Oil Production In The Bakken Is Due To Fall Faster Than Expected

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

Summary

Last month, I wrote an article detailing what the oil-related picture should look like in the Bakken, one of the major oil producing regions in the U.S.

What I discovered is that investors should expect production to fall at a fast pace.

Now, with fresh data out, I dug in and discovered that there's a good chance this decline could be more severe and faster-paced than I expected it to be.

Given the amount of oil the region contributes to the U.S., this should be material in nature and should prove bullish for long-oriented investors.

In a previous piece, I decided that it would be a good idea to dig into the Bakken region to see what the future of oil output in the area will look like moving forward if the energy environment does not improve. What I discovered is that it, like some other regions in the U.S., should start to see a meaningful drop in output over the next several months (through at least December) if rig counts continue to fall at a modest rate and if nothing else improves the situation there. After seeing fresh data from the EIA (Energy Information Administration), I've concluded that, despite a revision to decline rates, there's a high chance that domestic oil production in the region will fall a bit faster than previously forecasted, a move that should be bullish for long-term investors.

A look back at the Bakken

In the table below, you can see what my overall projections were for the Bakken a month ago. Based on three core assumptions I made, I figured that decline rates of 5%, 6%, and 7% (on a monthly basis) would result in production declining by December of this year to 881,568 barrels per day, 804,425 barrels per day, or 733,930 barrels per day, respectively. This represents a massive drop compared to the 1.158 million barrels per day the EIA claimed was extracted in December of 2015.

Click to enlarge

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

No matter how you stack it, this represents a sizable decline year-over-year. However, any sort of forecast is only as good as the assumptions it makes. In that piece, I had estimated that decline rates were, indeed, 5%, 6%, or 7%, to account for uncertainty. After seeing the EIA come out with revised numbers, which you can see in the graph below, I believe my analysis warrants a downward adjustment.

Click to enlarge

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

For the conservative scenario, I'm now assuming a monthly decline rate of just 4.5%. Meanwhile, the moderate (which is the most likely track in my opinion) scenario has been revised to 5%, while the liberal scenario now assumes a decline rate of 6%. Obviously, this will have a negative impact on the results of my analysis, but what matters is not that we see a rosier picture but that we see a more realistic picture.

In the graph below, you can also see the trend relating to rig productivity improvements on a month-to-month basis. Interestingly, we've been seeing improvements in the Bakken worsen almost every month since April of 2015 and the EIA is currently forecasting that the improvement in March will come out to just 0.18%. To be conservative, however, I'm using a base case of 1.5% each month moving forward, which is half of the 3% improvement I used previously. Although this is a major change, it should be mentioned that we haven't seen a level at least that high since last May and we haven't seen a level at or above 2% per month since last October.

Click to enlarge

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

Finally, I had to figure out whether my assumption relating to rig declines still makes sense. In my last article on the topic, I suggested that January's rig count should be 52 and that we should see rig counts fall by 4 units each month moving forward. According to the EIA's data, the rig count in January actually dipped to 45 units and the trend doesn't look like it's going to let up anytime soon (unless oil prices rise meaningfully). Because of this, I've decided to increase my monthly rig decline to 5 units, which seems more reasonable at the moment.

The oil production drop may be larger than expected

As a result of my analysis, you can see what the picture should look like for oil production in the Bakken for every month this year through December. This, of course, assumes that my estimates turn out to be accurate. In the conservative scenario, which involves rigs falling by five units, drilling productivity growing by 1.5%, and decline rates averaging 4.5% each month, the Bakken should be producing 835,017 barrels per day by the end of this year. Under the moderate scenario, production would fall to 798,448 barrels per day, while the liberal scenario would see production drop to 763,342 barrels per day.

Click to enlarge

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

To put this in perspective, we should look at the table below. If my analysis turns out to be accurate, this would mean that my new forecast under the conservative scenario would see an extra 46,551 barrels per day come offline. My moderate scenario would result in 5,977 barrels per day coming offline compared to last month's estimates. However, due to the sharp downward revision in decline rates, the liberal scenario would see an extra 29,412 barrels per day staying online. Although the liberal scenario is disappointing when compared to last month's assessment, it's still a massive decline year-over-year.

Click to enlarge

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

Takeaway

Right now, many investors are focused on the current pessimism in the oil market and this does warrant some attention. Having said this, however, I do believe the market is overreacting to some extent because of the fact that the oil picture in the U.S. should show signs of improving soon. As the rig count in the U.S. has plummeted, it has set the stage for a massive decline in oil production at home, one likely larger than what many analysts and the EIA have in mind. Without any doubt, the Bakken region will play a big role in this process.

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.