How The Story of Shale Has Developed

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The Organization of Petroleum Exporting Countries (OPEC) at the turn of the year openly declared war on expensive oil – and targeted US shale. The effects on LNG and other fuels has been profound in the short term, but could hold some bonus.

The OPEC conduct may also have given a subliminal message to certain unruly members to restore some discipline to the cartel itself.

Fereidun Fesharaki, Chairman of energy consultants FACTS Global Energy, and executive David Isaak have published this latest opinion piece:

“It is true that US shale developed under a high-price regime, and that many projects were presented to investors on economics that assumed floor prices of US$80 per barrel and expected prices well above $100/bbl.

Shale also developed with an immature technology base, and on land long considered non-prospective. (Indeed, much of the land in the shale plays was considered useless for any purpose at all.)

The result was a characteristic American phenomenon, the “Rush” – like the Land Rushes in Oklahoma, or the Gold Rushes in California or Alaska.

In a Rush, the overriding concern is not to arrive too late, after all the good land is taken or all the best claims are already staked.

When the “War on Shale” began, it was common to hear that substantial drops in production would occur at S$90/bbl, $80/bbl, or $70/bbl. And it was true that to make the overall economics work, those sorts of prices were needed for many producers in certain plays.

But the overall economics include the lease costs, which for some producers represents a very large fraction of the total costs. But lease costs are sunk costs, and once the investment has been made, they do not have much effect on production economics.

So there are projects that might require US$70/bbl to make money, but still keep producing at US$40-60/bbl.

Some aspects of shale economics were improving at astonishing rates, even with the cushion of high prices. Total well depths typically more than doubled in the last half-dozen years, as did lateral runs lengths.

Despite greater depths and lateral runs, typical drilling times per well were cut in half (from 35 to 17 days), and some wells are now drilled in 9-12 days.

In addition, multiple wells are now being drilled from single production pads, meaning that the drilling equipment can be repositioned and restarted in a matter of hours rather than days.

As is widely known, productivity per well has also skyrocketed. This is the result of many factors, such as fracturing practices geared to specific local geology, improved use of proppants such as sand, and the longer total runs per well.

But one of the reasons productivity is climbing is simply that the producers have begun to concentrate on the best plays. In addition, many wells in the Great Rush were drilled simply because lease terms required a certain amount of drilling and output to avoid the lease reverting to the owner (leases “held by production,” or just “HBP drilling” in industry jargon).

But as long as oil prices remained high, there were costs that tended to rise rather than come down. Labor was short, operating costs tended to rise, good drill rigs were at a premium, proppants and chemicals saw major price increases, and common items such as compressors were backordered. In addition, limited (and expensive) transport infrastructure cut netbacks to the wellhead.

Lower prices and increased productivity have to some extent reversed those trends. In the new low-price environment, costs have fallen – some producers report operating costs down by 20 percent or more.

Rig counts are down, and this not only lowers the cost of rig hire, but it also means that only the best rigs are employed. Finally, although cheap transport infrastructure still falls short of demand, improvements in getting liquids to market have been steady.

That does not mean prevailing prices do not hurt. They have definitely put an end to the Great Rush. But the main effect has been to put the US shale business on a sounder footing.

In the new environment, the less productive leases and plays are likely to be abandoned (which will look to the market like another major increase in well productivity). Improvements in drilling and production economics improved the bottom line before, but now additional improvements are required rather than optional.

What does this mean for production of tight oil and gas? With all the time-lags involved, it is becoming harder to assess.

The large producers have slashed their E&P budgets for 2015 by about a third; and smaller producers have implemented even bigger cuts. Despite this, most of the producers report that their output of oil will be higher for 2015 than for 2014.

Monthly production declines are already occurring – although even the modest crude price revival of the last few months was enough to encourage a few producers to begin deployment of additional rigs for mid-summer.

But a confounding factor is that many producers have elected to delay completions on wells that have already been drilled. Completion (casing and installation of production trees and piping) is expensive – and not needed unless the well is going into production.

Some statistics suggest that as many as half of the wells drilled in the Bakken are deferring completion. Some companies are actually deferring more wells in 2015 than their total new wells in 2014. This means that in the coming months and years, there may be small surges in production that are seemingly unrelated to drilling.

Crude prices need to be driven well below recent levels to put shale out of business. Conversely, mild increases in price can draw in new production comparatively rapidly. Deferred well completions add to the price responsiveness.

Shale production is surprisingly resilient in the range of $50-60/bbl, and prices above $60/bbl may draw in significant new production.

The War on Shale is turning the US shale industry into less of a casino and more of a sober, bottom-line business. There will be losers in the ongoing shakeout, but those that remain standing will be far more formidable and competitive.”

 

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