In hope of price surge, oil wells kept in reserve

DUC (drilled but uncompleted) wells are a bet on higher oil prices than current level of about $38 a barrel

In hope of price surge, oil wells kept in reserve
The price of oil keeps dropping. But that didn’t stop a work crew from drilling a well recently on what was once a cornfield, carefully guiding the last sections of 13,000 feet of pipe spiraling into the hard Niobrara shale with a diamond-tipped bit.

Their well, one of hundreds drilled by Anadarko Petroleum in eastern Colorado’s Wattenberg field this year, could someday gush as many as 800 barrels of crude oil a day. But Anadarko is not planning to produce a drop of crude from the well for at least another year because the price of oil is now so low.

The well here is just one of more than 4,000 drilled oil and natural gas wells across the country producing nothing, but ready to be tapped quickly. Many constitute a new form of underground storage, a new well inventory strategy for an industry in distress, one that has been forced to lay off tens of thousands of workers, decommission most of its rigs and write down assets.

For individual companies like Anadarko, the deferred completions — known in the oil business as DUCs (an acronym for drilled but uncompleted) — are a bet on higher oil prices than the current level of about $38 a barrel, which is about 60 per cent lower than in the summer of 2014. They are viewed by oil executives as a way to hoard cash as service costs plummet and are a flexible lever to rapidly increase production whenever oil rises again.

“We are adapting to market conditions,” Moe Felman, the Anadarko Rockies drilling operations manager, said as he watched workers pump drilling fluids and screw pipes together within sight of the snowcapped Rocky Mountains. “We are focused on what we can do to be ready to accelerate when the market returns.”

But the incomplete wells are also another reason many analysts say a recovery in the oil price is nowhere in sight. Together, the well backlog could produce as many as 500,000 barrels of oil a day, about the same amount of oil that Iran is expected to add to the glutted global market after it complies with the recent nuclear deal by the end of next year.

Some analysts say oil companies like Anadarko, EOG Resources and Continental Resources may collectively risk suffocating the very price revival they anticipate by releasing abundant new supplies once prices inch up. Others say the eventual impact would be small and short-lived, but since the industry has never used this strategy before, no one can be sure.

“If prices start to creep up in the US, a lot of production could come on line in a quick manner that could put pressure on the supply-demand balance in the market,” said Christopher Kopczynski, a senior oil analyst at Wood Mackenzie, a consultant firm.

The new strategy is made possible by the shale revolution in Texas, North Dakota and Colorado, which nearly doubled national oil production in six years before the price of oil plunged and production began to wane.

Before a shale well can be productive it must first be drilled, then completed with hydraulic fracturing, known as fracking, the process of blasting through shale rock with water, sand and chemicals to release oil or gas. With rigs drilling multiple shale wells from a single production pad, operators have multiplied the efficiency of their rig drilling.

And since shale wells flow the most during the first year or two of production, waiting for a higher price can maximise profits, executives say. “It’s dry powder,” said Raoul LeBlanc, an oil expert at IHS, a consultant firm. “It’s a form of spare capacity.”

Today there are 1,300 horizontal wells — typically the most productive drilled in shale fields that will offer the biggest output their first year — that were drilled at least six months ago that remain incomplete in the nation’s major shale oil fields. That is more than three times last year’s average, according to Rystad Energy, a Norwegian consultant firm that tracks world oil fields.

Anadarko, EOG Resources and several other major producers began intentionally warehousing wells and effectively storing oil underground after the price of oil collapsed in late 2014 and early this year in the hope of a quick rebound.

“The reason we have deferred the completions is to really substantially increase the rate of return,” Bill Thomas, EOG’s chairman and chief executive, acknowledged in an investment conference call. “We want to make sure that we allow prices to firm up.”

The price did not rebound, but the economics of drilling and completing wells have changed. As the oil price dropped and drilling crews were let go, the cost of drilling wells fell as much as 30 per cent. At the same time, those companies that cancelled rig contracts were forced to pay costly severance costs.

On the completion side, fracking crews are easier to come by and their contracts tend to be more fluid. Now those completion costs have also come down — meaning that the uncompleted wells will eventually be brought on line at a lower cost, executives say.

Cheaper old wells

Even if oil prices do not rise substantially, some companies say they will work through much of their warehoused wells in 2016 because with the drilling costs already paid, it will be at least 40 per cent cheaper to complete old wells than drill new ones. That should enable them to keep their production flat or rising even as they further cut their capital expenditures.

But Anadarko remains cautious for 2016. “Should the commodity price change, we can ramp up,” said Darrell E Hollek, Anadarko’s executive vice president for onshore exploration and production. “We may find that we complete a lot of these intentionally drilled and uncompleted wells but we may find we only want to do half of them. But from a capital standpoint, it truly is a lever for us.”

Anadarko lost $2.2 billion last quarter and the company’s stock price has been cut in half. Its executives have devised a strategy to slow investment into new production in its onshore shale wells to devote more cash to developing high-stakes projects in the deep water Gulf of Mexico and abroad. The strategy should lift its revenue in several years when most experts think the oil price will be higher.

Anadarko already has 6,800 wells producing oil and natural gas in the Wattenberg field and has identified 4,000 additional drilling locations. It is drilling 380 wells here this year, 11 more than in 2014, with fewer rigs drilling more efficiently designed wells. But while all the 2014 wells were completed, it plans to defer 130 completions of this year’s new wells for a year or so.

The company is following a similar strategy in its Texas fields, making it the oil company with the most uncompleted wells after EOG Resources. Wall Street analysts have generally agreed with the strategy.

“Relative to others Anadarko is managing through the cycle effectively,” said Mark Hanson, a Morningstar analyst. “These guys are looking down the road a bit further.”

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