Knowledge, technology improvements boosting U.S. upstream opportunities

Nov. 2, 1998
Is the U.S. running out of upstream opportunities? The intuitive case that it has seems to be overwhelming. Petroleum, after all, is the classic nonrenewable resource. Nowhere in the world has more effort gone into exploring, developing, and producing petroleum resources for a long period of time than in the U.S.


Richard Nehring
NRG Associates
Colorado Springs, Colo.
Is the U.S. running out of upstream opportunities? The intuitive case that it has seems to be overwhelming. Petroleum, after all, is the classic nonrenewable resource. Nowhere in the world has more effort gone into exploring, developing, and producing petroleum resources for a long period of time than in the U.S.

Since Col. Drake drilled the first oil well in Pennsylvania in 1859, practically every sedimentary basin in the country has been explored. Hundreds of play concepts have been tested. More than a quarter million exploratory wells have been drilled, discovering more than 10,000 significant oil and gas fields and an even greater number of minor fields. More than 2 million wells have been drilled to develop these discoveries.

Oil production from these wells has exceeded 5 million b/d for the past 50 years, a level of production that only three other countries have ever attained.

Natural gas production has been more than 10 tcf/year for more than the past 40 years, a level of annual production that only one other country has exceeded.

If ever a case could be made for resource depletion and the consequent diminishing of opportunities, the petroleum resources of the U.S. appear to be the prime example.

Increasingly, the petroleum industry in the U.S. also believes that and behaves as if the U.S. is running out of upstream opportunities.

During most of this decade, the majors have been shutting onshore exploration groups, limiting domestic exploration efforts to the Gulf of Mexico (and increasingly to deepwater prospects only) and to Alaska. They have sold many onshore properties and reduced their onshore development efforts.

Even independents, those longtime standardbearers of industry optimism, are flagging in their enthusiasm. In a recent survey of industry problems, small independent companies indicated that the biggest problem facing them domestically was a lack of opportunities. Consequently, workshops abound tempting these independents with the allure of international operations.

The question whether the U.S. is running out of upstream opportunities is ultimately neither a matter of theory nor of perception. It is a matter of fact.

What is actually happening in the U.S. upstream? What do the available indicators of industry opportunities tell us? This two part article examines those indicators, both in the aggregate and in the specific, in an attempt to answer those questions.

Opportunities in the aggregate

Annual gross reserve additions are the best single aggregate measure of recently realized upstream opportunities. They measure the increase in estimated ultimate recovery. By comparison, net reserve additions (gross additions less production) indicate annual changes in remaining reserves.

During the past 8 years, gross reserve additions in the U.S. varied from 4 to 7 billion BOE/year, averaging 5.65 billion BOE (Table 1 [45,020 bytes]). Gross reserve additions plummeted from 1990 to 1991 but increased steadily thereafter.

The highest levels of additions for the period were realized in the past 3 years. In fact, gross reserve additions in 1997 were the highest achieved in the U.S. since the initial reserves for Prudhoe Bay were added in 1970.

Understanding the significance of recent gross reserve additions requires placing them in context. No single context, however, is adequate for this task. Several appropriate contexts exist, each of which provides its own insights.

To provide a fuller and more balanced appreciation of the significance of recent reserve additions, this article discusses six such contexts:

  1. The estimated ultimate recovery of U.S. petroleum resources.
  2. Recent U.S. petroleum production.
  3. Recent upstream expenditure.
  4. Historical additions to reserves.
  5. Historical drilling effort.
  6. The broad geographic distribution of recent reserve additions.

U.S. EUR, production

Table 2 [56,988 bytes] indicates the significance of recent reserve additions within the first two of these contexts. Despite the long history and high maturity of the U.S. upstream petroleum industry, industry efforts in the 1990s have resulted in major gains to ultimate recovery.

More than 11% of all the petroleum reserves ever added in the U.S. have been added in the last 8 years. This measure does exhibit considerable variation by product. Relatively, the ultimate recovery of natural gas liquids increased the most, followed by natural gas, with crude oil additions bringing up the rear.

