Today we will take a look at both Whiting Petroleum (WLL) and Continental Resources (CLR) as far as their Bakken economics. Overall the numbers will show that, despite claims of low cash costs per MBOE ($16 or so for CLR) and high IRRs on $60 WTI, the facts say otherwise. In addition, the analysis will show how very high depletion rates combined with falling rig counts spells trouble for Bakken production growth despite better efficiencies per well. The analysis will be based on April presentations of both companies from which the graphs below are taken. I should note these economics are not much different from Eagle Ford, the second most prolific addition to US production growth in past years.
Firstly one must understand that the easy money via QE from the Fed and zero interest rates allowed many shale players to burn free cash flow while showing operationally net of capital expenditures (which were funded by cheap flowing monies via FED) cash generation. To be clear, that model is now broken as the era of free Fed money appears to waning as both QE, and soon, zero rates become a thing of the past. The cost of capital is no longer falling but is now rising through higher bond yields and/or lower stock prices.
The madness that is occurring in financial markets on discounting these events despite very weak, almost recessionary economics, boggles the mind. Despite the consensus of both ending, the realities are that FED will eventually reverse course on both in the realization that they can’t talk up economic growth any longer and easy money policies finally get recognized as failures. But that may occur only after another equity bubble bursts and in either case shale producers may find that equity markets are no longer going to fund production. In the end what’s likely, regardless of outcome, is that funding will be more difficult for shale producers who must constantly run in place to replace huge depletion rates.
All year we heard that the 50% reduction in rig count didn’t matter as producers focus on lower cost most prolific areas. Yes producers are getting more efficient as they are able to increase rates of production. The chart below from WLL’s April presentation depicts this. However, if you are able to increase the rate of oil flow by 27% over a 90 day period while depletion runs at nearly 70% as your rig count declines, how does one grow production, never mind maintain it? By WLLs own math, flow rates decline from 1,777 to 543 in 90 days! So it’s clear the efficiency is more than offset by depletion and so, as time passes, as the rig count declines, so will production.
The same can be shown with CLRs presentation although it shows depletion at 20% for first 30 days, but if extrapolated out to 90 days it would be similar to those depicted by WLL at 90 days.
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Further, the efficiency up lift only offsets some of the depletion effects, as CLR claims 30-45% increases over a 90 day period as depicted below:
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The huge IRRs at $60 oil have to be understood as they are excluding the need to continually replace production through huge capital expenditures. Looking at WLL’s financial statements this is readily understood.
CF from operations in 2014 was $1.8 billion. However, to perpetuate production they invested nearly $3.0B resulting in negative free cash flow. The same is true with CLR as it generated $3.35B in cash from operations but needed to invest $4.8B to maintain and grow production. It should be noted that these states are much worse on $55-$60 WTI.
We recently discussed how the Saudi strategy does not appear sound on assumed Brent prices and production rates. However, it should be noted that easily accessible money is needed to grow production and if it ceases then it will result in massive restructuring for producers and declines in production. And this may be the Saudis ace in the hole if the era of access to easy money is ending. One way or another it may be that the E&P companies who are hoarding cash will be the last shale player standing to take on Saudis in the end. Understanding this is critical to refute the calls by EIA and others what shale will continue to grow in the years to come. We are most likely seeing US production peak unless producers see much higher prices and/or easy money continues.
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As far as investing goes, highly leveraged companies should be avoided and ones in better financial shape considered first, as they will be the ones rising from the ashes.