Fitch; Rig-Linked 2H US shale production decline of 7% possible

Production decline

The nearly 55% drop in US Lower 48 rig counts during the first half of 2015 is forecast to contribute to a second-half 2015 production decline of roughly 7% in tight oil & shale gas regions at June operating and activity levels, according to Fitch Ratings. This exit production rate would be around 3% lower than year-end 2014 levels. Further, Fitch anticipates that some of the productivity gains realised during the first half of 2015 will lead to a lower, longer term US Lower 48 rig run-rate of 1200-1300.

Extrapolating from US Energy Information Administration (EIA) data, Fitch forecasts that at June operating and activity levels oil production, including crude and condensate, declines from tight oil & shale gas regions will outpace the fall in gas production. Fitch calculates that the 2015 exit oil production rate from tight oil & shale gas regions will be about 9% below the 5.5 million boe/d June 2015 rate. The projected exit oil production rate would be nearly 6% lower than year-end 2014 levels.

The EIA's estimated new well production per rig and legacy well decline rates are key inputs for Fitch's second half 2015 production forecasts in tight oil & shale gas regions. To account for movement in these operating metrics, Fitch conducted several sensitivity analyses. For example, a 15% improvement in new well production efficiency per rig, assuming rig counts and legacy well decline rates remain constant at June 2015 levels, second-half 2015 total production in tight oil & shale gas regions would decline by 3%. This would result in the total production exit rates being modestly higher year over year.

Fitch's longer term U.S. Lower 48 run-rate estimate is 1200-1300 rigs. This is 30%-35% below the recent peak US onshore Lower 48 rig count of 1868 in mid-November 2014. Fitch believes that a key implication of this 'new normal' run-rate for onshore drillers, such as Nabors Industries, Ltd. (BBB/Stable), is likely to be the heightened importance of maintaining a US rig fleet weighted toward the most efficient, highest quality rigs. Fitch anticipates that these types of rigs are best positioned to work during and after the cycle.

Pricing support for a larger scale ramp-up in activity may be several years into the future. Fitch still views a longer, slower rig recovery profile as likely based on Fitch's West Texas Intermediate (WTI )price assumption of US$60 per bbl for 2016 and US$70 per bbl long term. Historical downcycles suggest that trough-to-previous peak rig response (though tight oil & shale gas has likely created a new normal run rate) depends on the speed and intensity of the price recovery. The 2001 U-shaped bear market recovery required about 35 months to return to peak levels, while the 2009 V-shaped bear market needed roughly 28 months.

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