Monthly Archives: August 2015

Ghost Rigs & McDonald’s Geologists

a rig abandoned in 1982 and remained there for 3 years or more. (poor quality slide)”

My friends with OKT Resources, out of Edmond, Oklahoma made a prediction that I have thought about and agree with. Namely, there were 4,900 drilling rigs in 1981. We got down to some 700 or less rigs by 1999. Where were the rest? Scrap metal or parts for salvage. Was it the worse rigs that were taken out of commission? No. It was the largest and best in the fleet. Why? Because they cost too much to run in a $24/bbl. environment that was the norm from the early 1980s into the late 90s. The Cadillac rigs were simply too expensive to run and no one wanted to drill 20,000’ deep wells many of the larger rigs were designed for.

Today, the crush of oil prices means that the only investments to be made in drilling will be shallow, cheap prospects for traditional intermediate and heavy oils. These are the kinds of oils that our refiners are capable of handling. The reason the Canadian tar sands oils are attractive is that they are very heavy and when blended with the very light crude oils that come from places like the Bakken and are almost all of what horizontal drilling produces, it creates a blend that the refiners can run.

The very lightest oils are selling for half that of the posted oil prices. There simply is too much of it and we cannot export it. But this stuff is what many other countries have and can benefit from that “crack spread” – the increased profit margin when a crude blend is optimized for the refiner and thus maximizes the income from cracking the crude into refined products. So we need to be able to export these light oils.

But today, many of the “legacy” rigs that were designed to drill vertical holes have been moth-balled. The demand for rigs that are specifically designed to drill horizontal holes has boomed since 2006. And thus, over half the fleet of rigs are rapid deployed, computerized, and above all, expensive. They are expensive to build, expensive to maintain, and expensive to run. But with the new low price of oil, the only projects that will be funded are low-cost, shallow conventional oil prospects. They don’t require expensive rigs, in fact, will not hire them. Or, as my friend at OKT explained, “Looking for a rig, the drilling contractor asked me if I wanted a top line rig and I said no, and the owner said he had 20 rigs running this time last year and had only one rig drilling today.”

During the 1980s bust, a few rigs remained in place with the roughnecks simply walking away when their employer filed bankruptcy. Expect a few more such “Ghost Ships of Oil” to dot the landscape of the “unconventional” plays.

There isn’t going to be any demand for many of these top notch rigs. They are going to get old and the ones they cannot keep busy will end up in the scrap pile or cannibalized for parts just like their counterparts from 1981. You will see much less horizontal drilling over the next couple of years. Footage-wise, the 4900 rigs of 1981 were probably drilling no more hole than were the 1,900 rigs running in mid-2014. But the cost per foot is much higher today. If oil goes much below $38, then you surely see the problem. Oil was $24 a barrel in 1984 before the Saudi’s drove the price to the wall – down to $8/bbl. That forced the Iranian and Iraqi governments to end a war between themselves, and set Saddam on a path of looking for money by shaking down Kuwait. So do you think low oil prices did anything but destabilize the Middle East? What consequences will this downturn have on world peace?

Finally, the joke in the oil patch in mid-1980s was that the out of work geologist was at his wit’s end so he went to McDonalds and applied for a job. They said, “Sorry, all our geologists have master’s degrees.” That joke isn’t going to be very funny for a lot of folks real soon.

PS – The new generation of geologists are experts at geo-steering and shale oil environments. But they have very little expertise or experience in prospecting for conventional plays. Can they adapt?

