Oil drillers dial back as gas firms did in '12

A Southwestern Energy worker rigs equipment at the top of a well head near Clinton in November.
A Southwestern Energy worker rigs equipment at the top of a well head near Clinton in November.

When natural-gas prices plunged in 2012, energy producers found refuge in the nation's liquid-rich shale formations where they could pump out oil, natural gas and natural-gas liquids for a larger profit.

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Arkansas Democrat-Gazette

Charts showing natural gas production and drilling rig count in Arkansas.

Now that crude prices are tumbling, what happened in the natural-gas market a few years ago may prove to be a model, albeit imperfect, for oil drillers, analysts say.

Energy companies, as they did with natural gas and Arkansas' Fayetteville Shale, are reducing the number of drilling rigs in response to weaker oil prices.

With oil rigs dropping in the United States, it would be expected that production would also fall. But that may not be so, analysts said.

The "precedent of the U.S. natural gas market raises the possibility that the impact of this rig decline on oil production growth could likely be limited and that the price response to weekly rig counts will diminish," a Goldman Sachs analyst said in a recent research report.

The U.S. shale boom led to energy producers pumping out record amounts of crude from formations across the country, contributing to a glut in the global oil market. Non-OPEC countries added 1.9 million barrels of oil per day to the global supply in 2014 -- the highest since 1978.

U.S. production accounted for most of the growth (about 1.5 million barrels per day of oil and liquids) through expanded exploration in the Bakken Shale in North Dakota, and both the Eagle Ford Shale and Permian basin in Texas, according to a report by Bank of America Merrill Lynch.

As the market became flush with oil, a slowing global economy weakened demand -- causing prices to fall more than 50 percent since last summer.

The global glut of oil expanded on Thanksgiving Day when the Organization of the Petroleum Exporting Countries refused to cut its production levels -- a move, analysts say the cartel took to preserve its share of the market and curb output from U.S. shale.

Energy companies have reacted to the drop in oil prices by lowering their capital spending plans for 2015. This includes Murphy Oil Corp. of El Dorado, which plans to only spend $2.3 billion, a 33 percent drop from 2014.

And with the cuts in spending, comes the drop in active drilling rigs.

U.S. oil producers shut down 200 drilling rigs in January and are quickly pulling more. An additional 200 rigs went off line during the first two weeks of February, according to Wood Mackenzie, an energy consulting firm.

"For a lot of companies it's not worth drilling one of these wells," said Scott Mitchell, director of supply chain at Wood Mackenzie.

Analysts with Bank of America Merrill Lynch project that U.S. drilling and completion spending will decline 36 percent this year, with the number of operating drilling rigs declining 29 percent from 2014.

The report said that with the drop in rigs, total daily U.S. shale oil production will increase only 450,000 barrels per day this year, down from 1.2 million barrels per day added last year.

U.S. oil production reached 9.28 million barrels per day during the week ending Feb. 13, that's up from 8.1 million barrels per day last year, according to the U.S. Energy Information Administration.

This slowdown in oil drilling almost mirrors what happened with natural gas, including in the Fayetteville Shale in north-central Arkansas, analysts said.

The slowdown in oil drilling is "a little bit more severe," Mitchell said.

Drilling initially peaked in the Fayetteville Shale in 2008. At that time prices ranged between $6 and $10 per million British thermal units, and at least once hit above $13. That same year, the number of drilling rigs operating in Arkansas peaked at 60.

But drilling activity in the Fayetteville Shale began to wane in 2012 when natural-gas prices dipped below $2 per million Btus and struggled to rebound to $4.

In response to the drop in prices, the three main companies operating in the state transferred rigs to other U.S. shale formations that are abundant in oil and natural-gas liquids, which are more profitable than the Fayetteville Shale's dry gas.

Now there are nine drilling rigs in the Fayetteville Shale and a total of 11 rigs in Arkansas, according to Baker Hughes, an oil-field services company.

The number could drop further as Southwestern Energy Co., the main company operating in the formation, has said it plans to move at least one of its Arkansas rigs to the Northeast where it recently bought assets in the Marcellus and Utica shales.

Despite the drop in drilling rigs, the amount of natural gas extracted from wells in Arkansas increased from 447 million cubic feet in 2008 to 1.139 trillion cubic feet in 2013, according to the U.S. Energy Information Administration.

The reason production continues to grow for natural-gas and oil wells, despite the idling of rigs, is because there is a lag -- between three and six months -- when a well goes online and when a rig is pulled, said Jason Wangler, an analyst with Wunderlich Securities.

"The [oil] rig count peaked in late September, early October ... so we're just now feeling the effects of that rig count," Wangler said about current oil production.

Some analysts say the decline in drilling rigs will cause a drop in oil production, others say production will continue to grow but at a slower rate.

"Slowing U.S. production will have a positive impact on prices, yes," Wood Mackenzie's Mitchell said. "But production is still actually growing. Essentially you need production declining elsewhere in other parts of the world."

The decline in oil rigs is similar to what happened with natural gas a few years ago, but it is not an ideal model, the analysts with Goldman Sachs said.

We "find that the U.S. natural gas market is a misleading template to draw from as the sharp decline in the 2012-13 gas rig count was in large part offset by strong growth in associated gas and highly productive Marcellus [shale] production, both of which have no equivalent in shale oil today," the analysts with Goldman Sachs.

Another difference between the slowdown in oil and natural gas is that when natural-gas prices fell, companies were able to shift their rigs to other shale formations with other resources, such as oil and natural-gas liquids.

But now, Wangler said, "there's really nowhere to hide."

SundayMonday Business on 02/22/2015

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