FRACTIONAL FLOW

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More on LTO Economics in the Bakken

The goal for any commercial company is to make as high as possible profit and returns on invested (employed) capital, primarily the owners’ capital, equity.

Light Tight Oil (LTO) extraction from the Bakken and Three Forks formations in North Dakota had a new high of 1,17 Mbo/d in Apr-18 according to data published in Jun-18 by the North Dakota Industrial Commission (NDIC).

This article is an update of this (which has more details on specific costs to which there are small changes) and is a small expansion focused on profitability/financial metrics.

  • Scenarios were run there no wells were added as of Jan-19 (in the Bakken, Three Forks formations) with an initial flow above 1,2 Mbo/d to get estimates on NPV (DCF) and returns for the project and on equity (owners’ capital), ROE and ROI with a sustained oil price of $60/bo and what oil price would provide the project with a 7% return (ref table 1).
    All at the wellhead (WH).
    These runs had cut off end 2040.
    The objectives with such scenario analysis is to establish baselines from which it becomes possible to follow developments in several financial metrics, also adjusted for oil price movements.
    Applied to companies, it provides for benchmarking of companies’ management performances.
  • At $60/bo (and $2,50/Mcf for natural gas) the Bakken project would return about 4%.
  • A 7% return was obtained with a sustained oil price of $73/bo (and $3,00/Mcf).
    • The above estimates do not include costs for acreage, 800 Drilled UnCompleted (DUC) wells with an estimated total cost (employed capital) of $2,0B – $2,4B, any refracking (ref Marathon), flared gas and future costs for Plugging & Abandonment (P&A) for about 12 000 wells started as of Jan-09 to end 2018, estimated at a total cost of $1,8B – $2,4B and recognized write downs.
  • Including the items described above, the estimates show a full cycle return of 7% for the Bakken as one big LTO project would be achieved at a sustained future oil price at about $80/bo [$90/bo WTI].
  • One of the best and most reliable metrics for investors are NPV projections for Equity (Owners’ Capital).
    A NPV projection for equity that comes in at about 0 with a discount rate of 10% (the higher the better) is considered acceptable (reference also tables 1-5).
    This metric allows comparisions across sectors.
  • A run was done to estimate the effects from pushing back the time from where no wells were added with 5 years (from 2019 to 2024) while remaining close to cash flow neutral (all other things kept equal). This reduces the return for both the project and equity (owners’ capital).
    The discounted return on equity (owners’ capital) was lowered from 14% to 10% with $73/bo at WH.
    Alternatively a higher oil price is required to achieve some targeted return.
  • By applying financial leverage in the extractive industries, like oil extraction, it allows to extract the reserves faster (accelerate the depletion). In the Bakken the use of high financial leverage explains the rapid buildup in extraction levels.
    In this article financial leverage expresses the ratio of debt [inorganic funding] to equity [owners’ capital] used in a company’s investment.
    When financial leverage works, it boosts return (acts as a multiplier) on owners’ capital.
    If it does not work (what many companies painfully discovered after the oil price collapsed in 2014), leverage works fast in the opposite direction and destroys owners’ capital.

    • From companies’ SEC reports it was found that there is a huge span in their financial performances in the Bakken, one major big oil company has lost all their equity of $4+Billion [in the Bakken], one was found to have big negative retained earnings (accumulated deficit) of $2+Billion and then there are several companies on trajectories towards varying degrees of profitability.
  • The 3 years, 2015-2017 with the oil price under $50/bo left primarily the wells of the 2014 – 2016 vintages (ref also figure 2), suffering from the low oil price, and it is now projected these vintages could incur total losses (write downs) of $6B – $8B with a sustained oil price of $60/bo.
    These losses are and/or will be recognized on the companies balance sheets (equity, reduced owners’ capital) as the wells end their economic life and are Plugged & Abandoned (P&A).

    • Older vintages and future wells could fully or partially make up (cover) for these losses from their profits at a sustained oil price of $60/bo. A lasting oil price above $60/bo speeds the healing.
      Irrespective of a future higher oil price and how this probable loss is handled by the oil companies, the 2014 – 2016 vintages will for many years provide strong headwinds to the profitability for many companies in the Bakken.
      This is one of the many things that is hard (close to impossible) to identify from the companies’ SEC filings.

This post includes some estimates with some profitability metrics for the average 2017 vintage well for 2 price scenarios and how a company with solid finances and strong discipline can boost discounted return on equity.
This also illustrates why project NPVs, undiscounted cash flows, time to pay outs, ROE and ROI may be poor metrics when analyzing and ranking several projects and/or companies.
Short story, several metrics should be estimated and compared to get the best possible information about the prospects for financial profitability for any project/company.

Figure 1 Bakken annual NCF and Cumulative 2009 to Apr 2018

Figure 1: The chart above shows the estimated net cash flows by year [black columns]. The red area shows the estimated cumulative net cash flow since Jan-09 and per Apr-18. LOE, G&A and interest rates (effective, i.e. adjusted for tax effects) based on a weighted average from several companies’ SEC 10-K/Q filings. Taxes according to what was in force. Price of oil, monthly North Dakota Sweet (NDS) and realized gas price; the average from several companies’ quarterly reports.

NOTE; the chart in figure 1 shows an estimate (red area) on the development of total capital employed (equity and borrowed) (as from Jan-09 to Apr-18) that first needs to be recovered before profits can be made.

The payouts were reached late 2022 at $60/bo and late 2021 at $73/bo.

The chart does not give any indication about future profits or losses.

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