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  • Roger S. Conrad

Oil Prices, Production Volumes and MLP Investment Strategy

By Elliott H. Gue on Feb. 4, 2016

The most recent issue of Energy & Income Advisor, Dusting off the Crystal Ball, laid out our outlook for the stock market, the US economy and the prices of oil, natural gas and natural gas liquids (NGL) over the coming year.

These views shape our strategy for investing in master limited partnerships (MLP) in the near term and for the long haul. Our near-term outlook calls for crude-oil prices to suffer another leg down in the first quarter, perhaps to as low as $20 per barrel—a price point that would prompt producers to shut in production from some existing wells.

Ultimately, we expect crude-oil prices to find a bottom this year and start to recover toward our lower-for-longer price range of $40 to $60 per barrel. The timing of this process is fraught with uncertainty, especially if deterioration in the US economy leads to disappointing demand during the summer driving season and/or the inventory of drilled but uncompleted wells delays the supply response. (See Outlook 2016: Energy Prices.)

Regardless of the timing of this process, one thing remains certain: Any improvement in oil prices hinges on a decline in overall production, a chunk of which will come from shale plays in the US onshore market.

The US oil-directed rig count has plummeted to 498 active drilling units from its October 2014 high of 1,609—an almost 70 percent drop. All signs point to this downtrend continuing in the near term, as rig contracts roll off and the inventory of drilled but uncompleted wells grows.

(Click graph to enlarge.)US OIl Rigs

With upstream operators focusing on their core acreage and using enhanced completion techniques (longer laterals, reduced spacing between fracturing stages and larger loads of silica sand) to pull production forward, US oil output has proved remarkably resilient since prices began to fall in mid-2014.

Nevertheless, the decline curve is the one constant in the ever-changing oil and gas industry; in the back half of last year, reduced drilling activity and the natural retreat in output from existing wells started to assert themselves.

Data from the Energy Information Administration indicates that the growth rate in US onshore oil production declined by almost half last year, with output through the end of November up 9.48 percent from the prior year.

(Click graph to enlarge.)US Annual Onshore Oil Production and YoY Change

In May 2015, US onshore oil production from the Lower 48 began to decline on a sequential basin, while the year-over-year growth rate slowed significantly as the year wore on.

(Click graph to enlarge.)YoY and QoQ Change in Monthly US Onshore Oil Production -- Lower 48

Production trends in states with significant output from shale oil plays—Colorado, North Dakota, Oklahoma and Texas—tell a similar story.

(Click graph to enlarge.)YoY and QoQ Change in Monthly US Onshore Oil Production By Shale Play

All signs point toward US onshore oil output rolling over in 2016, fueled by lower commodity prices, capital constraints and expiring hedges in the upstream segment. .

Commentary and guidance from the handful of prominent US exploration and production companies to provide business updates in recent weeks reflect these challenges.

For example, Continental Resources (NYSE: CLR)—a leading producer in the Bakken Shale and the promising South-Central Oklahoma Oil Province (SCOOP)—on Jan. 26 announced a capital budget of $960 million for 2016. This level of spending represents a 66 percent reduction from 2015.

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