Understanding the Dynamics of U.S. Oil and Gas Production in Response to Price Changes

The landscape of U.S. oil and gas production is significantly influenced by the current price environment. With a substantial number of wells already capped or awaiting drilling, producers face a complex decision-making process before reactivating them. This article explores the factors that influence the immediate and sustainable increases in production, providing insights into the behavior of different types of producers in the face of rising oil prices.

Why Wells Remain Capped

There are numerous wells in the U.S. that have been capped or are nearing this stage, particularly in the Bakken region. These wells represent an inventory of untapped resources that could be reactivated once market conditions become favorable. For instance, wells that had economics ranging from $45 to $50 per barrel of Brent crude oil are expected to become active again, as prices rebound.

However, a significant reduction in oil and gas production has not occurred during the 20-month period following the price drop. This suggests that some domestic oil production is currently incurring losses. The protracted trend of low prices has made it challenging for producers to secure the necessary future contracts to hedge revenues and ensure a sustainable profit.

Factors Influencing Drilling Decisions

Drilling is a capital-intensive process, and the decision to activate idle wells or commence new drilling projects is heavily contingent on price certainty and future contract availability. Onshore drilling operations typically require turnaround times ranging from 3 to 6 weeks. However, these plans must align with future contract arrangements, which provide a financial buffer through hedging strategies. For instance, if a drilling company can secure enough future contracts at a comfortable price and over a wide range of maturity points on the futures curve, they may proceed with drilling new wells. This scenario is basin-specific, with some regions being more cost-effective than others.

Offshore Drilling Considerations

Offshore drilling presents a more prolonged timeline, where the planning and spending to bring a new deep-water well into production can span 1 to 2 years. This extended period means that broader financial planning and contract commitments are required. Consequently, the ramp-up process is slower, and the decision to resume offshore drilling is contingent on securing long-term contracts at favorable rates.

Inventory Wells and the Immediate Rebound

Some producers already have a substantial inventory of onshore wells that are drilled and cased but not yet completed. These wells represent an immediate opportunity since the incremental cost to activate them is relatively low. This group of wells is likely to enter production first when prices rise. However, this inventory is finite, and it is expected to last for 4 to 6 months before the next round of production decisions become necessary.

The rapid deployment of these wells will help stabilize prices in the short term but will be insufficient to address any significant price increases. The subsequent steps in the production ramp-up will involve larger and better-capitalized companies. These players are more likely to proceed with drilling once global oil prices align with their break-even points, which are typically higher than those of smaller operators.

Financial Constraints of Small and Midsize Operators

A more critical aspect is the financial situation of small and midsize upstream operators. These companies often face severe cash flow issues and tight credit conditions. Commercial banks tend to be cautious about lending, and a sustained increase in oil prices for at least 12 months is usually needed for these institutions to become more entrepreneurial. This implies that, even when prices rise, many small and midsize operators may not have the financial resources to start drilling again immediately, limiting the speed at which new production can be brought online.

Conclusion

The path to increased U.S. oil and gas production following a rise in prices is neither immediate nor straightforward. The sequence of producers to reactivate or drill new wells is as follows:

Small and midsize onshore explorers with drilled but uncompleted wells. Well-capitalized onshore explorers. Small and midsize onshore explorers. Large offshore explorers. Small and midsize offshore explorers.

Only the first two groups are likely to produce into the first wave of price rises up to $50 per barrel. The third group will consider production when prices double from the current level, while the fourth group may wait even longer. The last group, small and midsize offshore explorers, might never consider further drilling.

The intricate interplay between market prices, financial conditions, and operational logistics underscores the nuanced approach required for a meaningful and rapid increase in production. As the market continues to evolve, these factors will remain critical in shaping the trajectory of U.S. oil and gas production.