With the supply of oil even higher than last spring, the recent price rally makes little sense. It is a hope for things unseen, and basically, unobtainable. The impetus is the notion that production is going to decline. So far it hasn’t.
There is no economic justification for a single rig to be running in the U. S. The cost is basically exceeding the imaginary future profit. The rare exception would be some shallow vertical test drilled cheap or to replace or re-enter an existing legacy well to up production. So why has production been so slow to fall? Surprisingly to many, including myself, is that these wells are holding up better than expected. The decline rates, while very high in the first months of production, have fell to as low as 10% or below annual decline in the out years. And put in perspective how many wells have been drilled.
The Arkoma Basin in Arkansas has been drilling gas wells since the depression and even earlier. Gas was dramatically ramped up in the 1950s as gas utilities expanded their network of consumer gas lines in both Northwest Arkansas (Rogers, Bentonville, Springdale, and Fayetteville) and in the Fort Smith area and down the Arkansas River Valley (ARV)…Clarksville, Ozark, Russellville, etc. 4,500 wells have been drilled in the past 55 years – around 100 wells per year average. But in the Fayetteville play, which basically started in 2006, just 10 years ago, there are already 5,500 wells. This is over 500 wells per year and at peak some 49 rigs were drilling for gas. Today neither the Arkoma fairway nor the Fayetteville Play have a single rig running. The supply of gas is large and no drilling is needed to supply current consumption, perhaps for another two or three years.
The problem however is that eventually that decline kicks in, big time. And in doing so, the question is how soon can one ramp back up and drill for new production with the ancillary question, do we have enough sense to balance the reserves drilled with the demand? The first issue may be very important. A 30 year old who has some 4 to 10 years of oilfield experience is now unemployed. They are not close to retirement, and many have already been caught with pants down…that is, they were in debt and in losing their job, they quickly had to try and sell out, get another job to make payments, and otherwise endure a lot of economic pain. Foreclosure already much higher than it was during the recent housing crisis in oil field towns. Once in a secure job, they are going to be reluctant to return to the field that burned them so badly regardless the salary. Therefore, where is the talent going to come from?
The “old heads” that trained the generation of the last decade and a half were the survivors from the crash in the 1980s, a double whammy that saw a price collapse in 1981, then a further decline when oil pricing wars (once again waged by Saudi Arabia) saw oil prices plunge to $8 ~circa March 1986. The survivors of that generation trained the hands of today. But the old timers are just that. They are between 55 and 70 years old…like myself. We are returning to room temperature soon. A ten year hiatus between this bust and the next boom will basically wipe us out. The young guys leave. The old timers are dead and because of the 1985-1999 bust there are no middle aged oilies to take over training that next generation. It may take a long time to rebuild the drilling fleet. Or, we may have to import Middle Eastern experts to do it for us. Think about that.
But even so, natural gas prices stayed relatively high during the 1980s as oil collapsed, and gas only followed into the pits around 1990. Even then, prices have not seen the lows that we have seen over the last couple of years, even worse, that we can expect in the next year or two when some gas was sold for $1 an MCF or less, just to get rid of it. The gas associated with oil production is glutting the market. Only time is going to cure this market. But as Keynes said so eloquently decades ago. The market can stay irrational longer than you can stay liquid.