Bette Grande: On Revenues, North Dakota Has More Questions Than Answers

The ND Legislature released a revised revenue forecast last week.  Expected revenues continue to be strong but the days of increasing money appear to be over, for now.  Forecasting revenue 2½ years into the future is always a challenge, but in our current environment we simply do not know how current oil prices will affect our State.  As I wrote here in December, the Republicans will show leadership this Session and the new revenue estimates will be fine tuned in March and April as more information is available.

Last session enough money was set aside to fund public priorities for the next biennium in case revenues dropped.  These ‘rainy day’ funds were set aside specifically for an economic downturn and the money will offset a drop in revenue in the short-term.

But, what about the long-term?  There are more questions than answers right now but information will come over the next many months to start answering those questions.

[mks_pullquote align=”right” width=”300″ size=”24″ bg_color=”#000000″ txt_color=”#ffffff”]”Last session enough money was set aside to fund public priorities for the next biennium in case revenues dropped.  These ‘rainy day’ funds were set aside specifically for an economic downturn and the money will offset a drop in revenue in the short-term. But, what about the long-term?”[/mks_pullquote]

There is a significant time lag in getting the numbers that the Legislature needs.

The next quarterly sales tax number that is released will cover the 4th quarter of 2014, before much of the steep drop in oil prices occurred.   Actual sales and income tax numbers for the first months of 2015 will not be available until the end of the Session and the full impact of any slowdown will not be felt until 2016.

As we wait for those sales and income tax numbers we can watch the level of oil activity for signs.   There is a lot of focus on the number of rigs drilling in ND, currently around 142, down over 40 rigs in the last month.  This is an important number because fewer rigs means fewer jobs.  But, the rigs that are being used today are very efficient, drilling a well in 15-20 days, which means even with fewer rigs working oil production could remain steady.

The level of oil production is very important in the budget process.  The revised revenue numbers released last week assumed the an oil price of $42/barrel (as I write this the price is back over $50/bbl) but also assumed oil production of 1.18 million to 1.2 million barrels of oil per day.   The assumption is that oil production will remain steady at the November, 2014 level.   If the actual daily production over the next 2½ years drops below that level it will have a significant impact on the newly revised estimates.

The January report from the ND Minerals Department (the “Director’s Cut”) showed that ND produced 1.18 million barrels/day in November (there is a 2-month lag in reporting production numbers).  Most of the experts predict that ‘shale’ oil production will continue to increase well into 2015 for several reasons.  Rigs are under contract to drill a certain number of wells and the oil companies have generally protected themselves from falling prices (for awhile) by hedging some of their 2015 production.  The revised revenue numbers reflect this assumption that oil production will remain at the November level.

We will know in time.  The February Director’s Cut will be released in a couple of weeks showing oil production from December 2014, before most of the drop in oil prices.   Before the end of the Session we will know the production levels from January and February.

The ND Minerals Department has stated that it takes about 150 new wells each month to maintain ND’s oil production level as new wells are needed to offset the production decline of existing wells.  With the current number of rigs working and the use of pad drilling we can drill 150 new wells per month.

But, there is another step that is required before each new well begins producing oil & gas.  Once the drilling is finished each new well must be fracked so that oil & gas will flow.  The number of wells completed, that is fracked, is the key to oil production going forward.  And here is where we will see signs for the future.

[mks_pullquote align=”left” width=”300″ size=”24″ bg_color=”#000000″ txt_color=”#ffffff”]”There could be a number of factors to explain these drops in production but they appear to be too consistent to be unrelated.  If producers were already choking back production from existing wells in October and November we will see a drop off in oil production sooner rather than later.”[/mks_pullquote]

The January Director’s Cut showed that there was an increase of 125 wells waiting to be fracked in November.  Some of this increase could be seasonal, but that is a very big increase in wells waiting for completion.  Assuming there were 185-200 new wells drilled in November the majority of those wells were not completed.  In fact, according to the Director’s Cut there were just 39 active wells added in November 2014.  Remember, we need 150 new wells each month to maintain production levels, the 39 new wells in November is not a good sign.  One month does not make a trend, but this is something to watch.

Why the big increase in wells waiting for completion?  The price of oil was dropping in November but not to the level that would normally lead to this increase in wells waiting for completion.  Perhaps the flaring restrictions from October impacted this number as oil companies were still adjusting to the new rules.  Whatever the reason, if the frac crews are not working it means fewer jobs, at least in the short-term.

Anecdotal Information

There are other signs that may provide some answers.  The Million Dollar Way Blog is a very good site for information on the Bakken (and other tight oil plays).  Recently he has found what he terms “strange production profiles” from quite a few newer Bakken wells.  This is anecdotal so far, but very interesting.  These “strange production profiles” show significant drops in production late last year that do not match the normal decline curve for Bakken wells.

There could be a number of factors to explain these drops in production but they appear to be too consistent to be unrelated.  If producers were already choking back production from existing wells in October and November we will see a drop off in oil production sooner rather than later.

The level of oil production is very important for North Dakota.  The revised revenue estimates assume production will be steady at last November’s level through the next biennium.  A drop in oil production will lead to further downward revisions to expected revenue.   It will affect jobs, income and sales tax revenue, and oil tax revenue.

There is a silver lining, if oil production drops from current levels (and if we see a similar drop from Texas) the drop in supply could increase and stabilize oil prices.  And when prices improve we will have a huge backlog of wells waiting for completion.  Oil production could be ramped back very quickly when prices recover.

One issue we continue to face is the global oil market and the prohibition of crude exports.  In addition to the revised revenue forecast, last week the ND House also passed HCR 3008 which urges Congress to lift the crude export ban.  I wrote about this issue on SAB earlier.  If Congress lifts the ban we could see a stabilization of both oil prices and our State budget.  Until then, the U.S. is at the mercy of global pricing without being a full global participant.  As I said, forecasting revenues 2½ years into the future is a challenge.