Tayvis Dunnahoe
Exploration Editor
An oil-price plunge that began in the second half of 2014 and continues into 2015 raises questions about production from unconventional resources in the US.
As cash flows fall in 2015, companies will set new priorities for capital spending. Across the industry, this will involve a balancing of unconventional development with work in another high-cost area: deep water.
According to a Dec. 9 study by Gaffney, Cline & Associates (GCA), deepwater projects in the US Gulf of Mexico (GOM) may become vulnerable as spending is reduced. The firm adds, however, "Economic rationality would suggest that where the opportunity exists, onshore shale spending would be a better short-term target for capital deferral because operating flexibility allows any adjustments made there to be reversed in equally quick order."
For deepwater GOM projects, deferral now could mean missing later gains. Therefore, the US shale market may see a rapid decline in marginal areas for many plays as companies attempt to halt short-term spending in lieu of lower oil prices and increased supplies. Deepwater projects thus may be better placed than unconventionals through 2015.
The question is how resilient US tight oil plays can be in the face of lower prices.
Break-even prices
Producing oil from shale is more efficient now than ever before. Douglas-Westwood notes that costs vary from basin to basin.
"It is reported that $80/bbl break-even is valid for only 4% of US shale production, and most unconventional plays will support prices at least $50/bbl (i.e., Bakken at $42)," the consultancy said in a recent report. "Furthermore, lifting costs have been reduced by some $30/bbl since 2012."
Technology improvements have reduced finding costs within the last few years. Within each play, the productive fairway tends to provide the best economics.
Shale oil and gas productivity and costs also vary within a specific shale formation. Break-even prices, while often broadcast for an entire play, can vary greatly from well to well for an individual operator in a specific play, depending on location and operational optimization.
McKenzie County, ND, for example, is the most prolific area in the Bakken-Three Forks play. The county's average output of 350,000 b/d is more than one third of total Bakken production (1.1 million b/d) as of August 2014. According to Harvard University's Leonardo Maugeri, McKenzie County's break-even price is $28/bbl, including a 10% internal rate of return.
By contrast, Bakken wells in Divide County, ND, which collectively produce more than 35,000 b/d, have a break-even price of $85/bbl. Maugeri estimates an overall break-even price for 80% of Bakken wells at $42/bbl. The marginal cost of production in the Bakken has a break-even point of $85/bbl; however, this number refers to less than 3% of overall Bakken production, said Maugeri.
The notion of "average" breakeven prices can be misleading when referring to shale, Maugeri argued. It is likely that such variance will be considered by operators looking to cut spending in shale areas should oil prices continue downward.
Analogous response
Some analysts point to previous price drops to draw conclusions about 2015. "In 2008, the (WTI) oil price fell $90/bbl, and the US onshore rig count was down by 1,000 within 6 months, although then rising again almost as rapidly as prices recovered," said GCA. By early December 2014, the WTI oil price had fallen by a little less than $50/bbl from its June high.
With 2008 as its guide, the firm estimates the rig count will fall by 500 rigs or more in 2015, which is 25-30% of the current rig count.
DrillingInfo recently reported that November 2014 drilling permits in Texas decreased by 50% from October. The firm noted that October saw a 24% increase in permits from September, however. Historically, drilling permit data have been volatile and do not always accurately predict drilling.
A decline in natural gas prices that began in 2008 and touched bottom at $1.90/MMbtu in April 2012 didn't obliterate production from shale, which some analysts believed required a price of $6/MMbtu.
Douglas-Westwood noted that after 2012, while production in higher-cost basins did fall, production increased in lower-cost basins such as the Marcellus.
Constant drilling
Shale plays require constant investment in drilling to maintain production, however. Typical oil wells in shale plays decline as much as 60%/year, compared with 7-10%/year for conventional wells.
As drilling subsides, production can be expected to follow, possibly late in 2015 or early in 2016.
Nevertheless, shale gas production nationwide has increased almost sixfold since 2008 in spite of plummeting prices and a decrease in drilling intensity for gas—both factors considered essential for sustaining shale gas production. Maugeri cites the expansion of the Marcellus and the overall reduction of drilling and development costs as the main drivers of sustained growth.
Natural gas drilling fell from a weekly average of 1,500 in 2008 to no more than 300 in 2014. While these numbers are in line with falling prices, gas production continued to rise. As of December 2014, shale gas production reached 42 bcfd, representing more than half of total US gas production.
In the Marcellus alone, production reached 15 bcfd through July 2014, up from less than 2 bcfd in 2010. Better knowledge of the formation and improved technology are primary contributors to this increase. Maugeri estimates that drilling and development costs for natural gas decreased by 40% across all shale plays from 2010.
With gas, lower prices have had little effect on sustaining production due to efficiencies in technology and reservoir engineering.
Comparable effects can be expected for oil, falling prices of which are prompting companies to review service fees and seek other ways to lower costs of operating in shale plays.
Outlook
With the price of West Texas Intermediate crude oil expected to average $58/bbl in the second quarter of 2015, the Energy Information Administration expects drilling to decline because of unattractive economics in emerging and mature oil production areas.
It is likely that most shale operators will redirect spending away from marginal exploration and research wells to focus on core acreage in established oil plays.
According to the EIA, oil prices should remain high enough to support drilling in the Bakken, Eagle Ford, Niobrara, and Permian basins.
According to Maugeri, US shale oil and gas production will continue to grow over the next few years barring a lasting collapse in oil price. Technology will continue to assist with this growth as pad drilling has offset the per well production decline.