Art Berman Newsletter: November 2020 (2020-10)

WTI futures closed yesterday December 2 above $45 per barrel. Prices have rallied almost $10 since the end of October (Figure 1).  The coincidence of this rally with the announcement of Covid vaccines might suggest that it is based on sentiment and that it may collapse like so many others in recent years.

I don’t think so.

The market is sending a price signal to producers to drill more wells.

In the August 2020 newsletter, I discussed why I believe that U.S. tight oil production will fall  further than most analysts forecast. Since then, I have done more research that indicates total U.S. output will begin falling in April or May of 2021 and reach about 7.25 mmb/d by September.

U.S. oil-directed rig count fell from 1,006 in February 2019 to just 189 rigs in July of this year (Figure 2). It has recovered to almost 245 rigs in November but that is only about 1/3 of what is needed to maintain 11 mmb/d.

I believe that the most-likely case is for production to fall below 7.5 mmb/d by late summer of 2021 and recover to about 7.76 mmb/d by year-end.

EIA’s forecast for average U.S. output of about 11 mmb/d (red, dashed line in Figure 2) for 2021 is unlikely.

The agency correctly states that there is about a 4-month lag between a new price signal and new rig activity.

The problem is that EIA believes that there is about a 2-month lag between the start of drilling and oil production. For anyone with experience drilling and completing wells, that should be a monumental red flag.

Assuming the average well could be drilled in 30 days—a general outlier—these are some of the things that must be done before producing the well: logging, testing, conditioning hole, moving the drilling rig off, moving a completion rig on, displacing mud with water, running pipe, cementing, letting the cement dry, perforating, treating or fracking, flowing back the treatment fluids and flow testing, running pressure tests, killing, negotiating sales contracts, building surface facilities/tank batteries, building a pipeline to connect to main pipeline, waiting on state to witness flow, and finally, re-opening and flowing the well.

Not even half of that can generally be done in a month.

Four states—Texas, North Dakota, New Mexico and Oklahoma—and the offshore Gulf of Mexico account for 80% of U.S. oil production. Table 1 shows the average number of days from well-start to first oil production by area. The production-weighted average is 140 days—2 1/2 times more than the 2 months that EIA uses for its production forecast.

The average annual decline rate for wells in Table 1 is 42%. There is a considerable time lag between first oil from an individual well and enough collective production from new wells to offset the decline of the total production base.

Figure 3 shows that this takes six to seven months.

Adding these together, the time from well start to enough production to offset base decline is almost a year—six times EIA’s estimate.

Shorten or discount any part of the calculation and the conclusion is the same:  it is nearly impossible for U.S. production to be flat at 11 mmb/d for 2021.

That is the reason that oil prices have increased to $45 per barrel. Once the market realizes how wrong the EIA forecast is, the price should go higher.