The Fuse

Production From Stripper Wells at Risk in Current Price Environment

by Nick Cunningham | January 06, 2016

With oil prices below $40 per barrel, it is becoming unprofitable to produce oil from most shale basins in the United States. Oil markets are closely watching production levels at key shale formations such as the Eagle Ford and the Bakken to gauge when and how quickly the supply overhang will rebalance.

Part of the supply adjustment could come from the hundreds of thousands of tiny stripper wells around the country, most of which escape regular market analysis.

At the same time, the supply adjustment could also come from the hundreds of thousands of tiny oil wells around the country, most of which escape regular market analysis. In fact, there are about 410,000 oil wells dotting the U.S. landscape, many of which produce only 15 barrels of oil per day, or less. Known as “stripper wells,” these micro-producers may seem insignificant, but collectively they produce about 1 million barrels of oil per day (mbd), or about 11 percent of the country’s entire output.

Stripper wells fallen on hard times

Many of the country’s 410,000 stripper wells are located in West Texas and California, and in some states, such as Illinois and Missouri, they make up all of the states’ oil production. They are marginal sources of production that eek out the last bit of oil from a well that is nearing the end of its lifespan. Unlike shale wells, which can cost several million dollars to drill, a stripper well, many of which are owned by small mom-and-pop operations, may only require $300,000 or less in drilling costs.

Unlike shale wells, which can cost several million dollars to drill, a stripper well, many of which are owned by small mom-and-pop operations, may only require $300,000 or less in drilling costs.

As with any source of oil production, stripper wells can only operate if they are profitable. The problem in the current environment is that oil prices are hovering right around levels where many stripper wells no longer make sense to continue to operate. With oil trading in the mid-$30s per barrel, stripper wells only earn a few hundred dollars per day, which may not cover the cost of electricity, chemicals, insurance, maintenance, and labor. “The low $30s is about it,” Mike Cantrell, chairman of the National Stripper Well Association, told Platts in December. “We’re not making any money…at below $30.”

As producers of the marginal barrel, stripper wells could be some of the first sources of supply to go offline. In September 2015, Citigroup projected that low oil prices could knock off a combined 300,000 barrels of oil per day from thousands of stripper wells located around the country. For its part, Bloomberg Intelligence said $30 oil could shut in 200,000 barrels per day. Another estimate from Tudor, Pickering, Hold & Co. projected that half of all stripper production would be shut if oil prices fell below $40 per barrel.

As producers of the marginal barrel, stripper wells could be some of the first sources of supply to go offline.

The problem with making an accurate prediction, however, is that each stripper well has different cost structures. As a result, data on the big picture is hard to come by. The Energy Information Administration (EIA) aggregates data on stripper production, but it has a two-year lag. Oil output from stripper wells could already be falling significantly, but the market doesn’t have an accurate picture of what exactly is occurring in this niche industry.

Stripper wells not done yet

Even still, there are several reasons why a stripper well may continue to produce even if the company is in the red. For example, shutting down a well can carry its own costs, including going through official regulatory compliance procedures for abandonment. At the same time, creditors often do not want to see production levels fall, which forces operators to continue to pump even if doing so does not necessarily make sense.

There are several reasons why a stripper well may continue to produce even if the company is in the red.

Yet another reason to continue to produce is to hold onto leasing rights. Leases often include clauses that do not allow a well to remain idle for more than 60 to 90 days. Finally, shutting down a well could end up being permanent. Unlike other sources of oil production, if a stripper well is shut down, water or sand can fill the well, preventing a restart. During the last major oil price downturn in the 1980s, a large chunk of the U.S.’ oil production from stripper wells was shut down.

These factors suggest that much of the 1 mbd that comes from stripper wells could stay online, as operators hope to prevent a permanent shut down. Stripper operators have slashed costs on labor and maintenance, cutting right down to the bone. For those that have seen profits vanish, they are taking on more debt to continue operating. Many have also become skilled at working around the lease requirements, idling pump jacks only to turn them back online at the last moment before a lease might expire.

The last gasp

If prices do not rebound, some stripper operators may run out of options. Companies that own stripper wells do not have the deep pockets or large credit lines that conventional and shale drillers do.

Oil prices have dropped into the mid-$30s per barrel, lower than at any time in the past decade. On the one hand, for the reasons mentioned above, stripper well production has likely stayed afloat up until now.

However, if prices do not rebound, some stripper operators may run out of options. Companies that own stripper wells do not have the deep pockets or large credit lines that conventional and shale drillers do. Stripper wells are some of the most vulnerable sources of production at low prices. With credit lines tapped and no more fat to cut from operating costs, wells may be forced to shut down permanently and leases could begin to expire. If crude prices remain below $40 per barrel for six months or longer, much, if not most of the nation’s 1 mbd of stripper well production, could be at risk. And unlike shale, if stripper production goes offline, it will not bounce back once oil prices rebound.

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