To preserve capital in a low oil price environment, nearly every energy E&P company has been slashing capital expenditures. While limiting project growth has provided much needed billions to a struggling industry, most companies have focused on driving down costs of existing wells. According to new data from the U.S. Energy Information Agency, well operating costs in 2015 fell 25% to 30% from 2012 levels. The reduction follows years of cost increases stemming from the rapid growth in drilling activity
According to the EIA, the cost reductions can be tied to quicker drilling and completion times as well as increases in well performance. The agency sees costs continuing to stay low. “Greater standardization of these drilling and completion practices and designs across the industry should continue to lower costs,” it said.
However, falling costs could be a mirage; they could merely be the industry focusing on the highest quality wells. In January, Reuters analyst John Kemp estimated that at $30 oil, “there are no parts of the Bakken, whether in the core areas of the play or on the periphery, where drilling new wells makes financial sense.” Given limited profitability, he believed the “imperative in the current environment will be to conserve as much cash as possible by limiting the cost of new drilling and abandoning plans to drill wells which are not profitable (which is most of them at current prices).” Operators in the Permian Basin and Eagle Ford in Texas would likely follow the same strategy.
So, the reduction in costs is likely a limited-time affair given it simply represents a temporary shift in production to the lowest-cost wells. Aside from this, many other factors are likely one-time in nature. A big chunk of savings has stemmed from contract renegotiations with rig leasers and raw materials suppliers such as fracking sand. Those renegotiations will not be recurring and likely will revert higher if prices rebound.
Slowing cost reductions would have a severe impact on an industry starved for cash, especially if costs start reverting higher. This could happen sooner than later. U.S. oil production is up roughly 2 million barrels per day since 2014, with most of the increase stemming from new wells. Production typically declines by about 70% after the first year. Aftward, the estimated annual decline rates are 47% for the Bakken, 55% for the Eagle Ford and 22% for the Permian.
Eventually, operators will need to replace production with higher-cost wells. As you can see below, drillers have gotten away with milking their highest quality wells to boost cheap production despite the rig count dropping about 80%. Due to rapid decline rates, this won’t take years to play out. If you’re invested in an oil E&P, take their triumphant claims of well cost reductions with skepticism.
