U.S. oil and gas producers are demonstrating industry fundamentals that the Department of Energy should watch closely. In its pursuit of a national energy strategy, DOE cannot ignore recent oil production declines. Any effective response to those declines must involve improvements to fundamentals within the government's control.
The production slide seems irreversible to some observers. Output has fallen by more than 1 million b/d since 1985; last year it averaged 7.6 million b/d, lowest in 26 years. Pessimists blame the numbers on resource depletion and say there's no point trying to slow the decline with policy changes. DOE must not fall into that trap.
WHY OPERATORS DRILL
Production declines result more from premature well abandonments and torpid overall drilling than from exhaustion of the resource, much of which hasn't even been explored. Abandonments are high, weekly rig counts low, because the fundamentals aren't right. Operators drill and produce where they see hope for sufficient excess of revenue over cost for each unit of output. They also drill only where they are allowed to drill.
Activity highlighted in Oil & Gas Journal's annual Exploration/Development U.S.A. report shows how these fundamentals work (see p. 49). Low rig counts notwithstanding, operators are busy in areas where they have access to the resource and promising combinations of oil and gas production volumes, technology, and tax benefits.
In the Arkoma basin, for example, high natural gas output from deep but not extraordinarily expensive wells more than compensates for sluggish wellhead prices. The big flows boost gross revenues and hold down unit operating costs. A regional drilling boom is in progress.
But high-flowing discoveries like those are rare in the U.S., where the drillable resource tends already to have been drilled. Much of the sparsely explored, high-potential resource-off California and Alaska, in the Arctic National Wildlife Refuge coastal plain, possibly in the Rocky Mountains and off the East Coast-can't even be leased.
Technology helps operators make the most of a shrinking drillable resource. It enables them to economically develop world-class reserves in the ultradeep Gulf of Mexico. It enables them to pinpoint elusive but productive drilling targets, such as the Pennsylvanian Morrow channel sands of the Las Animas Arch, where costs of successful wells are relatively low. And, in one of the biggest advances in recent years, it enables them to drill horizontally, vastly improving development economics of some reservoirs. Horizontal drilling booms are under way in the Austin Chalk of Texas and Mississippian Bakken shale of North Dakota.
FUNDAMENTALS MUST CHANGE
Tax incentives help, too, where they're available. An unconventional-fuels tax credit, expiring at yearend unless extended, has stimulated drilling for coalbed methane in the San Juan, Black Warrior, and other basins. In general, however, federal tax policy discourages drilling by failing to account for the wasting nature of oil field assets and the high risks involved.
As always, then, external fundamentals are driving U.S. drilling activity, the main determinant of oil and gas production. What DOE and Congress must decide is whether greater production represents a worthy objective of energy policy. If so, they should make some quick improvements in tax and leasing policy and increase support for industry research. If, on the other hand, they think energy policy should accommodate further production declines, continued spotty drilling, and overall decay of the domestic producing industry, the status quo will do.
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