There has been a lot of ink spilled lately about that infamous and endangered North American waterfowl, the Shale Duck, otherwise known as the Fracklog Mallard or, more specifically, wells that are drilled but uncompleted, or DUC.
At any rate, we have discussed this previously but it bears repeating because their impact, both in reality and in perception, is important in understanding some of the price dynamics floating around and the real and psychological impact that these creatures are having.

First the basics. As the name implies, these are wells that have been drilled and in essence capped off or parked until the economics come back sufficiently to warrant “completing” or finishing them. What this means is that these would be wells that aren’t productive yet, so they haven’t been fracked, completed and tied into the system. In many ways, these DUCs can be thought of as spare capacity in, primarily, the US tight oil and shale gas basins.

Estimates as to how many of these exist range from about 3000 to 4500, with most settling at a range of 3,900, so call it about 4,000 possible DUC’s.

The reason the number is hard to pin down is that a) no one knows the baseline to add or subtract from to determine what the “excess” is and b) since drilling never came to a complete standstill, there will always be wells awaiting completion.

Many in the media and the analyst class point to these wells and say they represent  well in excess of 1 million barrels a day of production just waiting to come onstream once oil crosses the mythical $50 line which of course will derail any nascent price rally and plunge the world once again into the depths of the oil bust we oh so recently climbed out of.

The premise of course being that these barrels are just waiting for the right price to start magically flowing out of the ground and into a refinery.

But hold the phone, if you’ll pardon the expression.

What all this analysis fails to take into account are the so-called “facts on the ground” that mitigate the risk of a mass DUC hunt.

Consider:

• The tight oil community is made up of hundreds of companies each with their own specific set of financial and operational circumstances. To assume these would march in lockstep seems highly presumptuous (note this is the same argument against the US as swing producer)
• The EIA estimates that close to 63% of the cost to drill and complete a well comes after the drilling is finished. What does this mean? It means that at an estimated cost to complete a well of $4.9 to $8.3 million a full build out of the DUC portfolio will cost between $12 and $21 billion. With most Exploration companies unable to fund even their own scaled down drilling programs out of cash flow, this capital would need to come from either new debt or new equity. Given the precarious state of the financial sector and the pull back in energy financings, particularly high yield debt, the prospect of wholesale DUC development is, politely, dim.
• Time is also a major factor. Even assuming the capital could magically appear, the time required to marshal resources, assemble manpower, line up equipment is significant, even assuming that all the resources are on stand-by (hint: they aren’t).
• The decline rate of US tight oil is high, conventional production less so, on average call it between 5% and 7%. At current production levels of about 8.5 million barrels a day, if all activity stopped, US production would fall by 400,000 to 600,000 barrels a day all on its own, which of course eats into any surplus production that the DUC could deliver.

About a month ago, it was suggested in here that the maximum the DUC’s could add was about 450,000 barrels given prices, time to complete etc. So about enough to offset decline rates. Assuming of course there is any money. Which leads of course to…

Brexit!

Admit it, up to about 24 hours ago, you hadn’t heard of or couldn’t give a rat’s hiney about a “Brexit” and if you had, you were probably like me and thought that a Brexit might in fact be a type of breakfast energy bar.

Well the joke’s on all of us. The Brexit, or the UK leaving the European Union is a real thing and they had a referendum on it and guess what – by a razor thin margin (51% to 49%) the UK populace elected to leave the European Union.

While we in Canada of course know all about referenda and their dangers (why in the world was the bar so low by the way – don’t they know the concept of “clear majority” over there?), we are all clearly taken aback by the result. As are the Brits, otherwise the top Google search in the UK today would be someting other than “what does Brexit mean to me”.

Many claim that the Brexit win is a signal of the ascendance of Trumpism and the nativist, racist, anti-immigrant populism he represents. And that is a part of it. Immigration and free borders have long been an issue in the UK (never mind all of Europe) and anti-Muslim sentiment (which has nothing to do with the EU by the way) is high in certain circles. And these people tend to be the loudest and ugliest supporters of Brexit.

But it’s way more complicated than that and I can assure you that a plurality of British voters are not xenophobic racists.

The United Kingdom is a middle power, island nation that actually has more culturally in common with North America than with Europe. Rather than being part of the tribal upheavals that swept Europe in the early 20th century leading to the creation of the European experiment, Britain has often been on the outside looking in, drawn in by treaty, loyalty and, ultimately, self-preservation. But the fit has always been weird.

For that reason, Britain’s role and relationship with the EU has always been complex and tenuous, witness the absolute refusal to give up the pound and its independent monetary policy. Historically the UK has benefitted from everything that is good about the EU (free trade and movement of people and goods) while avoiding what is viewed as bad – a one-size fits all German monetary policy, bailouts etc.. But the noose has been getting tighter and the drumbeat for the UK to go fully in to the EU was getting louder. And the EU is a spectacularly inefficient bureaucracy that many Britons rightly believe lead to higher costs for everything from food to petrol to social programs. As I said, it’s complicated.

