Source: Enverus Land Rig Newsletter, November 2019
Bob Williams, Director of Content, Enverus Drillinginfo
US oil and gas companies are in a quandary—to put it mildly. On one hand, in terms of productivity, efficiency, and sheer energy supply, these operators are arguably the most successful in the industry’s history. But on the other hand, these operators face a dearth of capital availability and investor interest. Even as new oil and gas export markets open up, the industry cannot build new infrastructure fast enough to capitalize on the new opportunities. The US is now the world’s top oil and gas producer and soon could be the top export supplier of both, threatening to replace OPEC as the pivot point in the global energy equation. Yet there is a growing outcry against the industry on a host of societal issues, ranging from single-use plastics clogging the oceans to a corrupting influence on developing nations to responsibility for climate change. But even as OECD oil consumption remains stagnant, the chief engine of projected growth resides among those same developing nations.
Every widely accepted forecast of energy use concludes that oil and gas will remain the predominant forms of energy for the foreseeable future. Yet the industry is often described in terms of being a “sunset” industry, fated to wither away in the face of rapid growth of renewables and energy efficiency—which are increasingly being mandated and subsidized by governments. If that weren’t enough, investors and lenders now seem to be insisting that producers live within the bounds of cash flow, threatening a longstanding tradition of operators relying on outspending cash flow in order to grow their companies. And some major US presidential candidates have vowed to ban all hydraulic fracturing, which would effectively put a halt to the very catalyst responsible for that remarkable, explosive growth of oil and gas supply. Even a newly gas-rich state such as Pennsylvania is spending millions of dollars to investigate whether fracking is responsible for a cluster of cancers in four counties.
But such measures fly in the face of the US being able to meet that projected future oil and gas demand. One only needs to look at a repressive government like Iran’s violently putting down its citizens’ revolt against increased prices and new rationing rules for gasoline to assess the difficulty of attempting to crimp oil demand in developing nations. Similar deadly revolts and repression have occurred in other key producing countries such as Venezuela. How can US operators plan successfully in this confluence of countervailing forces? We don’t presume to have the answers to such a conundrum. But is worthwhile to assess the metrics that has led to this situation.
The unconventional oil and gas revolution hit an inflection point in 2014, when newly burgeoning growth in crude oil production began to separate from the long-established improvement in natural gas output. In 2014, crude production growth roughly doubled the rate of growth in natural gas production, 18.5% to 9.6%. Despite the subsequent collapse in oil and gas prices year-over-year—47% and 37%, respectively— and unprecedented fall in the rig count to its lowest level on record, both commodities resumed their production growth to reach new record levels.
Last year, US production of crude oil had surpassed its crude oil imports for the first time in 25 years; it continues to set new records. In 2018, the US became a net exporter of natural gas for the second year in a row and continues to set new records. Despite the continuing volatility of commodity prices—especially for crude oil—the general trend since 2014 has been downward. That the US oil and gas continues to reach new high-water marks in oil and gas production despite this commodity price stagnation is a testament to its dogged pursuit of often incremental technological advances in productivity.
The role of DUCs
There is disagreement among the providers of data related to US drilled but uncompleted (DUC) wells— chiefly the amount of time allotted to an uncompleted well to qualify it as a DUC. This is a key metric to track, because it represents a significant potential overhang of oil and gas supply. Some would apportion respective vintages as categories to assess the likelihood of a DUC well adding to supply—the presumption being that, given enough time, a DUC that is withheld from completion after a lengthy period of time would be disqualified as a DUC and not represent future supply. In other words, the thinking goes, if a well goes uncompleted long enough, it won’t be completed at all.
But that brings up a host of other issues. Is the delay in completing a DUC simply a function of commodity prices at the time? Or is it due to lack of infrastructure, e.g., a temporary shortfall in pipeline takeaway capacity? Are many DUCs being withheld from production merely because operators are being more circumspect in their budgets? Or are their delays occurring because available capital is drying up? Or is unfettered growth in proved reserves and production a thing of the past for investors and lenders?
Some observers believe the burgeoning growth in the number of DUCs is overstated, and we might be lulled into complacency until an outage in global supply occurs. Others see it as a needed buffer for just such an occasion, and coupled with the price spike, that would accompany such an outage as a boon to both operators and the world’s energy security. Lately, others have cited the need to switch to renewables as rapidly as possible to fend off the worst-case scenarios of climate change.
That may be what’s behind some investors’ shunning of oil and gas companies and the growing efforts by activists to deem DUCs as stranded assets. There is much speculation over the status and role of DUCs in today’s oil and gas industry that won’t get settled here, but there are some definitive things we can say about them that point to overarching truths about the industry’s future.
First, of the total population of DUCs, there have been marked changes since 2014: Of the DUCs identified in 2014, 17% were not classified as either oil or gas; in 2019, that number dropped to 8%. In 2014, the number of total DUCs identified as oil-related outnumbered those as gas-related by a factor of roughly 2:1; by 2019, that ratio jumped to 5.5:1 in favor of oil.
Clearly, we are getting better at identifying DUCs, and there has been a noteworthy shift to them being dominated by oil. A simple explanation would be that takeaway capacity problems were resolved most recently by the chief gassy regions ahead of infrastructure improvements in oil-dominated regions. According to DOE’s tally of DUCs, that view is supported by looking at three key producing regions.
The total number of DUCs has generally been declining in the gas-prone Appalachia and Haynesville regions, while Permian DUCs have sharply risen (until recently), in accordance with their relative progress in dealing with their respective roadblocks in infrastructure. The recent rush of industry to the Permian is another factor.
That brings us to these overarching conclusions:
•As spectacular as the Permian’s recent surge in drilling and production has been, the latest data suggests that growth spurt is leveling off.
• A host of factors underlying that situation can include operator caution, investor/lender retreat, and a recognition of a worldwide glut of oil and gas.
• The only rig count market share by company classification that has shown growth recently is held by major oil companies.
• Overleveraged independents will face a flurry of mergers and acquisitions as the industry undergoes more consolidation.
• There is growing recognition that the industry faces of future of resource abundance rather than scarcity, irrespective of what happens with geopolitics and environmental issues. A good indicator of that is Saudi Arabia’s IPO of Saudi Aramco—cashing in its chips while it’s still ahead, so to speak.
It may be that we are seeing the beginning of the final stage of evolution of the oil and gas industry—the ultimate fruition of the “factory” business model. As oil and gas demand switches to an increasingly export-directed market, US drilling sector activity will be concentrated in fewer companies and likely fewer regions.
How long that prevails, only time will tell.
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