Basins.

Since the EIA has not revised the total field production or inventory as detailed in its Weekly Status Petroleum Report, the higher 4 Basin production is merely a shift from other production areas in the lower 48 states. However, the reduced legacy decline rates do impact estimated production going forward.

In January I presented an article discussing the impact of DUC completions on projected crude inventory. It concluded that US inventory would not return to a normal 23 days until the end of 2016, assuming constant imports and 2% annual demand growth. The assumptions that went into that projection are presented below:

BASIN

Bakken

Eagle Ford

Niobrara

Permian

Combined February

Combined

December

Rigs, Feb 16

44

79

25

200

348

 

Rig Productivity Bbl/mo

712

785

694

412

573

638

Mo Rate of Change, %

1.0

1.3

2.4

0.9

1.5

1.2

Monthly Decline Rate, %

5.6

11.0

11.0

4.1

7.0

6.3

December 15 MB/d

1,141

1,292

415

2,023

-

4,871

December 16 MB/d

881

790

251

2,077

-

3,999

Click to enlarge

Table by author, data by EIR

The resultant production and inventory levels were as follows:

 

+DUC

Net

Not

Total

Refinery

   

Month

Mbpd

Crd Imp

Accounted

Available

Input

US Inv

DOI

Oct-15

9,127

6,649

420

16,196

15,485

482,810

31.2

Nov-15

9,184

6,882

470

16,536

16,300

489,424

30.0

Dec-15

9,188

7,334

(119)

16,403

16,606

482,324

29.0

Jan-16

9,203

6,955

257

16,415

15,916

497,768

31.3

Feb-16

9,149

6,955

257

16,361

15,647

518,463

33.1

Mar-16

9,098

6,955

257

16,309

15,808

533,992

33.8

Apr-16

9,037

6,955

257

16,249

16,377

530,150

32.4

May-16

8,985

6,955

257

16,196

16,603

517,562

31.2

Jun-16

8,939

6,955

257

16,151

16,810

497,801

29.6

Jul-16

8,800

6,955

257

16,012

17,162

462,146

26.9

Aug-16

8,681

6,955

257

15,893

17,047

426,365

25.0

Sep-16

8,566

6,955

257

15,778

16,521

404,072

24.5

Oct-16

8,489

6,955

257

15,701

15,794

401,184

25.4

Nov-16

8,416

6,955

257

15,628

16,625

371,250

22.3

Dec-16

8,364

6,955

257

15,576

16,938

329,027

19.4

Click to enlarge

Table by author, data from EIA

Let us see how these numbers are affected by the revised legacy decline, using the latest rig and productivity estimates.

Production Assumptions based on February Drilling Productivity Report

BASIN

Bakken

Eagle Ford

Niobrara

Permian

Combined February

Combined December

Rigs, Feb 16

42

69

27

181

319

 

Rig Productivity Bbl/mo

735

804

729

421

577

629

Mo Rate of Change, %

0.9

1.2

1.7

0.6

1.4

1.0

Monthly Decline Rate, %

5.20

8.64

8.61

4.09

5.95

5.71

December 15 MB/d

1,159

1,370

430

2,021

-

4,978

December 16 MB/d

918

929

319

2,003

-

4,169

Click to enlarge

Table by author, data by EIA

Comparing the assumptions based on the February Drilling Productivity report versus those of the January report, we note that the monthly decline rate has dropped considerably from 7.0% per month to 6.0% per month. Rig productivity and its rate of change are roughly the same. December 15 production has been revised up 108 MB/d, and despite a reduction in rig count, December 16 production is projected to be 171 MB/d higher.

Incorporating the February assumptions into the inventory forecast, assuming DUC completions, we get the following:

 

+ DUC

Net

Not

Total

Refinery

     

Month

Mbpd

Crd Imp

Accounted

Available

Input

Rounding

US Inv

DOI

Oct-15

9,127

6,649

420

16,196

15,485

-

482,810

31.2

Nov-15

9,184

6,882

470

16,536

16,300

0

489,424

30.0

Dec-15

9,188

7,334

(119)

16,403

16,606

0

482,324

29.0

Jan-16

9,217

7,509

(38)

16,687

15,967

8

502,712

31.5

Feb-16

9,342

7,241

104

16,687

15,647

-

531,836

34.0

Mar-16

9,308

7,241

104

16,654

15,808

-

561,419

35.5

Apr-16

9,244

7,241

104

16,590

16,377

-

567,379

34.6

May-16

9,185

7,241

104

16,531

16,603

-

565,374

34.1

Jun-16

9,131

7,241

104

16,477

16,810

-

553,715

32.9

Jul-16

8,981

7,241

104

16,326

17,162

-

530,315

30.9

Aug-16

8,849

7,241

104

16,194

17,047

-

500,473

29.4

Sep-16

8,719

7,241

104

16,065

16,521

-

487,707

29.5

Oct-16

8,627

7,241

104

15,973

15,794

-

492,703

31.2

Nov-16

8,537

7,241

104

15,883

16,625

-

466,700

28.1

Dec-16

8,468

7,241

104

15,814

16,938

-

435,211

25.7

Jan-17

8,405

7,241

104

15,750

16,286

-

420,211

25.8

Feb-17

8,347

7,241

104

15,693

15,960

-

412,720

25.9

Mar-17

8,287

7,241

104

15,633

16,125

-

395,523

24.5

Apr-17

8,238

7,241

104

15,584

16,704

-

364,144

21.8

May-17

8,193

7,241

104

15,539

16,935

-

315,288

18.6

Click to enlarge

Chart by author, date from EIA

The upshot of reducing the legacy decline rate by 15% is to push a normalized inventory of 23 days out 6 months from November, 2016 to April, 2017, assuming completion of a 1,500 DUC inventory. However, this forecast leads to a smash up against storage capacity within the next several months as inventory levels exceed the working capacity of 550 million barrels. As seen from this week's Cushing experience, even approaching working storage levels will lead to blending logistic problems, such that the storage facility will have to decline incoming oil. That means DUC conversion will be delayed until later in the year, more rigs must come off line, and perhaps producing wells even taken out of service. Absent action by OPEC, with such inventory overhang it remains difficult to see how WTI price can recover until spring 2017.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.