The Eagle Ford's Decline Is Slower 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

Using recent data from the EIA, I looked at the oil production outlook for the Eagle Ford, a major oil and natural gas producing region in the U.S.

What I found is that the output decline should be significant this year, which is bullish for oil-related investors.

However, the drop is not likely to be quite as severe as previously anticipated, with revisions causing the falloff to come about more slowly.

Last month, I published an article on Seeking Alpha about the Eagle Ford, one of the seven largest oil-producing regions within the continental U.S. In it, I suggested that oil output, given current trends, can be expected to fall meaningfully this year but not quite as quickly as I had previously anticipated. Now that fresh data is out, courtesy of the EIA (Energy Information Administration) in its Drilling Productivity Report, I figured it would be a wise idea to revisit this topic and see not only what the picture looks like, but what it means for investors in the United States Oil ETF (NYSEARCA:USO) and other oil ETFs and oil-related companies.

Looking at my last piece

Before I was able to calculate anything meaningful in my last article, I had to make some assumptions related to rig counts in the region, decline rates, and drilling productivity improvement rates. Previously, I had forecast that the rig count would fall by 7 units each month but the actual number has been a bit higher. Between February and March, for instance, the rig count dropped by 12 units from 59 to 47 after having fallen 15 units a month earlier. I was going to stay the course with a 7 unit drop each month since oil prices have been on the rise but, so far this month, the count is already down by 5 units. For that reason, I am going to revise my monthly rig drop decline from 7 units to 9 for the time being.

In the graph below, you can see the historical trend that decline rates have taken in the Eagle Ford during the past few years (since 2007). Recently, the decline rate has been about 8.5% each month (a little higher but trending down). Due to this revision by the EIA, I am forced to change my three scenarios to make them realistic. In my last article on the Eagle Ford, I looked at a conservative forecast where the decline rate was 7.5% each month, which I am going to stick with. However, my moderate scenario of 9% will be revised down to 8.5% moving forward, while the liberal scenario assumes a decline rate of 9.5% as opposed to the 10% I thought last month.

Click to enlarge

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

The last indicator I had to look at was the improvement in rig productivity rates on a month-to-month basis. In the graph below, you can see the historical trend that these rates have taken since 2007. Based on the data provided, recent improvement rates suggest we should expect growth in productivity each month of approximately 1.5%. This serves as an upwards revision compared to the 1% improvement I used in the past and is a bearish indicator, ceteris paribus.

Click to enlarge

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

Using the old data in my last article on the Eagle Ford, I was able to create the graph below. In it, you can see that oil production this year can be expected to fall materially if my assumptions turned out to be accurate. Under the conservative forecast, for instance, we should have expected oil production in December of 2016 to average 764,319 barrels per day, while the moderate and liberal forecasts could see production fall to 677,567 barrels per day and 599,888 barrels per day, respectively. This all compares very favorable to the newly-revised December 2015 output of 1.46 million barrels per day.

Click to enlarge

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

Things are mixed but a bit more bearish

Unfortunately, it appears as though my revision to the data is making things look a bit worse. While the faster rig decline will help bulls in the space, the downward revision in the decline rates, combined with the higher productivity improvement rate, will result in the data in the table below. If this turns out to be accurate, investors could expect oil production in the Eagle Ford to average 746,114 barrels per day by December of this year under the conservative scenario. Meanwhile, the moderate and liberal scenarios call for output of 692,815 barrels per day and 642,838 barrels per day.

Click to enlarge

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

To put things into perspective, I decided to place my new forecasts next to my old forecasts in the table below. What you can see is that, if the conservative scenario turns out to be accurate, oil production will actually come in 18,205 barrels per day lower than I had anticipated last month. This is great but when you look at the moderate (and most likely (in my opinion)) scenario, you would actually see daily production come in 15,248 barrels above what I expected. This isn't terrible in the grand scheme of things but the picture would look bad if the liberal (and least likely) scenario turns out to be accurate, which would call for production to come in 42,950 barrels per day higher than I estimated in March.

Click to enlarge

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

Takeaway

Just as in the case of last month, I had to make some necessary revisions to my Eagle Ford forecasts. Such is the nature of imperfect data. Unfortunately, if I am correct, there's a pretty good chance that the amount of oil being produced will be higher than I had hoped but what is very positive is that, even with these changes, my forecasts call for very material reductions in production in the region. Assuming nothing bad happens, such as higher output elsewhere or a major revision in the data, this should be very bullish for long-term investors in this space.

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.