Summary of Executive Roundtable to Discuss COVID-19 and Commodity Price Related Issues Specific to the Upstream Industry
On Thursday, April 9th we hosted the fourth in a series of virtual roundtables targeted at bringing together the senior leadership from across the industry to discuss the impact and share best practices on how to deal with the current disruptions in the market. These roundtables will continue to be held weekly on Thursday from 3- 4:30pm CST.
Building on the conversation at last week’s event, we once again focused the discussion around the topic of Production Curtailments with a specific focus on the economic considerations surrounding whether or not to shut-in.
Notably, there has been a significant increase in the number of attendees who were supportive of the idea of a government coordinated supply response – 50% this week compared to ~30% on March 26th. While it is certainly worth keeping this shift in attitudes in mind ahead of the Texas RRC vote next week, there was notable dissent at the prospect of direct regulatory interference with the massive (and likely to increase CAPEX cuts) cited as proof that the market will self-regulate.
There has been much debate, both internally at Darcy and with our clients, around the parameters to consider when discussing production shut-ins. We were honored to host Ryan Keys, President of Triple Crown Resources, who was kind enough to share his thoughts on the situation with the attendees. Please see Ryan’s full presentation posted to the #exec-roundtable Slack Channel.
Netbacks Will Drive Much Of The Decision Process
While the headline WTI price movements in the last few weeks have been, well, something to behold… What has happened to the diffs and the NYMEX roll has gone somewhat under-the-radar. When compared to January 2020, the differential from Midland went from +$1.00 to ($5.00) with all indications that it will likely continue to increase as smaller regional storage centers head towards capacity. This pressure has been further exacerbated by the NYMEX roll for physical delivery which has increased from essentially flat to ($3.00) over the same time period. Just those two impacts alone have decreased wellhead realizations by $8.00.
Additionally, this doesn’t take into account the potential for crude quality discounts to come into play, which would only further negatively impact realizations. Much more difficult to track, but with the massive build in Jet Fuel and Gasoline, along with other distillates, has created a never before scene scenario where it is very difficult to predict future crude quality discounts.
This has all conspired to compress realizations at the wellhead in the Permian from ~$50 in January to ~$10-15 currently, with a downward bias for physical delivery (ex- benchmark recovery). Against this backdrop, we have seen the number of Roundtable attendees who have formally begun shutting in production increase from ~20% to 60% in the last two weeks. The typical amount of production shut-in by each attendee is currently indicated between 10-50% of baseline.
Prioritizing Shut-in Candidates
One of the points raised during the session was that under most scenarios there would be the desire to eventually bring the wells back online, which from a tactical standpoint means that many of the personnel level costs in the field would likely remain as fixed costs – assuming a 6-9 month path to recovery. This was notably and generally inline with most in attendance; the shortage of qualified labor in the field has resulted in a shortage of capable and trusted personnel.
Shifting focus to the well level economics – Triple Crown has been doing background work in terms of stratifying some of their wells based on artificial lift types to allocate typical LOE costs. The highest cost and likely first candidates to be shut-in are going to be the gas-assisted plunger wells with wellhead compression, followed by annular gas lift from a centralized compressor, then rod pump and so on.
When looking at the LOE costs at a granular level it is worth noting that ~20% of the “variable” costs cannot actually be removed from the system, again assuming the intention is to bring them back online. Additionally, the cost they expect to see when trying to restart these wells, is ~140% of baseline LOE which needs to be factored into the economics decision on whether or not to shut-in production.
It should be noted that when discussing the first wells to be curtailed, it is likely the lower-production legacy wells which would be shut-in first and likely last to be revived potentially resulting in significant mechanical impacts to the downhole infrastructure. With that being the case, even those low production wells need to be incrementally risked from an ability to resume operations perspective.
EUR v. Cash Flow
Interestingly, there were multiple people in attendance who raised the prospect of potentially shutting-in all of their production in the event that realizations were to hit the <$10.00 range for a protracted period (weeks-to-months). The rationale being, that in a sufficiently contangoed market they would keep the value of the reserves intact and bring production back online when prices recovered.
It should be noted that the conditions to allow this are fairly specific and not likely to be a widespread strategy – namely, private operators who are effectively strongly hedged. The benefit being, you’d monetize the value of the hedges and pull forward cash flow while maintaining the value of the commodity in-situ.
While shut-ins of this magnitude have never been contemplated before, it would appear that there would be minimal permanent damage to the reservoir. Canadian break-up shut-ins were highlighted as an example. However, it should be noted that when wells are brought back online, it would appear that the gas is slower to recover than the oil and liquids; it’s unclear exactly what the mechanism is for this.
Please note, at next Thursday’s Executive Roundtable (April 16, 3pm CST) we will take a slightly longer term view as Dan Pickering from Pickering Energy Partners joins the Roundtable to discuss trends they are seeing in supply & demand, storage, oil prices, and financial markets over the next 3-6 months. Dan will then stay to join our Roundtable Participants in answering questions and engaging in a discussion on how these macro factors drive decision making among O&G Producers and Service providers.