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Schafer: Cheap oil means pain in North Dakota

The state of North Dakota publishes a daily update on active oil drilling rigs. At last check, the number was down to 159, from 189 last year at this time and well off the May 2012 peak of 218.

The question is how low the count will fall this year. It’s clearly headed to fewer than 100. Closer to zero than 100?

That kind of pessimism might seem excessive, as industries just don’t get cut in half in a matter of months. But in talking with folks in the oil business last week, a 50 percent contraction in drilling activity is the view through rose-colored glasses. It’s perhaps more realistic to think it’s could be down 75 percent.

I didn’t reach any self-described pessimists. Perhaps they have already started looking for another line of work.

What’s happened in the global oil market is exactly what it appears to be — major oil producing countries are trying to put the Bakken out of business. They really have no shot at succeeding long term, but while they are trying, it’s going to be very painful for producers.

Prices have been sliding since last summer. Around Thanksgiving, representatives of the still powerful oil cartel, the Organization of Petroleum Exporting Countries, emerged from a meeting and said they weren’t going to cut production.

It’s not their job to keep the price stable, they said, and they don’t want to surrender market share to the upstart producers in North America.

That’s when the price of a barrel of oil slipped under $70. More recently it’s traded near $45 per barrel.

OPEC officials have said they aren’t really trying to hammer the shale producers, but earlier this month the oil minister from the United Arab Emirates more or less admitted it. It’s the American shale producers who will set the “floor” for crude oil prices, he said. That is, the price only stabilizes when they stop drilling.

Related: Layoffs in the Bakken and a shifting economy

It could take two or three more years.

The Bakken is the name of a shale rock formation, but Bakken also has come to mean the oil-producing area of western North Dakota and eastern Montana. It’s far from the only place where hydraulic fracturing and other technologies have made it possible to make money drilling into shale, so it’s not really fair to suggest OPEC is gunning just for the Bakken.

But Maggie Savage, an analyst with Robert W. Baird & Co., points out that what distinguishes the Bakken is that, of the major North American shale-oil regions, it has the highest marginal cost of production. “The consensus view in the industry is that the Bakken is going to be the worst hurt.”

Her firm regularly calculates the price it takes for an average well to break even. Baird’s estimate for what she called “Bakken core,” the best drilling sites, is $56 per barrel. It’s $69 per barrel on average for other wells in the region.

Prices that consistently have been much higher than that in the last five years are the reason North Dakota production surged to more than a million barrels a day. The U.S. benchmark crude traded above $100 per barrel for much of the past four years and was $104 per barrel as recently as last July.

A little window into the thinking of a Bakken oil boom promoter is still on the website Vimeo. In just a few minutes the chatty managing partner of Harvest Oil Partners lays out the case for jumping in. Making money looks so easy that Gomer Pyle could’ve banged out 30 percent annual returns.

Of course, all his numbers were based on an after-tax, realized oil price of $80 per barrel.

Given the price drop, it’s no surprise that exploration and production companies active in the Bakken have been chopping their budgets for new oil drilling.

Oklahoma-based Continental Resources, one of the big players in the Bakken, cut its capital spending budget from $5.2 billion to $4.6 billion in November and then cut it again just before Christmas, to $2.7 billion.

At Wayzata-based Northern Oil and Gas, Executive Vice President Brandon Elliott said the company hasn’t released its 2015 capital spending plans. Those competitors that have are probably already rethinking them, he said. There’s certainly more cuts coming.

“Maybe the average well doesn’t look profitable at these prices, there are areas that … break even at pretty low pricing,” Elliott said. “But you’re down into the core of the core that has a positive investment return at current prices.”

There’s another interesting factor at play when planning to drill, and that’s the production curve of a Bakken well. Unlike a conventional well, in the Bakken the oil output of a new well falls rapidly. To keep pumping oil, a producer has to keep drilling. That’s why Harold Hamm, who heads Continental Resources, has said working in the Bakken is more like mining for coal than it is drilling for oil.

But if much of a well’s total oil production comes out of the ground the first year, and with little chance to make much money at current prices, then why drill at all this year? “That’s the issue with these unconventional companies. If you don’t drill, your production is going to go down, depending on the age of your wells, some big number,” Savage said. “Our companies are growth companies, so they try to avoid that.”

The current economics of drilling in the Bakken are going to force operators to put their remaining rigs on the very highest producing opportunities, so as to not lose too much money. That means production may not fall as much as investment — and OPEC’s strategy of driving down shale oil is going to take some time to work.

The phones at Northern Oil and Gas have been busy with investors who want to discuss all this, and Elliott said he and his colleagues have repeatedly explained that the company has used hedging to protect realized prices into 2016.

“Up until now, most of the questions have been about liquidity,” he said. “It’s been ‘Help me understand how you guys survive through this downturn.'” That does seem to be the right question to ask.

 

This article was written by Lee Schafer from Star Tribune and was legally licensed through the NewsCred publisher network.

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