AUSTIN, Texas—S. Wil VanLoh Jr., Quantum Energy Partners’ chairman, co-founder, president and CEO brought bleak and not quite so bleak tidings to the oil and gas insiders gathered for the Energy Capital Conference March 29.

S. Wil VanLoh Jr.

Surrounded by the sumptuous greens of a golf course favored by movie star Sandra Bullock, VanLoh described the state of global oil: Saudi Arabia’s cash reserves are key to the end of full-throttle OPEC production. Emerging oil markets are where the action is. And the U.S oil and gas industry’s plight amid rising prices will, for a time, be a kind of game of whack a mole.

Because of high oil inventories, as prices move up companies storing oil will put their crude on the market—knocking the price back down. “Every time this price monkey starts to kind of rear its head, the storage monkey is going to whack it,” he said.

U.S. crude oil inventories are at levels never seen before. Current U.S. inventories are reported at 523 million barrels (MMbbl), about 44% greater than the 5‐year average. However, backing out line pack of 120 MMbbl, total crude oil in storage is 403 MMbbl, meaning storage is 77% full.

The U.S. also has a mounting supply of drilled but uncompleted (DUC) wells, particularly in the Eagle Ford Shale.

“The big question is what would U.S. production levels be had the DUC inventory had not grown,” VanLoh said.

In summer 2014, the Permian Basin, Eagle Ford, Bakken and Niobrara had about 1,200 oil DUCs. Today, about 2,100 wells are awaiting completion. Conservatively estimating an average 30‐day IP of 600 bbl/d of oil, the U.S. has more than 1.25 MMbbl/d of production in what VanLoh called “synthetic storage.”

“That’s a big overhang as we try to start to claw our way out of this price decline,” he said.

Natural gas inventories in the Appalachia are likewise increasing, though at a slower pace than oil. With more than 800 DUC gas wells and conservatively estimating an average 30‐day IP of 10 million cubic feet of gas per day (MMcfp/d), the U.S. has more than 8 Bcf/d of production in synthetic storage, VanLoh said.

Unspecific Gravity

With the U.S. oil and gas industry trying to escape its own gravitational pull, Saudi Arabia has problems of its own.

One way or another OPEC has stretched itself to a point where a geopolitical miscue could sabotage its run at driving high-cost producers out of the industry.

In the 1980s supply-driven downturn, OPEC held nearly 19% of spare global oil capacity. Now OPEC is running at almost full through with spare capacity of less than 2% spare capacity—about 10 times less wiggle room.

“I think the key takeaway is with such razor thin margins for spare capacity, one wildcard event, a pipeline getting blown up in the Middle East, or couple of countries having political upheaval, you could very quickly get to a point and time when prices could rise rapidly.”

Global demand also doesn’t need much of an uptick to “sop up that remaining surplus capacity.” Emerging market consumption in India and China, if similar to other industrialized nations, will be massive drivers of global demand during the next decade.

And while U.S. cost structures have fallen up to 40%, Saudi Arabia is trying desperately to similarly lower its cost structure. While the kingdom’s costs for producing oil are low, the real overhead comes in the form of heavy social costs that keep the country from unrest.

“When you look at how quickly they’re depleting their treasury, at $40 oil Saudi can really only maintain this for about four years,” VanLoh said. “And in four years, they completely deplete their sovereign wealth fund. We’re almost two years into that four year time.”

The kingdom’s argument has been consistent that low-cost producers should not subsidize high-cost producers, VanLoh said.

“They’re going to keep prices as low as they can for as long as they can, but they do have a clock that’s ticking and its ticking quickly,” he said. “The question is who can win the game of chicken. Who can stay in business longer?”

The Plight Of Recovery

Amid the downturn, the U.S. energy industry has driven efficiencies and productivity, putting downward pressure on prices.

Mostly, this has made much of the chatter about rig counts somewhat irrelevant. What’s more important, VanLoh said, is the productivity of each rig.

“Five years ago, the average rig was generating 100 to 200 barrels of oil per month,” VanLoh said. “Today the average rig generates 400 to 800 barrels per month. On average we’ve had about a 300% increase in rig efficiency in just the last four years.”

With lower costs and more productive rigs, the commodity prices needed to generate acceptable returns are much lower, he said.

“Clearly a question is how sticky is that? The service industry has been cut to razor thin margins,” VanLoh said.

However, at present $45 oil and $2.50 gas makes a number of plays economically viable.

Still, the service industry has lost much of its capacity in human power and equipment.

“We’re going to need to put a lot of rigs back to work at some point,” he said.

But it may be 18 to 24 months before that can happen.

“There is a real limit to how quickly we can ramp production back up,” he said.

Service companies will also see prices pop back as their services are needed again, giving them tremendous pricing power.

He also said that debt capital will be harder for companies to come by and will cost more.

The severity of the downturn will “change in material ways” how banks underwrite loans.

Acquisitions will also require more equity, which should drive down asset prices.

“The downturn will refocus public companies on what they should have been doing all along, which is making money as opposed to growing production and reserves,” VanLoh said.

Darren Barbee can be reached at dbarbee@hartenergy.com.