New Math for the Shale Energy Supply Chain

Tuesday, February 7, 2017

A market information service for members of Shale Supply Intel ®

Insights for Suppliers of Construction, Equipment, Materials, Supplies, Services, Logistics and Technology to Energy Operations

June 15, 2016. This energy supply chain monthly market letter is provided as a service for EEIA members, partners and sponsors. We maintain a continuous scan of government, analyst and media reports of facts and trends in shale energy relevant to supply chain participants, and integrate the most important information into this monthly summary of the market. Focus areas include markets for crude oil, natural gas production and energy midstream infrastructure, as well as on developments in Washington and in the states affecting the outlook for energy. Comments and feedback are welcome. If you would like others in your organization to receive these letters, please click here and provide their names, titles and email addresses.

How the coming shale recovery will be different from "the good old days"

The shale recovery we forecast in our April issue looks closer today. Supply chain business leaders should be paying attention to leading indicators. This issue provides context and perspective on some widely-reported numbers that give clues to market direction.

The timing and degree to which the recovery unfolds for supply chain businesses will depend on your product/service focus and the geographies of your markets. For suppliers, this cycle will be very different from the heyday of 2011 - 2014.

Rising global demand and the ongoing decline in production have brought supply and demand for crude oil close to balance. U.S. crude inventories, although still near historic highs, have logged four small weekly declines over the last five weeks, after a seemingly endless string of increases going back to early 2014. Crude prices have risen steadily from sub-$30 early in 2016 to the $50 region, bringing some shale plays back into the zone of profitability.

Forecasts generally call for further increases to year-end 2016, ranging from $55 to $70, and continued modest growth thereafter as a global supply deficit continues to build. A damper on the upside remains enormous global crude inventories, now at over 3 billion barrels, which will be a ready source of making up some of the supply deficit.

Given the financial carnage of the past 18 months, US shale producers can be expected to re-enter the field slowly, cautiously and selectively; focusing first on completing DUCs (drilled uncompleted wells) and deploying rigs only to their richest acreage. Many can be expected initially to take advantage of higher prices from currently producing wells to repair balance sheets before investing in new production. Most new horizontal drilling for crude will be concentrated in the Permian, with the Eagle Ford, Denver-Julesburg and Bakken coming back into new production as the recovery builds.

Oil analyst Tom Petrie of Petrie Partners believes that a widespread drilling recovery won't happen until prices return to the $70 vicinity, because most producers will need new capital to restart rigs, and access to debt and equity markets won't be available until then.

Some well-positioned producers should do better, sooner. Pioneer Natural Resources CEO Scott Sheffield recently stated the company's intent to add 5-10 rigs in the Permian and Eagle Ford when prices are in the $50 range and supply/demand fundamentals look positive. Continental Resources CEO Harold Hamm announced the company will begin completing already-drilled (DUC) Bakken wells at the $50 level, but won't start rigs drilling there until the $60 level is reached.

In any event, recovery of US production is coming. But the outlook looks very different for much of the supply chain from past experience. Activity will be influenced significantly by rig and well productivity gains of the past two years. As the recovery proceeds and crews, equipment and supplies are in greater demand, some of the cost efficiencies of the buyers' market will fade back into better price realization for supply chain providers of equipment, supplies and services.

Rig productivity is a major factor in the shape of the recovery. Because of efficiencies and technology advances gained over the last two years, it takes fewer rigs to drill a given number of wells today, and each rig produces substantially more oil and/or gas than before.

On average, a rig is now producing half again to twice (or more) the volume of oil and/or gas than in December 2013, although with wide variations by region or shale basin. According to BTU Analytics, on average, a single rig can now drill approximately 1.6 wells per month.

Productivity gains have come from tighter spacing, longer laterals, improved drill site operations and logistics, and enhanced drilling technologies and completion processes.

More efficient operations and logistics include "pad drilling", where often more than 20 and up to 60 verticals are drilled from a single drill pad, substantially reducing the time needed to start the next well. A host of other efficiencies are realized including water and sand logistics, less need for access roads, more centralized gathering, separation and storage infrastructure and facilities, less need for power generation, material handling, earthmoving equipment and storage tanks.

Centralized drilling also makes it economic to use pipelines rather than tank trucks to carry water to and from the drilling complex. One producer reports previously needing 10,000 to 12,000 truckloads per well, of which 75% were water. Pad drilling using pipelines for water transport reduced their cost from $10 - $12 per barrel of water by truck to $1.50 - $2.00 per barrel by pipe, while reducing community impacts of truck traffic such as noise, congestion, exhaust emissions, and road wear. That's bullish for smaller diameter pipe and related construction work for installation, but bearish for the tank truck business.

Watchers of weekly rig count data for clues to market direction should be cautious in interpreting the data. Because of high productivity gains, the ratio of rig count to production has changed significantly. The relationship is definitely not linear looking backward, with production off roughly 10% but with rigs off 77% since late 2014. But it may be more linear looking forward, with the probability that the dramatic productivity gains of the past, driven in part by collapsing prices, won't be continued into the future at the same rate.

The horizontal rig count, which bottomed at 314 in May (down from late 2014's 1,371), has since ticked up by 9 rigs with the gains coming mainly from West Texas and the Bakken. BTU Analytics estimates that at current prices, production would begin growing again with the addition of fewer than 200 rigs; and with only 100 needed to keep production from falling further.

For supply chain business leaders, real business intelligence requires looking deeper, beyond the gross rig count reports that appear in the business press weekly. To assess impact on your business, you need to see where, geographically, the rigs are being added or laid down, whether the rigs are aimed at crude oil or natural gas, and whether they are horizontal rigs (aimed at shale) or vertical/directional rigs, aimed at conventional reservoirs.

Bottom Line: A production turnaround is approaching, with both crude oil and natural gas supply and demand coming into balance as demand grows and supply gains are limited. This has supported higher prices for both crude oil and natural gas, and a few well-positioned producers are putting rigs back to work. Production growth will be slow but steady, and uneven with respect to geography. The near months of the recovery will be limited by big inventory overhangs. But the overall direction has changed from negative to positive, and companies should stay closely tuned to new supply opportunities.

© 2016 Shale Supply Intel Editors.