Energy Prospectus

Dan, In your View from Houston you state that a lot of today's production is "sub-economic". What does that mean?

Does it mean wells at cash flow negative or - on the basis of their cost - they are generating a life of well ROI needed to justify the initial investment?

Using your inventory analogy - a company can generate positive cash flow by liquidating inventory but not if they have to spend the money to replace that inventory.

I see this term in lots of places. I never see it explained. Help.

Bob

Take a hard look at the chart at the top of page 4 in the newsletter.

1. There are hundreds of thousands of oilfields in the world. Some "fields" are just one well. Some have over 1,000 wells.
2. Every oilfield in the world goes on decline shortly after it is fully developed (i.e. all drilling locations are drilled and completed)
3. At some point on the decline curve there is an "economic limit". This is where the field goes cash flow negative.
4. As the price of oil & gas goes down (causing less revenue per boe of production), the economic limit line moves up the decline curve.
5. With oil prices dropping from $100 to under $50 rapidly, thousands of oilfields reached their economic limit virtually overnight.

When a field goes sub-economic (cash flow negative) the operator must (a) do something to get it cash flow positive again (i.e. workover, go to secondary recovery), (b) shut-in the wells until oil & gas prices go back up, or (c) plug and abandon the wells.

Since there are tens of thousands of marginally profitable wells ("strippers") in the U.S. at any point in time, a sharp drop in oil prices will cause a sharp drop in production. I have seen estimates that if oil stays under $50 all year, the U.S. will loose up to 800,000 bbls per day of production by year-end. This is why EIA is now forecasting that U.S. oil production will go on decline during the second half of this year (see chart on bottom of page 3 in the newsletter).

When I became the U.S. E&P division controller for Hess Corp. in 1994 we had over 80,000 producing wells and several thousand "fields". Each month my accounting group published cash flow statements on each field. The district managers had to report on why any field in their area was cash flow negative and how they were going to fix it or shut it in. This is something every E&P company does.

Dan, I read your response to say many oil fields are cash flow negative at $50. Wow. I was of the opinion that new investment would not pay at $50 - but existing fields/wells would be cash flow positive (eg simple inventory liquidation). We shall see just how rapidly US production falls.

Bob

See chart on page 3 of the newsletter. EIA now saying that U.S. onshore production will be on decline by 3rd quarter. Much of the decline will be the result of shut in sub-economic properties. By the end of the 1st quarter the active rig count will be close to 1,000. There is no way the U.S. can maintain current production with only 1,000 rigs running. Remember, the active rig count was up near 1,900 six months ago.

Now, go look at how global demand is expected to jump up in Q3 at: https://www.iea.org/oilmarketreport/omrpublic/

What happens when production goes down and demand goes up?

Now watch this video: http://finance.yahoo.com/video/oil-slum ... 00425.html

Good stuff Dan. However, I must say I have as much faith in EIA as I would have in MSNBC.

"Much of the decline will be the result of shut in sub-economic properties." - I would have thought it was due to depletion of wells not being supplemented by new drilling.

Bob

It is about half and half. It may take a couple quarters before we see a decline as a result of less drilling. Remember, it is the completion of wells that adds production, not drilling. There were a lot of wells waiting on completion in December. It will take several months to work off the inventory.

What I think EIA and IEA are yet to realize is the increase in demand resulting from lower fuel prices.