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US Shale: How Smoke And Mirrors Could Cost Investors Millions
Submitted by Rune Likvern via OilPrice.com,
In this post I present what I found from applying R/P (Reserves divided by [annual] Production) ratios for Light Tight Oil (LTO) for 3 big companies in Bakken/Three Forks/Sanish.
The companies are; Continental Resources, Oasis Petroleum and Whiting Petroleum, which operated 28% of total LTO extraction in the Bakken (ND) in December 2014.
Undertaking oil and gas reserves assessments are just as much an art as a science.
From previous work with LTO from Bakken I kept track of the R/P ratio for wells/portfolios and generally found it was in the range of 3 – 4 after their first year of flow. This suggested that 25 – 35% of the wells’ Estimated Ultimate Recovery (EUR) was extracted in their first year of flow.
This made sense as extraction (production) from LTO wells are heavily front end loaded and have steep initial declines.
Examining some big Bakken companies SEC 10-K (SEC; Securities and Exchange Commission) filings for 2014 I noticed that these had R/P ratios for Proven Developed Reserves (PDP) that ranged from 7 – 9.
That did not make sense and R/P ratios give away powerful and very valuable information about likely future extraction trajectories.
About 50% of the companies’ total LTO extraction (flow) in Dec 2014 in Bakken (ND) were from wells started in 2014. In other words, the flow was dominated by “young” wells which decline rapidly. Therefore, whatever flow data (monthly, quarterly) that was annualized it should be expected a R/P ratio for total extraction around 4 for 2014.
What I present is how PDP, extraction data and R/P data derived from the 3 companies SEC 10-K statements compares to what was derived from actual data. Further, what actual data now is projecting for EUR for the average well for these companies.
(Click to enlarge)
Figure 1: The chart above shows developments in average well first year LTO totals (productivity) for some companies and by vintage. The colored columns for 2013 and 2015 show projected financial performance based on average well first year LTO totals.
For 2013 the chart is based on: WTI at $98/b and a type well at $10M was found to have a 0% return with a total first year LTO flow at about 50 kb.
For 2015 the chart is based on: WTI at $60/b and a type well at $8M was found to have a 0% return with a total first year LTO flow at about 90 kb.
The chart illustrates that the well productivity has been on an upward trend. So far the productivity improvements and cost reductions have not fully compensated for the effects from a much lower oil price.
The profitability equation of the type well was solved for the equivalent total first year flow for various oil prices and costs on a point forward basis.
A lower oil price makes the red columns “push” the other ones upwards (moves the profitability bands upwards).
Wells of 2015 vintage (pre May) are on a trajectory close to those of the 2014 vintage.
kb, kilo barrels = 1,000 barrels
LTO in Bakken will now generally work profitably with an oil price (WTI) above $80/b.
The willingness of several companies to sell more debt (obtain more credit), assets and equity to continue to manufacture LTO wells which estimates showed were not commercially viable have had many analysts puzzled.
Something was likely overlooked, and chances are that this is related to EUR driven incentives to expand assets/equity on the companies’ balance sheets (or “book to model”).
As companies drill wells and puts these in operation (production), it allows them to book reserves on the balance sheets. And reserves are the biggest portion of the LTO companies’ balance sheets.
The rush to use credit/debt to drill what likely would become unprofitable wells (applying project economics) with a lasting, low oil price appears driven by some perverse incentive to grow booked reserves to grow assets and thus equity on the companies’ balance sheets, overriding outlooks for poor profitability. High equity on the balance sheets allows for more debt.
Looking at actual, hard well data (from NDIC; North Dakota Industrial Commission) this strategy will at some point have to face up to the realities of physics and Nature. And physics and Nature do NOT negotiate.
- Using actual data for LTO wells strongly suggests that the PDP (and thus PUD) estimates in companies’ SEC 10-K filings for 2014 are grossly inflated. If so, this has inflated the assets/equity numbers on the companies’ balance sheets.
