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Proposition 112 puts Colorado’s oil and gas future in the hands of voters

The Denver-Julesburg (DJ) basin in Colorado has turned into a huge success story for the oil industry in recent years, but the upstream sector in the state could be dealt a critical setback when voters go to the polls on 6 November. Oil companies in the DJ basin have realized dramatic improvements to well economics, with average wellhead breakeven oil prices falling from $80/bbl in 2010-2011 to just $30-$32/bbl in 2017-2018.

The DJ basin does not get the level of attention generated by the highly prolific Permian basin in West Texas and New Mexico – the primary contributor to US oil production growth of late – but the upside potential of Colorado’s oil output is formidable. This upside, however, could effectively be struck down by next week’s decision on Proposition 112, when Colorado voters cast their ballots in the US midterm elections. The proposal would restrict oil companies from drilling any wells within 2,500 ft of homes, water sources and areas designated as “vulnerable.”

Ahead of the upcoming vote on Proposition 112, Rystad Energy has observed the following:

  • Colorado oil production has gained significant momentum over the summer months, trending towards 550,000 BPD by the end of 2018.
  • We see strong evidence of operators fast-tracking permitting activity to mitigate potential effects of an unfavorable outcome of the Proposition 112 vote.
  • If passed, Proposition 112 would eliminate – to varying degrees and depending on proximity to residential areas – many future drilling locations for operators in the DJ basin, ranging from 67-71% for HighPoint Resources and Noble Energy, to 94-97% for Anadarko and PDC Energy.
  • Impact on DJ basin oil production won’t be visible before 2021, but output would likely enter into a multi-year phase of decline after 2020 if Proposition 112 is passed, as opposed to expectations of continuous growth through the mid-2020s if it is rejected by voters. The long-term impact of Proposition 112 for Colorado’s oil & gas production and industry would be dramatic.

“Rystad Energy observes strong evidence that operators are hedging against a potentially adverse voting outcome. Given that permits approved before the vote will be exempt from the new restrictions, we have seen a strong uptick in permitting activity in the DJ Basin during Q3 2018,” Artem Abramov, Head of Shale Research, said.

Weld Country, the core producing county in the DJ basin, exhibited a sequential jump of more than 200 drilling permits granted in Q3 versus Q2, creating an anomaly in the number of approved permits relative to the permitting activity range seen in the previous six quarters.

Rystad Energy has also clearly seen that the recent increase in permitting activity has been driven by locations within the buffer zone, emphasizing attempts by E&P companies to secure locations in case Proposition 112 is passed. Broomfield County represents an interesting case of how this has played out practically.

“No new wells have been turned-in-line since 2012, but this year alone Extraction Oil & Gas suddenly received permits for 71 Niobrara locations, all with proposed two-mile lateral spacing. Needless to say, there is literally no land in Broomfield that is outside the 2,500 ft buffer zone proposed in Proposition 112,” Mr Abramov said.

Looking at the potential impact of Proposition 112 on activities in the DJ basin, it is worth noting that three out of the six largest operators (Anadarko, Extraction Oil & Gas and PDC Energy) have more than 90% of their net acreage within the buffer zone. For PDC Energy, the impact of Proposition 112 would be particularly dramatic, invalidating 97% of the company’s acreage. Noble Energy, SRC Energy and HighPoint Resources would also be severely affected, but to a lesser extent, as they show, respectively, 71%, 79% and 67% of their acreage within the buffer zone.

“DJ acreage ranks high in portfolios of all active operators. Hence, even a reduced size of the remaining Tier 1 well inventory should not eliminate its development as long as operators’ decisions are guided by economic rationale. In the medium term, we expect activity to migrate gradually towards federal lands,” Alexandre Ramos-Peon, Shale Analyst at Rystad Energy, said.

With activity migration towards federal lands where permit processing times are much longer, Rystad Energy expects to see gradual decline in activity as current permit inventory depletes. In such scenario, we see DJ oil production peaking in early 2021 and falling below current production levels by 2023-2024.
With activity migration towards federal lands where permit processing times are much longer, Rystad Energy expects to see gradual decline in activity as current permit inventory depletes. In such scenario, we see DJ oil production peaking in early 2021 and falling below current production levels by 2023-2024.

Rystad Energy expects that Proposition 112, if passed, would have only a marginal impact on oil and gas volumes that are expected to come from currently producing wells, drilled but uncompleted wells (DUCs) and already-permitted drilling locations. Hence, existing DUCs and approved permit inventory is sufficient to maintain oil production growth through Q2 2020 and will be able to push DJ basin production upwards from 470,000 BPD in Q3 2018 to more than 630,000 BPD in Q2 2019 without contributions from future permits. Significant production support from existing permit inventory will extend even into 2021, as the current size of inventory suggests that not all permits will be drilled within the initial two-year period and they will have to be renewed to be drilled later.

“If Proposition 112 fails to find sufficient voter support, we see DJ basin oil production approaching 800,000 BPD by the end of 2021. However, if Proposition 112 passes, we conclude that some operators, whose inventory size is impacted dramatically, would not be able to deliver on expectations,” Mr Ramos-Peon said.

“The long-term impact of Proposition 112 on Colorado’s oil and gas industry would be dramatic. While the state economy is believed to be well diversified, the impact would be felt by the entire state with up to 200,000 anticipated job losses, up to $10 billion in lost tax revenue by 2030 and a reduction of more than $200 billion in GDP over the same period,” Mr Abramov said.

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