U.S. oil producers are reaching the limits of their ability to bring in more oil for less by operating only in the most productive formations. (Bloomberg photo)
U.S. shale drillers can't seem to pump bigger bounties of crude with fewer rigs anymore.
Newly drilled oil wells in the nation's three biggest shale plays have produced roughly the same amount of crude during each of the past three months, signaling an end to big productivity gains that helped keep gas and oil flowing from shale even as producers sidelined more than 1,200 drilling rigs.
The development could sting next year as U.S. drillers struggle to keep churning out as much oil as they can to keep cash flowing, even with oil prices roughly $15 to $20 a barrel lower than it costs to produce. And it could mean the U.S. daily crude production could slide further than the half-million barrel decline the U.S. Energy Information Administration projects.
"We're seeing the degradation of U.S. production," said Allen Gilmer, CEO of DrillingInfo in Austin. But that doesn't necessarily mean supplies will fall enough to raise prices, since Saudia Arabia and other Middle Eastern producers can ramp up low-cost production if necessary to keep oil flowing into their markets. Energy
U.S. crude rose 60 cents on Christmas Eve to $38.10 a barrel on the New York Mercantile Exchange, climbing 12 percent from the year's lows reached earlier this week.
The 18-month oil-market crash has spurred more oil-company bankruptcies in one quarter than in the six years since the financial crisis, and U.S. oil and gas job cuts have reached 70,000 so far, the Federal Reserve Bank of Dallas said in a new report last week. It counted nine Chapter 11 court filings in the fourth quarter, one third of the year's casualty count. Barclays says share prices for big North American oil companies have plunged 41 percent this year.
Next year, the Dallas Fed said, global crude supplies could outpace demand by 600,000 barrels a day, and the world's storage tanks may not start to drain until 2017 - which could mean another year without a recovery in oil prices.
For oil producers, the financial pain of another bad year will be amplified if they can't squeeze out more oil from existing wells or ones about to come online while paring back on billions in investments and sidelining hundreds more rigs.
This year, output from the nation's major shale plays fell by 14.3 percent of their output compared with 2014 – a lot better performance than many analysts had expected, given that nearly two thirds of U.S. rigs have been hauled out of the oil patch this year.
But drillers sent their most efficient rigs and their best crews to their most productive sweet spots this year. In the Eagle Ford Shale in South Texas, for example, companies borrowed rigs from oil-heavy regions and put them in areas rich with natural gas and a superlight oil called condensate, both of which help hydrocarbons move faster through shale rock and boost overall production from new wells.
Through that process, known as high-grading, operators figured out how to draw three times as much oil from wells in the Permian Basin in West Texas and two thirds more in the Eagle Ford. In North Dakota, Bakken Shale drillers have boosted crude production from new wells by nearly half, according to Energy Department data from June 2014 to this month.
The data show productivity growth in new shale wells surged from March to September, but began petering out in October and now has sunk to virtually nothing. The migration to the shale sweet spots is over.
"We're drilling the best of the best rock right now," said James West, an analyst at Evercore ISI. "At some point, we'll have to move out to lesser quality rock … That's going to increase break-even costs."
Break-even costs in the shale plays have come down from an average $65 a barrel to $50 a barrel this year, according to Evercore.
Drillers had plenty of flexibility in picking and choosing regions they could neglect without hurting a company's overall output, because all wells aren't created equal in the shale oil patch. About one in five shale wells drilled in the United States over the last few years produced four out of five new barrels of crude, according to consulting firm IHS Energy.
"There was a lot of fat to cut out of the system," said Raoul LeBlanc, a top researcher at IHS Energy. "But as in everything, you eventually start cutting into the muscle. The limits of high grading have come into view."
A smaller portion of this year's shale productivity gains came from technological advancements and new drilling techniques. Producers pumped greater amounts of sand and water into their wellbores to stimulate productivity through the completion process called hydraulic fracturing. They also lengthened their drilling laterals to expose more shale rock to the blasts of water and sand, and took advantage of more precise measurement tools, said Christopher Kopczynski, an analyst at Wood Mackenzie.
"We think operators will continue to make technological breakthroughs," Kopczynski said. But any efficiency gains next year will be far more limited than this year, he said.
Another source of pain relief from cheap oil also is wearing off. Oil field services companies reduced their equipment and service prices by 20 percent to 30 percent this year, helping oil producers squeeze out more oil for less money.
But analysts say the financial distress of the oil bust could force tool suppliers into corporate combinations, giving them more negotiating power on prices.
"Costs are about as low as they're going to get," LeBlanc said.
Gilmer, of DrillingInfo, said he wouldn't be surprised if U.S. oil production sank well below current Energy Department projections next year. His firm estimates the amount of oil that can be extracted in the United States has dropped 31 percent, based on crude prices and the equipment in place, in the past 12 months, while the number of new wells being drilled has fallen 58 percent.
U.S. crude production may edge up somewhat in January and February because of increased drilling activity last summer, when crude hovered around $60 a barrel. But after that, production will likely fall off sharply, Gilmer said.
It's unclear how much that would help ease the global oil glut that has kept prices low this year. Goldman Sachs believes the Saudi Arabia-led Organization of the Petroleum Exporting Countries will increase crude production next year by 640,000 barrels a day.
And OPEC recently said it doesn't expect crude prices to recover to $70 a barrel until 2020, in part because of slower oil demand, but also because U.S. shale producers can ramp up production quickly in response to any oil-price increases.
In coming years, both OPEC and shale drillers may one day have to fill a void in production left by others that are canceling $200 billion in big, multiyear projects to cope with low oil prices.
"The deep-water fields, the oil sands, the frontier projects that were being planned aren't going to be around in five years," said Michael Maher, an energy economist at Rice University. "That's what Saudi Arabia understands."
BUL Price at posting:
2.9¢ Sentiment: Buy Disclosure: Held
