Ah spring, is there anything more refreshing than spring in the air? Allergies, buds pushing up from the ground, leaves getting ready to burst forth, the migration of ducks… Or should I say DUCs? You remember those, Drilled but UnCompleted? Those thousands of drilled wells in the US that were ready to flood the market, what happened to those anyway?

It’s an interesting phenomenon those DUCs. I wrote about them about a year ago in the context of the massive overhang of DUCs that existed and their potentially destabilizing impact on the oil price recovery but also the mitigating factor of a collapsed rig count. And in fairness, in the first post, I used the world’s most annoying term “fracklog” before transitioning to DUCs, which I reserve the right to rename the “quacklog” if pressed, that being the “backlog” of unfracked DUCs. Anyway let’s take a look at the numbers then, and the numbers now.

In early 2016, the fracklog, okay quacklog, was sitting at about 4,000 spread across the three major tight oil plays, being the Eagle Ford, the Bakken and, of course, our new best friend, the Permian. The theory at the time was about production and how much could reasonably be expected to be added by aggressively drawing down this number, offsetting the effects of a drastically lower rig count. After a bit of mumbo-jumbo followed by some hocus pocus about things like “time”, “money” and “equipment and labour”, the guess was that the added production might be in the 450,000 bpd range which would measure against the tight oil decline rate of about 6% and the legacy field decline rate to result in an annual decline in US production of about 500,000 to 700,000 barrels per day. For the record, the annual decline was about 600,000 barrels a day, so the back of the envelope seemed OK.

Anyway, it seems appropriate now to revisit those numbers for the current year, especially in light of the surge in the US land-based rig count to see where we might be and, quite frankly, take stock of what the heck is going on and where we might go, with the DUCs…

As an added wrinkle something we didn’t consider at the time was that there is of course a very natural and ongoing baseline number of DUCs – call it the ideal or sustaining “quacklog” below which production likely falls and above which production grows. Or put another way, are we adding or subtracting to the “safe” (which as we all know is the term for a group of DUC’s on land, as opposed to the “brace” of DUCs, when they are all dead).

According to BTU Analytics, the “excess” DUC count peaked in early 2016 at about 2,250 (implying a base inventory of around 2,000) but since then it has pretty much disappeared with the exception of the Williston Basin in North Dakota where the balance sits at about 500. What this means is that the impact of these excess DUCs on US production numbers is already in the past, so going forward, the production story is really about the number of rigs, productivity and decline rates, which is how it should be. This drawdown in DUCs is corroborated by the Texas Railroad Commission which reports only 1,213 well completions year to date compared with 2,270 for the same period last year, never mind a staggering 3,976 and 6,749 in the same period in 2015 and 2014 respectively. How is this possible with the massive jump in rig count you ask? Well, it’s simple really – a rig coming into service doesn’t automatically start pumping out DUCs, it needs to be rigged up, staffed, permits applied for etc. In other words, there is a lag. And while permits are up (1,000 in February), the low level of completions YTD supports the “ramping up” hypothesis.

So, given that building up that massive DUC inventory required a fully capitalized industry running at 100 miles an hour with 1,600 rigs and oil at $100 (6,749 completions in 2014!), it is worth it to perhaps take a step back and think rationally about what can be accomplished by an undermanned industry emerging from a downturn with 600 or so rigs and oil range-bound between $47.50 and $52.50 a barrel. If the rig count stays at 600, with a 3 week per well time-frame, this suggests 10 to 12,000 wells drilled in 2017 and if completions catch up the to the 2016 pace, we’re kind of treading water on the DUC side. As suggested by the data. And data, while not the be all and end all, is important.

Look, I’m not saying we aren’t going to see production growth out of US tight oil, because for sure we will. I just wonder if it will turn out to be as aggressive as everyone anticipates, especially as the self-regulating nature of increasing service and labour costs starts to chip away at “efficiency”, never mind when 2016 mind-blowing productivity numbers start to slide as activity migrates to less “sweet” spots.

At any rate, wither the DUCs? I suspect a combination of some rigorous duck-hunting by cash flow hungry producers and, perhaps, a migration North.

A quick note on inventory

I know I harp about this a bit too much, but I keep reading all these articles talking about storage in Cushing and OPEC and how the OPEC cuts aren’t working because storage in Cushing is going up and storage in Cushing and did I mention Cushing?

Look, can we all be honest with each other for a minute? Because I think we are missing something. The storage amounts in Cushing have very little to do with OPEC and the OPEC cuts and much more to do with the level of production in the United States (high), imports from Canada (even higher) and, quite importantly, refinery utilization (low, because it’s turnaround season).

If you want to gauge the impact of OPEC cuts on storage, you need to be looking at OECD storage levels, specifically those areas that, I don’t know, OPEC sends most of its production to. Unfortunately, the further you get away from North America, the looser and less timely the data becomes so it is harder to pass a weekly opinion (particularly because the IEA data on OECD storage is monthly with a one-month lag, making the data we are looking at almost “real-time”). But that doesn’t mean you should use a largely irrelevant data point to discount the relative success of a OPEC’s production cut until you have the whole story – like an updated OECD storage report and, I don’t know, some appreciation for the Mallard Doctrine – the quacklog tapes, as discussed above. Incidentally, the last report on OECD storage showed a 48 million barrel build to 3.03 billion barrels. In January. Including US stocks which accounted for about 30 million barrels of the gain. On a percentage basis, this is a 1.6% gain for a month where refineries were in turnaround, lots of oil was in transit, OPEC cuts weren’t fully implemented… I, for one, would like to see February before I pull the pin on the oil trade.

