Shale Oil And Gas Production Set To Fall Off A Cliff

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Includes: FRAK, UNG
by: Zoltan Ban

Summary

Current US shale liquids & gas production amounts to about 12.5 mb/d and the legacy production decline for 2016 is most likely in the 3.75 mb/d range.

Current drilling pace based on the weekly Baker Hughes active drills report is only enough to stem less than half of the expected legacy production decline.

The so-called "fracklog" effect will only be enough to soften the rate of decline somewhat, but does not come close to the volume of wells needed to stem the decline.

The slide in shale production will most likely end once oil prices will remain in the $60-70.barrel range for a sustained period, which is unlikely to happen this year.

According to the Baker Hughes rig count weekly data, in the summer of 2014, there were on average over 1,300 rigs drilling horizontal wells in the US, mostly involved in shale projects. Today, there are a total of 359 horizontal rigs, most of which are deployed in the shale patch. These rigs are now set to wage a fierce battle to try to stop the decline of roughly 12.5 mb/d production of oil equivalent in legacy production in place. My estimate for total shale liquids and gas production comes from the EIA drilling productivity report, which covers the most important shale fields.

According to the same EIA drilling productivity report, average new production added each month per rig is about 530 b/d of oil equivalent.

EIA.

If we multiply that by twelve months and then by the number of rigs currently operating in the shale patch (which I am assuming to be the average number of rigs for 2016), we get roughly 2.3 mb/d in new production. This new production will come from roughly 6,000 new shale wells, which is a fact we should keep in mind for later, when factoring in the possible effect of working down the so-called "fracklog". My estimate of roughly 6,000 new wells being drilled is based on the assumption that 1.5 wells will be drilled per month per rig, which seems to be the approximate pace we are experiencing currently. We should also keep in mind that we have to factor in the decline of the new wells being drilled this year. As we know, first year production decline per well is in the 60-65% range, meaning that roughly one third of the new production added by new wells this year will be gone by the end of the year. This means that by the end of the year, currently operating rigs will be able to add perhaps about 1.5 mb/d in new production.

As far as legacy production decline goes, based on what we know in regards to the typical evolution of a shale well's production curve, a very conservative assumption of 30% decline of total production per year is a very reasonable assumption in my view. It might in fact be a slightly optimistic one if we look at EIA decline estimates for Eagle Ford wells.

Source: EIA.

I should note that this study does not include data for 2014 and 2015 wells, but I doubt that decline rates have changed too much since. In my "economics of a shale well" series, where I looked at several individual companies and their data as exemplified by the Anadarko article I provided in my link above, decline rates in the first year at least, seem to more or less continue to correspond to what we have seen in previous years.

A 30% decline in legacy production means that all shale wells drilled before January, 1, 2016 will contribute to a production decline of roughly 3.75 mb/d of oil equivalent by the end of the year. As I pointed out, drilling activity at current levels will replace about 1.5 mb/d, which means that we can expect a production decline of roughly 2.25 mb/d of oil equivalent coming from the shale patch this year, unless drilling picks up significantly from current levels, which might help stem the decline rate towards the end of the year.

The "fracklog".

A lot has been made about the buildup of drilled but not completed well inventory occurring in the shale patch. It seems that in fact, there are currently roughly 4,000 such wells which were drilled but not completed, which is referred to as the "fracklog". It seems that in 2015, this well inventory in fact declined overall from a high of about 4,500 wells. There is no doubt that this year we will see a decline in the shale well inventory which will most likely be even greater than last year, but we should keep in mind that the overall number represents not only wells completed and then deferred to be put into production at a later date, but also wells which are intended to be completed, but it takes a while to reach the point of completion from the moment the well was drilled. The well completion backlog will only reach zero some point in the distant future, when shale fracking will completely cease.

The "fracklog" has been cited many times by many people as a source of net production increase once oil & gas prices recover, which many believe that it will act as a brake on any future oil price rally. But if we look at it within the context of the magnitude of likely legacy production decline, and factor in the decline of added wells this year, working down the deferred well inventory this year would not make a huge difference. A 1,000 deferred well addition this year, would reduce the decline by about 250,000 barrels of oil equivalent per day, which will still lead to a roughly 2 million barrel per day of oil equivalent total shale production decline for the year. An even bigger drawdown of deferred wells would obviously have an even bigger impact, but at the same time, it is obvious that it will not come close to reversing the overall declining trend set by the current pace of drilling. At most, it can help temper the rate of decline.

The only factor capable of reversing the shale oil and gas production decline, which in fact started most likely about a year ago, is a return to oil prices in the $60-70/barrel range, which is when in my view we will see a doubling of drilling activity compared with current levels. A doubling of drilling activity is the minimum needed to stabilize production. I don't believe that we will see such a dramatic pickup in drilling activity this year, even if oil & gas prices start to rally. I don't believe we will surpass $60/barrel this year for a sustained period. We may reach the level of drilling needed to stem the production decline some time next year and a few month later we will most likely see the resulting end to the production decline. Until then, we will most likely see a steep decline in production, which will gradually become more gentle as the production decline will have an increasingly bullish effect on oil & gas prices. What this all means of course is that we are now more and more likely to be at the end of the oil price collapse, with the bottom most likely reached back in February and now more likely to head towards the $60-70/barrel range, rather than re-testing the February lows in the $27/barrel range.

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.

Additional disclosure: I own Chevron, Royal Dutch Shell, and Suncor stocks.