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US shale producers slash spending amid falling oil prices

Shale oil producers across the US are slashing spending and dropping rigs as the business faces its first major test from a steep decline in the oil price

Unless prices rebound in the next few months, a sharp slowdown in production growth, or even a reversal, over the next 18 months looks inevitable.

The US WTI benchmark oil price has fallen by more than half over since last summer to less than $50 a barrel (/b). And the situation is even worse for producers in the Bakken, where local crude grades are trading at a steep discount to WTI. On 7 January, Williston basin sweet crude in North Dakota was selling for just $32.19/b, according to listings by Plains Marketing. Eagle Ford producers are slightly better off, Eagle Ford sweet crude was trading at $45/b.

Shale producers have been quick to respond. Continental Resources plans said it plans to cut spending from just over $4 billion in 2014 to $2.37bn in 2015. ConocoPhillips is reducing spending by 19%, from $16.7bn to $13bn this year, with most of the cuts expected to come from its onshore US business. Denbury Resources is slashing its spending by half, from $1.1bn in 2014 to $550 million this year.WPX Energy, a major player in the Bakken, plans to spend $1.28bn this year, down nearly 25% from last year. 

Analysts at Raymond James say they expect onshore US spending to fall by around 35% this year to about $115bn, down from a peak of $180bn in 2014 and the lowest level since the financial crisis. Spending could fall even lower in 2016 if the oil price remains low. 

That could lead to a sharp drop in the number of rigs working in US oilfields. The rig count has already started to fall along with oil prices, with the current count at just below 1,500, down by more than 100 from September last year. That is likely to be just the beginning. Raymond James expects the rig count to crash in the coming months. From a peak of 1,931 rigs in 2014, the investment bank expects the rig count to fall by 850, or 44%, to a low of 1,081, in the first half of 2016. The analysts expect the 2015 average rig count to be down by 510, or 26%, in 2015 from the previous year.

Even with such a dramatic pull back, the industry could still face difficulty raising the financing it needs. “While an 850-rig decline may sound overly severe to some, it is important to note that, even with this sharp decline, our math says that US exploration and production companies will face a meaningful funding shortfall in a 2015 capital market environment that is not exactly friendly,” the Raymond James analysts said in a research report. 

What will this mean for US oil production?

Over the next few months, production will almost certainly continue rising at a healthy rate. The groundwork for early 2015’s new production was laid in late 2014. At the end of October, there were 650 wells in the Bakken that had been drilled but hadn’t started production because they were still waiting for fracking and completion crews. Those wells will start to come online in the first month of this year.

However, the production outlook for later this year, and into 2016 is much more bearish, especially if the oil price remain low. Because production from shale wells falls so quickly – typically by around two-thirds in the first year – a large number of wells need to be drilled to offset the declines. 

In the Bakken, for instance, the decline rate from legacy wells, i.e. the amount of new production needed to keep production flat, was around 77,000 barrels a day (b/d) in December, according to the US Energy Information Administration. In the Eagle Ford shale in Texas, the decline rate from legacy wells was 131,000 b/d. When oil prices were relatively high, enough wells were being drilled to more than offset these declines.

But with hundreds of rigs being pulled from shale oilfields, it is highly unlikely that enough wells will be drilled to sustain anything like the current pace of production growth. And if prices remain close to their current levels, which would force even more severe cutbacks, production could start to fall.

There are, however, a couple of wild cards that could keep production higher than expected even with steep declines in capital spending. 

For one, shale drillers are likely to focus only on their best acreage amid the price slump, meaning they are likely to get more output for each dollar spent than before. EOG Resources, for instance, has started drilling wells closer together and deploying new completion techniques that have allowed it to squeeze more out of its core Bakken acreage. 

This strategy holds both positive and negative implications for companies. On the positive side, it could allow them to keep production levels growing even as they slash spending. The down side, however, is that the companies will be developing some of their best projects at a time when those projects will see their lowest returns. Nevertheless, a shift in this direction is almost certain.

The industry will also benefit from a long-term trend of increased efficiency in the shale patch, a trend that has shown no signs of abating. In the Eagle Ford, production per rig has nearly tripled from around 200 b/d in mid 2011, when companies were still in the early stages of shale oil development, to around 558 b/d today. In the Bakken, that rate has risen from around 250 b/d in mid-2011 to 550 b/d. If anything, companies will focus even more on squeezing more efficiency out of their acreage amid lower oil prices. 

Similar trends helped shale gas drillers defy expectations of production declines when US natural gas prices crashed amid a supply glut a few years ago. US natural gas production has continued to see healthy growth rates in recent years even though natural gas prices have been lower than what was once considered the industry’s break-even point.

For US oil producers, however, this could simply prolong the pain of lower prices if it prevents a re-balancing of the global oil market. Saudi Arabia has made it clear that it is not going to step in with production cuts, and there is no sign of an imminent surge in oil demand to soak up the current oversupply. Most analysts, then, think US shale producers will be the first to be pushed out of the market.  

Analysts at Bank of America Merrill Lynch say WTI is at risk of falling to as low as $35/b if US producers don’t start to rein in production. In spite of a plunging oil price, “most North American companies continue to announce higher production guidance for 2015,” the investment bank said in a research note. “That needs to change and budgets have to be further curtailed, as low hedge ratios suggest that current [spending] plans are unsustainable.”

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