'Ducks' and Oil: Near Term US Crude Deluge Unlikely

Posted by Joseph Keefe April 20, 2015

Conventional wisdom holds that come June a pending $5.3 billion tax break in the No. 2 U.S. oil producing state, combined with a modest uptick in oil prices, will unleash a tsunami of new shale crude supply so big that prices may slump again.

Just one problem with that scenario: oil producers say this is not going to happen.

The fear of a worsening supply glut, a recurring theme of many industry research reports and conferences over the past two months, is based on a view that U.S. shale producers have built up a heavy backlog of drilled but uncompleted wells (DUCs) that can be turned on quickly.

The assumption is that oil firms will finish work on those wells, known as "ducks" in the industry jargon, once oil prices recover further and North Dakota activates its tax relief in response to a long market slump.

Crude prices are up so far 13 percent this month, but still almost 50 percent below mid-2014 highs after a long slide.

"You know you have an 800-pound gorilla that is potentially going to come after you if the price (of oil) goes up," Jackson Hockley, an analyst at wealth manager Northern Trust recently told clients in Houston about such fears.

Yet oil companies say neither the tax break nor the recent uptick in oil prices, which they regard as unpredictable in the short-term, will have much of an impact on their plans.

For instance, Greg Hill, president of Hess Corp, the No. 3 producer in North Dakota, told Reuters the expected tax relief was "not material" for the company.

An analysis of data on "wells in progress" also suggests bearish analysts may have seriously overstated their production potential.

DROP IN A BARREL

Data on such wells from the 22 largest U.S. exploration and production companies crunched by research firm Bernstein show there are fewer than 400 wells on which companies have intentionally delayed work to conserve cash and wait out the price slump.

Those 400 wells would only add 60,000 to 80,000 barrels of production per day to global supply, Bernstein estimated.

In relative terms, that would represent less than 1 percent of U.S. daily supply and less than 0.1 percent of global daily output. It would also be just 5 percent of present oversupply, estimated at 1.6 million barrels per day, based on data from public agencies.

The U.S. onshore industry has been completing about 12,000 wells a year for the last three years, and the number of wells in progress normally hovers just under 3,500.

Lately that number has risen to under 4,000 and some analysts have taken that figure as representing the looming supply overhang rather than the 400 well marginal increase in the backlog that Bernstein has focused on.

Furthermore, the North Dakota tax relief not only applies to just one, albeit crucial oil region, but also pales compared with drillers' overall expenses. For example, completion costs make 60 percent or more of a well's total cost of around $6 million.

Jim Volker, chief executive of Whiting Petroleum Corp , North Dakota's largest oil producer, told Reuters the pending tax break would only trim its expenses by 4 percent.

And even large companies, such as EOG Resources (EOG), which earlier this year sharply curbed fracking and let the number of uncompleted wells rise, are unlikely to simply flood the market once oil prices creep higher.

Such moves to build a "war chest" of wells are part of a strategy to bring them online slowly - not quickly - through 2016 as prices recover, an approach outlined by RBC Capital Markets analyst Scott Hanold in a recent report.

It would be also difficult both financially and logistically to complete unfinished wells within just a month or so, producers say.

Hess, Whiting and other firms say they need to keep on completing wells, albeit at a slower pace, if only to maintain existing relationships with Halliburton Co, Schlumberger (SLB) and other oilfield service companies that do the actual work of fracking wells.