What the DUCs Can Tell Us About Crude’s Comeback

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

Oil & Gas

To understand the state of the crude market, a lot of crude investors follow Baker Hughes’ (NYSE: BHI) weekly rig count…

It rose in the first week of May.

In the past 12 months, the number of rigs drilling in the U.S. is up 111.3%. That’s a year-over-year increase of 415 working rigs.

And that’s the highest number of rigs operating in the U.S. since the final week of August 2015.

But there’s another number all energy investors need to start paying attention to. It’s probably more telling of the crude market today than rig counts or production.

As the number of working rigs continues to rise, the number of drilled but uncompleted wells (DUCs) has soared…

 

From December 2013 to March 2017, the number of DUCs grew 48%. That’s an increase from 3,723 to 5,512. You can see this number pulled back from its January 2016 peak of 5,672…

But it’s started to climb again.

There are three factors causing this. The first has to do with the price of crude, which began collapsing in July 2014…

In February 2016, West Texas Intermediate (WTI) hit a low of $26 per barrel – a price not seen in more than a decade. And it represented a 75% drop from the more than $100 per barrel crude was trading at back in 2014.

The number of rigs working in the U.S. declined by almost an equal amount during that stretch at 73%.

DUCs shot higher because companies simply held off completing wells with hopes of higher prices in the future. It’s a basic oil and gas strategy: Why produce now when we can wait and get a higher price down the road?

From January to October 2016, the number of DUCS fell 11.9%. The price of crude jumped 57% during that time.

But here’s the current situation…

In November, following the U.S. presidential election, OPEC announced it’d take 1.2 million barrels per day off the market. Crude prices leapt… but the number of DUCs didn’t fall.

From that low in October, the DUCs have risen more than 10%, or 517 wells. And the number of rigs drilling for crude from the end of October to today has increased 56%.

DUCs Flock Together: The Permian Basin

If we drill down further into the data, much of the DUCs during that span are in the Permian Basin. In fact, the number of DUCs in the Permian since October 2016 has grown 36%… or 496 wells.

The Permian Basin accounts for almost all of the increase in DUCs we’ve seen since October 2016.

DUCs have declined in the Bakken, Marcellus, Niobrara and Utica shale areas. Meanwhile, DUCs have risen in the Eagle Ford, Haynesville and Permian. The Eagle Ford and Permian now account for 57% of all DUCs.

This brings me to the second reason for the rise in DUCs over the last couple of years…

Most leases have a three-year term. And they require a company to drill a well by a certain date. So during crude’s collapse, in order to meet the terms of their leases, companies needed to drill wells.

But that doesn’t mean they completed them…

And as the price of crude surged, the price per acre of land – especially in the Permian – surged along with it. That meant that in some areas, a new lease could cost five times what it did a few years ago.

So it’s better to lock in that lease.

Production from the Permian never faltered during the collapse in crude or the collapse in working rigs… its output chugged ever higher to new records.

The real takeaway here is that Permian production could easily be hundreds of thousands of barrels per day higher. There’s been a mad dash to drill wells to fulfill contract obligations… but output from the Permian is a lot lower than it could be.

That brings us to our final factor: fracking.

Here’s the deal: The cost of drilling represents just 30% of a well’s cost. The other 70% is fracking.

At the moment, fracking crews are in short supply. We’ve seen that some companies are unable to complete wells until later in the year because they can’t find the crews they need.

At the same time, innovations triggered during the downturn (our big focus in Oxford Resource Explorer) now make it cheaper to complete a well. Therefore, a lot of those DUCs could potentially become more cost-efficient.

DUCs Flock Higher… and Set the Ceiling for Crude

The U.S. and OPEC are currently at odds with each other. OPEC is trying to stem the flow of oil to boost the price of crude. The U.S. has been surging to fill the void left by OPEC’s cuts.

But what the DUCs are showing us is that the surge has been subdued so far.

OPEC wants $60 per barrel… and that’s fine. U.S. companies are poised to take advantage of that.

But I think we have a ceiling built in here with the number of DUCs as high as they are – and at a record in the Permian. The U.S. can flood the market if it needs to. And I think that means $100 per barrel of crude won’t be seen again for some time.

Good investing,

Matthew

P.S. There’s a new technology causing a sea change across several sectors, including oil and gas… I’ll be talking about it quite a bit in the June issue of Oxford Resource Explorer, which subscribers will be receiving in just a few weeks.

Investors who understand this revolution – and who invest in it accordingly – could see amazing things happen in their portfolios…

Want to know more? Check this out.