Anatomy of a Turnaround
Two highly respected industry observers share insights into the recovery of 2017—a recovery that, if not “officially” in the works, is bound to unfold. The thing is, this recovery will be different from anything we’ve ever seen before.
by Jesse Mullins
For the Permian Basin Petroleum Association, fall means fresh beginnings. It’s not that the organization is not as busy as ever during the summer months, it’s just that monthly gatherings of the membership are suspended. And so September marks a resumption of member activities and a fresh focus on agendas and priorities.
This fall was no exception. Sept. 17 brought bodies back to the familiar confines of the Midland Petroleum Club and an information-packed session. Attendees at the September luncheon of the PBPA caught a whiff of a more recovery-minded mindset in the agenda-setting and strategy- that was taking place.
The speaker was James Wicklund, managing director of Energy Research at Credit Suisse, and a former petroleum engineer. Wicklund spent 15 years in the energy industry before he went to financial services.
“One of the reasons we have the oversupply of oil, was because the United States increased production in one year by 1.4 million barrels,” Wicklund said. “No country in the history of the oil business has ever grown production by that much in one year. Everybody complained, ‘Well, the surplus really isn’t that great.’ It’s not the surplus. It’s not the level of the surplus that drove oil prices down. It was the fact that we were increasing that surplus by more than 50 percent a year. It’s the RATE of change.”
Wicklund said that the industry’s output was growing so fast that the market basically had to slow down that growth.
“The choice was either that Saudi Arabia turns a couple of valves, and they refused to do that. The reason they refused to do that is… well, it’s something they tried in the ’80s. They took production from ten million barrels down to two. You all remember how big of an impact that had. It had no impact at all. They said, ‘You know, we’re not stupid, we’re not going to do it again. We’re not going to be the swing producer. We’re going to let the United States be the swing producer.’”
But, as it turns out, the only way to get U.S. oil production to decline is to take money away from the E&P companies, Wicklund said.
“That’s it. The E&P companies know that you all hawk your grandmother’s silver, you’ll steal your wife’s credit card, you’ll do whatever is necessary to drill that one more hole. The only way to slow down activity is to take away capital, and so that’s what the market has done. This is what the market did.
“The magnitude of the decline has been dramatic. Now we’re starting to recover. That’s the good news. We’ve put some rigs back to work and everybody’s optimistic, but we are warning our investors right now not to get too optimistic too quick… There are people who think this is going to be a V-shaped recovery, there are people that think it’s going to be a U-shaped recovery, we think it’s going to be more of a bathtub-shaped recovery. We’re going to bounce along the bottom of that bath tub for a while before we start to improve.”
We’re actually starting to hire people, we’ve put 66 rigs back to work in the Permian so far. That’s hiring people back. In manufacturing we’re still laying off some people, but in field activity, especially in the Permian, we’ve actually started to hire back, and that is clearly positive.
The problem is, this is going to be a different recovery than you’ve seen in the past. We have rigs out there that are working on the contracts that were signed over the last several years at $26,000 a day, and now they’re going back to work at 14.5 to 17,000. There’s the famous Helmerich and Payne Yard in Odessa, now known, I think, as the Cemetery, and the problem is that a lot of those rigs won’t go back to work.
The rig count just broke 500 for the first time in a while. That’s after falling form 1,925 rigs less than two years ago. The problem is, we have a whole lot of rigs, and these things are designed to last 20 years. 75% of the rigs that have gone back to work are tier 1 rigs, and that’s good, but of the rigs available to work just two years ago, utilization’s still only 16%. If you’re in the rig business, or you sell things to rigs, that is going to be the most challenged market going forward. Pressure pumping, however, is different. You have all heard about frack intensity, and completion intensity, and what it’s doing for the market. The pressure pumping market is gonna be the first one to come back.
We actually think that pricing in the pressure pumping market is going to come back sooner than most people think. We think pricing and completions overall is going to start to come back in the first quarter of ’17. Since we’re sitting here in September of ’16, that’s really not very far away. The completion end of the business, whether it’s sand, pressure pumping, completion tools, plugs, bowls, it doesn’t make any difference. All that business is going to be a much better business than the rig business going forward. This is just an example of frack intensity, if you would.
Sand… We actually think that sand use in the industry overall will exceed the 2014 peaks by the middle of 2014, with a rig count that’s only 40 percent what it was in the ’14 peak. If you’re in the sand business, or thinking of going into the sand business, it’s not a bad idea.
The good part is, the Permian’s going to lead. I was talking to a young lady, a reporter, earlier this morning, thank you. The most important oil basin in the world for the next several years is the Permian basin. Right now you produce 2 million barrels a day. In four years you basically have to be producing 4 million barrels a day. 4 million barrels a day. You saw a minute ago where we had our forecast of the rig count. That forecast was not to keep production flat. That forecast is what it takes to take US oil production from today’s 8.7 million barrels to 12 million barrels a day by the end of ’18. That’s what we think the call on US production will be. We’re the swing producer. When there’s a call on oil it’s now the US who will answer that call, and that call will be from the Permian basin. The good part is, we’re not in the North Dakota, we’re not in central Texas, we’re not in western Louisiana, we’re sitting here in Midland-Odessa, and this is going to be the center of the world’s oil business for the next several years.
