Let’s face it, the last two to three weeks have been a complete train smash for shale operators and investors. We are price takers at the end of the day, so we as an industry are all trying to do what we always do – pick ourselves up by the bootstraps and find a way forward.
In this post, I’m going to discuss the following:
- Define Novi’s perspective on where things are at, and level set on what response vectors the shale industry has taken thus far as well as what responses are likely going to be necessary in the future.
- Outline five ways a more serious industry approach to the adoption of digital oilfield technology, particularly in the planning and capital allocation part of the value chain, could drive the efficiency, scale, and economic certainty the industry needs to survive.
- Offer a view on reasonable conclusions and next steps.
Where things are at
Although I am really try to avoid it, sitting here in my (hopefully) coronavirus free home office perfecting my social distancing techniques gives me too much time to keep hitting refresh on my Bloomberg WTI strip web page. This was mid-day the 18th of March, 2020, hopefully it doesn’t get worse, but I fear we haven’t found bottom.
The initial reaction from shale operators has been predictable – I think I have read at least twenty CAPEX reduction press releases this week. Some notable highlights:
- FANG – extra credit for being first, but probably need two bites at the apple
- OVV – 2/3 of their rigs…ouch
- PXD – 50% of rigs
- WPX – 25% capex reduction; and they are 70% hedged in 2020
The Journal of Petroleum technology did a very thorough CAPEX reduction overview in an article published 18-March. As bad as it has been for operators, it has been far more brutal for oilfield service companies. But, at least this time the industry did not wait and hope it below over like in 2016 – it was immediate and visceral.
My view is we are not even close to done here. More CAPEX reductions will be required…and…
…if this goes much beyond 90 days, G&A reductions are going to be required as well. Let’s face it, shale producers in 2016 still had access to relatively cheap debt, and equity markets were not completely closed. This does not hold true today. Capital market indexes across the board are down 30% to 40% due to the coronavirus pandemic. For Oil & Gas, it’s the triple whammy of global demand shock, global supply shock and shut capital markets.
I conclude that we cannot just reduce drilling & completions activity. For those who haven’t seen it, Bloomberg did an excellent basin-by-basin analysis back in mid-2018 that is still directionally correct in my view. While efficiencies have improved and costs have come down a little since that was written, no oil company is making money at $22 strip. We have to reduce operational costs, not just capital.
That means – G&A is going to be the target. G&A is mostly people. People that are doing work today. People that have already suffered through industry wide reduction in force last year. People executing core workflows such as forecasting, rate transient analysis, reservoir simulation, type curve analysis, decline curve analysis, etc, etc.
I am an entrepreneur, selling software to bankers and operators that also have the entrepreneurial spirit. We are survivors when we need to be as a whole. But we have to super attentive to the details here, or we are all going to the bread line.
So, the question is…what can we do collectively to survive this? I’m a digital oilfield software guy, so I want to outline what I am seeing our customers do, and my observations about how this is helping them.
Five ways digital oilfield technology can help the shale industry survive
The shale industry (and oil and gas in general) has been remarkably resilient to price shocks in the past. Thinking through Novi’s experience, we have observed four distinct periods:
- 2015/16 “Initial Price Shock“: this was an oversupply driven downturn that taught the industry how to operate more efficiently, improve supply contracts to add flexibility to CAPEX, and drill more efficiently. All of that meant that it reduced the cost to deliver new wells.
- Late 2016 to Mid 2018 “Lower for Longer“: digital oilfield technologies were piloted, but, the industry largely allowed workflows to continue to be executed using traditional labor intensive methods. As I like to say having lived through this…there was a lot of interest in digital oilfield, but no intent.
- Mid 2018 to End of 2019 “Investors Tire”: Oil & Gas investors become tired of the same old stories about losing money and demand return on capital. Stock buybacks, dividends, and 20 to 35% G&A reduction were the indicators that the industry was tuning for investor requirements. Digital oilfield began to be seen positively in the C-suite, but still was viewed as an existential threat amount the very use base it was intended to serve.
