The last barrel

The downturn in the U.S shale plays has been so severe that the OFS sector is starting to scrap entire fleets of fracing equipment. With half of the available hydraulic horsepower sitting idle, shale completion specialists, including Patterson-UTI Energy and RPC, are retiring truck-mounted pumping units and other redundant equipment. In previous market slumps, unused equipment was mothballed for use when demand increased. This time, gear is being stripped down for parts or sold for scrap.

History repeats itself (again). As over-drilling, stagnant oil prices and investor pressure discourage new shale development, service companies have an oversupply of pumps, frac iron and storage tanks. And the problem is also spreading to sand mines and the truckers who haul it. The stock price for U.S. Silica, the top supplier of frac sand, tumbled 38% in November after announcing plans to shut mines after disappointing quarterly results. Carbo Ceramics plunged 47% after warning investors that it may fail as a going concern, in part because its largest frac-sand customer halted purchases. “We don’t learn from our mistakes in this industry, do we?” said Joseph Triepke, founder of Infill Thinking LLC. “The U.S. oilfield service sector has overshot the growth cycle again, resulting in a capacity glut. There’s too much of everything, from horsepower to sand.”

Approximately 2.2 million hydraulic horsepower, or 10% of industry capacity, have been earmarked for scrap, according to Scott Gruber, an analyst at Citigroup. In addition to Patterson and RPC, Schlumberger and Halliburton are most likely retiring parts of their fleets, and another 1 million HHP need to be eliminated, to halt the slide in fracing fees. “Much needed attrition is finally materializing,” analysts at Tudor Pickering Holt told their clients. “We’ll need to see more attrition from other pumpers to clean up the market, absent a notable demand boost,” the Tudor analysts concluded.

Drilling crash imminent? The scrapping of frac equipment is a clear indication that a significant change in mindset has occurred. According to Mark Papa, chairman and CEO of Centennial Resource Development, who is also Schlumberger’s chairman of the board, the days of relentless production growth from U.S. shale fields are over. Papa has been sounding the alarm on a significant downturn in shale growth since February, saying the slowdown will be dramatic. Papa downgraded his 2020 shale growth forecast to 400,000 bopd compared to his previous estimate of 700,000 bopd. “This is likely not just a 2020 event,” Papa said during Centennial’s third-quarter call. “I believe U.S. shale production on a year-over-year growth basis will be considerably less powerful in 2021.”

Pioneer Natural Resources CEO Scott Sheffield added, “Investor calls for shale producers to slow drilling and stop burning through cash are being heeded. Shale output growth will slow next year, providing a boost for crude prices in 2020. I don’t think OPEC has to worry about more U.S. shale growth, long-term. Sheffield expects approximately 700,000 bopd being added next year. And talk of a shale slowdown has reached a fever pitch, as investors are demanding spending discipline. Occidental Petroleum, Apache, Cimarex Energy and Pioneer all have signaled plans to trim budgets.

As a counterpoint to Sheffield and Papa’s outlook, Exxon Mobil and Chevron plan to ramp-up Permian drilling. Exxon said its production from the basin rose 70% in the third quarter, compared with a year ago, while Chevron reported a 35% gain. Each plans to produce about 1.0 MMbopd from the basin by the early 2020s. This may provide an opportunity for independent producers to be bought, Sheffield said. The majors will have “to decide whether or not to bulk up their inventory over the next several years through M&A of smaller independents.”

Blue-sky vs reality. As of November, an exchange-traded fund that tracks shale producers has lost half its value, and about 24 companies have filed for bankruptcy, says Tom Loughrey, a principle with Friezo Loughrey Oil Well Partners. Loughrey has developed “sweet-spot” projections that help identify the gap between expectation and reality, when it comes to shale companies’ estimates about what their wells will actually produce. Loughrey uses data from state records and applies assumptions that he says are more realistic than those offered by shale producers in investor presentations. In one West Texas field, Loughrey says that projections are about 80% too high and warns other companies will face a reckoning, once their reserve estimates fail to pan out.  

Lack of spacing discipline. Optimistic expectations are compounded by assumptions about how close wells can be drilled to one another. According to Mark Papa, many producers have drilled wells too close together, resulting in a loss of performance. These “child wells” can interfere with output from the “parent well,” diminishing profits. It’s a problem that has affected Concho Resources, which revised down its production goals for the year after it drilled 23 wells too close together.

Severity of bust still in question. It’s evident that we are in the early stages of yet another bust cycle. Halliburton is closing a hydraulic fracturing hub in El Reno, Okla., and permanently dispatching 808 workers employed at the facility. NOV plans to suspend operations at a rig-building facility near the Houston Ship Channel and lay off 85 people. Drilling activity in the U.S. plummeted to 810 rigs in November, 25% less than the year-ago figure of 1,077. And with Saudi Arabia growing tired of carrying the bulk of OPEC’s production cuts, we are poised for another oil price collapse, if the kingdom continues to ramp-up production (up 1.17 MMbopd in October). If our industry leaders would act responsibly and self-regulate, based on lessons learned, maybe we could avoid repeating the painful mistakes of the past. After all, every collage science major is taught to draw inferences from the past to help predict future events, right?

About the Authors

Craig Fleming

World Oil

Craig Fleming Craig.Fleming@WorldOil.com