Expect This Oil Production To Fall Hard... But Not As Hard

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Includes: BNO, DBO, DNO, DTO, DWTI, OIL, OLEM, OLO, SCO, SZO, UCO, USL, USO, UWTI
by: Daniel Jones

Summary

In this piece, I revisit the Eagle Ford, one of the largest regions for oil production in the U.S.

In my previous work on the company, I concluded that the drop in oil production this year should be very material for the area.

However, fresh data from the EIA suggests that this decline may not be as large as prior data indicated, but the decline is still very sizable and very likely.

A few weeks ago, I published a piece regarding the Eagle Ford and suggested that, given current data, investors should expect production in the region to plummet. Now, in its monthly Drilling Productivity Report, the EIA (Energy Information Administration) reported that revised data is available that makes my previous report antiquated. In what follows, I will highlight how the data presented by the EIA changes my view regarding the Eagle Ford and that, although production is still slated to fall meaningfully in the months to come, the drop may not be as large as what older data implied.

Revisiting the Eagle Ford

In my previous piece on the Eagle Ford, I made three assumptions that have now been modified to some extent. First and foremost, I've had to adjust the decline rates associated with the region. According to the EIA last month, decline rates in the area were as high as 12% and seemed to be trending higher such that there was a chance (though probably slim) that this metric could hit 17%. In the graph below, you can see how this has changed in the current report provided by the organization.

Click to enlarge

*Source: Created by author with data from the EIA's Drilling Productivity Report

As revised data came in, the organization lowered these forecasts to around 9% per month. This is still sizable but is well below the scenarios I highlighted in my last article. To account for these changes, I decided to change my conservative, moderate, and liberal assumptions for decline rates from 7%, 12%, and 17%, respectively, to 7.5%, 9%, and 10.5%, respectively. Given current results, investors should probably expect the middle of this range moving forward, but this could change moving forward.

The second indicator I had to look at relates to the rig count in the region. According to the EIA, the rig count in January came out to 74 units. This was slightly lower than the 79 units I forecasted for the month. I still decided to keep the monthly decline in rigs to seven units, but since the Baker Hughes (NYSE:BHI) rig count suggests that there were 60 units in operation as of their first report this month, I'm using a base case for February of this year of 53 units (there's still plenty of time to fall by the end of the month).

Finally, I had to look at the change in rig productivity from month to month. In my previous report, I used a 2% monthly increase in rig productivity, which was on the conservative end since the past several months have seen the rate come in below that mark. In the graph below, you can see that this trend continues to worsen, with the EIA forecasting an improvement in March of just 0.94%. For this reason, I am switching my forecast for the region to just 1% each month moving forward.

Click to enlarge

*Source: Created by author with data from the EIA's Drilling Productivity Report

Using the original estimates from the prior report, I created the table below. Based on these initial assumptions, I figured that oil production in the Eagle Ford should fall to between just 344,678 barrels per day and 837,127 barrels per day by December of this year, depending on what happens regarding decline rates in the area. Compared to the nearly 1.370 million barrels per day the region produced in December of 2015, this constitutes a drop of between 532,389 barrels per day and 1.025 million barrels per day. No matter how you stack it, this is very much material in nature.

Click to enlarge

*Source: Created by author with data from the EIA's Drilling Productivity Report

The picture looks a little less favorable today

Due to the changes I had to make to my analysis, the picture doesn't look anywhere near as good in two out of the three scenarios today when placed next to last month's numbers. In the table below, you can see a revised version of my work, which shows that oil production under the conservative scenario should come out to 729,502 barrels per day by the end of this year, roughly 640,014 barrels per day lower than last December's data. Under the moderate scenario, which I think is the most likely to transpire, production should fall by 733,420 barrels per day to just 636,096 barrels, while the liberal scenario would have production drop by 815,733 barrels per day to only 553,783 barrels.

Click to enlarge

*Source: Created by author with data from the EIA's Drilling Productivity Report

No matter how you look at this, the drop expected in the Eagle Ford is very, very large and is likely to have a major positive impact on the supply/demand imbalance that exists today, ceteris paribus. However, both the moderate and liberal scenarios are less appealing than my original analysis, as you can see in the table below. While the conservative scenario benefited the most from an increase in the decline rate assumption, the moderate and liberal scenarios were harmed meaningfully.

Click to enlarge

*Source: Created by author with data from the EIA's Drilling Productivity Report

Takeaway

Right now, Mr. Market is very bearish on the price of oil, but it's important to keep the long-term perspective in mind. Using data provided by the EIA, I was able to forecast what I believe is likely to happen (unless the data changes again) in the Eagle Ford from a production standpoint. Of course, an increase in the rig count or some other unforeseeable event could change this forecast, but it would take quite a large uptick there to avoid a large drop in output in the region.

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.