- Today: all shale operations are unprofitable at current strip. Mass CAPEX reduction, more to come. Mass G&A reduction on the near term horizon. The question now is, what will this mean for Digital Oilfield adoption?
I presented on these topics at the first ever Tudor Pickering & Holt Energy Disruption Conference back in December of 2017, more than two years ago. You can watch that below if you would like.
It’s time that the industry stop kicking the tires on digital oilfield, adoption is now necessary for survival.
For Novi’s part, we build software that drives efficiency in key capital allocation and well planning & forecasting workflows. Right now, customers are using our software, and the data our software produces, to reduce risk, improve returns, and drive workflow efficiency in the following ways:
- Fully Automating PDP Well Forecasts – no DCA, RTA, curve gerrymandering, etc, etc. Put your wells in one end of Novi, and get your forecast out the other end. This is a huge efficiency boost generating savings in G&A and other costs.
- Right Sizing Well Designs to Rock Quality – tuning the completion and spacing designs to match with current strip price expectations leads to reduced decision errors on designs and highest possible returns. Great material on this available in my colleague Ted Cross’s recent blog posts on tier one inventory in the Bakken as well as tuning completions to spacing and subsurface.
- Balancing Reduced Capital with Inventory and Reserves – One of the knee jerk reactions to reducing capital that we observed in the downturn of 2016 was to drill a bunch of single well parents to hold leases by production, with the idea being that the downturn would be short, and the return to those areas would be eminent. The lessons of parent-child have been reverberating through the industry ever since. Novi models learn from these mistakes. You are typically better off fully developing a small number of units than orphaning wells with a strategy of hope. My colleague Ted Cross created a great blog post on this subject that quantified the cost of some of these decisions.
- Running and Re-Running Basin Wide Economic Scenarios – compute and algorithms can run at scale and accurately predict a large number of possible economic scenarios with extreme efficiency. We covered this in our economic analysis of Parsley’s acquisition Jagged Peak.
- Acquisition & Divestiture Analysis – there are definitely going to be opportunities to buy and sell. It is unclear how those will manifest, or who the winners and losers might be. Follow this link to see how our software can add value to this workflow.
I recorded a quick video showing how Novi’s Prediction Engine software helps our customers run economics for different planning scenarios very quickly – that’s embedded below if you care to take a look.
The bottom line is simple. Digital Oilfield technologies backed by machine learning algorithms, compute power, and purpose built interfaces designed for our industry add efficiency, scale and certainty across planning workflows. We need those things now as an industry.
If we are forced as an industry to live with less G&A to survive, there is no other way to replace lost workforce other than by implementing these platforms and integrating them into workflows. While digital technologies do cost money to purchase and integrate, the investment can be measured in terms of 2 to 8 FTEs, which is far less than the investment required to continue to do these workflows manually.
We have observed that 2019 G&A cuts have taken planning and engineering teams to the bone already; further cuts mean that work quality will suffer if digital oilfield technologies do not fill the voids created.
- It’s early innings here…maybe Saudi or Russia will blink, maybe they won’t. Maybe coronavirus will abate in coming weeks and business travel will continue as it was, maybe it won’t. Savvy operators and investors are going to conserve cash in any way they can and assume the worst case.
- Even the “lucky hedgers” such as WPX and HES are cutting CAPEX aggressively – it is just pragmatic at this stage.
- Recent CAPEX reductions will have to be followed by G&A reductions if this goes beyond 90 days. It’s an uncomfortable truth.
- For shale to survive price shocks of this magnitude, it must stop with the toe in the water approach and go widespread adoption digital technologies. It’s now or never. I’ve outlined the Novi case above – how we can delivery efficiency and help the industry survive. There are similar cases to be made for digital oilfield technologies across the value chain.
- The rich are likely going to get richer – strong balance sheets with lots of cash stored up from recent pro-industry tax policies are going to put together comprehensive strategies to acquire assets.
- Private Equity sponsors flush with cash are going to have a huge advantage in hunting for higher quality assets at lower prices.