Upstream Texas - Fall/Winter 2016 - 15
places without great transparency," he says.
"There have been indications we are drawing
down Saudi, Nigerian and Brazilian stocks.
That is translating into the places that are
transparent-the United States and Europe-
looking heavier than they may, in fact, be. We
may be at the balancing point."
Kleinman considers how the previous market
boom resulted from an acute imbalance from
the other direction. Early in the previous
decade, when Chinese demand took off, it
became apparent there was not enough oil,
and really not enough of anything to produce,
transport or refine it, he details.
"The entire supply chain was stretched to its
breaking point," he says. "We did not have
enough offshore rigs, petroleum engineers,
tankers, pipelines or refineries. When oil
reached $100, a lot of bears said it made no
sense that the market was 30 percent above
the top of the entire cost curve, but it was
not only about oil. Oil prices had to go high
enough-and stay there-to expand capacity
throughout every link of the supply chain."
Just about the time at which all those links
in the hydrocarbon supply chain came online,
Chinese demand began to flag. The result has
been a market correction that has pruned back
both inventories and the supporting material,
"The market shifted so that oil prices would
sink enough to squeeze out some of that
excess supply chain capacity," he says. "Now
there are lousy refining margins, painfully low
pumping margins and such."
Fortunately for those in the industry left
standing, Kleinman says, that portion of the
cycle not only might be near its end, but soon
those people will be needed to fill a gap left
by the last couple years' neglect. "We are
setting ourselves up for not having enough
oil in 2018. It is simply a question of where
the oil is going to come from. Non-OPEC
is in solid supply decline while demand-
though muted-is still going up. Those lines
are going to cross and I simply do not know
where the incremental supplies are going to
The folks at RSP Permian agree that the
relative lack of drilling actually may be
setting the world up for another price
spike. Chief Executive Officer Steve Gray
and Vice President and General Counsel
Jim Mutrie say an oil price analogy
increasingly cited among the company's
personnel compares the market's fixation
on oil inventory numbers with complacency
based on a well-stocked refrigerator. You
may look in the refrigerator and see that it's
full, but if farmers are not planting crops and
producing nearly as much food as they once
were, restocking that fridge becomes much
more questionable and expensive.
"People who know the market realize we are
setting ourselves up for another supply shock,"
Gray suggests. "Whether that comes in a year
or two is debatable, but it is coming."
In the meantime, Mutrie indicates, the
company is moving cautiously.
"With cost structures coming down, we have
the ability to turn a profit at a much lower oil
price, so we are continuing to produce and
giving ourselves the flexibility to ramp up,
but we are not making any major, long-term
commitments that would put us in an overextended position if things do not improve,"
One helpful factor to which Gray points is the
old real-estate adage of "location, location,
location." In this case, he is referring to the
company's Midland Basin assets.
"It is probably one of the handful of places
in the United States where you can make a
profit at $40 a barrel oil," he says. "We have
slowed way down, but we can still drill and
make positive returns. Horizontal wells in the
Wolfcamp and Spraberry are probably some
of the country's most economic."
Jud Walker, president and CEO of EnerVest
Operating, says his company has spent the
downturn staying true to its financially
conservative roots. Had the company been
willing to take on more debt, he says, it easily
could have run more than the 16 rigs that
it was running at the end of 2014. That
number eventually dropped to zero, he
says, although the company has picked up
one rig to drill shallow, vertical coalbed
methane wells on a Virginia leasehold in
which it owns the majority of the mineral
rights and has picked up a second rig in
South Texas' Eagle Ford Shale, where many
of its 14,000 acres sit in the core of the oil
window. With a 25-30 percent projected
rate of return on the CBM project and an
estimated breakeven in the high $20s in the
Eagle Ford, Walker says the projects meet the
company's economic parameters.
"We are slowly getting back in and seeing
prices approach the level we need to get out
and drill," he says. "Any project has to achieve
a 20 percent rate of return."
And just as activity is starting to exhibit signs
of life, Walker adds, industry optimism seems
to be doing the same.
"I have noticed morale picking up at events
around town and simply as I talk with
colleagues," he says. "Our company culture
has tried to rise above the gloom and doom.
There is no doubt it has been a tough two
years, but we are tired of the pessimism."
Another source of comfort for producers is the
extent to which many of them have devised
ways to trim costs, Mutrie reflects. Just as
innovation spearheaded by U.S. independents
helped spur the production surge that
contributed to the oversupply, he notes, many
of those same companies are now devoting
their creativity to lowering costs.
"You oftentimes see it less with the majors,
but the smaller and mid-cap operators are
nimble and able to experiment and adjust
quickly to different fracturing and completion
designs and techniques, drilling times, drilling
efficiencies-all those things," he says. "For
these operators, it is not like turning an ocean
liner, but more like turning a small boat. I think
the United States is better positioned to deal
with this than anyplace else."
And when prices improve, U.S. independent
producers will have to scramble. With so few
wells coming online in the past couple years,
the turnaround may be dramatic enough to
"The fundamentals of supply and demand are
starting to take hold and we think they are
very favorable," Walker says. "There will be
a few bumps in the road, as we witnessed in
late summer, but in the near-term and beyond,
we see strengthening fundamentals, which is
a fantastic statement to finally make."
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