Peak Permian Oil Production May Arrive Much Sooner Than Expected

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In mid-January, Adam Waterous, who operates the private equity firm Waterous Energy Fund, made a prediction about the crown jewel of the U.S. shale oil industry, the Permian shale play that straddles Texas and Newย Mexico.

โ€œWe think we are at or near peak Permian,โ€ Waterous told Bloomberg. โ€œThe North American oil market has been grossly overcapitalized, which is notย sustainable.โ€

Bloomberg reporter Simon Casey goes on to qualify that โ€œ[p]redicting peak Permian output for 2020 isnโ€™t a mainstream view.โ€ However, evidence is piling up that the U.S. shale industry may indeed beย close to peaking as it runs out of the two things required to continueย increasingย oil production:ย money and what’s known as โ€œtier one acreage.โ€

Tier one acreage is the term for the areas that produce the most oil per well. It’s also known as โ€œsweet spots,โ€ โ€œcore acreage,โ€ย or โ€œgoodย rock.โ€

The idea of the U.S. shale revolution peaking long before either the broader oil and gas industry or the Energy Information Administration expectsย isnโ€™t a popular one. And the idea was even less popular when DeSmog started detailing why it was likely all the way backย in October 2018, and even when the Wall Street Journal made the case a yearย later.

Today, as more and more Permian oil companies go bankrupt and wells in the nation’s most prolific oil patch turn out less and less, one early warning nows seems especially prescient. In 2018, Paal Kibsgaard, the CEO of Schlumberger โ€” one of the largest oil services providers โ€” cautioned about declining well productivity in the Permian Basin, pointing to increasingย โ€œchild wellsโ€ and to the boom-gone-bust Texas oilfield, the Eagle Fordย Shale.ย 

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โ€œWe are already starting to see a similar reduction in unit well productivity to that already seen in the Eagle Ford, suggesting that the Permian growth potential could be lower than earlier expected,โ€ warned Kibsgaard,ย who was replaced as CEO inย 2019.

Another warning from a former Schlumberger executive noted that Permian performance results were misleading, becauseย satellite data had revealed that a thousand wells that had been fracked had not been reported,ย skewing the basinโ€™s overall performance to look better than itย is.

Schlumberger lost $10 billion in 2019 and laid off 1,400 U.S. workers, making Kibsgaard seem smart to be worried the year prior. The company has also cut in half the amount of fracking equipment it will have available. That is not a sign of optimism for the future of U.S. fracking or its crown jewel,ย theย Permian.

The End the Era of Being ‘Grosslyย Overcapitalized’

As DeSmog has detailed, the fracking industry has lost hundreds of billions of dollars and now is saddled with debts it will never be able to pay back because the best days of U.S. shale oil production appear to be in theย past.

The flow of low interest loans to shale oil and gas companies has dried up, signalingย the end of the era of being โ€œgrosslyย overcapitalized.โ€

And while there is still much debate about how much oil the Permian can yet produce, there isย little debate anymore about the fact that investors are no longer eager or willing to loan companies money to frack โ€” unless the companies can prove to be profitable โ€” which is something the majority of themย have failed toย do.

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Last week, investment website Seeking Alpha highlighted Abraxas Petroleum,ย a Texas-based company with Permian assets, describingย the company’s โ€œflawless history of producing negative free cash flowโ€ โ€” a brutal way of saying the company has never made a profit,ย like many of its peers.

But Abraxasย has produced oil and gas in an era whenย the industry was โ€œgrossly overcapitalized,โ€ which enabled the company toย continueย borrowing more money to keep drilling. But those days are over and companies like Abraxas canโ€™t continue to exist without investors somewhere giving them more money to keep up a very expensive production process. Seeking Alpha speculated that a possible Chapter 11 bankruptcy may be in the fracker’sย future.

The whole situation was summed up well in a recent article from Barron’s:

โ€œEquity infusions have dried up, and lenders are getting picky. They insist that borrowers actually demonstrate cash flow and sustainability, qualities evinced by a shrinking number of shale producers. And starting in 2020, these companies face a wall of debt totaling $71 billion and maturing over the next seven years, according to research and analytics provider Rystadย Energy.โ€

The industry as a whole is facing huge amounts of debt and the only way to pay it back is by making money selling oil and gas, something the industry has failed to do even at much higherย prices.

