LONDON, Dec 8 – In the next few months, everyone in the oil market will be intently watching the volume of new drilling activity in the shale plays of the United States for any signs of a slowdown in response to the fall in oil prices.
There are more than a dozen major shale plays in production. But just three account for almost all the rise in oil output since 2009 and nearly two thirds of all rigs in operation: the combined Bakken/Three Forks in North Dakota and the Eagle Ford and Permian in Texas.
These three are the most mature plays and least likely to be affected by the decline in prices. Marginal plays are more likely to bear the brunt of any decline in drilling activity. Nonetheless, the big three account for so much of the shale boom that any slowdown will have to encompass them.
Fortunately, drilling activity in North Dakota can be tracked in real time. North Dakota’s Department of Mineral Resources (DMR), which regulates oil and gas drilling in the state, publishes comprehensive data on drilling permits in its Daily Activity Report, a monthly summary entitled the Director’s Cut, as well as a daily list of rigs operating in the state, all on its website (www.dmr.nd.gov).
The department also publishes comprehensive monthly data on the number of wells and their daily output. In addition, public data is available on prices that Bakken producers are able to realize for their crude from buyers such as Plains Marketing, which posts standardized buying prices on its website (www.paalp.com), as well as from the DMR.
With all this information, it is possible to establish an accurate baseline for the amount of drilling activity in the state before the price slide and how drilling activity responds to lower prices.
A Reuters’ chartbook on “Benchmarking the Bakken,” which shows the most important statistics and time series, can be downloaded here:
NO DRILLING SLOWDOWN YET
The first point to note is that while oil prices have been falling since mid-June, the volume of drilling activity, as measured by applications for new permits, has shown no sign of slowing so far.
In October, exploration and production companies filed for permits to drill 328 new wells, the second-highest number on record. In the weeks since then, there has been no clear evidence of a slowdown, according to the daily lists published by DMR.
The sharp drop in prices should eventually feed through into less drilling and slower output growth, but there is no sign of that happening yet.
Prices will affect drilling only with a lag, since most rigs are contracted weeks and months in advance and are likely to continue operating until their current work programs are complete.
Once the current drilling programs are complete, however, exploration and production companies are likely to contract for much smaller ones in future if prices do not rise.
Continental Resources, one of the biggest and most long established producers in the Bakken, announced in November that it would maintain its current level of drilling activity and defer planned increases in 2015, implying a $600 million reduction in the previously forecast capital spending.
But much deeper cuts will be necessary by some firms if production growth is to slow and be brought back into line with lackluster demand.
IDENTIFYING PRICE THRESHOLD
Bakken producers receive far lower prices for their output than international benchmarks such as Brent or domestic markers such as WTI, reflecting the cost of transporting the crude from the remote north plains to refining centers as well as restrictions on exporting it, which limit marketing opportunities.
In November, the Plains Marketing posted price for Williston Basin Sweet averaged under $59 per barrel, compared with a posted price of $72 for WTI and Brent futures of almost $80.
Substantial discounts of $10-$20 to WTI, and even more to Brent, have been the norm for the past five years. Between 2011 and 2013 even larger discounts were common, but the discounts have narrowed this year, mostly as a result of improved pipeline and railroad takeaway capacity.
The narrowing discounts have cushioned Bakken producers against some of the drop in international prices. For example, Brent prices have fallen $57 from $125 in March 2012 to less than $70 currently, while Williston Basin Sweet is down $26 from $76 to $50 over the same period.
Nonetheless, there are limits to how far discount compression can protect Bakken producers from the impact of lower international prices. At around $50 per barrel, Williston Sweet Crude posted prices are now at the lowest level since the first half of 2009.
POSSIBLE PARALLELS WITH 2008/09
Between June and December 2008, Williston posted prices slumped from $118 to just $17, and they did not recover above $50 until June 2009.
The price crash temporarily slowed the rate of drilling and even resulted in a reduction in oil output, according to the DMR. Both effects lasted just a few months. But even after production growth resumed, it was at a much slower rate for the rest of 2009, before accelerating in 2010.
It is not clear whether the events of 2008 and 2009 provide a useful guide to what may happen if Bakken prices remain at current levels.
First, prices in 2008-2009 fell much further and faster than they have done in the last five months, creating a much bigger shock for the industry. The current downturn is milder by comparison.
Second, 2008/09 was not just an energy crisis but a banking and financial crisis as well. Credit markets ceased to function. Many commentators believed the economy was on the brink of a new depression. In that respect, the crisis of 2008/09 far exceeds anything that the shale industry is experiencing at the moment.
Third, the Bakken shale play has become more mature in the past five years. The extent and quality of the resource is better understood. Infill drilling has largely replaced wildcatting. Drilling techniques have been improved and streamlined. In theory, drillers should be able to break even at much lower prices in 2014 than they needed in 2008/09.
Fourth, lower prices can be expected to stimulate cost-cutting and even more efficiency.
In practice, it is impossible to identify the breakeven threshold for shale producers in advance with certainty, though with Williston Basin posted prices sub-$50 it is likely to be quite close now.
If Bakken prices remain stuck at $50 for six months, production growth is likely to slow, even if output does not actually fall.
(editing by Jane Baird)