The Niobrara - Not Quite As Attractive

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

Summary

With rig counts having fallen and productivity improvement rates too low to offset the decline, the Niobrara is set to see oil output fall hard this year.

This should be a very bearish move for long-term oil investors but not everything is great in the region.

Due to some revisions, the drop in crude production will not be quite as large as I had anticipated but it should still be material.

Last month, I published an article on Seeking Alpha regarding oil production in the Niobrara, one of the seven largest oil-producing regions in the U.S. (not counting the U.S.' hold on the Gulf of Mexico). Based on my findings, I discovered that, if current trends persist, we should see a massive decline in output this year but that it wouldn't be as large as I had anticipated earlier. Now that fresh data is out in the form of the Drilling Productivity Report, a monthly analysis provided by the EIA (Energy Information Administration), I decided that it would be a good time to revisit the picture and see whether or not this holds true and what the future will look like for investors in oil-related ETFs like the United States Oil ETF (NYSEARCA:USO), as well as for oil-related companies.

What I thought previously

In my last article on the topic, I had to look at three variables to see what the future should look like in the Niobrara from a production standpoint. The first of these was the rig count in the region, which I had expected to drop by 4 units each month. Interestingly, I was off and the actual decline last month totaled 5 units, bringing the rig count down from 23 to 18. Despite this increase, however, it's probable that the recent uptick in oil prices will make such declines harder so I intend to stick with my estimate of 4 units falling each month moving forward.

In addition to looking at changes in the rig count over time, I also had to analyze the month-to-month drilling productivity improvement rate in the Niobrara. Based on previous forecasts, I used a rate of 3.25%, up from 2.5% a month before that. However, as you can see in the graph below, the trend has shifted downward again and, for the month of May this year is forecasted to hit about 2.58%. Because of this, I am going to shift my month-to-month productivity improvement rate down to 2.75% but additional revisions by the EIA could necessitate a change on my part.

Click to enlarge

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

The final indicator I had to look at was the decline rate in the Niobrara. Last month, I provided investors with three scenarios; a conservative one whereby we could expect decline rates of 7% each month, a moderate one where the rate should be about 8.25%, and a liberal one with a rate of 9%. Now, however, data seems to be pointing toward a monthly decline rate of about 8% as opposed to 8.25% so I've decided to revise my moderate scenario down to that while keeping the conservative and liberal ones unchanged. Keeping all else the same, this should be slightly more bearish for the moderate scenario than I expected a month ago.

Click to enlarge

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

By analyzing all of this data last month, I was able to create the following table below. In it, you can see that oil production this year was expected to fall dramatically. By December of 2016, my previous forecast resulted in oil production in the Niobrara averaging 259,620 barrels per day under the conservative scenario, 233,935 barrels per day under the moderate (and most likely) scenario, and 219,628 barrels per day under the liberal (and probably least likely) one. Overall, this would have led to a sizable decline compared to last month's December 2015 estimate of 462,617 barrels per day and the now-revised number of 466,467 barrels per day.

Click to enlarge

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

The picture looks a tad bit worse

After incorporating the necessary adjustments mentioned above, I was able to create the following table below. In it, you can see that oil production in the Niobrara is still expected to fall dramatically, hitting about 263,661 barrels per day in December of this year under the conservative scenario, 244,856 barrels per day under the moderate one, and 227,218 barrels per day under the liberal one. All-in-all, this implies a year-over-year decline of between 43.5% and 51.3%, a major bullish indicator if you are only looking at production in the Niobrara.

Click to enlarge

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

To put things in perspective, I create the next table, which shows my current forecasts compared to my prior ones. Due to the revisions, output in December of this year will likely be between 4,041 barrels per day and 10,921 barrels per day above what I had anticipated last month. It should be mentioned, however, that these changes were driven by a combination of a higher expected production amount in December of last year last month compared to this month and the fact that rig productivity was revised much higher month-over-month (it was up about 8% in March in the recent data set versus last month's data set). Without these changes, the numbers would have been more or less the same.

Click to enlarge

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

Takeaway

As of this moment, it's pretty clear that the future for oil-related companies is looking up. With output expected to fall meaningfully through the end of this year (assuming that the trends I outlined above remain unchanged), investors should be more comfortable now than they were a few months ago on the domestic front. The one bad thing is that total output in the Niobrara looks like it will be higher than I thought a month ago, which is a net negative, but the number is not so large that investors should be scared.

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.