This article can also be found at my LinkedIn profile, available here.
While I absolutely appreciate the white noise machine that activates in my head and quite likely the majority of heads of my oil and gas industry cohorts when the phrase “I predict that oil prices will be <insert price here> in the year ____,” it seems that there are at least general comments and postulations that can be discussed. So, let’s all suspend our collective skepticism and disbelief for a few minutes and look at the situation.
Most of us would agree that the scales are tipping in the favor of the United States in terms of being the decisive producer in the global oil and gas marketplace; much of this has come directly through the advent of shale fracking. Many of those commenting on financial networks about rig counts dropping missed the crucial fact that companies were high-grading their asset bases (which mitigated the impact of such rig declines); their presupposition that all rigs produce equal amounts of hydrocarbons was flawed. Looking forward, there seems to be a similarly erroneous presupposition being baked in to predictions regarding pricing, that being the fracked wells producing and soon-to-be-producing will have flatline and consistent production for the life of the well – the spigot will flow consistently for years and year. However, let’s take a look at an example of the typical production forecast for a fracked shale well, a Wolfcamp/Spraberry Formation (A/K/A Wolfberry) production declination curve from a 2012 Laredo Petroleum quarterly earnings report (full report available here).
Now first, I will point out that drilling efficiencies and technologies are always improving – the exact numbers are less important than taking notice of the very general declination curve. If we assume that this curve is even remotely reflective of the current state of fracked shale well efficiency, then it becomes clear that the majority of any given shale well production occurs in the first few years of its life. (NOTE: Yes, I realize this specific graph pertains to vertical wells, but the same phenomenon applies to horizontal production, too).
Given the commodity collapse (oil, as well as copper, natural gas, etc.) that we are currently working through, there is less drilling of new wells occurring at this time. Many wells have been drilled but not completed, as well. I would argue that a majority of the wells that will be producing for the next year or two have been drilled. If this is the case, then we are currently enjoying the production fruits from wells that are easily producing at peak flows. As these wells begin to produce less than their peak flows several years from now, American oil supply will be at lease somewhat lessened. If pricing is still somewhat depressed in a year or two, I believe that these factors could result in the market slack being tightened quite quickly, bringing prices up with all deliberate speed. Although economic figures from China are indicating much less demand than that which spurred the pricing increase several years ago, demand in many parts of the world is steadily rising. An eventually dwindling supply (the author assumes that OPEC/Saudi Arabia will not be flooding the market a few years from now, lest their social programs and kingdom crumble) and increasing demand could meet together in a sudden manner in 2016 or 2017. Ultimately, the longer the oil pricing depression, the harder the snapback will be, whenever it occurs.