The Complexities of Crude Prices

The evolving Bakken story has just added a new, utterly complex twist. Crude prices, economically advantageous for the shale oil industry in the past five years, have fallen. Few, if any, can predict when the price bottom will be reached.
By The Bakken Magazine Staff | December 15, 2014

The evolving Bakken story has just added a new, utterly complex twist. Crude prices—economically advantageous for the shale oil industry in the past five years—have fallen. Few, if any, can predict when the price bottom will be reached or what falling crude prices will mean to the Bakken shale play.  And, although many have tried, few, if any, can offer an acceptable prediction on what falling crude prices will mean to the Bakken shale play.

In mid-October, when falling crude prices had officially caught the eye of analysts and before mainstream media picked up on crude prices as a major-implication story, the North Dakota Department of Mineral Resources team held its monthly update on the state of the Bakken. Unlike previous updates, this session was largely focused on crude prices. At the time, Lynn Helms, director of the DMR, offered his perspective on the complexity of the issue. “There are too many facets that need to be considered,” he said, regarding what the prices mean.

Since then, many others have offered the same assessment. In Pioneer Energy Services’ third-quarter update,  Stacy Locke, president and CEO, said, “I would tell you that as we look out into the future, one has to be cautious with oil prices where they are today.” Client activity in the Bakken has stayed level and will stay level, he added, but “it’s just too early to tell.”

Lee Boothby, president and CEO of Newfield Exploration, provided a similar perspective. In the company’s third-quarter call, Boothby said at the time that the past eight weeks for the industry had been brutal. “We were all reminded that oil is still a commodity,” he said.

Price Considerations
Ann-Louise Hittle, head of Marco Oils research and John Dunn, lead analyst for Wood Mackenzie’s North America upstream unit, believe the main factor behind the recent decline in price is weakening global oil demand growth. Oil demand growth this year in Europe, Japan, Russia and China has slowed and we now expect only a 0.8 million barrel per day increase from 2013 to 2014, Hittle and Dunn say. “Combined with very strong gains in U.S. oil production, this had led to a global oversupply of oil since this summer. Then OPEC decided not to cut its production to ease the oversupply. Saudi Arabia’s decision not to cut output allows it to protect its market share in Asia,” Dunn says.

There is no magic per-barrel price of West Texas Intermediate—the globally traded crude most closely linked to Bakken crude—that will indicate when exploration and production companies will drastically alter their respective Williston Basin operations. The decision for change is, however, dependent on the following factors.

Geology and Surface Location for New Wells
Because the oil and gas industry typically operates using two- to three-year contracts for drilling rigs and other oilfield services, wells currently in production or awaiting completion will become operational due to the contractual obligations. But, the drilling and completion of existing pads and future wells could be impacted by the location of the new wells. To date, oil prices trading in the $90/barrel and higher range have allowed operators to drill throughout the Williston Basin as long as it included portions of the Bakken or Three Forks shale. Not all areas of the Bakken or Three Forks formations offer the same access to hydrocarbon availability or the type of geology well-suited for hydraulic-fracturing-based oil retrieval. The Bakken and Three Forks plays fit into the motto used in real estate, it’s all about location.

With wells still awaiting completion and other infrastructure in the works necessary to service existing wells, many, including Helms, believe the potential location for new wells will indicate oilfield activity in the future. Exploration and production firms will use their understanding of location geology to guide their work. The core of the Bakken will receive more focus and the fringe areas of the Bakken and Three Forks could see less future activity until prices increase.

Currently, 85 to 90 percent of all new wells are drilled on multi-well pads. Wildcatting is not a prevalent part of the play for the vast majority of operators. Wells that are drilled today are done so in proven fields yielding nearly 100 percent success rates.

Initial Production Rates
Even though most new Bakken and Three Forks wells will produce, there is a wide range of production potential for wells in various parts of the play. The reason potential well geology will drive future activity decisions relates to the initial production rates a new well may offer an operator. Certain fields are more naturally pressurized or contain higher quantities of recoverable oil. Those areas therefore produce higher IP rates. At a time when oil producers are in need of receiving the highest rate of return for the large sum of investment required to bring a well online, higher IP wells—as proven by previously completed wells—offer those operators the best case scenario for a quicker return and payback ability on their investments. Wells that offer higher-than-average IP rates allow operators to continue oil extraction during times with lower-than-average crude oil prices.

