Low oil and natural gas prices are now expected for the foreseeable future, as is evidenced by a glance at future strip prices that are unusually flat – crude oil futures prices, for example don’t rise above $50 until 2022. Low price expectations are primarily based on the notion that infinite shale resources will leap forth from the ground upon command, at the first sign of commodity price increases.
That may be so in the short term, but an important misconception is that these newly developed resources have endless deliverability. US shale deposits are indeed large, but have a very distinct and finite size. Each has areas that are of particularly high quality, the “sweet spots”, which are joyously mapped by shale enthusiasts.
Of particular interest are the maps that show the quality of shale reservoirs. A common misconception, fueled in epic proportions by the cheap-energy-is-here-forever PR mill, is that a shale well is a shale well, and they are all gifts from heaven. The standard commentary never strays far from a singular and reverent message about how more gas/oil is being produced by ever-fewer wells, at ever-lower costs. The explanation is trotted out every time resilient production is mentioned, like this trend of lower cost/higher output will never stop. A simple extrapolation therefore indicates that within a few years a single well will cost less than 10 bucks and will deliver enough natural gas to heat Chicago.
As with any mania, it pays to keep one’s feet on the ground, so a closer look at a few rarely mentioned but important factors is time well spent.
First, the sweet spots of these shale plays are a fraction of the overall size. And these sweet spots are being drilled up quickly in a low price environment. It’s only natural that a producer will drill up their best prospects first, especially in a low price environment where cash flow is needed. Imagine a company drilling crappy locations first and saving the best for later. That slide never goes over well in IR presentations.
Here’s an example of the how this development is unfolding. The sweetest spots of the Marcellus (according to this map), appear to be about the size of 5 Long Islands. Long Island is about 1,400 square miles, so the prime Marcellus acreage is about 7,000 square miles. Some parts will be inaccessible, such as urban or NY state off-limits areas, so let’s say 6,000 square miles of sweet spot is available for drilling. Each 3 well pad, if drilled in sort of an “E” pattern with 2 mile long horizontals, will develop about 2 square miles, meaning there clearly is a finite size to the best parts of the Marcellus. And there currently are about 50 rigs drilling in the Marcellus, meaning that, even with a drastically slashed rig count, close to 20 square miles is being developed every 10 days or so. That would be 700 square miles per year even at these low drilling rates. When you read in the news that North America has a hundred years of gas supply, keep this in mind – the Marcellus is one of (if not the) best of the shale reservoirs, and it could be drilled up in 10 years, or faster if prices rebound.
Second, the sweet spots are being drilled up with a scorched earth mindset, brought on by market expectations and the current dire situation in the energy industry. In a technical article published by the Canadian Society of Exploration Geophysicists, there is a note on how shale plays are best developed: “Shale formations often have a complex mineralogy requiring a more sophisticated petrophysical analysis to define the relationship between desirable petrophysical and mechanical properties and elastic rock properties. Then a simultaneous AVO seismic inversion is performed to determine elastic properties, which are used to characterize the important petrophysical and mechanical properties of the shale reservoirs and allow us to predict how the rocks will respond to hydraulic fracing.”
This sounds like an admirable game plan to me, or it would if I understood it all, but it doesn’t stand a chance against a CEO who’s about to meet his maker (or worse, the stock analysts) unless he delivers that 10 percent production growth that he promised.
The end result is that in many instances, the best locations are being drilled and blown out in a low price environment. In December for example, a Canadian company brought on 12 fantastic new high productivity wells that cost a hundred million dollars in total in the worst gas price environment in years. It seems like a crazy thing to do, but the same principle guides any tribe in survival mode; if wood was the only available heat source people would burn every tree in sight to heat their homes, with thoughts of forest preservation losing all appeal when the alternative is freezing to death.
Further compounding the issue is a popular tactic used to drive well costs down. Shale wells used to be up to a mile in horizontal length, with maybe 10-20 fracks. Producers realized that by dramatically increasing the horizontal length of wells, some as far as 3 miles out, that the cost to drill a well can be driven ever downwards since more producible area is covered by a single wellbore. It makes sense that the costs of a single lease site be amortized over as many feet of reservoir drilling as possible.
What these producers often fail to mention is how poorly these drilling programs optimize recoveries, particularly in the best parts of the reservoir that are being drilled first in this low price environment. Long lateral wells can’t be managed as well as shorter horizontals, because service equipment can’t easily or effectively get to the toe of the well. In fact, it’s hard to have any idea what’s going on at the toe of the well; it’s totally blind. No one can even claim to know exactly where all the production is coming from; it could be from any combination of any of the 50+ fracks that were completed; it might be from 2 fracs or from 40, it’s hard to say. This is obviously an oversimplification, drillers may have some idea of what’s happening for parts of the well, but the true picture is far from clear.
As evidence, consider this startling admission: at the 2014 DUG Eagle Ford Conference in San Antonio, Tammi Morytko, a Baker Hughes’ VP, estimated that about 60 percent of frack stages are wasted, or ineffective. No one can claim to understand that a reservoir is being managed properly when even the salesperson admits to having no idea.
In more graphic terms, this method of extracting petroleum is like grocery shopping in the supermarket with a backhoe. Yes, you did indeed scoop a lot of eggs into your cart, but look behind you. It’s a totally ham-fisted way to extract finite resources, unless the only goal is short-term maximization of production.
The whole shale drilling frenzy is being treated as a one-shot opportunity to bleed the reservoir. Proper reservoir management would require a full understanding of what these carpet-bomb frack jobs are doing, or at least an overall plan to maximize total recoveries, but that’s not happening – instead it’s a free-for-all race to the bottom. It’s like Ladyfern reservoir all over again, except it’s about survival these days and besides that, well results are spectacular. But then so are timber-harvesting results if one clear-cuts a forest.
An interesting contrast is the Ghawar field in Saudi Arabia, the world’s largest. As much as us free marketers scoff at government ownership of resources, the fact is that Ghawar has been producing for 50 years, it has been extremely well managed, and it still produces nearly 5 million barrels per day. Saudi Aramco, the operator, takes the time to thoroughly understand the whole reservoir, including a type of finite element analysis, where approximately every square meter of the 120 square mile field has been catalogued. That doesn’t happen when it’s a multi-owner free for all where the biggest straw wins. Yes, shale fields are different, but the principle remains – indiscriminate drilling and flat out production may mean a lot of the resource is forever left in the ground.
There’s no doubt that the latest shale plays are huge resources that have changed energy markets in a big way. But the resource is not infinite, and the more crudely they’re developed, the less recovery there ultimately will be.