DRILLING EFFICIENCY BLAMED FOR WEAK GAS PRICES

June 1, 1992
Marked improvement in drilling efficiency in recent years is a major reason for weak natural gas wellhead prices in the U.S. That conclusion comes from John P. Mahedy, Morgan Stanley & Co., New York. He told the Independent Petroleum Association of America's petroleum cost and finance committee despite the decline in Baker Hughes Inc.'s U.S. active rig count, Morgan Stanley's "efficiency adjusted rig count" remained steady throughout the 1980s. That's one of the big reasons a

Marked improvement in drilling efficiency in recent years is a major reason for weak natural gas wellhead prices in the U.S.

That conclusion comes from John P. Mahedy, Morgan Stanley & Co., New York.

He told the Independent Petroleum Association of America's petroleum cost and finance committee despite the decline in Baker Hughes Inc.'s U.S. active rig count, Morgan Stanley's "efficiency adjusted rig count" remained steady throughout the 1980s. That's one of the big reasons a gas surplus has persisted, he said.

The increase in drilling efficiency stemmed from better rigs, bits, and personnel and improved technology, mainly horizontal drilling and 3-D seismic surveys, Mahedy said.

He presented Morgan Stanley's findings last month at IPAA's midyear meeting in Orlando, Fla.

EFFICIENCY IMPROVEMENT

Mahedy contrasted U.S. gas drilling activity efficiency for 1977-81 with 1986-90.

In the first period the number of wells required to replace gas production at the 1990 volume of 17.5 tcf was an average 20,893/year, compared with only 12,551/year in the second period. That's largely because reserves added in 1986-90 were 1.4 bcf/well, up 75% from 800 MMcf/well in 1977-81.

What's more, the number of wells drilled jumped 49.3% from 14/rig/year in 1977-81 to 20.9 in 1986-90.

The combined effect of the increase in reserves added per well and wells drilled per rig was a reduced number of active rigs required to sustain production and reserves.

Mahedy broke the explanation for the decline in number of rigs into two components: drilling efficiency and finding efficiency.

In drilling efficiency, he pointed out that footage drilled per active rig rose substantially in 1982 and 1983, then remained relatively constant. He said that indicated the natural increase in difficulty of drilling is being offset by improved rig hardware and drilling techniques.

Mahedy said the required number of rigs to sustain gas production and reserves is influenced more by the finding efficiency.

During the past 5 five years, gas reserve additions per foot drilled have been about double what they were in the previous 10 years.

Mahedy said the improvement had been dismissed by industry as an anomaly associated with the timing of reserve revisions.

However, he contended there has been a marked improvement in the finding efficiency.

He pointed out that, as expected over time, the average new field size declines.

But the industry has found more and more large fields-fields that ultimately will yield more than 1 million bbl of oil equivalent. In 1980 the finding rate was two or three large fields per 100 new field wildcats drilled. This has increased to seven or eight large fields per 100 new field wildcats today.

The Morgan Stanley study discounted the timing of reserve additions as a major reason for the increase. It said reserve data for all fields follow a similar historical revision pattern, and that neutralizes the effect of arbitrary timing of revisions.

ADJUSTED RIG COUNT

Mahedy said a precise explanation of increased finding efficiency is difficult, but there are two main reasons: a 50% decline in gas prices, which is a strong incentive to look for larger fields, and improved technology.

To illustrate the shift in efficiency, Morgan Stanley developed its efficiency adjusted rig count.

Mahedy said the 75% drop in Baker Hughes' U.S. active rig count from 1981 to the present should be an indicator of underdrilling and declining reserves.

But Morgan Stanley's efficiency adjusted rig count does not show that sharp drop in drilling. It concludes that underdrilling did not occur until 1991, not 1985 and 1986 as is commonly thought.

Assuming no growth in U.S. gas demand, the gas rig count must trend up toward 700 to replace production even in today's era of very efficient drilling, Mahedy said.

Morgan Stanley does not see drilling efficiency continuing to rise. So without a further dramatic plunge in commodity prices, as witnessed in the 1980s, drilling will remain efficient, but the gains will not match those of the 1980s. Therefore, increased activity will be required.

U.S., NON-U.S.

Morgan Stanley also compared the drilling efficiency of U.S. and non-U.S. exploration, taking into account the shift in budgets to non-U.S. programs.

The industry has spent about six times as much per new field wildcat outside the U.S. during the past 5 years as it has in the U.S.

Spending in the U.S. averaged $332,000/well, compared with an average $2.03 million outside the U.S. The higher spending level stems from greater outlays for data services, the higher cost of drilling offshore, and fewer competitors for sales of goods and services, "which leads to higher prices."

Mahedy asked, "Is this money being spent wisely?

"If we look at reserves found per new field wildcat, we see that non-U.S. wells have averaged about 12 times a U.S. well ... Thus we wonder if the shift in budgets will one day be looked upon as having caused a major efficiency gain in spending for oil reserves."

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