Trouble In The Eagle Ford?

| About: The United (USO)

Summary

Oil prices have fallen lately, driven in part by an increase in rig counts, which has caused me to make revisions to my expectations for the region this year.

Based on the data provided, it seems as though the amount of production in the Eagle Ford will be materially higher than I thought just a month earlier.

However, when you factor in other revisions made by the EIA in the Eagle Ford, this increase in the rig count may not mean too much this year.

Around a month ago, I published an article here about the oil production trends of the Eagle Ford, one of the seven largest oil and natural gas producing regions covered by the EIA (Energy Information Administration) in its monthly Drilling Productivity Report. Now that fresh data is out on the region, however, I figured that it would be a wise idea to revisit the picture and see what it should mean for investors in companies like Memorial Production Partners (NASDAQ:MEMP), Approach Resources (NASDAQ:AREX), and Legacy Reserves (NASDAQ:LGCY), as well as for the United States Oil ETF (NYSEARCA:USO) and other oil-related ETFs.

Prior data calls for major revisions

Last month, I wrote an article on the Permian where I called for a meaningful increase to production compared to my prior forecasts due to some revisions that were needed. This month, I have the same bad news regarding the Eagle Ford. You see, in my prior work on this region, I assumed that the rig count would fall by an average of 9 units per month moving forward, but after seeing the rig count tick up from 32 to 33 and then to stay flat through much of July at that level, I now believe that it would be most appropriate to assume that the count doesn't change from that for the rest of this year unless data changes again.

In addition to changing the rig count, I had to go back and look at the month-to-month rig productivity improvement rate over time. Unlike in the case of the rig count, I was able to make a bullish (from an oil price standpoint) revision here. You see, while last month I used a monthly rig productivity improvement rate of 2.75%, the graph below, which shows updated data provided by the EIA, is calling for a rate closer to about 2.25%.

Click to enlarge

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

The last indicator I had to revisit was the decline rate in the region. Last month, I looked at three different scenarios; a conservative one where the rate would be 7.5% each month, a moderate one where it would be 8.5%, and a liberal one where it would be 9.5%. Now, however, the EIA has revised those numbers down drastically and, as you can see in the graph below, they believe the rate is closer to 7.5%. Because of this, I have dropped my conservative scenario down to 7%, my moderate one down to 7.5%, and my liberal one all the way down to 8%. Just as in the case of the rig count change, this will have a material and negative impact for long-term oil bulls when it comes to predicting production from the region.

Click to enlarge

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

After incorporating all of my assumptions in last month's forecast, I was able to generate the table below. In it, you can see that, under the conservative scenario, investors should have been expecting oil production to drop from a now-revised amount of 1,459,169 barrels per day in December of last year to 816,702 barrels per day by the end of this year. Under the moderate (and most likely) scenario, production should have dropped to 774,123 barrels per day, while the liberal (and least likely) scenario called for output to fall to as little as 733,346 barrels per day.

Click to enlarge

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

The data has changed... for the worse

Unfortunately, after I added the new assumptions made for the Eagle Ford into my model, the picture looks far worse for output for the end of this year. In the table below, for instance, you can see that the conservative scenario is now calling for production to fall to a more modest (but still significant drop to) 942,811 barrels per day. The moderate scenario should see output fall to about 924,585 barrels per day, while the liberal scenario should see output fall to 906,643 barrels per day. Even the liberal scenario today is calling for materially-higher oil production than the conservative scenario called for just a month earlier, thanks to both the change in the rig count and the downward revision by the EIA regarding decline rates.

Click to enlarge

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

Putting my old forecasts next to my new ones, we can see that the difference is meaningful. Under the conservative scenario, investors can now expect oil output to be 126,109 barrels per day higher than I called for a month ago. The moderate scenario is calling for production to be a whopping 150,461 barrels per day higher, while the liberal one is calling for production to be higher by about 173,297 barrels per day. All of this looks negative and it sure does warrant some sort of reaction, but what's interesting is that if you look at the average production forecasts in today's model compared to last month's model, the overall impact for the year isn't that large.

Click to enlarge

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

The average change under the conservative scenario, thanks to downward production revisions by the EIA for prior months, actually means that output this year in the Eagle Ford will be about 4,204 barrels per day less than I was forecasting a month ago. In the moderate scenario, it should be an increase of only 3,632 barrels per day, while the liberal scenario's increase will only be about 11,190 barrels per day. If anything, the changes made in the Eagle Ford will have little to no impact on the oil market compared to last month's numbers for this year but it should have some impact next year in the form of a higher starting base for production compared to what it would have been otherwise.

Takeaway

Based on the data provided by the EIA, it seems pretty clear to me that the revisions made by the EIA, combined with my own assumption regarding the change in rig count, will have a meaningful impact on my prior forecast for the rest of the months this year. Thankfully, however, due to other revisions provided by the organization, the average impact on the crude market shouldn't be that large this year, so investors would be wise to not overreact to this otherwise bearish news.

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: I own LGCYO, not LGCY

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