Crude stubbornly drills toward record

December 18, 2014 04:49 AM

Crude oil production from U.S. wells is poised to approach a 42-year record next year as drillers ignore the recent decline in price pointing them in the opposite direction.

U.S. energy producers plan to pump more crude in 2015 as declining equipment costs and enhanced drilling techniques more than offset the collapse in oil markets, said Troy Eckard, whose Eckard Global LLC owns stakes in more than 260 North Dakota shale wells.

Oil companies, while trimming 2015 budgets to cope with the lowest crude prices in five years, are also shifting their focus to their most-prolific, lowest-cost fields, which means extracting more oil with fewer drilling rigs, said Goldman Sachs Group Inc. Global giant Exxon Mobil Corp., the largest U.S. energy company, will increase oil production next year by the biggest margin since 2010. So far, the Organization of Petroleum Exporting Countries’ month-old bet that American drillers would be crushed by cratering prices has been a bust.

“Companies that are already producing oil will continue to operate those wells because the cost of drilling them is already sunk into the ground,” said Timothy Rudderow, who manages $1.5 billion as chief investment officer at Mount Lucas Management Corp. in Newtown, Pennsylvania. “But I wouldn’t want to have to be making long-term production decisions with this kind of volatility.”

A U.S. crude bonanza that has handed consumers the cheapest gasoline (NYMEX:RBF15) since 2009 has left oil exporters like Russia and Venezuela flirting with economic chaos. The ruble (CME:R6F15) sank as much as 19% on Dec. 16 to a record low of 80 per dollar before recovering to close at 68; Russian bond and equity markets also crumbled. In Venezuela, the oil rout is spurring concern the country is running out of dollars needed to pay debt and swaps traders are almost certain default is imminent.

Profitable Wells

U.S. oil production is set to reach 9.42 million barrels a day in May, which would be the highest monthly average since November 1972, according to the Energy Department’s statistical arm.

Output from shale formations, deep-water fields, the Alaskan wilderness and land-based wells in pockets of Oklahoma and Pennsylvania that have been trickling out crude for decades already have pushed demand for imported oil to the lowest since at least 1995, according to data compiled by Bloomberg.

Existing wells remain profitable even as benchmark crude futures hover near the $55-a-barrel mark because operating costs going forward are usually $25 or less, Tom Petrie, chairman of Petrie Partners Inc., said in a Dec. 15 interview on the Bloomberg Surveillance television program.

Shut Ins

That’s why prices that have tumbled 47% from this year’s peak on June 20 haven’t prompted any American oil producers to shut down wells, said Petrie, a U.S. Military Academy at West Point graduate who has advised Saudi Arabia, Alaska and the U.S. government on energy issues.

The average cost to operate an existing well in most parts of the U.S. “is about $20 a barrel,” Petrie said. “It might be $5 higher or it might be $5 lower, that’s the out-of-pocket costs that we’re talking about. Until you dip into that and start losing money on a cash basis day in, day out, you don’t think about shutting in” wells.

Benchmark U.S. crude futures (NYMEX:CLF15) rose 0.3% to $56.63 a barrel at 9:55 a.m. in New York Mercantile Exchange trading. The futures are still on track for their fourth straight weekly decline.

Once oil companies sink cash into drilling wells, lining them with steel pipes and concrete, blasting the surrounding rocks into rubble with hydraulic fracturing, and linking them to pipeline systems, they have no incentive to scale back production, said Andrew Cosgrove, an analyst at Bloomberg Intelligence in Princeton, New Jersey.

Sunk Costs

Those investments, which represent “sunk costs,” are no longer a drain on cash flow, Cosgrove said. Instead, they generate capital companies use to repay debt, fund additional drilling, pay out dividends and buy back shares, he said.

Exxon, the world’s biggest oil producer by market value, is expected to boost crude and natural gas output by 2.8% next year to the equivalent of 4.1 million barrels a day, based on the average of eight analyst estimates compiled by Bloomberg.

That would arrest a two-year production slide for the Irving, Texas-based company, which is spending about $110 million a day this year on everything from rig leases to offshore platforms to refinery repairs. Chairman and CEO Rex Tillerson pledged in March to raise output by an annual average of 2% to 3% during the 2015-2017 period.

Cheapest Oil

At the same time, Tillerson said capital spending would drop below $37 billion in each of those years, partly because mammoth investments like the Kearl oil-sands development in western Canada and the Gorgon liquefied natural gas project on Australia’s Indian Ocean coast will no longer be absorbing cash.

In the U.S., Exxon spent an average of $12.72 to extract a barrel of oil last year, its cheapest operating region aside from Asia and Europe, company figures showed. Some operators have even lower costs: Continental Resources Inc. spends about 99 cents to pump each barrel from its 1.8 billion-barrel discovery known as the South Central Oklahoma Oil Province, or SCOOP. Continental, controlled by Oklahoma billionaire wildcatter Harold Hamm, discovered the SCOOP in 2012.

Laredo Petroleum Inc., an explorer of Texas’s Permian Basin that has more than tripled production since 2010, said this month it will slash capital spending by about 50% next year. The company still sees 2015 output expanding by 12%. Shares in the Tulsa, Oklahoma-based company jumped as much as 15% after the Dec. 16 announcement.

As oil explorers retrench in response to the market’s decline, they will drill more selectively, Eckard said. Seismic surveys will be more closely scrutinized to ensure the best chances of striking crude and only the most-promising opportunities will be greenlighted, he said.

“We’re only going to see the very best wells drilled over the next 12 to 18 months,” Eckard said. “It’s going to be exciting.”

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