- The findings from this study suggest that the massive drilling activity funded by growing debt, was likely motivated by balance sheets expansions of assets, and thus the equity from inflated EUR numbers (“book to model”) which made room to take on more debt.
- An inflated balance sheet that allows for a debt load above the carrying capacities of the real underlying collateral, will at some point in time turn against their creators and call for revisions of future plans and expectations.
- It will be interesting to see how the LTO companies’ balance sheets and their profitability respond as it become Mother Nature’s turn with the bat.
NOTE: Actual well data used for this analysis are all from North Dakota Industrial Commission (NDIC). For wells on confidential list, data on runs were used as proxies for extraction (production).
Production data for Bakken, North Dakota: Monthly Production Report Index
Formation data from: Bakken Horizontal Wells By Producing Zone
Data on wells kindly made available by Enno Peters’ excellent and tireless work.
Continental Resources; Investor relations, SEC filings
Oasis Petroleum; Investor relations, SEC filings
Whiting Petroleum; Investor relations, SEC filings
The companies selected for this study were based on their number of producing wells (high portion of wells with 30 months or less of flow as per December 2014, their portion of total Bakken LTO extraction and these represent some spread of better and poorer than the average Bakken well.
Some companies’ 10-Ks PDP shows reserves by area/field split on oil, NGL and natural gas and are also totaled as BOE (BOE; Barrels of Oil Equivalents).
The R/P ratio
The R/P ratio for (oil, gas, coal) is a useful and powerful metric that gives away tons of information.
The R/P ratio is a snapshot about how long the annual production level for any year versus the (estimated) remaining proven reserves at the end of that same year could be sustained.
The R/P ratio is a number which describes a theoretical rectangular production profile.
In the real world things do not work this way. The R/P number changes from one year to another and it also needs to be seen together with the production level described by it for the year in question.
The Bakken LTO companies looked at
Analyzing the time series for around 8,000 LTO wells in Bakken for 2008 – 2015 makes for a solid foundation to develop predictable trajectories towards their EUR as the time series grow. It is a Nature thing.
This study/analysis presents some data on and derived from R/P for 3 companies that are big in LTO extraction in Bakken (ND) and what to expect from actual data versus those reported on their SEC 10-K 2014 filings.
EUR trajectories for the average wells by vintage: Continental Resources
(Click to enlarge)
Figure 2: The chart show development in the EUR trajectories for LTO for wells by vintage and which are operated by Continental.
Exclusive of the 2008 – 2010 vintage wells, the average for the younger ones are within a small trajectory band.
Oasis Petroleum
(Click to enlarge)
Figure 3: The chart show development in the EUR trajectories for LTO for wells by vintage and which are operated by Oasis.
Wells of 2014 vintage pulls the average down. Wells started in 2015 have so far performed better, but are not included in this study. Exclusive of the vintages 2010 and 2011, the average for the younger ones are within a small trajectory band.
Whiting Petroleum
(Click to enlarge)
Figure 4: The chart show development in the EUR trajectories for LTO for wells by vintage and which are operated by Whiting.
Whiting’s operated wells of 2014 vintage started out better than average and have in recent months moved to a trajectory converging with the average. Wells so far in 2015 are closely tracking the average for all.
Exclusive of the 2008 – 2010 vintages, the average for the younger wells are within a small trajectory band.
LTO Wells and Extraction
Table 1: The table shows some key data on extraction (production), EURs and number of wells included in the study.
Table 1 shows that the wells in this study that had flowed 30 months or less as per December 2014 constituted a major portion of the total LTO flow (production) and total number of wells.
Long time series with actual data provides more reliable descriptions about what to expect than relying on extrapolations of Initial Production (IP) numbers and/or shorter time series of production followed by tweaking some exponential/hyperbolic factors in the equations for well models.
The R/P Analysis
How the R/P numbers based on actual data were derived?
By totaling the projected EUR of LTO for the average well that started to flow from Jan 08 to Dec 14, adjusting this with what had been extracted (this is measured and reported by NDIC!) for the same period, results in an estimate of PDP (the R for the R/P equation) at end 2014.
The P is total LTO extracted/produced in 2014.
