Oil Production Will Still Take A Beating Here

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

Summary

Oil production in the Niobrara is falling faster than most any region, driven by high decline rates and a falling rig count.

In my last piece, I forecasted a sizable drop in production this year, but fresh data out suggests my original assessment was too bullish.

To account for this, I've elected to write an updated piece with the freshest data to forecast the decline moving forward.

Clearly, the drop won't be as large as I had hoped, but it will still be quite significant in the grand scheme of things.

Last month, I wrote an article detailing what is happening in terms of oil production in the Niobrara. Located mostly throughout Wyoming and Colorado, the region is one of the seven largest onshore oil-producing locations within the U.S. that the EIA (Energy Information Administration) covers. In what follows, I've decided that it would be a good idea to look back at the Niobrara and highlight some changes in my analysis that show that, although investors should still expect a major drop in production this year, that drop will probably be smaller than I thought it would be.

A look back at the Niobrara

In my last piece on the Niobrara, I determined that oil production in the region should fall quite hard during 2016 if the energy environment does not improve. In the table below, you can see what my expectations were moving forward. Under a conservative scenario, with oil production declining by 7% each month, I figured that output in December of this year should be 212,656 barrels per day. Under the moderate scenario (the most likely outcome in my opinion), with a decline rate of 12%, production should drop to 194,435 barrels per day, and the liberal scenario, with a decline rate of 17%, would see production drop to a mere 72,913 barrels per day. This all stands in stark contrast to the 429,530 barrels per day the region produced in December of 2015.

Click to enlarge

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

To arrive at these conclusions, I had to make some key assumptions. The first related to decline rates, which varied widely due to data provided by the EIA. Since then, however, the organization has come out with revised decline rates, showing that the number isn't nearly as attractive as I initially thought. In the table below, you can see what the EIA thinks has been happening post-revision to the decline rates in the Niobrara. Based on this change, I'm moving the moderate decline rate scenario down to 9% and the liberal one down to 11%, while keeping the low decline rate scenario at 7%.

Click to enlarge

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

Another change I had to make relates to the rig count over time. In my prior work, I decided to use a rig count in January beginning at 19 units based on what I saw in the Baker Hughes (NYSE:BHI) rig count data, but the EIA thinks that number last month was 26. Going off of Baker Hughes' data again, current rig counts should be about 21 so I'll be sticking with that for February. Moving forward, I assumed a drop of 4 units each month and, based on the historical trend, I believe that that's still reasonable moving forward.

Finally, I had to revisit my assumptions relating to rig productivity. In my previous piece, I used historical productivity improvements on a month-to-month basis to assume that rigs continue to grow their productivity each month by 3%. This is actually higher than any point since last October that we have seen and the trend continues to decline. If the EIA is correct, the number in March of this year should be just 1.68%. To remain conservative but to also be more realistic, I'm moving the 3% rate down to 2.5% moving forward, but, if we continue to see a downward spiral like we have over the past several months, this number may drop to 2% starting with next month's report.

Click to enlarge

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

The picture looks less favorable now

After making these adjustments to my prior analysis, I concluded that, if my estimates are correct, the conservative scenario should see oil production fall to 234,530 barrels per day by the end of this year. Using the moderate scenario as our base, the number should decline to 194,435 barrels per day, while the liberal scenario (which is the least likely) would result in production declining to 160,615 barrels per day by December of this year. In the table below, you can see the complete analysis I conducted.

Click to enlarge

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

When placed next to how much oil was produced last December, any of these scenarios show really positive improvements for the oil industry. However, I am a little disappointed by the fact that my results aren't as impressive as they were expected to be in my last piece on the region. Because of the massive downward revision in decline rates reported by the EIA, an extra amount of crude totaling between 21,874 barrels per day and 87,702 barrels per day will be left on the market compared to what I had been expecting. Even with this, though, the news is still very positive for the U.S. oil industry, which needs production to drop and/or demand to rise in order to see this glut dissipate.

Click to enlarge

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

Takeaway

At the moment, Mr. Market is scared about the oil glut and seems to be thinking that it will continue for an extended period of time. While anything is possible, given the uncertainty in demand, news from OPEC, etc., it seems highly unlikely that this will end up being the case. This is especially true after seeing what should happen in the Niobrara in the months to come if the market doesn't see a meaningful rebound in price that drives rig counts back up and it is something that investors who are long oil and oil-related companies should find some solace in.

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.