Bakken likely to be hardest hit by oil-price slump

Feb. 10, 2015
Opinions varied among analysts and consultants contacted by UOGR regarding which unconventional US plays will maintain robust drilling and investment this year despite dropping oil and natural gas prices. But, the Bakken formation was commonly said to be the region most apt to feel the sting.

Opinions varied among analysts and consultants contacted by UOGR regarding which unconventional US plays will maintain robust drilling and investment this year despite dropping oil and natural gas prices. But, the Bakken formation was commonly said to be the region most apt to feel the sting.

North Dakota and Texas are likely to "bear the brunt of the pain" of falling oil prices because those two states accounted for more than 90% of US production growth during 5 years, J.P. Morgan economist Michael Feroli said in a research note.

Yet, Feroli and others envision no immediate curtailments in unconventional oil production even though US light, sweet oil prices dipped by about 50% in 2014 because of abundant world oil supplies, stemming in part from shale plays. The oil price slide continued in early 2015.

J. David Anderson, North American services and equipment analyst for Barclays Capital Inc., said he believes the Bakken formation likely "is going to be the hardest hit."

Continental Resources Inc. of Oklahoma City is a major Bakken producer. In December 2014, Continental Resources revised its 2015 budget to $2.7 billion from its November guidance of $4.6 billion. The company now expects production will increase 16-20%, down from its earlier projection of 23-29%.

"We are minimizing what we're doing with near-term cash flow so we're not taking on debt at this time," said Harold G. Hamm, chairman and chief executive officer. "This revised budget prudently aligns our capital expenditures to lower commodity prices."

Continental Resources planned to decrease its average rig count from about 50 in December 2014 to 34 by the end of first-quarter 2015. The company planned to average 31 operated rigs for full-year 2015.

In early January, WBH Energy Partners filed for Chapter 11 bankruptcy protection with a federal court in Austin, Tex. The privately held company, based in Austin, has leases in the Barnett shale.

Rex Energy Corp. of State College, Pa., expects its 2015 operational capital expenditures to be $180-220 million, down 44% from the midpoint of its 2014 capital expenditure guidance and down 43% from the midpoint of its previously announced preliminary 2015 capital expenditure plans.

A small independent, Rex Energy operates in the Illinois basin, the Niobrara, the Marcellus, and the Utica shales.

Leonardo Maugeri, a former Eni SPA executive who is now a senior associate at Harvard Kennedy School's Belfer Center for Science and International Affairs, noted in his Global Energy Trends Briefing No. 2 that the US shale revolution is more resilient to lower oil and gas prices than most believe.

For instance, Maugeri noted shale gas production increased fourfold even though gas prices plummeted since 2008.

"The US shale oil and gas revolution will likely continue to defy gloomy forecasts," Maugeri said, adding that for more than 10 years, some forecasts have called unconventional activity a temporary bubble.

"The dire warnings have returned," he said, adding he sees some analysts grossly underestimating shale potential because of misleading numbers. He suggested a cautious approach toward break-even prices in cost analyses (see sidebar p. 4).

Spending forecasts outlined

In its annual E&P Spending Outlook, Barclays forecast the US onshore rig count will fall by 500 rigs to about 1,250 rigs by Dec. 31. The report noted the horizontal rig count was not necessarily correlated to oil prices.

"In reality, the horizontal oil rig count is almost binary, it's either on or off," Anderson said. He said the Barclays rig count estimate assumed a 10% reduction in well costs. It also took into account the historic trend in natural gas rigs and the most "at-risk" rigs by operator and equipment quality.

The Barclays rig count estimate for yearend assumed a 25% reduction in North American E&P spending during 2015 compared with 2014.

As far as sustained unconventional activity levels for 2015, Anderson sees the South Texas Eagle Ford as being the most resilient. Anderson also sees parts of the Permian basin as being resilient.

Investment banker Cowen and Co LLC's annual study of 476 oil and gas companies regarding 2015 spending concluded drilling in the cores of the Eagle Ford, Permian, and Bakken will hold up well.

Cowen's model indicated that in the event of a 20% drop in spending, the rig count would decline 550 units from the 2014 fourth-quarter average. Cowen also forecast completions would fare better than drilling in 2015.

The Permian basin in West Texas and East New Mexico will continue to be an active area, said Nicole Leonard, analyst with Bentek Energy.