Table 2: R/P ratios derived from actual data versus those derived from companies’ SEC 10-K filings for 2014. PDP numbers derived from actual data versus those derived from companies’ SEC 10-K filings for 2014. Total PDP after adjustments for estimates on the companies’ average WI in 2014.
NOTE: The estimated overstatement of PDP at end 2014 does not equate to a similar estimated divergence for the EUR of the average well, refer also table 1.
The estimated magnitude of PDP overstatements was tested and confirmed by alternative approaches, like using BOE as a basis, Q4 2014 numbers for production in the R/P ratio and more.
The Balance Sheets
Now let us move over to these companies’ balance sheets as these were filed with the SEC in their 10-Ks for 2014.
A balance sheet contains a lot of useful financial information about a company.
Here it will be kept simple focusing on the relation as described by the equation below:
• Equity = Assets – Liabilities

Table 3: Main data from the companies’ balance sheets from their SEC 10-K filings for 2014.
* * *
If, it is, as I have shown in this post/analysis that the presented companies’ PDP reserves for LTO (in Bakken) are grossly overstated (hard numbers and Nature do not lie!), then what follows from logic is that it should be expected that the numbers on Proven UnDeveloped (PUD) LTO reserves are subject to about the same inflation as the PDP numbers.
This leads to some interesting prospects.
LTO companies’ assets on their balance sheets are primarily described by their PDP and PUD numbers (the reserves).
If, this analysis by direction and magnitude reflects reality, then this with time will show up in financial performance (not only from oil price changes) through metrics for profitability. There are several good profitability metrics that with time will reveal imbalances from an inflated balance sheet with poor/none profitability. Profitability metrics will be the proverbial canary that will give away the true strength of the balance sheet.
If, PDP and PUD reserves are overstated by a very high percentage, ceteris paribus (all things equal, i.e. prices as per 2014), then the balance sheet assets at some point in time will have their day of reckoning and deflate to reflect reality.
Now add the effects from a much lower oil price at end 2015 relative to 2014.
(and…..equity is gone!)
* * *
As reserves are depleted (extracted), this becomes recognized on the balance sheets as depletion. From what has been shown in this post the unit depletion numbers are probably based on inflated EUR numbers which understates depletion adjustments which thus overstates assets and equity.
The reality of this arrives as the “non-existent” volumes do not show up.
The focus from Wall Street analysts on Initial Production (IP; production for a well during a defined period of time as the well starts to flow, normally during a 24 hour period early in the well’s life) is misguided from the belief that there are good correlations between IP and EUR in the shales. Statistical analysis for correlations between IP and expected EUR in shales from actual data has shown these to be poor.
In LTO extraction there has been little empirical data available for benchmarking of the models. This will with time change as longer time series of actual data become available to calibrate the models with.
Overly balance sheets focused (as in myopic) investors/creditors will continue to be confident from the numbers of IP and balance sheets and will in the near future spend sleepless nights wondering why such good IPs and strong balance sheets produces poor or no profits and/or why they do not fully receive the money lent.
Their worries will gradually morph from being focused on return on investment to return of investment.
The mysteries created by Nature’s lack of cooperation with the balance sheets will surpass any other existential questions; also the one about what there was before the “Big Bang”.
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If they could lower oil prices to punish Putin and bankrupt the shale industry why didn't they do it a deacade ago to help out the average American?
The markets are manipulated. We all understand this. The question is, would you rather have something of value when the music stops, or be left holding some worthless stock or paper promise. Now is the time to obtain real, hard assets.
Because they don't give a shit about the "average American". As long as Joe 6 pack can pay his taxes and continue borrowing on his credit cards, then it's all good.
/s
Good point but prices were pretty low in the 90s and the "conventional" wells being drilled then had the same decline profiles as the shale wells do today but the production per well was about 1/10th the production of LTO wells. Most wells will decline 40% in the first year. The shale haters won't tell you that. I think the real takeaway from all of this is that the price of oil today is unrealistically low and the rig count proves it as it's back to 2009 levels. The domestic E&P oil business was dead in the US prior to 2009.
