Oil prices are now below $50 a barrel and wrecking havoc across the oil-producing states as rig counts are coming down. According to Baker Hughes, a service company that tracks oil rig counts, oil rigs in the United States dropped by 61 in the week that ended on January 9, and fell by 26 the prior week. The current rig count is at 1750, down by 146, about 8 percent, from its 2014 peak.[i] Helmerich & Payne, a large contract rig company, has mothballed 11 rigs and it announced last week that it plans to idle up to 50 rigs over the month. So, in just a few weeks, the company’s shale drilling activity will be reduced by about 20 percent. Oil prices are now low enough that many oil companies expect drilling costs to be higher than the market price, leading to lower production and eventually higher prices. Experts believe that this low oil price environment, however, will last at least six months.[ii]
There are about 100 jobs associated with each drilling rig, including field hands and maintenance workers. According to Joseph Triepke, a financial analyst and managing director of Oilpro, an industry publishing company, exploration and production budgets are down by 30 to 40 percent. As a result, Mr. Triepke expects the big three land drilling companies — Helmerich & Payne, Nabors Industries and Patterson-UTI Energy — to cut approximately 15,000 jobs out of the 50,000 people that are currently employed over the next six months.
Oil producers try to cut costs before cutting output. As a result, the day rates that oil companies are willing to pay for rigs have fallen by 10 percent. Despite these employee reductions, large layoffs across the industry are not expected, at least not in the near future. Producers contract their rigs for as long as three to four years, and many companies have hedges that lock in higher prices than the going market rates. In addition, producers often need to drill just to retain their leases or keep their revenue up.
The U.S. oil industry employs about a million people, including extraction, pipeline construction and refining, and the oil boom added about 150,000 industry jobs over the last three years, according to Citi Research. Industry executives say companies are reluctant to let highly skilled workers go, especially when oil prices are likely to rebound in the next couple of years as global energy demand rises. It is expected that rig and hydraulic fracturing crews will be let go first because those workers can easily be rehired or replaced when drilling rebounds.
The Bakken Experience
Despite oil prices near $50 a barrel, North Dakota’s Bakken shale producers this month are selling their crude for as little as $34 a barrel, according to prices posted by Plains Marketing. Bakken oil is more vulnerable to low oil prices than Texas shale oil because of a shortage of pipelines and a farther distance to major markets. Oil executives believe that North Dakota, the nation’s second largest oil producing state behind Texas, may suffer the biggest reversal in investment and output in the coming months because drilling in North Dakota is relatively expensive.
Prices for Bakken oil have fallen by almost two-thirds since June 2014, when the average posted price was nearly $92 per barrel for Williston Sweet. This decline in prices is reminiscent of the price collapse in the second half of 2008 and early 2009 when Williston prices fell from $116 in July 2008 to less than $17 in December 2008. Williston prices are now lower than at any point since January 2007, with the exception of a four-month period between November 2008 and February 2009.[iii]
Between 2008 and 2009, prices for Williston Sweet rebounded fairly quickly. That quick rebound is not expected to happen this year because OPEC is keeping its production up. When the financial crisis hit in 2008/2009, OPEC cut its production allocations by almost 4 million barrels per day to rebalance the market and maintain high prices. But this time, OPEC’s strategy is to force U.S. shale oil producers to reduce production by maintaining, rather than cutting, its output. Given the current price war, prices could remain lower for a longer time period than in the 2008/2009 period.
And many forecasters expect the price war to last longer because shale oil differs fundamentally from conventional oil. With shale oil, the time lag from exploration to production can be about 12 months compared to a 5-to-10 year long time lag for offshore production. Further, hydraulic fracturing is much cheaper and requires less onerous technology than offshore oil production. Also, shale drilling costs are getting less expensive as oil-service companies are charging less for rigs and workers, thus shifting the breakeven cost of drilling, the price needed to drill a new well, in many areas to the mid-$50s-per-barrel, according to Deutsche Bank. In December, ExxonMobil indicated it makes money at $40 a barrel.[iv]
Despite that, oil drillers are pulling back from marginal areas, but remain full-tilt in the richest seams. So-called “sweet spots” have higher oil reserves and tend to be more-economical to drill. Four counties in North Dakota (Williams, McKenzie, Dunn and Mountrail) now produce 90 percent of the state’s oil. With oil prices around $100 a barrel, some smaller companies were willing to take the risk and drill in other counties, such as Divide where the breakeven oil price is around $85 a barrel. That compares to a breakeven price of $37 a barrel in Williams County due to better geology, among other factors.[v]
Other oil-producing states are watching oil’s price fall to see where it will land and whether drilling can remain economic in their area. As might be expected, in Canadian fields, companies are dropping rigs at a faster rate than in the United States. However, existing oil sands surface mines that are produced by open pit technology can make money at about $30 a barrel, and the most efficient underground oil sands projects can remain in the black at $35 a barrel, which is above the breakeven levels of many traditional oil wells, but below some other unconventional sources of crude. Major Canadian oil sands producers are expecting output to be 6 to 7 percent higher in 2015 than in 2014.[vi]
Low oil prices mean less investment in drilling for oil companies since profits will be down considerably. Areas of the Bakken are already feeling the pinch. That means that the economies of oil-producing states will not be as robust as they were with $100 per barrel oil. Still, where seams are rich in oil in the “sweet spots”, oil production will continue, but will probably not gain the past production increases of about a million barrels a day seen in the United States over each of the past 3 years. According to the Energy Information Administration’s Short-Term Energy Outlook, oil production is expected to be 9.3 million barrels per day in 2015, 0.6 million barrels per day higher than the expected oil production in 2014. But, due to continued low oil prices this year, oil production is only expected to reach 9.5 million barrels per day in 2016.[vii]
[i] Baker Hughes, U.S. Rig Count–Summary Report, January 9, 2015, http://gis.bakerhughesdirect.com/Reports/StandardReport.aspx
[ii] New York Times, U.S. Oil Producers Cut Rigs as Price Declines, January 7, 2015, http://www.nytimes.com/2015/01/08/business/us-oil-producers-cut-rigs-as-price-declines.html?emc=edit_th_20150108&nl=todaysheadlines&nlid=63692790&_r=0
[iii] Reuters, Bakken oil prices not far from 2008-09 lows, January 7, 2015, http://www.reuters.com/article/2015/01/07/oil-prices-bakken-kemp-idUSL6N0UM2SK20150107
[iv] Quartz, A return to oil at $32 a barrel is no longer unthinkable, January 13, 2015, http://qz.com/325794/oil-at-32-barrel-is-no-longer-unthinkable/
[v] Yahoo News, North Dakota county feels Bakken boom ebb away as oil falls, January 11, 2015, http://news.yahoo.com/north-dakota-county-feels-bakken-boom-ebb-away-141420218–finance.html
[vi] Wall Street Journal, As Oil Slips Below $50, Canada Digs In for Long Haul, January 12, 2015, http://www.wsj.com/articles/as-oil-slips-below-50-canada-digs-in-for-long-haul-1421114641?mod=WSJ_hp_LEFTTopStories&autologin=y