When Will My Minerals Get Drilled?

Cost of Extraction

Mineral rights only have value to the extent the underlying resources can be extracted in a profitable manner. You could be sitting on the largest oil reservoir in the world, but if it costs more to access than it’s worth, it will never be tapped.

How far oil needs to be transported for refinement, how far beneath the surface it is and how much rock needs to be bored through are a few of the variables that influence the cost to produce.

The quality of the oil and current demand influence the price paid.

The net is that not all mineral rights are created equal. Minerals that are easy to extract and transport are more likely to be drilled, and are thus have value. Minerals that are inaccessible, or prohibitively expensive to access, likely have no value.

Supply + Demand

In early 2020, crude oil prices fell from above $60 per barrel to below $20 per barrel (even hitting negative $37 at one point). Because oil companies need oil prices of around $45 per barrel just to breakeven, they are losing somewhere around $30 for every barrel they produce at these prices. With daily U.S. production at ~13 million barrels, oil companies are losing nearly $375,000,000 per day.

The impetus for this price crash was the basic economic principle of supply and demand. COVID-19 and the resulting global shutdown destroyed demand, dropping it from 100 million barrels per day to around 70 million. At the same time, Russia and Saudi Arabia increased production in an attempt to capture additional market share for themselves. The net result was the oil supply far out-stripped demand. So much so, in fact, that the world started running out of places to store it. This is why prices turned negative.

Reducing Supply

In order to fix this supply-demand imbalance, oil consumption either needs to increase or the amount of oil produced needs to decrease. With no clear timeline for a “return to normalcy” on the demand-side, oil companies have no choice but to reduce output. This means turning off currently producing wells, and more importantly, cancelling plans to drill additional wells.

Oil companies across the globe have already cut billions of dollars from their 2020 capital budgets. Exxon Mobile alone is cutting $10 billion, which represents nearly 1/3 of its drilling budget. This means significantly fewer new wells will be drilled in the near-term.

Companies are also not completing wells they have already drilled. These wells may not come on-line for years, if at all. Most costs of a well come during completion, not drilling, so operators will wait until oil prices rise enough to justify the cost to complete. This may or may not happen.

Return of Demand

Supply can be controlled. Demand can not. Nobody knows what the world’s oil consumption patterns are going to look like post-COVID19. With so many people now unemployed and a large work-from-home shift likely to take place, what impact will this have on oil usage?

Even assuming oil demand does return to normal levels at some point, there will already be more oil available than needed. This oil will need to get used up before operators will be inclined to start turning wells back on or drilling new ones. If operators ramp up production too early, it will flood the market again, driving prices down. There will be a several year lag between the return of demand and any resulting drilling activity increase.

Impact on Mineral Owners

In order for minerals to have value:

• They need to be accessible and extractable
• There needs to be sufficient demand for the oil to justify the cost

Unless both of these are true, minerals will never be drilled.

There is historically low demand for oil. This leads to historically low oil prices. This means producing oil is not a profitable venture. As such, operators will not drill additional wells. Adding more oil to the market keeps prices depressed. Until enough demand returns, driving prices up to a sufficiently high level, operators “lay down their rigs.”

The key takeaway is that mineral owners should not expect any near-term drilling activity. It will likely take years to work through the impact the global shutdown had on the oil industry. Countless producers are going to go bankrupt. There may never be a return to “full demand.”