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US shale production stalls on lower prices

As companies cut costs, output growth of shale has also fallen

The low oil price is starting to take its toll on US shale production. As companies have pulled rigs out of the oil patch and decide not to start producing from new wells, shale output growth has ground to a halt. 

The US Energy Information Administration (EIA) said in its Drilling Productivity Report this month that total US shale production would grow by just 1,000 barrels a day (b/d) in April compared to the previous month, its slowest rate in years. 

Production will fall in the key Bakken and Eagle Ford shale plays in April. The Permian Basin in Texas is the only major shale oilfield that continues to see strong output growth. It is expected to add 21,000 b/d of new production in April. The Bakken, meanwhile is expected to see a monthly drop of 8,000 b/d and the Eagle Ford a decline of 10,000 b/d.

The figures provide some of the first hard evidence that US shale drillers are not bringing new barrels into production fast enough to sustain the sort of torrid production growth seen in recent years. The EIA calculates the production data by subtracting legacy production from expected gains from new wells. 

The production declines are coming despite continued efficiency improvements in the shale patch as producers make technological tweaks and – crucially – choose to produce from only their best wells amid lower prices.

Bakken producers are getting nearly 600 b/d of production per rig compared to 500 b/d per rig about nine months ago and 300 b/d per rig in early 2013. Eagle Ford drillers are now averaging 680 b/d of production per well, a 36% gain from the 500 b/d per rig they were getting at the start of 2014. The Permian basin continues to see strong production growth in large part because of a rapid improvement in drilling efficiency since the start of this year. 

Some investors say productivity gains of more than 20% could be seen this year as companies focus on their best acreage and improve completion and drilling techniques.

Still, it may not be enough. Because of the steep and rapid production decline rates in shale wells, drillers have to bring new wells online rapidly, simply to sustain existing production. If the shale industry is like a treadmill, as it is often compared to, then producers’ heart rates are rising, they are starting to sweat and their legs are starting to feel weary. 

Shale producers have adopted a range of strategies to cope with the price decline, starting with steep spending cuts. While investment plans have been slashed across the industry, shale producers have been particularly aggressive. Spending could fall by as much as half in the US shale patch this year, according to corporate plans put out in recent months. 

EOG Resources, for instance, is cutting spending by 40%. Chesapeake Energy says it will likely cut 2015 spending by around 37% from 2014. Companies in more perilous financial positions, or with less attractive acreage to drill, are making even deeper spending cuts.

Companies are also pulling rigs out of the oil patch at a much faster rate than analysts expected several months ago. The US oil directed-rig count has fallen by 38% since the start of the year to 922, according to data from Baker Hughes. The rig count peaked at just over 1,600 in October last year, a few months into the oil price drop. The number of horizontal rigs, which are used in shale drilling, stands at 895, down 30% from the start of the year.

All indications are that the rig count will continue to fall. Permitting activity, a leading indicator for drilling, remains slow. “Weekly permit activity continues to decline with no sign of finding a bottom … assuming the rate of decline stays flat, the rig count will be down 955 rigs peak-to-trough, by the end of [the first quarter of 2015],” analysts at Raymond James, an investment bank, said in a recent research note. 

And where companies do still have rigs active, it is focused only in their best acreage, where wells are the most productive and profitable. Industry executives like to call it “high grading”. For large shale producers with the best acreage, this means pulling rigs from a shale play’s fringe and focusing drilling on the sweet spots. For smaller players, who may not have much acreage in the sweet spot, it means drilling the best acreage in their portfolio, even if it isn’t economic at today’s prices. 

Continental Resources is a case in point. The company told investors earlier this year that it would reduce its rig count and drill only on its best Bakken acreage, which is in the play’s sweet spot. The result: the rig count would fall from 18 at the start of the year to just 10 by the middle of the year. But initial and ultimate recovery rates from those wells drilled would be significantly higher than the previous average because they are being drilled at the company’s best acreage using the company’s best drilling and completion technologies. 

As the latest EIA figures show, however, the improved efficiency does not appear to be enough to offset the drop in the number of wells being drilled.

The most recent tactic adopted by shale producers to deal with the low-price environment has been to continue drilling wells, but not producing from them. Anadarko, for instance, has reported that it will have 430 drilled but uncompleted wells by the end of this year, compared with 305 in 2014. EOG says it will have around 275 drilled but uncompleted wells at the end of 2015, up from 200 last year. Barclays says that of the companies that have reported so far, there will be at least 1,000 drilled but uncompleted wells in the US by the end of the year.

Company motivations for leaving wells uncompleted, Barclays points out, vary. Some are simply trying to preserve cash. Well completions account for around 50% of a well’s total costs. For others, the reasoning is more strategic. They are hoping to negotiate cheaper service contracts to cut costs or waiting for oil prices to increase to bring wells into production.

This has introduced a new dynamic into oil markets. By drilling wells but leaving the oil in the ground, producers are essentially building storage levels, at a time when US crude storage levels are already near record highs. Uncompleted wells will not be as quick to respond to rising prices as storage tanks, as fracturing and other completion operations take time, but it represents a large amount of potential production which could hit the market quickly if prices were to rise.

At exactly what price companies might start bringing large numbers of uncompleted wells into production is an unknown, but increasingly important question for the industry and markets. 

“In an extreme scenario in which a large [inventory of unfinished wells] develops, the decision to complete begins to resemble a game theory scenario where, if you are slow to react to higher oil prices, you may miss your opportunity. This competition may result in lower price targets as producers attempt to telegraph rising oil prices and prepare accordingly,” Barclays analysts said in a recent note. 

While Saudi Arabia and other Opec members will cheer the latest EIA numbers, it should be worried about the rising number of uncompleted wells. The decision to leave oil in the ground is clearly hitting production figures, but it is also creating a situation in which large amounts of US oil is ready and waiting for higher prices. This could act as a drag on any price rally later this year, as US shale oil production is likely to rise quickly on any sign of higher prices. 

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