Crude… In Like a Lion

Matthew Carr By Matthew Carr, Emerging Trends Strategist, The Oxford Club

Oil & Gas

The price of crude has cratered 9% so far in March. It’s now trading below $48 per barrel.

It’s been a while since we’ve had such downdrafts in crude. November was the last time the U.S. oil price fell below $48. That was also the last time we had such volatility.

On October 19, U.S. crude was at $51.59 per barrel. By November 14, it’d fallen a little more than 16% to $43.29.

It’s possible crude might take a similar path… especially as we’re approaching the end of maintenance season, which I’ve talked about here before.

Now, there’ll be volatility in share prices of energy companies, as we’ve already seen…

But there’s no need to worry.

During the collapse in the price of crude from mid-2014 into early 2016, drilling activity across the U.S. was gutted.

At the same time, we witnessed some anomalies within U.S. shale plays.

Even though drilling activity screeched to a halt, crude production cotinued to rise.

There’s always going to be some lag. But in the Permian Basin, production continued to soar unabated, despite the rig count being slashed by more than 50%…

The Permian was the only region in the U.S. where production was pretty much unaffected by a significant reduction in rig count.

And there are several reasons for that…

First, one of the secrets for the Permian’s unfaltering production is that the rigs that left the shale basin during the crude collapse were vertical rigs. These drill conventional wells, not the gushing shale wells.

Then there’s a large number of nontight oil wells in the Permian. These conventional wells are slow and steady. And their production rates decline at a slower rate than fracked shale wells.

Finally, average initial production rates of fracked shale wells in the Permian have exploded in the past several years…

As drillers continue to perfect the art of hydraulic fracturing and are now able to drill longer laterals, well production is increasing dramatically.

In fact, in 2015, 48% of U.S. crude production came from wells drilled in the previous two years. For comparison, in 2007, those new wells accounted for just 22% of total U.S. production.

At the same time, the downside of U.S. shale is the rapid decline in production. That means to maintain and increase output, U.S. drillers need to drill constantly. It’s a race against declining production rates.

In the Permian, there are currently 1,764 drilled but uncompleted wells. Crude would have to fall below $14 per barrel to make these unworthy to complete. In the U.S., there are 5,443 drilled but uncompleted wells. Crude would have to fall below $30 per barrel for these to not make economic sense to complete.

After a blistering run in 2016, crude has struggled this year.

But for the majority of U.S. drillers, breakeven costs average between $30 and $40 per barrel. And in many areas, those costs are even lower… especially in the Permian.

In 2016, companies spent $28 billion acquiring acreage in Texas’ Permian Basin.

This was triple what was spent in 2015.

And real estate in the Permian is going for as much as $60,000 per acre… which is several times the price of other shale areas.

But for good reason…

The Permian is not only the largest shale formation in the U.S., but also the most attractive for drillers.

There’s already an extensive pipeline network in place. That means product can easily be lifted out.

There’s no shortage of workers.

And there’s no such thing as “winter”… meaning work can continue year-round.

What all of this means is the price of crude can fall at least another 37.5% before drillers really have to start worrying. The increased initial production from new wells, on top of falling costs to complete wells – particularly in the Permian – has created a cushion for shale drillers.

Of course, demand would have to completely tank for crude to collapse that far. And that’s not likely to happen… particularly with U.S. driving season ahead of us.

This means E&P companies that operate in the Permian will still be profitable even if oil prices dip further.

Good investing,

Matthew

P.S. In the April issue of Oxford Resource Explorer, I’ll reveal a little-known company that operates in the Permian and is seeing triple-digit revenue growth. It’s a must-read. To ensure you don’t miss the issue or the pick, click here.