Lifting costs, half-cycle and full-cycle metrics all have a place
Breakevens are a critical metric in the oil and gas industry that are commonly referenced in both investor presentations and economic discussions about the industry and the viability of various oil and gas plays.
However, “breakeven cost” can refer to several different metrics, each of which means something entirely different.
Schlumberger and MIT have partnered in a recent paper examining these costs. The idea is an attempt to establish consistent nomenclature and determine when each measure is appropriate. According to these researchers, there are three common breakeven points, lifting cost, half cycle and full cycle.
Lifting cost: for use with a cash cow
Lifting cost refers to the cost of producing one additional barrel of oil from an existing field.
This particular measure includes lease operating expense, royalties, transportation fees, water disposal, G&A and reservoir management OpEx costs. Several other industry terms typically refer to this particular breakeven measure, including “production cost” or “operating expense.”
Half cycle: popular in company investor presentations
Half cycle breakeven refers the cost of a well in an established field.
It includes everything in lifting cost, along with the construction of the well and well pad, building local pipelines, reservoir management CapEx, and financing costs related to these activities. In addition, proper half cycle breakevens also include the potential costs of workovers and refracture jobs, and the eventual decommissioning expense. This breakeven is the one most commonly cited by companies in investor presentations.
Full cycle: loved by analysts
Full cycle development is the cost of going from a totally undeveloped field to a producing well.
This breakeven includes both half cycle and lifting costs and the expenses related to overall field development. Exploration, leasing and reservoir delineation, commonly called “finding costs” are included, along with overall engineering, roads, infrastructure, regional pipelines and financing these activities. As a kind of “all in” comprehensive breakeven, full cycle costs are most commonly used by analysts.
Source: Kleinberg, 2018
Each metric has different applications
All three of these breakeven measurements are valid, and are useful when applied properly, the researchers concluded.
Lifting cost, according to the MIT/Schlumberger researchers, “is the appropriate breakeven point to use when the producer acknowledges a field is in decline and is functioning as a ‘cash cow’, for which little or no further investment is anticipated in the present phase of the business cycle.”
Lifting costs were also very relevant during the early stages of the downturn, when oil prices were in free fall. At the time, producers were simply focused on survival, rather than investing capital in field development.
When activity is concentrated on infill drilling in established fields, half cycle breakevens are most relevant. When producers are moving into a new play, however, half cycle breakevens are not appropriate. Instead, full cycle costs best represent the expenditures needed to bring the area to production. During the recent Permian land rush, for example, most companies advertised very attractive half cycle returns on investor presentations and other communications. However, these generally do not include the costs of acreage, early exploration wells and installing infrastructure.
Full cycle breakevens are down $20-$40 since mid-2014
In mid-2014, for example, these three breakeven costs differed significantly. At the time, full cycle breakevens were in the range of $60-$90/bbl, while half cycle costs were $50-$70/bbl and lifting costs were usually below $20/bbl. Producers have been able to lower these costs, but full cycle returns are not as robust as is often represented.
John Gerdes is Head of Research at KLR Group. In November Gerdes and his team analyzed the full cycle breakevens for the major U.S. unconventional plays.
Oil play breakevens, according to Gerdes, have fallen significantly in the past three years, and all major plays are breaking even at current prices. The most economic basins require only $40/bbl oil, while more expensive basins break even at just over $50/bbl. Full cycle breakevens are more difficult for gas plays, with necessary costs ranging from $2.95/Mcf to $3.65/Mcf.
Gerdes found that while half-cycle returns—well-level economics—often paint a very pretty picture of current activities, full-cycle costs are often significantly higher. A trouble well can easily cost double expectations. Full cycle well costs, then are about 50% higher than standard marketing representations. Well recoveries are also typically below the presented type curve, because essentially every unusual event in a well’s life results in lower production.
These two facts mean industry capital intensity is significantly above well-level assumptions. With this in mind, Gerdes calculated breakeven NYMEX prices for the primary oil plays in the industry.
Gerdes found the Midland basin has the lowest breakeven and lowest price needed for a 10% return. $41 per barrel will generate a 0% unleveraged return, enough to breakeven, while $63 per barrel is enough for a 10% ROR. The Permian, Eagle Ford and Wattenberg all have similar breakeven prices, around $42 per barrel, but vary greatly in what price is needed to generate returns.
The Williston has the highest breakeven costs, at $52 per barrel, but the low oil composition of the SCOOP/STACK gives that basin the highest needed price for 10% ROR.