Low oil prices combined with negative natural gas prices in the Permian, plus the end of easy access to investors, is not a formula for Permian success. While there is ample evidence that shale CEOs have no problem losing other peopleโ€™s money as long as they are getting paid, expectย a lot fewer opportunities for that type of work in the Permian going forward. But don’t think that that strategy will stop beforeย all the remaining cash in the industryย has driedย up.

It’sย possible that the industry has reached peak debt, and thus, peak production is likely toย follow.

The Rocks Donโ€™t Care If CEOs Promiseย Oilย 

Even if the shale industry had made money the past decade and was sitting on a pile of cash, it would still have another serious problem:ย It’sย running out of tier one acreage. Money pays for drilling,ย fracking, and CEO bonuses,ย but it canโ€™t make oil appear where there isnโ€™tย any.

In 2018, Mark Papa,ย then-CEO of shale company Centennial Resource Development, was already warning of the lack of tier oneย acreage.

โ€œThere are good geological spots in shale plays and weaker geological spots, and a lot of the good geological spots have already been drilled,โ€ Papa explained during a panel discussion at theย industry conference CERAweek.

Papa is now the chairman of Schlumberger andย made another prediction about U.S. shale production at an industry conference this pastย January. Trent Jacobs of the Journal of Petroleum Engineering live-tweeted Papaโ€™s comments, which include the warning: โ€œA change isย coming.โ€

And even though the industry is in serious financial trouble, Papa says resource depletion is the bigger issue. Even if investors were foolish enough to continue to loan money to the shale industry, the oil isnโ€™t there to pay back the loans, much less make a profit. โ€œStarvationโ€ and โ€œdepletionโ€ are not words used to describe a boom. Will the industryย listen to Schlumbergerโ€™s warnings in 2020 after ignoring them inย 2018?

Jacobs also reported that Papa believes two other large shale basins โ€” the Bakken in North Dakota and Eagle Ford in Texas โ€” have alreadyย peaked.

This week, theย Journal of Petroleum Technology (JPT) highlightedย how quickly shale well production declines and the news isn’t goodย for the Permian’s prospects. JPT notedย that new data reveals a flaw in โ€œ[on]e of the key assumptions that justified the long-term economicsโ€ of shaleย wells.

To put it simply, the oil companies promised investors 30 years of oil production, but in reality,ย the wells dry up much faster thanย that.

Evidence is building that CEOs promised an amountย of Permian oil that very likely isnโ€™tย there.

The Shale Boom Is Becoming aย Bust

As DeSmog reported last December, the energy analysts at Wood Mackenzie haveย a very good track record of early and accurate predictions about the shale oil industry. In aย webinar on decline relates of Permian oil wells, Wood Mackenzie research director Ben Shattuck outlined a potential future for the oil patch’sย wellย producion.ย 

โ€œWeโ€™re transitioning to a point in time, where the investment community was enamored of the next well and how big it might be,โ€ Shattuck said. โ€œThat has changed for a variety of reasons. One very important reason is the next well might not be bigger. It might beย smaller.โ€

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That is one very important reason. And it comes down toย geology, the end of tier one acreage, and the industry trying to produce more oil by packing in more wells closer to each other (โ€œchild wellsโ€ that surround a โ€œparent wellโ€).ย  All of which results in an oil field beginning to peak in production and thenย decline.

To be clear, the Permian has not yet peaked. And because companies like Exxon and Chevron are now major players in the region and still have access to the money required for oil production โ€” unlike many other producers โ€” those companies will continue to increase production even if it isn’t profitable. However, both of those companies just deliveredย disappointing financial results, meaning even that scenario can’t go onย forever.

The lack of remaining tier one acreage is something that evenย Exxon and Chevron canโ€™tย change.

The math is simple. If each newย well drilled produces less than the earlier, and unprofitable,ย wells, then the peak is quicklyย approaching.ย 

Main image: Advertisementย noting oil field declines that is posted in the George Bush Intercontinental/Houston Airport. Credit: Justin Mikulka,ย DeSmog

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Justin Mikulka is a research fellow at New Consensus. Prior to joining New Consensus in October 2021, Justin reported for DeSmog, where he began in 2014. Justin has a degree in Civil and Environmental Engineering from Cornell University.

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