I recently took the opportunity to visit and spend time in and around Williston, N.D., to see the future being made. While my original intent was simply to visit, what I saw going on there and the impressions it made upon me have led me to write this piece.
If Williston hasn’t yet made it to the top of your “must-visit” list, let me tell you something about what I saw and determined as a result of that trip.
For those for whom Williston doesn’t ring any particular memory bells, it has gained prominence as one of the main U.S. hubs for the fracking revolution in the energy business, something that was hardly a factor in the economy five years ago.
Fracking, short for hydraulic fracturing, is a process developed for drilling wells for crude oil and natural gas. It’s used in areas where the hydrocarbons are effectively locked into tight shale rock formations and, prior to the development of this technology, had been pretty much unrecoverable. To get the product to flow, a mixture of water and sand is forced into the well. A small explosive charge then causes the rock to fracture, allowing for the free flow of hydrocarbons up the pipe.
To put the speed of the local growth in some perspective, the 2010 US Census said 14,716 people called Williston home. By 2014, the population had boomed up to over 21,000, making it the sixth largest city in North Dakota—and that’s not counting all the growth in the outlying areas.
I made the 800-mile drive from Spokane to North Dakota for personal and professional reasons.
The personal was because our son has earned himself a position as a service manager with the Williston branch of a major provider of tools and heavy equipment. I wanted to see how his new life and career are doing. I’m quite happy to say that “very well,” thank you, is the short answer to that question.
The other reason for visiting there was professional curiosity. Ever since we lived in Alaska, I’ve had a significant interest in the energy business. A large part of the working populace in Anchorage had—and still has—some connection with the oil business. While there, I had the opportunity to spend time at Prudhoe Bay on the North Slope, which is where the oil begins its 800-mile trip through the 48-inch pipeline to Valdez. I’m sure the moon has more attractive terrain than the Slope does.
I’ve followed the development of the Bakken Formation during the past few years. I had heard the stories of Williston and “suburbs” being the Wild West and all that went with that. Then, last year, along with the big drop in oil prices, the consensus flying all around the financial media was that all or most of this newly started fracking production would be shut down as a result of the big drop, and the boom would become a bust. With that came the talk that the industry was headed for widespread layoffs. Not so fast.
My bias is that a great deal of what shows up in the mainstream financial media every day is not much more than highly-charged hot air only loosely based on facts. The problem is that most investors simply accept those daily conclusions as fact and act accordingly. Witness the across-the-board selling in the last quarter of last year and into the first couple months of this one of anything even remotely related to energy.
One of the best and unexpected parts of the time I was there was that I was extremely fortunate to have my son’s general manager provide an extended tour of the area. His in-depth knowledge of the area, the energy business, and the range of companies working there added significant value to my visit.
A little shale geology
The Bakken (bok-ken) Formation covers about 200,000 square miles and is part of the Williston Basin. It encompasses in northeastern Montana and most of western North Dakota, as well as parts of Saskatchewan and Manitoba in Canada.
The recent development of the fracking technology, together with the refinement of directional drilling where the operator can, in essence, aim where the drill bit goes, has had a major impact on the ability to get to those assets.
Additionally, as opposed to traditional wells, these recoverable pools are at, relatively, shallower depths, so it’s quicker and less expensive to recover the oil and gas than through the older methods. Put another way, operators can drill more wells for the same money and spend less time per prospect.
In April 2013, the U.S. Geological Service projected that the Bakken had recoverable assets of about 7.4 billion barrels of oil, 6.7 trillion cubic feet of natural gas, and another 530 million barrels of natural gas liquids. This is a major field.
For the record, there was NO shale production anywhere just 10 years ago. According to Oppenheimer & Co.’s oil analyst, the shale sector today alone produces 4.5 million barrels of crude per day; that’s up to just about half of our current total US production.
The Bakken itself has only really been under focused development since about 2010. That has ramped up rather spectacularly as North Dakota has moved past Alaska to become the nation’s second-largest oil producing state in 2014.
Primary energy source
My homework says that we’ve had seven price drops in oil since the last big one in 1986. Some very confused people have actually suggested that the current oversupply is because the demand for oil-based energy has topped out.
A couple thoughts to help remove that concern. The first is that the population of the world continues to rise, and the other is that those people living on the emerging market countries are now moving en masse into the middle class—with all that entails.
What has to be understood about this so-called oil glut is that it’s temporary in nature. Demand around the world hasn’t really dropped; it’s the rate of growth in demand that’s dropped from what was previously seen. New energy sources have to be located and developed continuously. Fracking, per se, is a relatively new technology which has given us access to what previously were thought of as either unrecoverable or marginal prospects. Now, even newer technology is being developed to enhance and expand the processes further.
What about renewables instead? Well, they look good on paper—but not in practice.
Last year, according to the U.S. Department of Energy, fossil fuels provided more than 83 percent of America’s energy consumption, which was nearly unchanged from the 85 percent fossil fuel share 20 years ago, in the early 1990s.
A quarter of a century from now, in 2040, the DOE forecasts that fossil fuels will still be the dominant energy source, providing more than 81 percent of energy needs. So, despite the wrong-headed dismissal of oil and fossil fuels as “energy sources of the past,” forecasts from the DOE tell the story of a hydrocarbon-based energy future where fossil fuels serve as the dominant energy source to power our vehicles, heat and light our homes, and fuel the U.S. economy.