Doing More with Less
“We’re going to all have to do more with less.” Such was the conclusion from Wicklund.
“Technology is the key, both in the office and down home,” he said. “We’re the swing producer for good or for bad. When people send a shock home, we drop production by 700,000 barrels, but if the world’s oversupplied by 1.2 million, that means we have to drop another 500,000 barrels.
That’s the way life is. Whether you like it or not, it is the role of the U.S. now. We have to live with it. We aren’t going to go back to 1,600 rigs. In fact, I don’t think we’re going to go back to 1,000 rigs in the next several years. If you go back to 1,000 to 1,200 rigs in the next 2 years, you almost guarantee that you’ll see $27 oil in ’18 or ’19. Efficiency and return on capital trumps growth. Business will get better, and you guys will lead. It’s not the 80’s, and it’s not 2009, but it’s still going to be good and better. Thank you all very much.
It’s kind of been some fortunate events over the last number of years during the boom and all, because of infrastructure development in the Permian and things like that. Would you agree?
I would certainly agree. As a matter of fact, that’s a thought that applies to your previous question as well. When we were going into, broadly speaking, this most recent expansion … Let’s call that expansion not just 2010 to 2014 or 15 but more like 2003 to 2014, interrupted by a recession in 2009, which, of course, crude oil prices tanked. Didn’t stay down for very long, but clearly that was a recession interrupted event there. As you know, crude oil prices started to go up late 2002 and really did so all through mid 2008. The industry, then, in terms of its response to that price increase … As you know, going into that there weren’t as many rigs in existence as turned out to be the rig count in 2008 going into that thing in 2003, so in terms of equipment, in terms of labor, in terms of infrastructure, the industry was really responding to … That’s why that took years.
Now all of that’s in place. Even the labor I don’t think is going to be all that difficult to take back. People fret about people leaving the industry and throwing their hands up and leaving for good. Well, you know, when those jobs come back and they pay as much as they do, that will always attract labor back to the industry, so I’m not all that worried about that. The equipment largely exists; it’s just sitting out there idle somewhere, and it hasn’t been idled for so long, even at this point, that it’s going to be difficult to bring back into service. This is not a scenario that’s akin to the early part of the decades of the 2000’s where none of this was already in place. It is in place now, and that makes it much easier, much more quickly deployed than was the case then. That kind of speaks to that other question as well about the volatility of future price increase and the ability to respond to that demand, because we have to ramp up, but all you really have to do is go yank that rig out of the yard and go park it somewhere and start drilling with it, as opposed to building it and having to go through all of that process.
In terms of infrastructure, the basin was really struggling with keeping up on the infrastructure side. These contraction events that we are still in the midst of, but, as you said, kind of hopefully seeing the light at the end of the tunnel, these are cleansing events, and they kind of give … I mean, you wouldn’t pick this. We would have picked a softer landing if it were up to us. However, this is what we got, and it’s frankly giving infrastructure of all sorts, from roads to pipelines to electricity to you name it, the opportunity to kind of catch up with what’s been going on in there.
PBOG: As for a rebound in the Permian, Texas/New Mexico, how does it look compared to just a general rebound of oil in the United States?
“It looks more pronounced, for one thing, because it continues to be the lion’s share of the regional economy there. There’s just little doubt about what that is. It’s a much more pronounced phenomenon in the Permian than it is even in statewide Texas and certainly than it is nationally. Any concentrated production region would be that, but it’s just more pronounced and the responses on the broader economic side of the picture, just in terms of general spending and employment and auto sales and hotel/motel activity, all of these things are tied to that, so, again, that recovery is just much more pronounced in the Permian than it is at the broader geographic levels.
Taking the United States as a unit, what does the recovery in the price accrued worldwide … How does that impact the United States as opposed to rest of the world?
It impacts us dramatically differently, because our economy operates in a different fashion than virtually every other producing country, including every OPEC country. The conventional wisdom has been to think that OPEC’s response to this is bizarre, that the Saudi response to this price increase is bizarre, that they’re kind of flooding the market and all of this sort of stuff. It’s true that they have not really reduced their production in response to price decrease, but it’s also true that they didn’t really increase production at all and if they did, not very much during the period of time of price increase. They just don’t operate in that fashion.
We operate as a market economy, where individual companies respond to prices. They do not do that because it’s centrally controlled over there. What that means is we have production declines in response to price declines, they do not. We have production increases in response to price increases, they do not. When crude oil price begins to recover here, that puts the fear into the Saudis and OPEC countries, because they are certainly aware at this point that the US crude oil producer can produce enough oil to push prices down globally. That was not the case going into this shale expansion. It is the case now. Price recovery at the US level means companies go back to work. There’s no governmental crude oil [koobah 00:28:28], thank goodness, that says, “You can’t raise production that fast; it’s going to affect prices,” or something like that. Companies, their actions are economically self-serving, so it affects the US dramatically different than it does any other place on the planet just because our economy thankfully operates in a market fashion rather than a centrally controlled fashion.