"Many large Permian producers that have announced drilling plans for 2015 have indicated that they still intend to grow production in the basin, especially in the Delaware basin, where Bentek expects producers can still realize a 27% internal rate of return at $60/bbl oil," Leonard said.

2014 slump vs. 1986

Feroli compared the oil-price drop of 2014 with the oil-price collapse of 1986. During 1986, the Texas state unemployment rate rose within months while the regional real estate market went into a prolonged skid that depressed prices yet the national housing market rose.

"The last act of this tragedy was a banking crisis, as several hundred Texas banks failed, with peak failures occurring in 1988 and 1989," Feroli wrote.

He believes a regional recession is possible for Texas. The oil industry accounts for a larger portion of the North Dakota economy than it does in Texas, yet the Texas economy is 35 times bigger than North Dakota.

"Given its much larger size, the prospect of a recession in Texas could have some broader reverberations," into other industries, Feroli said although he sees little likelihood of a nationwide economic weakness.

MoneyRates.com, a financial web site, listed North Dakota as the first of 10 states where falling oil prices will reduce state tax revenues and put jobs at risk.

"What clinched its spot as the state most impacted by lower oil prices is that because it has a small population, the oil business represents a major portion of its economy," MoneyRates.com said of North Dakota.

The other states listed in descending order of being hardest hit were Wyoming, Alaska, Oklahoma, New Mexico, Colorado, Montana, Texas, Kansas, and Utah.

Texas ranks first nationally in both the number of oil-related jobs and oil produced, but its large population and diversified economy help soften the economic consequences of falling oil prices, MoneyRates.com said.

John England, Deloitte LLP vice-chairman, US oil and gas leader, was optimistic about unconventional production going into 2015, saying the shale plays are more resilent to price pressures than many might realize.

For instance during the global recession, states having significant shale assets experienced lower unemployment rates than the US average. He noted Texas holds about half of the shale-related jobs because of the Eagle Ford, Permian, Barnett, and Haynesville plays.

"With oil prices falling, oil and gas company profits will take a short-term hit that may postpone future drilling plays," England said. "Given the amount of investment oil and gas companies have poured into North America in recent years, there's no question that a reduction in that investment will have a negative effect on the US economy. However, this negative impact will likely be offset by growth in employment in the broader US economy."

Servicing debt could be an issue for some oil and gas companies, he suggested.

"Some companies that came late to the game and paid a premium for shale assets may experience some difficulties," England said. "However, there is still a lot of production that is coming online now and will continue through the first half of 2015."

Pressure on services

Moody's Investors Services said spending cuts announced by exploration and production companies as of early January would have only a limited effect on oil supplies.

If the price of West Texas Intermediate crude oil recovers to an average $75/bbl for 2015, then North American exploration and production industry's capital spending would drop by 20% below the 2014 level, said Moody's Senior Vice-Pres. Pete Speer.

"But if oil prices remain below $60, companies will make more drastic cuts, reducing capital spending by 30-40%." As operators cut spending, they will seek rate cuts for services, Speer noted.

Oil prices averaging $75/bbl this year would reduce service company earnings by 12-17%, he estimated. Prices below $60/bbl would lower overall earnings by 25-30% before interest, taxes, depreciation, and amortization.

Moody's Senior Vice-Pres. Tom Coleman said many integrated oil companies "have been more measured in their response to the drop in oil prices than E&P and service companies, which are more directly exposed to commodity price risk."

Before the price collapse, major companies already were focused on capital discipline, asset optimization, cost reduction, and raising shareholder returns, Coleman said. He expects those companies will make more capital cuts, delay investment decisions, reduce staff, and trim costs.

Coleman said activities at risk of reduction or elimination include "nascent unconventional shale plays." Anderson of Barclays also expects service costs will move lower in 2015.

In its E&P Spending Outlook survey, Barclays noted companies expect a 10% or greater decrease in drilling and completion costs on average driven by pressure pumping. Anderson said proppants are expected to continue to be one of the tighter components of the supply chain.

"North American spending in unconventional basins is binary," Anderson said. "Hyperbolic decline rates in unconventional production and the increased scale of operations and logistics to drill and complete wells, has resulted in binary activity levels in the major basins: it's either on or it's off, depending on the price of oil and the basin break-even costs."