Mixed Signs On Oil

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

Summary

In this article, I revisited some data I looked at previously regarding the Marcellus and Haynesville regions.

In my prior work, I forecasted output to fall this year in both areas, with one expected to drop at a faster pace than the other.

Now, however, with revisions to the data being necessary, things look less appealing, on the whole for both regions but are still looking up year over year.

With fresh data out by the EIA (Energy Information Administration), I figured now would be a wise time to revisit an analysis I conducted around a month ago that suggests we should see a sizable drop in U.S. oil production this year in regions like the Marcellus and Haynesville. Ultimately, if this still holds true, the news should be bullish for long-term oil investors like myself as well as for any other investors who hold stakes in the United States Oil ETF (NYSEARCA:USO) and other oil-oriented investments.

Making some necessary revisions

In my last article on the Marcellus and Haynesville regions, I had to operate under three core assumptions, which covered rig counts, decline rates, and rig productivity improvements on a month-to-month basis. In that piece, I made the case that rig counts in the Marcellus would decline by 4 units per month, with the number falling from a base case of 36 units in January. During February, the unit count in the area actually fell by 6 to 30 units but I'm still sticking with my core assumption for the near-term. Similarly, even though we saw the rig count plummet by 7 units in the Haynesville area last month (from 25 to 18), I'm going to hold firm with my guess that unit counts continue to fall by just 1 unit per month moving forward.

On top of looking at the change in rig count over time, I had to figure out what makes sense from a decline rate in each region. In the graph below, you can see that the decline rate in the Marcellus seems to be around 6% each month. This is down meaningfully from the 10% estimated by the EIA just one month earlier. Because of this, I'm going to lower my conservative, moderate, and liberal scenarios for decline rates in the area down from 5%, 10%, and 15%, respectively, to 4%, 6%, and 8%, respectively, moving forward. In the graph below that, you can see the results of the Haynesville region, which show a rate of about 2.5% in recent months. This had led me to revise the decline rates for the conservative, moderate, and liberal scenarios in the area down from 2%, 3%, and 4%, respectively, to 2%, 2.5%, and 3%, respectively.

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

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

Finally, I had to come up with a realistic estimate for rig productivity improvement rates in both areas. In the past, I assumed a rate of about 2.5% for the Marcellus but the problem is that, in the graph below, you can see a severe degree of volatility, the likes of which no other region really experiences. At the risk of being wrong, though, I'm going to stick with this estimate for now. In the Haynesville, however, I've decided to move the rig productivity improvement rate down from 1.5% each month to just 1% thanks to the new data provided by the EIA, which you can see reflected in the graph below.

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

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

Once I took the older data associated with the Marcellus and Haynesville regions, I was able to create the tables below, which show what the picture looks like for each between January of this year and December of this year if my estimates turn out to be accurate. Based on the findings, we should likely see a decline in output from both the Marcellus and Haynesville with the former leading the way with potentially significant production declines. In the grand scheme of things, each location's drop does not appear to be all that meaningful but, when you add them together, it should have a measurable impact on total U.S. production this year, ceteris paribus.

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

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

Things don't look as bright now

After incorporating the necessary revisions I had to make based on the EIA's new data, things still look bullish but nowhere near as bullish as before. In the tables below, you can see that production in the Marcellus should be somewhere between 29,152 barrels per day and 40,191 barrels per day by the end of this year. Although this is a welcomed improvement over the estimated 40,588 barrels per seen in December of 2015, it's not as impressive as the older data implied it might be. In the Haynesville region, the picture does look more positive, with production ranging between 40,318 barrels per day and 43,639 barrels per day versus last December's 50,151 barrels per day.

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

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

To put matters into perspective, I've provided the two tables below, which show what the picture looks like with the Marcellus and Haynesville areas now compared to what my forecasts looked like a month ago. While we are likely to see output drop in both areas year-over-year, the data looks only slightly more favorable in the Haynesville under the conservative and moderate scenarios (but not the liberal one). However, things look far worse in the Marcellus, with output expected to be between 6,203 barrels per day and 15,807 barrels per day above where I previously forecasted. This is largely a product of the sharp downward revision in decline rates for the area.

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

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

Takeaway

Based on my findings, investors should be happy that oil output in both the Marcellus and Haynesville regions will likely drop this year compared to last year but the picture doesn't look anywhere near as bullish as it did in February. This is certainly a let-down because it paints a less-bullish picture for the domestic oil market than previously anticipated but the drop for the year is still a net positive.

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.