John Auers and John Mayes
The U.S. upstream industry can certainly relate to the feelings expressed in Joni Mitchell’s classic 1960’s folk song about clouds, especially given the dramatic ups and downs of just the last few years. Domestic production has gone from ever accelerating growth in the first few years of this decade to a collapse in drilling activity and falling output over the past couple of years. But recent developments lend hope to producers that perhaps they are seeing another turnaround and can begin looking again at the “good side” of upstream prospects. In today’s blog we provide some perspective to those thoughts and discuss recent developments which will be important in determining whether the prospects for U.S. production will be as “ice cream castles in the air” or whether they will “rain and snow on everyone”.
Rows and Flows of Angel’s Hair
Back in mid-2014, it was hard not to be optimistic about U.S. upstream prospects. Crude prices were north of $100 per barrel and U.S. production was in the midst of an historic boom period. In those “good old days”, everyone and his brother had a prediction where production was headed, and each forecast seemed to be higher than the previous estimate. There was certainly good reason for the optimism, given the ever accelerating level of crude being extracted from all the various light tight oil (LTO) deposits
After declining for several decades, U.S. crude production bottomed out in 2008 at 5.0 million BPD. With the introduction of hydraulic fracturing (fracking) and horizontal drilling, output reversed its long term decline and began to rise. As in almost all markets, the optimism evolved into exuberance and forecasts of steadily rising output began to proliferate. Most estimates for 2020 were in the 10 to 13 million BPD range and some were even forecasting domestic volumes to reach 15 million BPD. Even the Energy Information Administration (EIA), notable for very conservative forecasts, had U.S. production growing to 10.6 million BPD by 2020 in their 2014 outlook.
I Really Don’t Know Life (Production} at All
After the crude market collapse, which began in 2H2014, and was primarily caused by the U.S. LTO boom, production forecasts began to disappear. Even though output was still rising in the early phase of the downturn, everyone recognized the low prices would eventually take their toll. Uncertainty on what that toll would be is very high, and almost no one was willing to go out on the limb with even relatively short term forecasts. Production ultimately peaked in April of 2015 at 9.6 million BPD, and the trend has been downward since. By September of 2016, output had fallen by 1 million BPD to 8.6 million BPD, drilling had slowed to a fraction of what it had been in the 2014 heyday of the boom, and pessimism was prevalent throughout the oil patch.
From Up and Down but Still Somehow
But developments over the last few months show some signs of sun peeking through the clouds. In fact it is very possible that the worst is over and the 17 month downward slide is already transitioning to another up-cycle, although likely not as strong as what we saw pre-2015. Already we have indications from weekly data (though somewhat unreliable) in November and early December that production rates have turned upwards, perhaps by as much as 150 to 200 MBPD from September lows.
The most positive indications of an upturn are the weekly oil rig counts published by Baker Hughes. After bottoming out at 316 in May, the oil rig count has risen steadily, and just last week increased to over 500 for the first time since early 2016. 
With the rig count currently standing at 510, it is up by over 60% over the low, with increases accelerating in recent weeks (see Figure 1 above). It should be noted that this metric somewhat underestimates the potential for growth, in that the production efficiency per rig is has increased significantly over the past two years, and continues to grow. Also providing support for the notion that production rates are on the verge of increasing is the number of drilled but uncompleted wells (DUCs). The EIA reports that the number of DUCs has risen to over 5,200 by November. These wells would be expected to be completed and put into production as crude prices rise.
Certainly the recent OPEC production agreements bode well for increased U.S. crude output. While previous agreements have been very porous, the recent announcements appear to signify an improved level of cohesion, both within and outside of OPEC. Time will tell whether these production agreements will produce any lasting results.
Even the recent Presidential election could be viewed as a positive sign for the petroleum industry. With a stated agenda to reduce taxes and regulations, and a noticeable positive attitude towards petroleum, Trump could make life much easier for the oil industry than did the Obama Administration. President-elect Trump has already stated he would approve the Keystone XL pipeline and will likely immediately reverse the recent rejection of the hotly contested Dakota Access pipeline (DAPL). The return of a business friendly political environment and even the nominations of former Texas governor Rick Perry to head the Department of Energy, Oklahoma Attorney General Scott Pruitt to lead the EPA and Exxon CEO Rex Tillerson as Secretary of State can be very reasonably viewed as positive signs for the industry.
The Obama Administration can be credited for at least one policy change which will help support future domestic production growth -the ending of the crude oil export ban in late 2015. When output was rising previously, crude exports were not permitted and ever-increasing volumes of light grades had to be absorbed by the U.S. refining industry. This necessitated not only substantive changes to existing refineries but also the construction of condensate splitter facilities. This need to develop additional refining and midstream infrastructure had a depressing effect on domestic crude prices and likely slowed production growth.
In the future, this impediment will no longer be a factor. The bulk of the incremental crude production is likely to be comprised of very light crudes and condensates, which can now be exported. Heavier grades, which are more suited to match the configuration of U.S. refineries, can continue to be imported.
The one aspect of an environment of production growth which has yet to return is the myriad of output forecasts which were so prevalent in the 2010 through 2014 period. The EIA continues to expect production growth, but the forecast tends to be very linear. There is a dearth of forecasts from banks, consultants, and other analysts however, especially in regards to the mid- to long-term. After being burned before, it seems no one is willing to “get back on the horse”, and forecast petroleum production volumes given continuing uncertainties in all aspects of the crude market.
TM&C will be tackling this challenge as part of the upcoming release of its Crude and Refined Products Outlook. Due for publication in early February 2017, this report will discuss the numerous challenges and opportunities facing the petroleum industry and will also present our outlook on U.S. crude production rates through 2030. We are currently in the process of developing this data which is compiled on a field by field basis. More information on this subject can be obtained by visiting our web site at turnermason.com or calling Shanda Thomas at 214-754-0898.