On September 10th the EIA reported a production decline in the Lower 48-essentially shale production-of 208,000 BOPD. That is a staggeringly enormous number, approximately 10 percent of the estimated global over-supply. Additionally, it was a week-over-week number which makes it all the more impressive. Yet it received little attention through the week. Rather, Goldman Sachs was grabbing all the headlines with its $20 call on oil.
This week, I was looking for a possible correction in that number with a zero decline or possibly even a gain (remember, the EIA numbers are estimates). But instead we got another decline of 35,000 BOPD.
Back in June I wrote about the coming decline. Shale oil wells lose a lot of production up front, maybe 70 percent in the first year before tapering off at a 5 to 10 percent annual decline over the next few years until leveling off for the life of the well-maybe 20 years or so out. You can think of it as a slope. Once you crest it, the drop is precipitous and picks up speed before finding a bottom. We are undoubtedly now racing down that slope.
To date, we have lost about 500,000 BOPD in the Lower 48. We will lose that again before the year is out. Pundits will claim otherwise, suggesting that oil in the 50's or 60's will spur activity. But if that activity is in drilling, we won't see any effect for a half a year or so. If it is in fracking drilled but uncompleted wells ("DUC's"), that won't mean much either over time. DUC's have been the story of 2015 though they have had little effect on stopping the declines being put in.
Back when the onslaught began, which I mark as Thanksgiving Day 2014-when OPEC declined to cut-Wall Street began talking of shale as being a switch; as in you can turn it on and off. Well, in the perspective of a remote offshore project and the 10 years that it takes to bear fruit, then the answer is yes. But shale is not a switch when it comes to controlling commodity prices, which are much more impatient. It took a full 6 to 7 months for the falling rig count to cast a shadow over production declines. And even then the initial declines were shallow, more of a cresting action really. So, going forward, we may have a new metric. That is, a sudden decline in rigs will take 6 to 9 months to show up in production in any meaningful way.
We also still have a somewhat uneducated media that continues to shrug off its homework. We're about a year into this bear market and oil has been covered to death on the financial news but it is still being misreported. As I mentioned above, the thought that $60 causes a switch to be thrown is wrong.
Operators are battered and bruised. Sensible ones like EOG are holding onto their money. Others like Pioneer are thumping their chests claiming they can drill anywhere any time on their better prospects (but what company is going to claim holding mediocre acreage?). Full disclosure: I own stock in both, but should I stumble upon a few bucks (I run a frack company so these days I'm not counting on it) it would go to EOG.
But, for the most part, very few operators are going to run headlong into a drilling program on a modest recovery. There is also the matter of their banks. They won't let them. The shine is officially off shale in the debt markets. There are the private equity folks and other bottom feeders that are finding their way into the market but for the most part they are spending money on distressed assets, not new oil and gas wells.
Then there are the service companies. If you imagine your worst enemy, someone that you wanted to see suffer some punishment, then let them run a service company right now.
When the work stops so does the income. All of it. That puts you in the position of watching receivables, which you begin staring at very, very closely, waiting for the cracks to develop. Back in the good old days-2012 or so-a single stage on a shale job was being priced at $125,000 or more. The money being made was giddy. In 2014, that same stage was running around $75,000+ because of heightened competition. As of September 2015, that same stage is now down into the $30,000's. That's underwater. Smaller pressure pumper's are quietly accusing the goliaths of dumping. Wall Street pundits would have you believe that there are new efficiencies being uncovered, but the fact is that those who can are jostling for (a) market share and (b) are using their weight to crush and snuff out the newbies that have come on in recent years with all that private equity money.
When prices come back and operators are chomping at the bit to get back to work, idled service equipment will have to be brought back on-line, which is costly and time consuming. You can't just turn a key to restart a mothballed blender or frac pump. Idled time always translates into repairs. This is when all the weak points in your equipment are suddenly and unexpectedly exposed. New crews will have to be hired and retrained because the old crews have either moved onto other industries under mass layoffs or will move on once their 6 months of unemployment benefits run out. It is time consuming to hire and re-train. And these are only some of the challenges, the biggest being the cost of ramping up without cash flow to rely on.
Consolidations in service providers are now well underway. We've seen Halliburton and Baker Hughes but that was pre-downturn. There's a few other M&A deals but for the most part it has been a story of closings and consolidations. North American frack camps are being closed at an alarming rate. Equipment that could only be bought new last year is now plentiful at Richie Brother's auctions. Frack sand trailers are parked in front yards and lots all across American's oil and gas plays. Service yards that are normally empty in good times are stuffed right up to the chain link fence with trucks, trailers, pickups and assorted equipment.