A Look Back At The Permian

|
Includes: OIL, USO
by: Daniel Jones

Summary

As the price of oil has taken a beating recently and as decline rates appear to be elevated, it's likely that the Permian will face some downward pressure.

This stands in stark contrast to what has been happening over the past year, when falling rig counts were met with rising output.

Collectively, this should help the market to rebalance sooner than anticipated, which should be bullish for long-oriented oil investors moving forward.

Earlier this month, I looked into data involving the Permian Basin and concluded that it's likely the region will continue seeing its oil production rise through part of this year before, possibly, reporting declining output by year-end if all goes well. After analyzing that data, the EIA (Energy Information Administration) put out some fresh data that indicates a good possibility that this trend will actually happen quicker and the potential year-end decline will be more pronounced. In what follows, I will dig into the production data a bit more and talk about the rationale surrounding it and how this should prove bullish for investors down the road.

A look back at my past prediction

In my previous piece, I analyzed the decline rates, drilling rig productivity, historical rig count decline in the Permian, the single largest oil-producing region in the United States, followed by the Eagle Ford and Bakken. In that piece, I provided the following table, which assumes what the overall trend should be for production in the region if rig counts continue to fall by 8 units per month, if rig productivity continues rising by 1% month-over-month, and if the decline rates range between 2% (conservative), 3% (moderate), and 4% (liberal).

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

All of this data was based on a very rational methodology. In the table below, for instance, you can see the historical (and updated) graph, which shows the decline rate of wells in the region from January of 2007 through what is estimated for February of this year. In my piece, I did not think that it would be wise to assume a 4% decline rate but, as we can see, this trend is continuing so, in this piece, I am moving the range to 3% (conservative), 4% (moderate) and 5% (liberal).

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

Regarding rig productivity, I made the 1% month-to-month growth rate assumption based on historical data provided by the EIA. In the graph below, you can see that oil efficiency has been very lumpy between the start of 2014 and today but the trend these past few months has been, without any doubt, toward productivity improvements that are smaller than it was when the energy downturn began. If the EIA is accurate, productivity growth should stand at just 0.48% for the month of February, a number that I'm echoing in my new analysis but, beyond February, I'm still sticking with my 1% target for the sake of conservatism.

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

Given that all my analysis from the past article turns out to be accurate, oil production in the Permian would range anywhere from 1.99 million barrels per day by the end of this year up to about 2.40 million barrels per day. This compares mostly unfavorably to the 2.02 million barrels per day seen during December of last year. However, I have reason to believe any output increases that might develop over this timeframe will be more shallow than I initially forecasted.

You see, if my work had turned out to be accurate, it would mean that oil production in the Permian during February of this year should come out to between 2.044 million barrels per day and 2.084 million. The updated data provided by the EIA indicates this number should be 2.040 million. This disparity was driven, in part, by a decline rate exceeding 4% (4.07% to be precise), somewhat offset by a change in rig counts for January so far. To adjust for this, I decided to redo my analysis, incorporating the aforementioned changes in my data set.

Output won't be as stubborn

In the table below, you can get a glimpse at the fruits of my labor. By shifting the decline rate range to a level that appears more reasonable and by changing the rig count (increasing it by one unit), we can see that the low end scenario for the Permian suggests the max year-end output should rise to (assuming rig counts don't climb) about 2.137 million barrels per day, an increase of 114,335 over what we saw this past December. Compared to the 3% estimate used last time, this suggests that 17,556 barrels per day will vanish from the sensitivity analysis.

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

Certainly, by itself, this is still a negative for long-oriented oil investors but this is the most conservative scenario that I believe to be reasonable (unless oil prices climb). Under the more realistic 4% decline rate scenario, investors can expect output in the region to hit 1.96 million barrels per day, a drop of 62,753 barrels per day year-over-year and a shortfall of 32,114 barrels per day versus my last forecast. Should decline rates rise (something that is possible but not something investors should bet the farm on) to 5%, then output would plummet to 1.798 million barrels per day, a year-over-year drop of 225,030 barrels per day compared to what we saw this past December.

Takeaway

Right now, many investors fear that the oil glut will continue but, absent rig counts rising again, this simply cannot persist. While I do think it's unlikely that we'll see a significant drop in output from the Permian, I do think the region, which is the largest and one of only two that has seen production climb during this energy downturn, will ultimately see oil production drop by year-end, a move that will prove bullish for investors who are long crude and crude-related companies.

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.