In this post I present some of the methods I have used to get estimates based on actual NDIC data on the Estimated Ultimate Recovery (EUR) for wells in the Bakken North Dakota.
The Bakken is here being treated as one big entity. As the Bakken shales [for geological reasons] are not ubiquitous there will be differences amongst pools, formations and companies.
One metric to evaluate the efficiency of a Light Tight Oil (LTO) well and a large population of wells are looking at developments in the Reserves over Production (R/P) ratio.
The R/P ratio is a snapshot that gives a theoretical duration, normally expressed in years, the production level for one particular year can be sustained at with the reserves in production at the end of that year.
Further, as LTO wells decline steeply and a big portion of the total extraction has come/comes from wells started less than 2 years ago, this dominates the Reserves/Production (R/P) ratio. The flow from a big population of high flowing wells in steep decline results in a low R/P ratio (and vice versa).
The R/P metric says nothing about extraction in absolute terms, which is another metric that needs to be brought into consideration in order to obtain a more complete picture of expected developments.
Development in Well Totals by Categories
The average Bakken well is now estimated to reach a EUR of 320 kbo [kbo; kilo barrels oil = 1,000 bo]. Based on this, the average well has an R/P of 2.7 after its first year of flow, which suggests that about 27% of its EUR is recovered during its first year of flow.
Estimates done by others based on actual NDIC data puts now the EUR for the average Bakken well slightly below 300 kbo.
As from what point the wells reach the end of their economic life, educated guesses now spans from 10 bo/d (0.3 kbo/Month) to 25 bo/d (0.75 kbo/Month).
At first glance it is hard to see how oil, interest rates and debt are connected. Two of them are human constructs while oil (fossil sunlight), a gift from Mother Nature, took tens of millions of years to process. Oil is an endowment extracted from a confined underground stock and is now the most dense and versatile energy source known to man.
Both lines are SIGNALS, and most likely plan their future based on only one of them.
The 10 Year Treasury (or similar) rate is the reference used for amongst other things to set interest rate for mortgages. Most now, aware of it or not, base their future plans on the expectations to developments of the 10 Year Treasury.
What is now playing out in the oil market may be described as below;
This is important as the present huge global debt overhang weighs heavily in the consumers’ balance sheets and their affordability for costlier oil. It is also important for oil companies’ long term planning to bring costlier oil to the market.
A lasting, low rate makes higher debt loads manageable. Interest rates works both sides of the demand/supply equation.
A higher interest rate will have serious implications for highly leveraged consumers and oil companies.
The dynamics may be described as below:
Higher interest rate => lowers demand => downward pressure on price [deflation]=> makes it harder for [highly leveraged] consumers/oil companies to service their debt overhang => lowers investments to develop costlier supplies
At some point in time the present oil supply overhang will come to an end. This will become reflected in a higher price.
The timing of these events creates uncertainties and the agile and financial strong oil companies will sweat out a lasting low oil price.
Few are aware of that the costs of accessing our real capital (like oil) that runs our economies are rapidly increasing.
What is different this time is that the oil price may remain lower for longer than the estimated full cycle break even costs for new developments.
The suggested path for costs is believed in the near term to come down as oil service companies have reduced their prices to shoulder the burden from the recent price collapse. Over time, the capacities of the service companies will become aligned with the demand for their services and products. At some point, as the oil price recovers and investments pick up, the market mechanisms will bring the prices from the service companies up as the service companies also need to make a profit to stay in business.
In figures 4 and 5 are shown how the combination of lower interest rates and a lasting, high oil price encouraged the oil companies to rapidly take on more debt to develop costlier oil on the expectations that consumers had remaining ability to take on more debt/credit to pay for this, thus allowing the oil companies to retire their debts.
The oil companies’ behavior in the recent decade is reminiscent of group think. Few expected the oil price to collapse, though the oil industry itself repeatedly point out the cyclical nature of the oil price.
The aggregate of developments (primarily driven by an amazing growth in the extraction of light tight oil [LTO]) gradually resulted in a supply overhang that made the oil price collapse.
