The Tide Is Turning In The Utica

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

Summary

Previously, I had expected the outlook for oil production in the Utica to not be so great due to the economics in the region.

While this is still true to an extent, when compared to other regions, the data is showing some positive signs.

Given current trends, it appears as though there's a good chance some oil production in the Utica will fall this year, which should help the supply/demand imbalance to some degree.

Around a month ago, I published an article about the Utica, one of the seven largest oil and natural gas producing regions in the continental U.S. that's covered by the EIA (Energy Information Administration) in its monthly Drilling Productivity Report. In that last article, I concluded that current data seems to be pointing to a scenario whereby oil output in the Utica is all but guaranteed to increase this year compared to what was seen in December of 2015, a sign that would be bearish for investors in the United States Oil ETF (NYSEARCA:USO), other oil-related ETFs and oil-related companies like Linn Energy (NASDAQ:LINE) / LinnCo (NASDAQ:LNCO), Breitburn Energy Partners (NASDAQ:BBEP), Approach Resources (NASDAQ:AREX), and Memorial Production Partners (NASDAQ:MEMP). Now, however, with fresh data out by the EIA, I have to doubt whether this forecast is accurate.

Last month's data and some revisions

Before I get to the new data, it's important to analyze my conclusions from last month and determine what changes need to be made. For starters, I had previously estimated that, given the current trend in oil rig count declines, the number of units in the Utica would drop by 0.5 (on average since you can't actually drop by a half unit in reality) each month. Well, between February and March, we actually saw units fall by 2 from 13 to 11 but, because of the overall trend rig count declines have taken and because of the recent increase in oil prices, I'm going to stick with my original guess moving forward.

In addition to looking at changes in the rig count over time, I also had to look at changes in the decline rates in the region. This is how much oil production of existing locations will fall by from month-to-month. Last month, I used historical data (dating back to 2007) to figure out a reasonable range. By taking this range, I looked at a conservative scenario, whereby the decline rate would be about 4.5% each month, a moderate (and the most likely) scenario, where we could see a decline rate of 4.75% each month, and a liberal (and least likely) scenario that would result in a decline rate of 5% each month. In the graph below, you can see that the overall trend has pointed, in recent months, to a similar range so I plan to keep these estimates unchanged for the foreseeable future.

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

Finally, I had to analyze the month-to-month rig productivity improvement rates. This one, unlike in the two cases above, forced me to make some changes. In the graph below, you can see that recent rates are around 4% each month, which means that the same rigs will result in 4% more oil than they would have a month prior. This represents a modest decline compared to the 4.5% productivity improvement rate I had used in the past and it will result in a more conservative outcome but I have to stay true to the data or else this exercise is meaningless.

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

After incorporating my prior assumptions, I was able to create the following table below. In it, you can see that each of the three scenarios resulted in an increase in oil output over the course of the year, with the conservative forecast calling for 85,680 barrels per day in output and the moderate forecast estimating 84,255 barrels per day. Meanwhile, the liberal forecast would result in output rising to 82,854 barrels per day, which is still above what was seen in December of 2015.

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

Data suggests a trend reversal

Thanks to the additional decline in the number of rigs in March, to the lower month-to-month rig productivity improvement rate moving forward, and to a downward revision in overall oil output in the Utica, the picture has gotten more favorable. In the table below, you can see that my current model calls for oil output in the Utica to come in at 79,497 barrels per day by December of 2016 under the conservative scenario, while my moderate one is pointing toward output of 78,277 barrels per day. The liberal scenario calls for even lower production, which is forecasted to be about 77,075 barrels per day if nothing changes.

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

To put things in perspective, I created the following table below. In it, you can see how my new scenarios compare to my prior ones. Under the most conservative forecast, we should see the largest disparity, with output now coming in 6,183 barrels per day before what I expected before. This changes for the moderate and liberal scenarios, which estimate that production will be between 5,978 and 5,779 barrels per day, respectively, below what I had thought. This is great news but we should keep in mind that only the liberal scenario would see oil production come in lower than it was in December of 2015.

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

Takeaway

Right now, a lot of investors are excited about the oil market, as evidenced by the surge in prices. In most areas we should see domestic production fall year-over-year but the Utica is the one area where this is unlikely to apply. While this is certainly depressing, it's important to look at the bright side, which calls for my output forecast coming in below where I thought it would a month ago, which is sure to be positive for long-oriented investors.

Disclosure: I am/we are long BBEP, AREX, MEMP.

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.

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