At any rate, experts far more informed than I will no doubt have lots to say on this, but judging by the market reaction, many people got this result wrong and possibly treated it with less seriousness than it deserves.

Markets of course “hate uncertainty” and the prospect of other countries lining up behind Britain to do the same thing (i.e. the Netherlands) and uncertainty as to how the 2 year transition period will work has sent the markets into a tizzy, with a new and unforeseen risk premium (note – irony alert, seriously was there no contingency plan for this?) driving down equity markets, driving up safe haven currencies and whipsawing commodity markets.

Canada, which recently finalized a free trade agreement with the EU and has its traditional trade relationship with the UK should be reasonably insulated from the unfolding drama (in fact, the TSE is among the better performing markets today). In all reality, it is the EU and the UK that have the most to gain/lose from how this evolving relationship changes over the next years and we are mostly bystanders. If I had a crystal ball (note Christmas list), I would suspect that this brings the core EU closer together and leads to a hard-negotiated free trade agreement between the EU and the UK. Mainly because they are integrated trade partners that need to trade with each other. When all is said and done, it’s probably going to look a lot like membership in the EU.

From an energy sector perspective,, it is in fact hard to see what all the fuss is about. Unless of course you are a DUC hunter, in which case the odds of scoring that low cost multi-billion dollar loan you need to re-flood the market with tight oil just got a lot longer.

Prices as at June 24, 2016 (June 17, 2016)

• The price of oil ended the week down sharply after holding tough through the week
  • Storage posted a decrease
  • Production was down
  • The rig count was down marginally
  • Conitnued production declines in the US are helping keep prices up as are the production shut-ins around the world
  • Oil above $50 is not sustainable in the short term. Expect a pull-back for a period of time until the realities of the supply situation in Nigeria and Venezuela become clearer
  • The Brexit vote pushed the US dollar up, negatively affecting oil prices and uncertainty in global markets accounted for the rest of the move down
• Natural gas rose during the week on bullish weather

• WTI Crude: $47.60 ($48.10)
• Nymex Gas: $2.662 ($2.623)
• US/Canadian Dollar: $0.7711 ($ 0.7769)

Highlights

• As at June 24, 2016, US crude oil supplies were at 530.6 million barrels, a decrease of 0.9 million barrels from the previous week and 67.6 million barrels ahead of last year.
  • The number of days oil supply in storage was 32.4, ahead of last year’s 28.1.
  • Production was down for the week at 8.677 million barrels per day. Production last year at the same time was 9.597 million barrels per day. The change in production this week came from a small decrease in Alaska deliveries and a drop in lower 48 production.
  • Imports spiked to 8,439 million barrels a day, compared to 6.765 million barrels per day last year. Imports are distorting the storage story.
  • Refinery inputs were down marginally during the week at 16.505 million barrels a day, but strong for this time of year
• As at June 17, 2016, US natural gas in storage was 3,103 billion cubic feet (Bcf), which is 28% above the 5-year average and about 25% higher than last year’s level, following an implied net injection of 62 Bcf during the report week.
  • Overall U.S. natural gas consumption was up 2% during the week with increases across all major sectors
  • Production for the week was flat but imports from Canada rose to meet demand.
• Oil rig count at June 24 was at 330, down 7 from the week prior.
  • Rig count at January 1, 2015 was 1,482
• Natural gas rigs drilling in the United States was up 4 at 90.
  • Rig count at January 1, 2015 was 328
• As of June 20, the Canadian rig count was at 68 (10% utilization), 43 Alberta (9%), 9 BC (12%), 16 Saskatchewan (14%), 0 Manitoba (0%)). Utilization for the same period last year was about 17%.
• US split of Oil vs Gas rigs is 80%/20%, in Canada the split is 20%/80%
• Offshore rig count was unchanged at 21
  • Offshore rig count at January 1, 2015 was 55

Drillbits

• Encana sold its Gordondale NW Alberta properties to Birchcliffe Energy for C$625 million
• Suncor raised C$2.9 billion in a bought deal equity financing
• QEP Energy bought some Permian acreage for $600 million
• A new study showed that OPEC’s revenue from oil has plunged $438 billion in the past year to a decade low. Ouch. You can buy a lot of gold-plated Ferrari’s for that
• Venezuela, the least covered story of the year, continues to spiral downward
• Joyeuse fête nationale to Quebec! Don’t drink too much.
• Drumpf Watch – Drumpf fired Corey Lewandowski, his controversial campaign manager. A review of fund-raising shows that while Drumpf may be worth a lot of shekels, he has a lot of trouble attracting them. Hilary trumped Drumpf by a whopping average of 10 times in fundraising, cash on hand and Super PAC cash on hand.