The costs of extracting real capital, like oil, has been rapidly increasing, yet we are making decisions for the future as if it were decreasing, based on the price of capital (money). This is a short term phenomenon that will last until supply and demand become balanced.
The present situation with an apparent oil glut and low prices is a temporary false signal.
This may also be the case with the low interest rates.
The near future will reveal how the competition for available funds to service a still growing huge global debt overhang fare towards the need to fund developments of costlier oil.
Can an increasingly leveraged global economy handle both higher oil prices and interest rates and still remain on its growth trajectory?
In retrospect, it becomes easier to understand the amazing growth and resilience of Light Tight Oil (LTO) extraction from Bakken (and other US tight oil plays) if the effects from the use of huge amounts of debts (including assets and equities sales) is put into this context.
Debt leverage together with a high oil price are what stimulated the US LTO extraction for some time to appear as something like a license to print money.
Now, and as long present low oil prices persist, the LTO companies are in financial straitjackets.
It was high CAPEX in 2015 from external funding, primarily debt and assets/equities sales, that created the impression of LTO’s resilience to lower oil prices (ref also figure 2).
Actual data show that so far there has been some improvements in well productivities [cumulative versus time]. However, these improvements by themselves do not fully explain the apparent resilience of LTO extraction to lower oil prices.
NONE of the wells now added in the Bakken are on trajectories to become profitable at present prices (ref also figure 3).
The average well now needs about $80/bo at the wellhead to be on a profitable trajectory. (The average spread between WTI and North Dakota Sweet has been and is above $10/bo.)
As far as actual data from NDIC on well productivity (EUR trajectories) provide any guidance it is not expected that well manufacturing will pick up in a meaningful way before the oil price moves and remains above$60/bo @ WH.
Writing down the drilling cost and rebasing profitability from completion costs [for DUCs, Drilled UnCompleted wells] does not change this fact.
The decline in the LTO extraction will (all things equal) relentlessly erode future funding capacities for drilling and completion [well manufacturing].
It is now all about the net cash flow from operations, debt service and retirement of debts [clearing the bond hurdles]. Debt management and debt restructuring will remain on top of the agenda for management of LTO companies. It should be expected that the management of these companies will do everything in their powers to clear the bond hurdles and keep their companies out of bankruptcy.
For 2016 well additions in the Bakken will fall below the threshold that allows to fully replace extracted reserves.
In the industry this is referred to as the Reserves Replacement Ratio (RRR). For the Bakken the RRR for 2016 is now expected to be below 50%. (This lowers the collateral of the LTO companies and their debt carrying capacities.)
At present prices several companies cannot both retire their debts according to present redemption profiles and manufacture a lot of wells. This is why it is suspected that halting all drilling (where feasible [i.e. Contracts without stiff penalties for cancellation]) and deferring completions have become a necessity born out of the requirements for debt management.
This analysis presents:
A forecast on total LTO extraction for Bakken (ND, MB/TF) towards the end of 2017.
A closer look at a generic LTO company in Bakken and its near future challenges with clearing the bond hurdles. (The generic LTO company is based on [weighted] financial data from several, primarily Bakken invested companies’ Security and Exchange Commissions (SEC) 10-K/Q filings for 2015).
To keep the focus on the (debt) dynamics in play,The Financial Red Queen, I opted to use a generic company. This is also done to play down discussions about specific companies.
The important message to drive home is how declining cash flow from operations, the big debt overhang and clearing the bond hurdles will constrain many LTO companies’ funding (CAPEX) for well manufacturing [drilling and/or completion] as long as oil prices remain below $60/bo @WH (or about $70/bo, WTI).
The companies operating in Bakken come in many sizes and business models and some of the majors (or subsidiaries thereof) likely have bigger financial muscles, lower debt costs (interest rates) and may have somewhat lower specific costs due to scale of operations.
With sustained low oil prices, the servicing of total debt has been and will be the power that forces companies deep in debt and heavily exposed to LTO into bankruptcies and causes losses on creditors and become the real driver behind the steep decline in LTO extraction.