EIA Overestimates US Production, Huge Production Drop in the Works

EIA uses a model based on rig counts and inventory levels to estimate weekly US crude oil production.  This model has some major flaws that arise when the mode of operation for US producers makes a drastic change.  In the current environment where price is pivoting around or is very near break even for producers and US producers are acting as the worlds swing producer by increasing and decreasing output based on price, these flaws become significant and lead to some wild overswings in prices as many traders have little idea of what is actually happening.

US shale wells have a decline rate of approximately 1%/week, 5%/month or 65%/year.  This means US producers must add enough wells every month to bring on 5% of the previous months output with new wells every month.  If producers bring on more or less wells than normal in a month EIA cannot compensate with its weekly model.

US producers temporarily store oil at wellheads and elsewhere.  If there is a dramatic shift in how much producers have in temporary storage, the EIA model does not compensate.  This becomes an issue in Gulf Coast states that have property/inventory taxes that are paid based upon end of year inventory.  This encourages producers to empty all storage leading up to the year end pumping oil into storage in other states.  This can be seen with increases in storage at Cushing, OK at year end and a draw down in Gulf Coast storage.

Another source of error appears to be where in the US oil inventory appears.  Indeed most traders treat Cushing, OK inventory as a proxy for US production so it is logical that the EIA weekly production model also treats Cushing inventory with heavier weight than elsewhere..  Indeed over the last several weeks US production has been shown to be rising as Cushing inventory has risen, while completely discounting large Gulf Coast inventory decreases.  Even though it is possible for inventory from Canadian and other inventory destined for the Gulf Coast to be temporarily stored in Cushing and for Gulf Coast oil to be pumped to Cushing to lower Gulf Coast inventory at year end.

The only method EIA uses to compensate for errors in its model is to report the error in Unaccounted for Oil which few track and is hardly ever mentioned in the mainstream media or by most analysts.

So this brings me to discuss the recent fall in US production that is drastically underreported by EIA data using data reported to the state of Texas as a proxy.  Data reported to the state of North Dakota confirms what is seen in the Texas reports.

Intuitively it shouldn't make sense that US production is little changed or even increasing even as rig counts and oil prices fall drastically.  Especially since price took a major downturn in August.  Granted the backlog of uncompleted wells can cloud this picture, but most US producers have been pretty vocal about not completing wells if price drops too far, and a look at producer financials indicates that most have severely negative cash flow at these prices.  Inspection shows many will have used up about 50% of their cash in the last year and at current prices will have no cash reserves in 6-12 months.  Who is going to lend them money to maintain operations with this kind of trend?

The first plot shows US production vs Unaccounted for Oil vs WTI spot price on Tuesday of the report week.  What should be noted is the odd significant increase in production + Unaccounted in October and November followed by the huge falloff in 2 out of the last 3 weeks.  Later it will be shown that the huge falloff correlates directly to production declines shown in both EIA monthly data, but more significantly in production and completion data reported to the state of Texas.


Fig 1:  Note the large volatility in US Production + Unaccounted for Oil since the beginning of 2015 as price ranged from appx $40-$65.  A significant point is that several big drops in Unaccounted for Oil led EIA estimates of falling production.  The size of the recent drops in Unaccounted for Oil are huge and just so happen to coincide with very large price drops, below the mid to low $40s which has been reported as the break even point for many US producers.

Data reported to the state of Texas for crude production as well as well completions further supports the case for recent production declines being under reported by EIA as well as projecting huge declines in the coming months.  It should be noted that there are appx. 180,000 producing oil wells in the state of Texas and analyzing the data indicates that appx. 1600 completions are required every month just to keep up with the severe declines in existing wells.

The distribution of wells shows for November 2015 shows 8132 producing greater than 100 barrels/day (BOPD), 45,259 with production greater than 10 BOPD but less than 100 BOPD and the large majority of wells, 130,491, producing less than 10 BOPD.  This means the newly completed wells most of which are producing near or above 100 BOPD due to high grading in this low price environment are responsible for a very outsized portion of total production since it only takes an addition of 1% of the total wells to compensate for a 5%+ monthly decline in the rest of the wells.  A failure to add some or all of these wells and/or a decline in productivity of these wells can lead to very large and fast production declines.


Fig. 2  Texas Oil Production Data  This chart clearly shows a major decline in Texas well completions starting in July/August as price declined.  Even the momentary return to prices in the low $50s didn't provide the incentive to increase completions to the 1600/month level required to maintain output.  Prices in the low $40s for the entire month of November caused completions to drop below 800 for the month and it is yet to be seen just how low completions were for the month of December.  EIA and Texas monthly production reports that lag two months clearly show declines matching the completion declines.

While EIA and Texas reported production levels tracked closely at the end of 2014 and early 2015 there has been a steady and wide divergence between the two data sets since March with the Texas data being much lower.  But if we project the summer/early fall declines using the EIA data set, it is not unlikely that Texas crude production has already dropped to 90MM bbl/month which is a 15% drop since mid summer.  This is important since the weekly data set only shows a 4.5% drop in production using production only and appx 7.4% drop using production+unaccounted.

The huge drop in rig counts and low prices provide little ability and no incentive for US producers to actually push production up quickly even if price were to quickly recover to over $50/bbl.  The data seems to indicate that even with prices essentially steady in the high $45-$50 range in September and October producers did not even attempt to maintain output, because only about 1100 completions were done per month in Texas while about 1600 were needed to maintain output.

Another point supporting huge drops in production coming is that in November the number of wells producing over 100 BOPD dropped by almost 1087 or almost 12%.   This is significant because for most months 1100 completions was enough to increase this count at least by a few and 1500+ completions added about 400/month to the count.  So a drop from 1138 completions in October to 776 in November caused this count to drop by almost 1100.

The EIA monthly reports for US and Texas production show the peak occurred in March, however the weekly data indicates the peak occurred in the May/June time frame.  Again this disparity shows how the weekly reporting lags reality, essentially exaggerating the increase in US production for months and delaying the reporting of significant declines for months.

Analyzing many of the largest producers latest quarterly financial reports showed their lowest hedging position at $46 which was commonly purchased put options and did not cover 100% of planned output.  This also supports the case for a big slowdown in output at current prices.

Conclusion
The conclusion is that as long as WTI remains below $46 the actual decline in US production will remain severe.  Recovery of output levels cannot be fast even with a large price increase.  After Jan 1 producers, refiners and storage players will return to a more normal mode of operation.  This means localized inventory levels could increase meaning less oil moves into reported storage making it look like production suddenly fell, Cushing inventory could fall or remain steady making it appear production dropped.  On the other side Gulf Coast inventory will spike in early January as a backlog of tankers is offloaded, of course we could see a huge drop in refined inventory in the next two weeks as that inventory is moved out of Gulf Coast storage compensating for a January crude spike.  At some point EIA will revise their data and adjust their models to compensate for recent inaccuracies.  Indeed the monthly reports will show huge declines that were not foretold in the weekly data.

As the huge decline in US production becomes obvious it could provide some incentive for OPEC producers, especially the Saudis, to be just a little less excited about dumping every barrel possible onto the US market.  This becomes especially true if they can get their total exports to the US close to 2013 levels.  More potential tail winds for prices in the coming months.  It's been my assertion that US production needs to drop to around 8MM bbl/day to allow room for Iranian oil and provide a larger market share to the Saudis and it appears that US production is likely much closer to that level than anyone realizes.