Archive for August 2015
In this post I present some of my observations and thoughts about the developments in the oil price, supply and demand, exchange rates (relative to the US dollar), petroleum stocks and what near term factors are likely to influence the oil price.
- The price of oil (and other commodities) appears to have been influenced by the central banks’ policies post the GFC of 2008 (Global Financial Crisis, primarily the Fed as the US dollar is the world’s major reserve currency) with low interest rates which allowed for growth in total global credit/debt.
- As the Fed confirmed its end of QE3 (QE; Quantitative Easing) program by the fall of 2014, the oil price started to decline. This decline became amplified by an oversupply resulting from years of debt fueled high capital expenditures by the oil companies to develop supplies of costlier oil for the market to meet expectations of growth in consumption.
- With the end of QE3 the US dollar rapidly appreciated versus most other major currencies, which offset some of the decline in the oil price in most economies (oil is priced in US dollar), the exceptions being the US and China (which has its currency pegged to the US dollar).
- Demand and consumption of oil (actual data so far only for the US) responded to the price collapse by some growth. However the world’s growth has not been sufficient to close the gap between supplies and consumption, thus sustaining a downward pressure on the oil price.
- The oil price collapse motivated oil companies with low variable costs (OPEX) to compensate some of the loss of cash flow by increasing their production (volumes), thus creating a dynamic where growing supplies went looking for demand.
- The oil price collapse and a period with a favorable contango spread incentivized a strong build in stocks and as stocks remain at elevated levels, it may take some time before stocks return to “normal” levels.
- As growth in global credit/debt slows, comes to halt or deleveraging sets in, this will affect demand and prices, also for oil.
Are the Light Tight Oil (LTO) Companies trying to outsmart Mother Nature with their Financial Balance Sheets?
In this post I present what I found from applying R/P (Reserves divided by [annual] Production) ratios for Light Tight Oil (LTO) for 3 big companies in Bakken/Three Forks/Sanish.
The companies are; Continental Resources, Oasis Petroleum and Whiting Petroleum, which operated 28% of total LTO extraction in the Bakken(ND) in December 2014.
- Undertaking oil and gas reserves assessments are just as much an art as a science.
From previous work with LTO from Bakken I kept track of the R/P ratio for wells/portfolios and generally found it was in the range of 3 – 4 after their first year of flow. This suggested that 25 – 35% of the wells’ Estimated Ultimate Recovery (EUR) was extracted in their first year of flow.
This made sense as extraction (production) from LTO wells are heavily front end loaded and have steep initial declines.
Examining some big Bakken companies SEC 10-K (SEC; Securities and Exchange Commission) filings for 2014 I noticed that these had R/P ratios for Proven Developed Reserves (PDP) that ranged from 7 – 9.
(Refer to the end of this post for more detailed explanations/definitions of PDP and PUD)
That did not make sense and R/P ratios give away powerful and very valuable information about likely future extraction trajectories.
About 50% of the companies’ total LTO extraction (flow) in Dec 2014 in Bakken (ND) were from wells started in 2014. In other words, the flow was dominated by “young” wells which decline rapidly. Therefore, whatever flow data (monthly, quarterly) that was annualized it should be expected a R/P ratio for total extraction around 4 for 2014.
What I present is how PDP, extraction data and R/P data derived from the 3 companies SEC 10-K statements compares to what was derived from actual data. Further, what actual data now is projecting for EUR for the average well for these companies.
LTO in Bakken will now generally work profitably with an oil price (WTI) above $80/b.
The willingness of several companies to sell more debt (obtain more credit), assets and equity to continue to manufacture LTO wells which estimates showed were not commercially viable have had many analysts puzzled.
Something was likely overlooked, and chances are that this is related to EUR driven incentives to expand assets/equity on the companies’ balance sheets (or “book to model”).
As companies drill wells and puts these in operation (production), it allows them to book reserves on the balance sheets. And reserves are the biggest portion of the LTO companies’ balance sheets.
The rush to use credit/debt to drill what likely would become unprofitable wells (applying project economics) with a lasting, low oil price appears driven by some perverse incentive to grow booked reserves to grow assets and thus equity on the companies’ balance sheets, overriding outlooks for poor profitability. High equity on the balance sheets allows for more debt.
Looking at actual, hard well data (from NDIC; North Dakota Industrial Commission) this strategy will at some point have to face up to the realities of physics and Nature. And physics and Nature do NOT negotiate.
- Using actual data for LTO wells strongly suggests that the PDP (and thus PUD) estimates in companies’ SEC 10-K filings for 2014 are grossly inflated. If so, this has inflated the assets/equity numbers on the companies’ balance sheets.
- The findings from this study suggest that the massive drilling activity funded by growing debt, was likely motivated by balance sheets expansions of assets, and thus the equity from inflated EUR numbers (“book to model”) which made room to take on more debt.
- An inflated balance sheet that allows for a debt load above the carrying capacities of the real underlying collateral, will at some point in time turn against their creators and call for revisions of future plans and expectations.
- It will be interesting to see how the LTO companies’ balance sheets and their profitability respond as it become Mother Nature’s turn with the bat.