Well Completion Costs and Methods
One cannot solely use location and potential IP rates to understand which areas of the play will see an increase or decrease in activity, however. IP rates can be altered by completion methodology, and for those in less-productive zones, lower overall well costs can offset the cost of bringing a well online. In the Bakken, well completion methodologies are constantly improving. In the past year, many operators have added slickwater, increased frack sand injections, additional discrete frack stages and other tweaks to completion designs, all of which have allowed operators to report well production increases up to 100 percent for wells using the new methodologies in the same fields as wells using previous methods. And, as well completion designs continue to improve a well’s overall production from start to finish, the cost to bring a well online has dropped for the majority of firms. Reported increased well costs are typically related to that firm’s addition of sand or water injection for new wells. Due to evolving completion designs that increase IP rates and potentially dropping overall well costs, operators can opt to tweak well designs to increase overall production.

Operating Costs
Following the well’s location, potential IP rate and completion methodology, operating costs can also be tweaked. Cutting operating costs is a major option for producers looking to revamp profit margins decreased by low crude prices. Currently, wells that present unique challenges or above-average maintenance costs will be looked at. Wells or fields that feature high-water cuts could be economically challenging to pursue. Well sites planned or in need of onsite power linked to diesel may also put operators at an economic disadvantage insurmountable to justifying further investment in the area at current low oil prices. Wells planned for established fields on existing pads will continue to receive volume service discounts, however.

The Spread
The spread between Bakken crude and WTI is expected to continue, according to the U.S. Energy Information Administration. With the continuation of the spread, the price of WTI will remain a false indicator for what exploration and production firms looking to sell crude sourced from the Williston Basin are actually receiving. It also places continued importance for operators to access multiple oil markets on the east, west and Gulf coasts.

The Curve
The EIA has also shown that global oil supply is outstripping demand. The scenario, if linked to the EIA’s projected prices for crude in 2015 that are lower than their 2014 projections, should continue for the foreseeable future. The Organization of the Petroleum Exporting Countries did not choose to cut its supply of crude into the world market at the end of November. The decision by OPEC has many analysts believing that the global supply of oil will continue on its current pace of growth. But, although some chose to take no action with their oil production strategy, many members of OPEC will not be able to meet their respective budgets at current oil prices, which could in turn cause a cut in OPEC’s production in an effort to curb supply to increase crude prices.

According to LDV Oil and Gas Consultants Inc., a Texas-based firm that specializes in oil marketing and hedging, supply or demand for oil, however tough to predict, could be impacted in 2015 by the following factors: a major oil producing country curtails production due to political crisis; Iranian political tension with the U.S. could reduce Iranian exports causing an increase in prices; lower oil prices could spur economic recovery which in turn would increase demand and raise prices.

Potential Outcomes For 2015
Oil prices may continue to decline. But, even as they do, it is clear that certain members of the industry are not in fear. Continental Resources has already bet big on recovering oil prices. The Bakken exploration and production giant sold off its oil futures hedges in late 2014, netting Continental $433 million. The move could allow the company to partake in the current market price for oil it is selling as the price recovers, according to Harold Hamm, CEO.

Helms believes only 10 percent of the industry could stall, or at least those operators with drilling rigs running in the North Dakota counties of Bowman, Slope and Divide. Whiting Petroleum did not shy away from its decision to acquire Kodiak Oil and Gas, an exploration and production firm with many assets outside of the core of the Williston Basin.

Many operators have already stated that although they will continue current pace, plans to accelerate work in 2015 will be put on hold until prices increase. Hittle and Dunn are following global oil demand growth. “Does oil demand recover in the U.S., the world’s largest consumer, due to low prices?” they ask. “If the growth rate of oil demand picks up, that will help absorb the oversupply.”

For the upstream spending and activity portions of the oil and gas industry, Dunn is focusing on potential cutbacks in drilling programs that would indicate low prices are having an effect on oil production. “Eventually this would cause supply growth to slow. This would again help balance the market.” Other factors that could also rebalance the market include supply outages in the Middle East due to geopolitical risk or a decision later by OPEC to cut its output, Hittle says.

“We will see companies focus on the core of the plays that matter and there will be an increased focus on reducing costs and increasing efficiencies.  We also expect companies to innovate through an increased push for technological improvements,” Dunn says.

And, for the companies with the financial firepower, there could be merger and acquisition opportunities to fill gaps in their portfolios at a lower than previously expected cost, according to Hittle.

Even if it is difficult to quantify when a major decrease in acvitity will occur, if at all, there may be no better indication of how crude prices impact the entire shale industry than the commentary related to a recently released survey of 100 oil and gas chief financial officers.

“The past six months have seen the oil markets return to the volatility that has historically characterized the industry,” Charles Dewhurst, partner and leader of the natural resources practice at BDO USA LLP, a consulting firm, said following the release of a survey completed by BDO that took the pulse of 100 oil and gas industry CFOs. “However, while headlines may be saying these price declines herald the end of the shale boom, U.S. companies have been preparing for a return to fluctuations and are well-equipped to navigate through this transitional period.”

Author: The Bakken Magazine staff