Who is "they" and since when is it in their interest to help the "average American?" So far as punishing Putin. You got the shoe on the wrong foot ..
Putin’s Opportunity to Bust the US Petro DollarAnd this is the dirty secret about Russia, that everyone must ask the so-called free press why they have failed to inform ..
They did it 3 decades ago to punish Gorbachev. Read a history book.
Poor "average" Americans are only about 10th worldwide in oil consumption, unacceptable!
The shale industry didn't exist 10 years ago and Putin wasn't a threat to the NWO 10 years ago.
Interest Rate Utopia
Interest rates aren’t the answer because they are not going to be applied to governments. Puerto Rico is a prototype that cannot possibly yield results for the larger government that is going to bail it out, with more paper, and no change in behavior. That’s objective-based-management and best-business-practice, derivative replication, for you, China printing to prop up California real estate, sending grants to municipalities to buy trucks at 0% interest, on interest on interest, brilliant.
Warren Buffet is a welfare ‘earner’ giving advice to welfare earners on how to earn welfare, all convinced that they are earning other people’s debt, issued for the purpose. The only way this gets better/worse is if the majority hires Jerry Brown and Ralph Nader to run the country. Congress is just swapping welfare deals paid for with Wall Street money, oil at $89, off-sheet. The fact that the critters are buying to let, in a demographic collapse and density still increasing at the port, tells you were you are in the dc positive feedback loop.
The Internet is just a temporary stepping stone, where you can see just how stupid the system is, derivatives Facebook and Twitter arguing about rights, which they both stole from others, neither of which is the solution. Netflix and Amazon, like Wal-Mart before them, are about the territory, not the product, controlling the tile game gate, forcing the cattle through the chute and taxing them in every iteration, with falling living standards in the form of real estate inflation, which they were granted by government for free.
Funny, just walked by a typical scene in town these days, an old man on SS working as slow as possible on a piece of property, for $10 cash, being watched/supervised by a middle aged man, with his little girl watching his example. If you can temporarily ‘work’ at $10 for a landlord, who is going to ‘earn’ increased rent in accounting perpetuity thereafter, which you must pay to keep a roof over your head, until you can’t, which party do you want to be?
If your answer is neither, you probably worked at some point in your life. Only you can tax communism out, by discounting its paper in your decisions. Somebody is heavily discounting government, or it would have an exit. What matters is discretionary income and how it is being directed, but there is no real discretionary income in the empire, because credit and debt, all it has, is tied to behavior compliance. If you don’t buy the crap the empire tells you to buy, you lose your credit and the associated job, so what is it worth?
Price went up and price went down, and tax was increased to lock the retail price ratchet in, surprise.
In the end the FED ZIiRP economy created the problem and forced a drive toward yeilds and now all the optimists who believed the carnival barkers like GS were actually helping them when they were really running them through a sausage machine......
Still so many oil bulls who just don't understand what's going on here.
So many words and charts for what is really common sense.
Another industry with companies addicted to debt and going for broke.
OAS, CLR and WLL all 3 going to ZERO. OAS first, then WLL, then CLR.
OAS, most likely, CLR, possible, WLL, not a chance
There's a typo: It's "b," not "m."
This shale oil charade will last until October and then we will have bankruptcy, M&A or FED bailout by buying their junk bonds.
I think it will be mostly bailout with some bankruptcies for show, like Lehman. a scapegoat.That would mean price war with Saudis continue.
More on that:
https://sostratusworks.wordpress.com/2015/01/15/the-shale-game/
Like hungrydweller said it is really common sense. You pretty much knew that when NDIC was dragging it's feet on putting out numbers that it was going to be a shitshow. The second people did get data and started putting it together you had articles like the "red queen" coming out left and right.
In addition to all of their other games, their reserves are a joke and it it very unlikely that they will be in the money at 80 a barrel. It's all bullshit. The sweet spots are about drilled the hell up, the bakken is a pin cushion.