Dream On, Oil Magazine Trades

Several years ago World Oil magazine fired an editor for running editorials from Art Berman, one of a few oil field experts who claimed the Emperor had no clothes and the value of shale gas and shale oil plays were vastly over-rated. Art has continued to vet the “unconventional revolution” with his petroleum truth blog, http://www.artberman.com/blog/ . Meanwhile, he was dissed by the players and the oil trade magazines that depend upon those players for most of their revenue. No one speaks evil about the hand that feeds it. And all these Pollyannaish magazines are no exception.
That really takes away from the value of such magazines because they become unreliable when they are unable to ask the hard questions nor tell it like it is. World Oil editorialized this very month that there were “rays of sunshine amid the storm clouds…” Really? Well, my bet is that a number of larger independents will merge or go bankrupt. Sandridge is down to less than 50¢ (August 20, 2015). And even the editor’s page was rather mealy-mouth about how that the money pouring in from the hedge funds and energy banks was likely to dry up. Well, duh…the industry has taken to this money like a drug addict. They cannot get enough and the more they get the bigger the dose they need. Now it’s cold turkey as the hedge funds realize they’ve made some very bad bets. KKR must feel really stupid right now as Samson is driven to the wall and will soon file Chapter 11. Will heads roll at KKR. They ought to. My buddies thought it a bad deal in 2011. But what do they know? They’ve only been part of the oil patch since 1974 and survived the 1980s and 1990s. Lest we forget, the bust wasn’t the half of it circa 1981-1985, the entire decade of the 1990s were plagued by low prices and that may be the fate of the industry for the foreseeable future, perhaps into the 2030s when us old timers will mostly have returned to room temperature.
Oil & Gas Journal, Reporter, and Oil & Gas Investor all tout the notion that the cost of drilling is much lower and the economics is still viable. Nonsense. How many companies have to file bankruptcy for the trade magazines to admit the income is exceeding the hemorrhage of cash? Until we stop producing huge quantities of oil and gas in the face of a glut, it will continue.
The economics of drilling has been put on its head. The over-optimistic projections have led to over-estimated reserves by skewing the old Arp’s decline formula and in the end, oil and gas just isn’t there in the ground like they say it is. Further, the SEC, by allowing companies to book reserves for undrilled prospects and to do so for five years, means that many companies are all hat and no horse. When the five years is up, they have to unbook the reserves and as a consequence all that money they borrowed against them now means they are as underwater as a 2006 McMansion in Las Vegas. The AAPG cannot scratch up enough presentations for their meetings. An Oklahoma trade show was canceled for lack of participants. NAPE is a meeting between the desperate and the unexcited.
And the industry itself has been in denial. Harold Hamm, supposedly some sort of oil patch genius, cashed out the hedges Continental Resources held and now is watching the company implode. It’s only the beginning folks. You heard it here.
Canada is peddling oil at $23 a barrel. Some reports say Marcellus gas in places is selling for 55¢ per MCF, and most gas players nationwide are getting prices that were around in 1991 when I couldn’t sell a deal because gas prices were at $2 an MCF. Half the drill rigs in the U. S. are laid down as I speak. They will not be coming back on a moment’s notice. Small drillers who have borrowed money will simply fold up and these rigs await the same fate as many did in the early 1980s. Namely, they will be cut up for scrap metal and salvaged for parts.
This was all foreseen by the old heads. The old gray- or bald-headed guys that went through 1982-86 know that capitulation is coming. The final blow will downsize the U. S. industry. And the banks, if they have a lick of sense, will avoid them like the plague until the next generation of bankers flush with cash, create the next bubble.
Meanwhile the “Trades” will continue to bubble their foolish talk and talk up a business that needs to have a voice that will tell the truth like Art Berman was doing years ago. No one wants to listen to a Cassandra. But remember Cassandra told the truth, something sadly missing from the industry magazines of today.

Mineral Owners – Sitting Ducks for Bankrupt Oil Companies

The success of the oil and gas industry should speak for itself. And the result however, has been very low product prices. As mineral owners, we know that the trade-off is there are a lot more mineral owners sharing a lot more royalties, but to recognize that when prices fall by 50%, our income follows. Unfortunately, it often falls more that the price. This is a product of the mineral owner being forced to be, for all practical purposes, a working interest partner with the oil company.

That means two serious issues exist. One is that the mineral owner who has post-production expenses deducted may see an ever decreasing slice of the pie. Are expenses being creatively calculated to benefit the operator at the expense of the mineral owner? We need legislation to prevent any mineral owner from getting less than 1/8th the proceeds from a well. It is insane to see post-production expenses exceeding 50% but that is regularly happening I am told.

The other issue looms before us. Bankruptcy. There will be a bunch of smaller companies that go under soon. They cannot survive $50 oil no matter what the pundits say. When an operator goes bankrupt, will your interest be preserved? If the past is key to the present, no is the answer. You may even be asked to refund the previous six months income back to the bankruptcy trustee. Can you do that?

We need to be protected. We OWN that oil, and should have secure access to OUR portion of the proceeds. When a big energy hedge fund –SemGroup – crashed in 2009, it also took down the arm of the company that did transportation and royalty management for companies. Hundreds were impacted and did not get their royalty checks. You are exposed to this problem from the first buyer, the intermediary or transporter (like above), or the operator and / or partners in a well. I fear many royalty owners are going to see significant disruptions to their royalties. They may recover some of it, but chances are they will be out legal expenses at a minimum, and perhaps be forced to take a haircut by the bankruptcy court. I remember being caught up a bankruptcy once and after seven years, my loss of $8,000 was 100%. My portion of the left over money was less than the registered postage to mail back the claim to the court.

Now is the time to buttonhole your representative and try to lay out the issues. We need protection.

Air-drilling “tight sand” in Rangley, CO – 1979