Gas prices dipping to their lowest levels since 2009 may be pleasing to American drivers at the pump, but Midwestern oil producers are feeling the pain at their small wells.
With oil demand and prices down, so are profits for small-barrel producers in western Missouri and eastern Kansas. Those producers, who typically pull up tens of barrels — and sometimes even less than five barrels — from a well per day, are halting exploration and new drilling, and they’re cutting back on labor.
Some foresee shutdowns of existing wells if the price of crude goes further south. The ripple effect is being felt by drilling companies, field explorers, equipment and oil field suppliers, service contractors and more.
April oil prices have fluctuated between about $47 and $56 a barrel on the West Texas Intermediate index, the key benchmark for oil prices in the U.S. That’s down from $106 in June of last year. Led by Saudi Arabia and other Persian Gulf countries, OPEC has refused to cut oil production, pushing global inventory to record highs.
“Companies have cut by at least half, if not by 60 to 70 percent, in their exploration budgets,” said David Bleakley, a member of the State Oil and Gas Council, Missouri’s regulatory body for the oil and gas industry.
Bleakley also is executive vice president of Colt Energy, Inc., which is based in Mission, Kan., but has operations on both sides of the Missouri-Kansas border. His 50-person company has been forced to lay off 10 percent of its workforce.
“(Local producers) are cutting costs to the bare bones they can live on,” Bleakley said.
Two price thresholds
Large-scale oil producers pull up enough crude to allow them to ride the cyclical ups and downs of international prices. But Midwestern producers are more vulnerable to price volatility, as healthy margins are crucial for them to survive.
Prices above $60 a barrel bring in enough revenue to allow small-scale producers to take on new drilling and service existing wells. But when the national indexes drop below a floor of $30, local wholesale prices drop to around $20 – an unsustainable margin for many. “People will have to shut down their wells,” Bleakley said.
Facing massive costs of land investigation, drilling machines, on-site equipment and labor, a lot of local producers have halted new drilling ventures. Bleakley said his company maintains its current leases, but it won’t take on any new oil production in the coming months.
Nick Hess, president of Cobalt Energy, LLC, a privately-owned oil and gas exploration and production company headquartered in Wichita, Kan., said his company had planned to drill 15 to 17 new wells in 2015. But with the drop in crude prices, Cobalt has drilled only one well so far this year and doesn’t expect to drill more than eight or nine wells in total.
“We can continue to produce oil from our existing wells at current prices,” Hess said. “The current pricing environment does make it very hard to take on high-risk exploration activities. … There’s a certain price at which it may not make sense to produce oil.”
Business slows for suppliers, contractors
Oil exploration and drilling companies in eastern Kansas and western Missouri typically have fewer than 100 full-time employees, and some have staffs as small as five. They hire outside contractors and suppliers to help explore potential oil reserves and drill wells.
Suppliers’ and contractors’ main incomes are generated from new exploration and drilling projects. But lately, there is little such demand.
“You get a double hit. You get less jobs to do, and you are getting less for the jobs you are doing,” said Stephen Stanfield, president of Consolidated Oil Well Services, LLC., which provides pressure-pumping and other services in Kansas, Missouri, Oklahoma, Wyoming and western Texas. “It very quickly forces you into reevaluation of your staffing. It has a pretty dramatic effect, pretty quickly.”
Stanfield said his company has seen a 60 percent decrease in the number of wells it serves in the first quarter compared to a year earlier. That pressed the 500-employee company to lay off 25 percent of its workers.
Stanfield said he knows peer companies also have resorted to layoffs. “Until there’s a sustainable trend upward (in price), I don’t look for people to become very active,” he said.
Small and shallow oil reserves that range from a few hundred feet up to 1,500 feet deep scatter like stars in eastern Kansas and western Missouri, known as the Cherokee Basin. They have shorter life spans and are shallower than the thousand-barrel behemoths that lie several thousand feet deep in Oklahoma, the Dakotas and Texas.
As a result, producers in the Cherokee, under normal circumstances, drill more wells at a lower cost for each. With oil prices at record levels for several years, this kept independent contractors and machine suppliers busy. But now, all have been cutting hours, reducing prices and, in most cases, laying off employees.
Ironically, that means new wells can be installed and can produce more quickly since there’s no waiting time for contractors in the current economy. Take drilling rigs, for example.
Hess said there are many idled rigs right now. These days, his company can set up a rig, the fundamental machine for drilling wells, within a few weeks. “When the price was high, the demand for drilling rigs was higher,” he said. “Many rigs were scheduled months and months in advance, and sometimes a year (in advance).”
The increased availability and lower costs of such services might seem like an opportunity. But risk-averse small producers don’t practice capital leverage this way. With tight cash flow, they tend to protect themselves instead of speculating on the future.
Boom, glut and bust
Crude production volume data hasn’t reflected the decreased appetite for new drilling projects yet. The price hike in the past five years stimulated a lot of producers so that the ground had already been uncovered, bank loans had been issued and wells were waiting to be capped by rigs.
Those pump jacks likely will keep pumping because it makes little sense to stop in the middle of the months-long oil production process.
“Oil companies have throttled back — almost completely cut off — new exploration,” said Patrick DeHaan, GasBuddy.com’s senior petroleum analyst covering the Midwest. “But for pumps that are already open, throttling back or cutting production is going to mean less cash revenue. And a lot of these companies need the cash revenue to stay afloat.
“There’s a lot of oil producers, not only in Midwest but around the rest of the country, who might actually be trying to increase output to make up the drop in price.”
The U.S. produced about 285 million barrels of crude oil in January, the ninth straight month above 260 million barrels, according to data provided by the U.S. Energy Information Administration. Production has climbed as price has dropped by half.
“There’s a lag,” Bleakley explained. The industry needs for existing wells that were drilled in the past two years, when oil prices were at their peak, to be used up “so that people will stop drilling and see the price to go up.”
More drilling projects kicked off when oil prices were high. A group of eastern Kansas producers expanded drilling activities into western Missouri, where the oil potential hasn’t been fully evaluated. Missouri’s State Oil and Gas Council issued an increased number of permits in the past two years, but it expects the number of permits issued to decline at least 50 percent this year.
“Small oil producing companies would be fully exposed to the drop in oil prices with no way to offset those losses,” GasBuddy’s DeHaan said. “Bigger oil companies that are more diverse are better able to weather the storm.”
Small, private oil companies in the Midwest have to stay cautious all the time. They know price fluctuations are the nature of the business. In the past century, the oil rush in the Midwest was stimulated by price hikes and slowed by price slumps.
“We’ve seen that come forward, because you know it’s going to happen again, probably again and again,” Bleakley said.
Successful local oil producers who have been around long enough weathered price collapses in 1986, 1998 and 2008.
“Those who survived understand the cycle,” Bleakley said, “and understand it’s a cyclical business.”