PBOG: Can you comment on any predictions or estimates on where the price is going to go?
“We operate as a market economy, where individual companies respond to prices. They do not do that because it’s centrally controlled over there. What that means is we have production declines in response to price declines, they do not. We have production increases in response to price increases, they do not. When crude oil price begins to recover here, that puts the fear into the Saudis and OPEC countries, because they are certainly aware at this point that the US crude oil producer can produce enough oil to push prices down globally. That was not the case going into this shale expansion. It is the case now. Price recovery at the US level means companies go back to work. There’s no governmental crude oil poobah, thank goodness, that says, ‘You can’t raise production that fast; it’s going to affect prices,’ or something like that. Companies, their actions are economically self-serving, so it affects the US dramatically different than it does any other place on the planet just because our economy thankfully operates in a market fashion rather than a centrally controlled fashion.
As you’ve probably heard and as my buddy likes to say … I wish I could take credit for this, but you’ve probably heard it because he’s now widely quoted with this particular saying: ‘There are two kinds of people out there. Those who don’t know what crude oil prices will be in the future and- Oh wait, there’s only one kind of person out there,’ and that’s the person that does not know what crude oil prices will be in the future.
That applies to me as well, but I do know this. Again, people who should have known better have gotten every price prediction wrong. They didn’t think it was going to go as low as it did, they thought it was going to recover to a much higher level more quickly than it did. What they were, in part, basing that on was the previous price downturn in 2008-2009, but when you understand that these two price contractions were caused by two completely different sorts of things, you understand why that had to turn out to be the case. That was a demand driven event, this is a supply driven event. Even though production is falling, production is on the decline in Texas, in the Permian, and nationally, it still hasn’t fallen very fast and it really didn’t begin to pick up any steam in terms of the pace of production decline until early 2016. It’s just astounding that that’s the case, but it is the case.
Historically speaking, our production volume remains high even though it’s lower than it was last year finally, and we’re still awash in crude oil in terms of the amount of oil in storage out there. Again, I don’t know what prices are going to be in the future, partly because I don’t know what demand is going to be in the future, but I do know that the intent, the market intent of this price contraction from $100 a barrel to $20-something a barrel, the sole purpose of that was to somehow cause this glut, this overproduction, this massive amount of crude oil that we’re producing and storing to go away somehow or other. That has not yet happened, and that’s why we see crude oil go up to $45, $46, $48 a barrel and then go down to $39-something like it did yesterday. This is a longer, more tedious, more frustrating process, and, again, nobody’s gotten this right so far.
The safe money is to suggest that if you’re looking for $60 oil between now and the end of 2016, I’m not saying it won’t happen, but that’s not the safe bet. The safe bet is we’re still very slowly working through these market imbalances. Nothing has happened over the course of two or three months; there’s no reason to think that’s going to be the case now if people keep pushing back this time, this day, this pinpointing of the time when this market imbalance is finally corrected. Nobody but nobody is suggesting that’s going to occur in 2016.
Again, our crude oil production capacity is just much greater now than it was 10 or 15 years ago, so I’ve sort of been looking for maybe $50 oil by the end of 2016, but I don’t even know that that’s going to occur. We take a couple steps forward and a couple of steps back, and we’re just not quite getting there. Again, I’m a little concerned about the prices going up too quickly just because the response will be to bring more production into the pipeline and to push those prices right back down again.
Watch for next month’s issue when we continue this series with “What Goes Down Must Come Up.”
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Coming in State of Oil:
December: What Goes Down Must Go Up
Again, examining the world, national, and state situations, we show how the sheer severity of the 2014-16 oversupply and collapse has not only prefigured a pendulum swing in the opposite direction, but might be ushering in a demand cycle that could all but overwhelm the marketplace. The only question is, will crude prices rebound quickly enough to free up and stimulate market forces to answer that demand before oil shortages become the worldwide norm. It’s a volatile world we inhabit. The severity of the downturn—and the stoppages that have occurred—ensure a bumpy ride back to “normal.” How should an E&P company be poised in this climate? A service company? We go to the experts for commentary.
January 2017: The Results You’ve Been Waiting For
What the Election Means for the Basin. For more than a year, industry observers have said that the answers—for Texas and New Mexico, anyway—will not crystalize anytime before the general election. January will mark the first opportunity we’ll have to dissect the voting results of Nov. 1, 2016. We’ll have coverage of the implications not just of the Presidential election but the legislative restructuring of both the Senate and the House. And we bring to a close our four-part analysis of this brave new energy world we inhabit. In this issue, with the election behind, we’ll be able to make our sharpest prognostications yet. Where to from here? You’ll know what the Permian’s best minds have to say.