Oil Pain In The Bakken

| About: The United (USO)

Summary

In this piece, I explored oil production trends in the Bakken and discovered that, if nothing changes, production should drop there materially this year.

However, after making some necessary revisions to my analysis, I discovered that the picture looks less appealing than it did a month earlier.

Unfortunately, it's looking like oil output, while lower this year, will be measurably higher than I had hoped, a bearish bump on an otherwise bullish trend.

Last month, I published an article on Seeking Alpha regarding the Bakken, one of the big four oil-producing regions in the U.S. In that article, I made the case that, given current trends, oil production in the region should fall materially this year but that the drop would be lower than I had previously anticipated. Now that fresh data is out, courtesy of the EIA (Energy Information Administration) through its Drilling Productivity Report, I decided that now might make for a good opportunity to revisit the picture and see how things might have changed, as well as to see what this means for oil-oriented investments like the United States Oil ETF (NYSEARCA:USO), other long-oriented oil ETFs, and oil-related companies like Legacy Reserves (NASDAQ:LGCY), Memorial Production Partners (NASDAQ:MEMP), and Approach Resources (NASDAQ:AREX).

Some adjustments were required

In order to forecast what the future might look like for the Bakken, it's necessary to look at three core assumptions. The first of these is the change in rig count over time. In the past, I had used historical data to forecast what the rig count would be like and the general conclusion I arrived at was that we should see a drop of about 5 units per month moving forward. Now, however, after seeing the number fall by just 3 units in May, I've decided to lower my base case here to 4 units each month. However, this number could change in the months to come depending on the data from the region.

The second major assumption I had to look at relates to the month-to-month rig productivity improvement rate. In my last article on the topic, I assumed that rigs would become more productive each month by about 2.25%. As you can see in the graph below, the most recent data on the topic indicates that the rig productivity improvement rate stands at about 2.22% so this estimate of mine appears to be appropriate. Moving forward, I will maintain the 2.25% improvement rate assumption.

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 decline rate in the Bakken. In my last piece, I used three different scenarios; a conservative one where the decline rate would be 4.75%, a moderate one where it would be 5%, and a liberal one where it would be 5.25%. Now, however, as you can see in the graph below, this number has changed modestly. Because of this, I will be using 5.15% for my moderate scenario and 5.55% for my liberal one, while keeping the conservative scenario unchanged at 4.75%.

Click to enlarge

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

Using the prior estimates, I was able to create the table below. In it, you can see that, if my numbers turn out to be accurate, oil production in the Bakken should fall to 808,176 barrels per day by December of 2016 under the conservative scenario. This compares to 795,788 barrels per day under the moderate scenario and 783,560 barrels per day under the liberal one. This all compares very favorably compared to the now-revised 1,168,368 barrels per day in production that has been estimated for December of last year and is bullish in and of itself.

Click to enlarge

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

New data is less bullish

Absent a major change in the oil market, it's practically guaranteed that production in the Bakken will fall this year but now the picture isn't looking quite as bullish. In the table below, you can see revised data for the region based on the new numbers I provided above. Now, under the conservative scenario, production in the Bakken should be about 839,496 barrels per day by December of 2016. Under the moderate scenario, the number should be about 822,497 barrels per day and the liberal scenario is calling for production to average 805,778 barrels per day, just slightly lower than the conservative scenario's production prior to these adjustments.

Click to enlarge

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

To put this into perspective in the best way possible, I created the following table below. In it, you can see what the oil production outlook looks like moving forward now that I've made adjustments compared to what the picture looked like in last month's report on the issue. Overall, under the conservative scenario, investors can still expect a massive drop in production but the falloff will be about 31,321 barrels per day less than previously anticipated. Meanwhile, the drop will be 26,709 barrels per day less than it was a month ago under the moderate scenario, while the liberal one is calling for a drop that is smaller by 22,219 barrels per day.

Click to enlarge

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

Takeaway

No matter how you stack it, the oil production outlook in the Bakken is very bullish heading forward and I believe it's likely that this will have a positive impact on the oil market in the months to come. Having said all of this, though, there's no denying that the situation isn't as bullish as before, which is something investors should keep a close eye on since this has the potential to limit oil's upside moving forward. Overall, I am still very bullish regarding crude but I continue to watch this news as it is released.

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

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.

Additional disclosure: My LGCY position is in the form of preferred units, not common ones

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