Canada’s Awesome Budget

Canada had a budget on Wednesday. I was all prepared to rant and rave about tax increases on capital gains, the elimination of the small business tax credit and maybe the elimination of the lifetime capital gains exemption. But they didn’t do it. In fact, aside from ramping up spending on a whole bunch of social programs and “innovation” and delivering what is in fact a truly awesome deficit, the budget actually did nothing for the most part. I guess when you have a US government determined to slash taxes on companies and individuals, it’s best to sit back and wait a bit.

On the oil and gas front, the Federal Government did eliminate two interesting programs. One was the CEE or Canadian Exploration Expense which allows oil and gas companies to expense exploration expenses 100% the year they are incurred. Instead, now they will only be able to amortize them over a three year period. The other program eliminated was the flow-through share program where Canadian E&P companies were able to “flow-through” exploration expenses to shareholders, giving them a write-off against other income. Each of these programs have been less relevant in today’s market where there are less junior oil and gas companies and the nature of the basin has changed such that the uncertainty associated with exploration has been reduced somewhat. In addition, each of those programs was a flashpoint for the “oil and gas subsidy” cohort. Eliminating them effectively neuters their argument. Plus these programs have been in decline for years. On the plus side, the generous hoo-hahs in Ottawa saw fit to flip the unemployed and homeless service sector a $30 million coin for orphan well clean-up. Gee thanks mister…

Look, I get that Bombardier gets hundreds of millions if underserved interest free loans and equity investments from the Federal and Quebec government to build airplanes that no one is currently buying and trains that municipal transit companies want to give back and to enrich a dual share class structure that doesn’t exist anywhere else in the world, but really, we have our pipelines right? (hint – sarcasm).

The thought occurred to me though, as I was writing this, if the Federal Government wanted to kick start the oilpatch, the single most effective move it could make would be to reverse its decision on income trusts for Canadian oil and gas Exploration and Production companies. Cheap equity capital, distributions for unit-holders, the ability to develop marginal assets… I know, I know, it’s (formerly) the world’s only legally allowed ponzi scheme, but I can’t be the only one thinking it- would love to hear from some Canadian readers about this.

Seriously. Just do it. Justin? Bill? Want to make friends out west? Are you listening?

Prices* as at March 24, 2017 (March 17, 2017)

*Estimated 30 min to close because it’s spring break and I need to get outta here

• The price of oil took it on the chin early in the week before rallying on improved sentiment.
  • Storage posted an anticipated increase
  • Production was up marginally
  • The rig count in the US continues to grow, although at a slower pace

• Natural gas was weak early in the week on milder weather but rallied toward the end of the week

• WTI Crude: $48.00 ($48.78)
• Nymex Gas: $3.075 ($2.948)
• US/Canadian Dollar: $0.7483 ($ 0.7507)

Highlights

• As at March 17, 2017, US crude oil supplies were at 533.1 million barrels, an increase of 4.9 million barrels from the previous week and 31.6 million barrels ahead of last year. High import volumes and refinery turnarounds are holding back meaningful invetory reduction. Inventory draws typically begin this time of year
  • The number of days oil supply in storage was 34.2, ahead of last year’s 33.5.
  • Production was up for the week by 20,000 barrels a day at 9.129 million barrels per day. Production last year at the same time was 9.038 million barrels per day. The change in production this week came from a small increase in Alaska deliveries and increased Lower 48 production.
  • Imports rose from 7.405 million barrels a day to 8.307, compared to 8.384 million barrels per day last year.
  • Refinery inputs were up during the week at 15.801 million barrels a day
• As at March 17, 2017, US natural gas in storage was 2.092 billion cubic feet (Bcf), which is 15% above the 5-year average and about 16% less than last year’s level, following an implied net withdrawal of 150 Bcf during the report week.
  • Overall U.S. natural gas consumption was down by 15% during the week on decreased weather related demand increases across all sectors
  • Production for the week was flat and imports from Canada fell by 4% from the week before
• As of March 20, the Canadian rig count was 184 (31% utilization), 138 Alberta (29%), 29 BC (41%), 15 Saskatchewan (13%), 2 Manitoba (13%)). Utilization for the same period last year was about 20%.
• US Onshore Oil rig count at March 17 was at 652, up 21 from the week prior.
  • Peak rig count was October 10, 2014 at 1,609
• Natural gas rigs drilling in the United States was down 2 at 155.
  • Peak rig count before the downturn was November 11, 2014 at 356 (note the actual peak gas rig count was 1,606 on August 29, 2008)
• Offshore rig count was down 1 at 18
  • Offshore rig count at January 1, 2015 was 55
• US split of Oil vs Gas rigs is 80%/20%, in Canada the split is 56%/44%

Drillbits

• Early Friday morning, the US State Department approvesd the Keystone XL pipeline which will allow Canadian oilsands oil to be exported to the US Gulf Coast. This is a very exciting and postive development for the Canadian oil and gas industry. While it will certainly be accompanied by much hue and cry and protest, for now I think I will bask in this exciting announcement.
• Saskatchewan Budget 2017 – Not to be outdone on the budget front, Brad Wall’s government dropped an austerity budget on the province which included an increase in the PST and roll-backs of up t0 3.5% on public sector wages. Needless to say, the Notley government wasted no time in turning this bad news budget into a celebration of their own spendy mcspenderson budget
• Trican Well Services and Canyon Services announced a plan to merge in a $637 million equity swap deal.  The combined business would be the largest hydraulic fracturing company in Canada. Consolidation is on!
• Trump Watch: Health Care and Russia, Not necessarily in that order. Manafort? Operatives? Freedom Caucus? ObamaCare? TrumpCare? WhoCares? It appears that in the first show down between Donald Trump and the Koch brothers, the Koch brothers are ahead. Let the angry old rich guy fight continue! On the flip side – thanks for my damn pipeline!