The Oil Picture Looks Ugly 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

With new data out from the EIA, I figured now would be a good time to look back at the oil production trend of the Utica.

Due to some major revisions by the EIA, it appears as though the picture looks, for the most part, less favorable than it did a month ago.

Because of this, oil production is all but guaranteed to rise in the region this year, almost regardless of what prices do.

Last month, I thought it would be a good idea to look into the Utica, an area just West of the Marcellus Shale that is considered, by the EIA (Energy Information Administration) one of the seven largest onshore oil and natural gas producing regions in the U.S. My overall conclusion was that, while there was a modest chance that oil production will in the region, potentially helping out the oil industry's supply/demand imbalance, there seemed to be a much higher probability that oil production will continue to grow in the area, even with a slash in rig counts. In what follows, I will dig into the data once again in an attempt to see whether this picture has improved or worsened and what this means for investors in the United States Oil ETF (NYSEARCA:USO) and other oil-oriented securities.

A look back at the Utica

In my previous piece on the Utica, I determined that the situation for the Utica isn't likely to be all that positive moving forward. This was based on three core assumptions I had to make. One of these was that the rig count in the region would come out to 13 rigs in January and that it would continue to fall by an average of 0.5 units per month. Unfortunately, the rig count last month came out to 14 units and is, according to the Baker Hughes (NYSE:BHI) rig count, currently at 13 units. Because of this, I had to adjust the January and February rig count estimates accordingly but I am still sticking with my base assumption of a 0.5% rig count decline each month. Having said this though, if the rig count does manage to stay flat for a month or two, I will likely revise this to no change in the following months.

On top of making an assumption regarding the rig count in the Utica, I had to come up with decline rates that seem to be reasonable. Looking back at the data, I used the historical average decline rate to justify three scenarios. One of these was the conservative one, with a monthly decline of 5%. Meanwhile, the moderate and liberal scenarios assumed rates of 5.5% and 6%, respectively. Based on revisions made by the EIA, decline rates haven't changed materially but I believe my prior work in this regards should have been a bit more conservative. Because of this, I plan to use rates of 5% (conservative), 5.25% (moderate) and 5.5% (liberal) in this current analysis. In the table below, you can see the trend that decline rates have taken over the past few years.

Click to enlarge

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

Finally, I had to look at rig productivity rates and see what makes sense. In the graph below, you can see what the overall picture has looked like in recent years in terms of rig productivity. From my interpretation, it appears as though this trend will continue to worsen, which has driven me to revise down, slightly, the improvements in rig productivity I had been anticipating. In my previous piece, I forecasted what the situation would be like with a month-over-month increase of 6% but, given the fact that the rate is expected to hit 4.21% in March, I'm revising my estimate down to 5%.

Click to enlarge

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

In the table below, you can see what I initially projected for the Utica. Based on the three core assumptions regarding decline rates, changes in rig productivity, and the rig count, I was able to forecast what I believe is likely to transpire in the months to come for the region. As you can see in the table below, oil production is likely to grow in the Utica in two of the three scenarios I provided. In both the moderate (the most likely scenario in my opinion) and the conservative forecasts, output should only rise even as the rig count falls, largely driven by the large increases in rig productivity and the stubborn oil rig count. Only in the liberal (and least likely) scenario should this result in a drop in production and even it is modest at best.

Click to enlarge

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

Things look a little less favorable

Now that I've had the opportunity to re-evaluate the EIA's data and to reform my thoughts a bit, I was able to project what the future should look like in the months to come. Based on the data provided, which can be seen in the table below, oil production should climb, under the liberal scenario, to 78,336 barrels per day by December of this year. This is a tad bit higher than the 75,986 barrels per day seen in December of 2015. Under the moderate scenario, production should rise to 79,770 barrels per day, and it should hit 81,943 barrels per day if the conservative scenario comes to fruition.

Click to enlarge

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

To illustrate the year-over-year difference between my prior forecast and my current one, I've provided the following table below. In both the liberal and moderate scenarios, the picture should be worse this year than I expected, while the conservative scenario (which is the worst outcome overall) will see the disparity in production narrow by 711 barrels per day. By itself, these changes aren't material to the oil industry but they are important enough to warrant attention, especially when you factor these numbers into the numbers I'm working on for the other regions in the country.

Click to enlarge

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

Takeaway

Right now, the Utica and the Permian are the only two significant onshore regions in the U.S. that are seeing oil output rise but the Permian is likely to see the situation reverse itself in the months to come. This will leave the Utica as the standalone region where oil production is continuing to rise. Ultimately, if the other regions see oil output fall materially, this won't be a problem, but it can add to the headaches of investors in the months to come if other regions see production rise or stay stubbornly-high.

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.