Is This The Next Big Headache For Oil Prices?

By Nick Cunningham - Jul 22, 2016, 6:09 PM CDT oilprice.com

When oil analysts look at the markets to try to get a sense of where oil prices are heading, one of the great unknowns, at least in the U.S. shale industry, is the large volume of drilled but uncompleted wells (DUCs). As oil prices began collapsing two years ago, shale drillers increasingly decided to defer the completion of their drilled wells, hoping to wait out the downturn and bring production online at a later point when prices rebounded.

But with oil prices suffering from a prolonged downturn, the DUCS began to mount, leaving a huge backlog of potential production that was yet to come online. From the point of view of the nascent and fragile oil price recovery (or more accurately, several cycles of recovery in the past year or so), the DUCs threatened to kill off the price rally, as they would bring a flood of new production online right when prices rose high enough.

However, it appears that the “fracklog” is already getting worked through. According to Bloomberg Intelligence, the number of DUCs stopped rising in the first quarter of this year.

Data as of April 1 shows that the backlog of DUCs stood at 4,230 wells, which is largely the same since the start of the year. Moreover, by the end of 2017, Bloomberg Intelligence predicts that the DUCs could be completely worked through in the Permian Basin, and 70 percent of the DUCs could be finished in the Eagle Ford. That could occur even if prices remain in the $40 to $50 range.

There are two reasons that the DUC backlog stopped rising: Oil companies stopped drilling new wells to begin with following severe spending cuts, and they also began to complete some of those older wells.

“We think that by the end of the third quarter, beginning of the fourth quarter, the bullish catalyst of falling U.S. production will be all but gone,” Bloomberg Intelligence analyst Andrew Cosgrove said. “You’ll start to see U.S. production flat lining.”

The rush of new output will stop U.S. oil production from falling any further, stabilizing output at some point later this year. But there is another way of looking at such a scenario: The fracklog will no longer loom over the market, a bearish variable that could always trigger another price downturn. With the DUCs completed, the onus will be on oil companies to find and drill new wells, a much taller task than simply completing already-drilled wells. In other words, while the completion of the DUCs could bring new production online, it is also a sort of one-off, with production increases having fleeting effects.