I was in Bismarck, North Dakota and environs two days last week at the invitation of BNC Corp., and was fortunate enough to spend time with some bankers, operators in the Bakken Formation in the Williston Basin and some very successful hard-working people in the region. Some of them have benefitted from the energy activity in the area, but many have simply built businesses and/or run agricultural or related activities there with real success. This would include some wind farms associated with other power generation facilities in the state that has the highest potential for land-based wind generation in addition to all that oil and gas.
With the price of oil coming down over the last year in particular, drilling and production activity has slowed significantly, changing the economics of the region and the contribution of the area to the demand requirements of the US. Empty parking lots, stacked house trailers and idle heavy equipment parks were a common site. Some of the discussions were local, which I will touch on below. Other conversations were on broader topics coming from a very Midwestern viewpoint—refreshing, thoughtful and a bit angry. Let’s focus on the Bakken, though.
I was told that the numbers suggest a third of the Bakken has a breakeven price of $30/barrel on operating costs. The rest of the field goes up from there to about $80, but technology is taking the costs and the timeframes down. A bit more than 4,000 wells have been drilled in the Bakken and Three Forks Formations since 2008, which has led to a doubling of estimated ultimate recovery to about 7.4 billion barrels of oil and 6.7 trillion cubic feet of gas. Some would say those numbers are low. There are about a 1,000 wells that have been drilled recently, but not completed, and the state has extended the time for completion to two years from one, allowing operators to hold on to the acreage a bit longer. Folks are hoping prices will go up before then. I wish them well, although they have some arguments about why that may happen—maybe some element of hope over experience though, sort of like second marriages. In the meantime, the drilling and pumping in the lower cost areas is continuing by those entities that have creditors who want to get paid. And, the production per new well is up in a year by about 40% from 500 barrels per day to 700. Overall, taking into account the legacy wells, the total production is down by about 23,000 barrels per day from a year ago to a little under 1.2 million barrels/day. The race between new wells being drilled at higher productivity versus the decline curve on existing wells will likely result in production falling, although the rate of decline is uncertain. While some operators are shutting down to wait for better prices and higher returns, others are continuing to pump as long as the spread produces a cash contribution to keep lenders and investors at bay. The luxury to make a discounted cash flow calculation, based on higher prices at some point, which would suggest shutting in a well, doesn’t exist for those operating on leverage with creditors to pay. Even the state appears to want its share of the revenues to continue instead of shutting down as much as 500,000 barrels per day of production of a depleting asset.
While this noise is in the background, the better operators have upgraded their staffs as others have cut back. As I pointed out, the overall unemployment in the extraction industry is above 11% versus 6% a year ago. However, the Colorado School of Mines’ graduates (my alma mater) seem to be finding the good homes. Those operators that have access to capital are taking advantage of others’ misfortunes. The operators there don’t believe overall production will be able to increase quickly, if prices rise, since it will be difficult for their competitors to find the talent at the time it is needed. This applies even more, in their view, to some of the global offshore production and other fracking sites, which would suggest, when and if prices do rise, they could go higher than what one might expect. There may be a bit of the fallacy of composition at work here—each potential producer believing that they will be able to up production while others won’t. In the meantime, certainly in North Dakota, the local businesses are able—now at least—to hire employees at normal compensation levels. Whereas during the boom, I was told that McDonald’s was actually paying signing and retention bonuses to staff. At one point they, supposedly, only had enough staff to keep their drive-in window open. And, apparently, they weren’t alone.
Understanding what’s going on with the Bakken and oil in general is complicated on one level; on another level, it’s just economics. There’s a lot a value in the ground and it seems to be a different equation for the operators depending on their timeframe, their finances, their location and to whom they owe money. In the meantime, the technology and a lower breakeven keep marching on; energy demand and some supply increase; restarts become more problematic; Exxon and Chevron bide their time; and Saudi Arabia tries to figure out its own equation while its world becomes more chaotic. I still think we have some accidents ahead before something closer to supply/demand balance occurs. What happens in the Bakken may be a lead indicator on the rate at which production could increase as technology pushes costs down and oil prices fluctuate. Worth paying attention. If nothing else it’s a good excuse to go back and interact with some no-nonsense people in the middle of America as their world shifts.
While waiting for all of the above to occur, we are likely to see increased dispersion in results across the equity and fixed income spectrum well beyond the oil patch, as global growth slows, the dollar stays strong and the wealth transfer from the energy sector to other businesses creates a more diverse set of investment opportunities.