Even after billions of dollars in taxpayer subsidies for renewable energy, renewables last year provided only 7.1 percent of America’s energy, which was actually less than the 9.3 percent share that renewables provided in 1949, more than 60 years ago. That’s not a lot of progress for politically popular, but expensive renewables.
Since last Thanksgiving, the global price of oil moved from what had been effectively a set price determined largely by Saudi Arabia and OPEC into the wild world of free market pricing.
In terms of at what price Bakken shale prospects can be profitable, The Bakken Magazine recently provided an analysis from the North Dakota Department of Mineral Resources. The breakeven prices for the various counties around the field were determined. Breakeven refers to the price at which new drilling—not existing production—would stop.
In Williams County, where Williston is located, breakeven is $36 a barrel. For McKenzie County, just south of Williams, and actually the largest-producing county in the Bakken, breakeven is just $30 a barrel.
According to the analysis, by the third quarter of this year—and assuming that oil cratered to $25 a barrel—North Dakota would still be producing around 1 million barrels a day. Even if prices stayed that low, 800,000 barrels a day in the third quarter of next year. Not a likely event but it does show that drilling will go on in those fields. Lower prices would cause slowing, not abandonment.
I think the oil price is settling in at current levels of between $50 and $60 per barrel. A lot of the current production cutbacks have been due to companies operating in a floating price world, not having had any idea as to what either their costs or revenues would be. You can’t run a successful business of any kind like that. The drop in rig count that’s talked about is mostly for drilling rigs—the new prospects. There’s also a type called workover rigs. These are brought in to frack or develop a well. I saw lots of those still in operation.
Once the companies are comfortable with what passes for price stability in oil, projects will come back on line. Companies will drill their best, lowest cost prospects first and then the fracklog will be worked down. Fracklog, a term meaning a huge backlog of production that’s sitting and waiting for oil prices to come back, refers to those wells that have been drilled and then stopped within weeks of completion.
All of that must be done to complete them is inject high-pressure water, sand and chemicals into each well to crack the rock that’s holding the oil (frack the well). Some suggest that more than 500,000 barrels per day of production would hit from this fracklog if oil rebounded to just $65 a barrel.
There’s lots more to crude than the price at the local gas pump or even where and how to invest. Today’s world is ultra-dependent on crude oil and its derivative products—not just for fuel but for the many different products in which it’s used.
As I review the companies involved with fracking, and the energy business in general, it definitely seems that infrastructure throughout the shale fields is what’s really lacking, especially in storage and transport. Many sources refer to the multibillions of dollars that will be spent in this sector during the coming years.
The weak link today in getting the Bakken production to market is this total lack of major pipelines. Mr. Buffett’s BNSF Railroad is the only game in town for getting the oil to refineries or other users. In that regard, the U.S. and Canada have rolled out new oil railcar standards that require a new tank car design to be phased in. These will apply to new cars being built after Oct. 1, with existing tank cars having to be retrofitted to meet the new standards. Companies in the railcar business likely will be beneficiaries of this, both in terms of the new cars, as well as all the refurbishing that will have to be done.
Regarding infrastructure, it’s my belief that one of the best ways to participate in that space is through midstream Master Limited Partnerships. Midstream refers to the transport and storage component of the energy business. Through a MLP, there can be tax advantages for investors, in addition to nice cash flows and capital appreciation potential.
Highly-leveraged companies are going to have it tough. Costs are staying about the same yet income is down and the debt service remains. We’ve seen a couple companies file bankruptcy who were caught by this.
Prices can still fluctuate quite a lot as the market searches for a level. However, this volatility creates opportunities for investors. Energy companies will likely use market inefficiencies to reposition asset bases for the long term, opening the door to increased merger and acquisition activity. Production growth likely will occur, at somewhat lower levels for a time, along with lower service cost increases.
U.S. oil producers have shown a willingness to make fast responses to lower energy prices and have moved to rein in near-term capital expenditures. All of that seems to have already helped to stabilize prices and should continue to have a positive impact over the course of this year.
During my drive, I passed by Anaconda, Mont. About 100 years ago, Anaconda was a boom town, benefiting from the growth and development of electricity in homes, as well as telephone services. Today, virtually all that remains is a really, really big smokestack sitting by itself in the countryside. While no one knows the future, I feel fairly safe in saying that it doesn’t appear that Williston is in any real danger of becoming a ghost town anytime soon.
This oil price drop isn’t a death blow for the oil industry on any level; it’s that industry’s normal ebb and flow. The way forward is with added technological efficiency, which does seem to be coming. For instance, at a recent conference in Texas, one exec noted his firm cut the time to drill an 18,000-foot-deep traditional well in half. Another noted that the focus on efficient wells to drive output growth more cheaply is likely to slash costs significantly in the future and that the industry survivors will be stronger for it.
Further, local-area businesses that grew to meet the demand and companies that may have missed out on the boom altogether will, I believe, receive a second chance on capitalizing on the revenue the shale business brings to the area. This feels like just the start of the development there.
Michael Maehl is an independent financial adviser and Spokane-based senior vice president of Opus 111 Group LLC, a Seattle-based financial services company. He can be reached at 509.747.3323 or firstname.lastname@example.org.
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