If the shale oil is a charade there are two questions which are fundamental to understanding why the Oil lobby in the USA is STUCK in this hole which is now out of control :
1° CUI BONO if it works ? who does it benefit if it works ? Answer the Oil lobby consisting of gloablist oil majors and LOCAL oil minors; a huge maze that has now sucked in the financial NET ; aka the banks and shadow banking.
Too many people who have too much to lose! So why are they losing as they are very powerful?
Good question. One ONLY loses to bigger fish than oneself! So who is the ENEMY ?
Putin ? China? Nope, or at best, INDIRECTLY.
2° CUI BONO if it doesn't work ?
The Enemy is : Saud !!! The friend of a 70 year handshake that made Pax Americana king of the heap when they revoked BW and jumped into bed with Saud regime !
Why o WHy did Saud become US big Oil's dire enemy, and in so doing the dire enemy of US finance, now incestuous with US Oil in Shale plays?
Simple! ...They, the Wahhabites, have other value systems and don't like those of America, since Bush got replaced by Obama. And... the Lehman moment made US finance the potential Titanic, something that made oil rich Saud feel stronger in an age of go-go Chindia fed on US hyperconsumerism.
Now Saud think they OWN the White House as US finance is belly up and US shale is a dead duck !
Some conundrum US Oligarchy is in !
Meanwhile back at the ranch its a shoot out between Trump and Koch and Hillary and who knows who else !
As the clock ticks and Apple controls the fate of WS if it takes even a slight dip.
Amazing how China's shadow banking bubble resembles WS bubble resembles Euro bubble resembles Yen bubble resembles £ bubble! And Saud looks on as Western capitalism becomes a house of cards all the while Saud feels like new Xanadu, the land where CHEAP oil never stops guzzling and giving.
Anybody for some champagne?
At least its the real thing !
Still waiting Tyler, normally you'd be all over rigging like this.
http://oilprice.com/Energy/Energy-General/EIA-Capitulates-Under-Cover-Of...
Many investors know that when a company wants to mitigate media coverage of bad news, they typically release data on a Friday after the close.
Well last Friday, that is exactly what the EIA did, admitting the very thing I and Cornerstone Analytics have been arguing all year: EIA was and still is overstating U.S. production. The amount that they admitted to so far, as of Friday afternoon, was 254,000 barrels per day (b/d) or 1,778,000 barrels per week, 7,112,000 per month or 14,224,000 for June and July alone.
This is the most incredible cover up I have ever witnessed in my decade-long investment career and I have not seen one major media outlet even mention it so far. Instead China demand & Iran output are front and center as per prior posts in an attempt to divert attention (I call it moving the goal posts) away from the fact that both U.S. production and inventories were about to fall.
If true, then US oil production dropped from 9.6mbpd to 9.35mbpd. That is still up from 8.6mbpd last summer while consumption has barely increased. The fact is that oil in storage is supposed to dropped dramatically during summer, but it has barely inched downwards according to API and EIA.
That tiny drop will be swamped by the extra 2mbpd increase from Iran. Basically all growth in oil consumption since 2006 has come from China. If China crashes, oil consumption crashes.
If true... ok, faggot.
US production peaked almost 5 decades ago and still you can't find one person in a hundred thousand who knows it.
Now the US tight oil peak is in, coinciding perfectly with the Russian peak, and again, no one knows it. Nothing to see here, better go buy some more stocks.
Geology? No! It was the Fed and the oil majors and the banks and the speculators! IT'S A CONSPIRACY!! Where's my energy independence? America has 10,000,000,000 years' worth of cheap energy!
US oil production is 9.6mbpd, same as it was 5 decades ago. Shale has not peaked. Production is decreasing due to reduction in capex.
There are vast areas of Russia and Central Asia that have not been touched. The arctic has not been touched. Greenland and the coast off Brazil have barely been explored.
Peak oil theory has been around since 1920 telling us that we would run out of oil in 10 years. Do you think 4.6 billion years of plant and animal life can be sucked out of the ground in 100 years? Costs go up, then technology catches up and costs go down again.