We are indebted to our anonymous, Mid Atlantic energy advisor for providing the important analysis below.  It demonstrates why some producers may be subsidizing continuing operations to support cash flow demands — on the hope that prices will rise in time to rebuild the financial strength of those producers.

One notes with concern that Alaskan and Canadian oil and gas operations have special difficulty with low price environments.  Most of their competitors operate in areas closer to markets, with lower labor costs, lower transportation costs, lower logistical costs and lower climactic costs/risks.  Many of those competing areas also offer lower political risks, more fiscal certainty.

This is why Alaska and northern Canadian areas should be investing time and honest analysis into how they might remain/become competitive for industry investment dollars in both low and high price environments.    -dh

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Thesis: Crude oil producers have become akin to utilities. They have relatively high fixed costs, through contractual commitments (including debt, rigs rentals, throughput obligations, among others) that do not lessen much with falling commodity prices.  Like utilities, steady cash flow at a high base level is an imperative.  Production declines in fields such as the Bakken can only drop modestly in order to keep cash coming in even if the price does not provide a profit margin, and may even increase to cover fixed obligations.  In prior years, the companies could have just borrowed more money; no longer.  Now the default choices are to maximize production even at unprofitable pricing, or issue stock (or both).

We have been following the Bakken to monitor production increases or decreases on a monthly basis. With this, we pay attention to rig count, number of wells drilled, and DUCs (drilled but uncompleted wells).  It is a great laboratory to track the relative trends of these three metrics to ongoing production. As we have said on numerous occasions, the weekly or monthly data of rig counts tells us very little about what is really going on at the field level.

Consider the table below:

• In the last 21 months, the oil-directed rig count has dropped from 194 to 28, with a low of 27(green highlight). It has dropped virtually every month along the way.

• Despite the drop, the number of new wells completed has been all over the board. To test a “lag effect”, we adjusted a comparison of rigs operating by 60 days to compare that to new wells (see “Lagged Wells Added Per Rig”), but we could still find no trend.

• Daily Oil Production has dropped by 189,388 barrels per day (16.2%) from the high mark in December 2014 despite a massive 85% drop in rigsoperating.  Production in May had ticked up after a 6.5% drop in April, and a 2.1% drop in June. This is a clear indication that rig count by itself says little about short- or intermediate-term trends in production.

• Daily production in June was the lowest monthly production since April 2014. At that time, the Bakken had 7,474 wells operating. In June 2016, there were 10,657 wells operating to get the same level of production. This is an increase of 3,183 wells (42.5%). Average daily production per well in April 2014 was 127 barrels/well, while in June 2016 the per-well volume had fallen to 91 (down 28.3%). While we do not have the numbers to calculate the field decline rate, it is apperent that the decline rate has kicked in.

• Production has now declined seven out of the last ten months. Given the number of rigs operating, further reductions should decline further through the summer, but there is no guarantee as to what volumes will be going into the fall.

• The price of oil is continuing to show a significant discount to WTI, at a current price of $32.25, with WTI above $40. Part of this, of course is a function of competing oil coming in from Canada, plus high transportation costs. Despite the “rebound”, no one is really making money.

• The DUCs fell in June, to 887, down from 19% from a high of 1091 last August. However, we still find this number to be a bit of a head-scratcher. We believe operators are also shutting in or closing some wells, so that DUCs does not tell enough of the story to fill in all the operating blanks.  However, the number of inactive wells is now listed as 1486, down 98 in June. in the last three months.  If the number of DUCs have dropped 45, and the number of inactive wells have dropped 98, why is the number of wells operating only up 58, which could have been drilled by 27 rigs?

In any event, we believe that producers are focusing on wells that are high volume, in a low priced environment. The casual observer might think that producers would hold back production waiting for a higher price in the future. However, the “drowning man” scenario is in place. Producers need cash flow, and they will do what they can with existing wells to generate as much cash as possible. Interest payments on debt do not wait for higher commodity prices.  Profits be damned.

This is the link to the monthly report on Bakken production from the North Dakota DMR:

https://www.dmr.nd.gov/oilgas/directorscut/directorscut-2016-08-12.pdf