Thread by @karim__fawaz

The “inevitable” underinvestment bull thesis for oil hinges on the lack of investment in new production and assumes the path of mature/existing production as mostly set in stone. It’s not.

A long🧵about the (in)famous “base decline” and why it matters #OOTT

Short version: The price reflation (if sustained) can and likely will lift medium-term oil supply by shoring up spending on existing production. Over a 5-yr horizon, shallower base declines could “add” 1-2 mb/d of supply without a single additional project.

Quick note first: this thread focuses primarily on conventional production, the majority of global crude production.

Shale has its own unique wedge and decline characteristics that warrant separate discussion.

Let's jump in.

Oil supply is like an iceberg – the visible tip is new FIDs/projects/developments and shale growth –the land of capex (let’s call it the “wedge”) but most of it comes from mature producing assets which decline over time – the land of opex (the “base”).

The base decline has recently been the favorite refuge of bulls just as it was for peak oil proponents in the early 2000s and doomsayers dating to Hubbert's peak. The theory naturally feeds bullish biases; it combines two key ingredients: intuitive logic and very complex data

The dirty little secret about base decline modeling is that it’s as much art as science. Two questions matter most: 1) what factors influence the base decline? And 2) what is the range of outcomes? i.e. how much of a difference can it really make?

The short answers are 1) a LOT, and 2) wider than you think and through the magic of compounding it can potentially materially change the supply picture 3-5 years out.

It's worth unpacking this a bit further

1. What drives the base decline?

The common misconception about base declines is that it’s all about geology. Sure, a lot of it is geology, but base declines vary by project, region, basin, terrain, operator behavior, and above-ground conditions.

Importantly, base declines shift depending on how much capital each operator is willing and planning to spend on a given producing asset. Unsurprisingly, companies rarely (if ever) provide that data.

When prices and cash are low, and each bbl produced earns a narrow net margin, spending money you don't have on shoring up the base often doesn’t make economic sense - declines ⬆️

When prices are high and you’re cash-rich (as the industry is today), the highest margin barrel is often the one you don’t lose to base declines - declines ⬇️

In other words, base declines are neither exogenous/independent of prices nor static. They are dynamic and quite price responsive.

2. Does it move the needle?

At the single project level, deviations in base decline are small but when considering the size of the global conventional base (70+ mb/d) and the compounding effect over time, the scale can get market-altering in a hurry

Take a sample - projects on stream in 2000 outside of Gulf OPEC, Libya and Venezuela (to remove OPEC cuts/sanctions/disruptions).

Roughly 25 mb/d of mature production - not a small sample.

Annual declines have been as high as 5-6% (2015-2016) and as low as 1-2% (2011-2014).

Obviously the global production base is larger and less volatile than this sample of the most mature projects. But with a 70+ mb/d conventional oil base, it doesn't take much to move the needle by a lot.

Every 0.1% change in annual decline rate is 70 kb/d.

Enter time and compounding - over multiple years, small divergence in declines across the base can compound to large deviations in the trajectory of global supply.

To use another example (numbers purely illustrative): assume a 0.5% shallowing of the annual base decline from say 4% to 3.5% for a 70 mb/d system over 5 yrs (not impossible) - Cumulative supply "not lost" by year:
Yr 1: 350 kb/d
Yr 3: 970 mb/d
Yr 5: 1.5 mb/d

In other words, if producers use the recent influx of cash to spend on *existing* production and shallow the decline rate even modestly, it could add as much as 1.0-2.0 mb/d of supply by 2027-2028 without a *single* additional project.

The challenge is how to track that this is happening. Data is scarce and spending can take many forms. It's workovers, infill drilling, tie-backs, EOR, repairing/replacing equipment... If you listen to the OFS sector it is happening, but still hard to quantify in a macro sense.

To sum up, the underinvestment thesis tends to be imbued with a sense of inevitability and scientific certainty looking years out, but the future of oil supply is never pre-ordained.

Sometimes, the part of the equation you take for granted could be the one that surprises /end