Economic activity is heating up in the Bakken, but operators and major players need to continue to effectively communicate production results and estimations, according to Subash Chandra, senior E&P analyst and managing director of Jeffries LLC.
Speaking at Hart Energy’s DUG Bakken and Niobrara conference in Denver on April 3, Chandra noted that a few years ago Continental Resources Inc.’s stock was a fraction of where it is today, and the Central Basin was in the initial stages of delineation, development and expansion. At the time, investors were focused on determining the size of the basin.
Fast forward to today: Wall Street considers the basin to be a mature play. Now, the question of realizations dominates the conversation about the region. “As we all know, success can breed excess, and takeaway has to keep pace,” Chandra said. “Sometimes, as you see in the Marcellus, that success brings other problems.”
A graph of the Clearbrook differential, comparing the WTI price with the average corporate realization, showed a slightly worse scenario for the Bakken. “What I want to highlight are areas that companies need to more effectively explain to investors, because I don’t always have the explanation for these folks,” he said.
From the corporate perspective, Clearbrook is a stranded and irrelevant market. A lot of rail has been built to transport oil out of the Bakken. “As a result, you would get some sort of PADD I price—let’s say transport,” he said. Income statements don’t always reflect this, though. As rail transport increased as a percentage of the total takeaway in the past few years, the Clearbrook differential experienced a steady uptrend. “So differentials improved, which is what one would expect. Get rid of the excess, evacuate the oil and the regional markets get better,” Chandra said.
In 2013, however, a back-and-forth market share rise between rail and pipe took place, depending on regional excess. As a result, the differential blew out in the fourth quarter of 2013. “It’s a question we have to answer as to why. Overall, perhaps we’re seeing a ‘Balkanized’ U.S. oil market,” Chandra noted. Using WTI price to determine the net asset value of earnings has been replaced by the Clearbrook differential. “That, I’m afraid to say, is probably the future, but I would love to buy in to the narrative that Clearbrook doesn’t matter. I’m not sure we’re seeing that evidence,” he added.
North Dakota Bakken production data show pipe and rail capacity of between 1.4 billion barrels per day (Bbbl/d) and 1.5 Bbbl/d. With plenty of capacity on paper, Clearbrook shouldn’t matter, Chandra said. By year-end 2015, Jeffries’ model shows about 1.9 million barrels of oil per day (MMbbl/d) of takeaway capacity, with production being quite a bit lower than that. “So there’s ample takeaway and capacity here—a much different situation than say, in Susquehanna County, and the gas growth that’s happening there in the northeast Marcellus, where takeaway and production are moving in lock step.”
“So this is a luxury that we should have,” Chandra added. “Yet, again, translating that into the differential issue is not happening.”
Industry interpretation of Continental’s Hawkinson pilot as a major talking point came as a surprise to both the company and Chandra. “Their view is that if you sweep more oil out of zones that are less prolific, even those from the same PADD, your capital efficiency is going down and your ROI is going down,” he said. “So why do it? And if it is going down, that means your future debt burdens, which are [tied] to that asset value, will ultimately impair the shareholder. That’s their point of view. The corporate view, which I completely buy into, is if I’m in a PADD I want to sweep it all at that point as long as [production is sufficiently economic].”
“I get that, and I think some of the publicly traded Bakken companies will attest to this, that when they go to these breakouts with investors. … The dominant question is, ‘Illustrate to us how this is improving your ROI.’”
There is a balance between recovery factor and ROI, he continued. Because the market wants to see improving ROI, Chandra said, that is an ongoing debate the industry needs to do a better job of explaining.
New completions methods also have taken center stage. “I’d say when oil first peaked at $1.05 after the third-quarter or early fourth-quarter of last year, this had a very bullish connotation to it,” Chandra said. Many in the industry came to the conclusion that slick water and using a lot of ceramic proppants is the way to go. The current market poses the question: If that is the case, why isn’t the industry as a whole adopting those practices where it finds positive estimated ultimate recovery (EUR) revisions?
Shale operators now have much more data than before, he noted. “When I talk to the public companies, they say, ‘It really varies by where we are.’ So there’s not a magic bullet in completion methods. I think in the third quarter, the market was of the mind that there was a magic bullet and that there was a step-change evolution in completion technology.” A gap exists between expectation and perception and the reality of the situation, he added.
“As far as EUR changes go, most of our companies have not changed their EURs,” Chandra said. He cited the viewpoints of John Lee of the University of Houston, who specializes in EUR and the new tools the U.S. Securities and Exchange Commission is allowing in the estimation of EURs. Some of the predominant models used in corporate presentations are decline-rate models that, according to Chandra, are inaccurate in Lee’s view. A lot more horsepower, Chandra said, is needed behind those calculations.
“[Lee’s] view is, of course, [during] the first six months of production—forget it. The reservoir’s not really talking to you,” Chandra said. Beyond that point, companies need to get a deliberate EUR estimation, looking at parent wells and monitoring bottomhole pressure.
“Companies are doing that now,” he said. “Those data are coming out. So if they’re not tweaking EURs every 90 days, I think that’s great. However, from a very meat-hungry market that needs to be fed constantly, that is something that’s sort of put the pause on things.”
Resource maturity also provides much fuel for discussion these days. “Resource maturity is not when production peaks. Resource maturity is when the number of locations that are priced into the equity peaks,” Chandra said.
A large runway of future locations that are unbooked—vs. unproduced—is needed and must be looked at from a capital efficiency point of view. In that case, “my number goes down, my asset value goes up, and I have a step-change in equity value,” he said. “Those are the things the market is looking for, and those are the things we’re looking for.”
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