The relative differences in the rate of increase in ultimate recovery by product are reflected in differences among replacement ratios among the three products. (The replacement ratio measures the proportion of production replaced by reserve additions.)

So far in the 1990s, natural gas liquids production, despite being at its highest levels ever, was more than replaced. Natural gas production, which was close to record levels, was also entirely replaced. In contrast, less than 80% of crude oil production was replaced.

The low crude oil replacement level was entirely the result of low rates of crude oil reserve additions from 1991-93 (only 55% replacement). By comparison, the crude oil replacement ratio for the other 5 years was 94%.

Overall, despite high rates of production and the high level of maturity of the U.S. upstream industry, more than 92% of the petroleum produced during the 1990s has been replaced by new reserve additions. In the past 3 years, reserve additions have even exceeded production by 8%.

Drilling expenditures

Adding reserves requires expenditure. Wells must be drilled and completed. Facilities must be built and installed. Annual exploration and production spending is thus a good measure of the effort undertaken to add reserves.

Expenditure is not a perfect measure because not all the spending in any given year is directed toward adding reserves in that year. Some, such as deepwater drilling expense or the initial investment expense of deepwater production facilities, may occur to add reserves in subsequent years. Other expenditures, such as lease bonuses, occur only to create opportunities for adding reserves in subsequent years.

Table 3 [44,340 bytes] shows a comparison of recent gross reserve additions to annual upstream expenditures as reported by Salomon Brothers. Salomon reports two measures of spending: planned as of the beginning of each year and actual as of the end of each year. The latter measure is used in Table 3 because it is a more accurate indicator of effort.

As the table shows, during the 1990s there has been a close correlation between spending and reserve additions. Except for 1991 and 1997, spending per BOE added has clustered tightly around $3/BOE. Most of the variation from this average is explained by two factors: first, variations in the size of the largest reserve additions by field added each year, and second, variations in the proportion of expenditures each year oriented toward future as opposed to current reserve additions. The latter is particularly relevant in 1997.

Historical reserve additions

The single most important context for understanding recent reserve additions is the historic one, comparing recent rates of additions to previous rates of additions. Such a comparison indicates whether opportunities have been declining or growing over time.

A cumulative ultimate recovery curve is the most useful presentational device for conducting this comparison. It not only shows how ultimate recovery changes over time. It also has the interesting property of providing a direct visual test of the diminishing opportunities hypothesis. If opportunities are truly diminishing, actual annual gross additions will initially be greater than average annual additions for the entire period being examined. As the period proceeds, annual additions will decline and become less than average additions. The resulting curve for the actual growth in ultimate recovery will thus both be gradually flattening and will consistently be above a line showing ultimate recovery increasing at its average rate.

Fig. 1 [35,609 bytes] shows how ultimate recovery of petroleum grew in the U.S. from 1970-97, showing both its actual and its average progression. During this period, the ultimate recovery of petroleum increased more than 55% from 261.7 billion BOE to 406.3 billion BOE. Thus more than a third (35.4% to be exact) of all the petroleum ever added to the U.S. reserves was added during this period.

The historic pattern of growth in U.S. petroleum recovery over the past quarter-century provides no support for the hypothesis that opportunities are diminishing. Instead, the comparison between actual growth and average growth in ultimate recovery supports the polar opposite view, namely, that improvements in knowledge and technology are increasing upstream opportunities. The effects of innovation are overpowering those of depletion. Throughout this 27 years the actual progression of ultimate recovery is less than the average progression. This pattern indicates that overall opportunities are growing instead of shrinking.

These patterns vary by product. Since 1970, ultimate recovery of crude oil has grown 46% from 132.3 billion bbl to 191.2 billion bbl. Ultimate recovery of natural gas has increased 61% from 654.3 tcf to 1,056.1 tcf. Ultimate recovery of natural gas liquids has grown 93% from 20.3 billion bbl to 39.1 billion bbl.

Correspondingly, the composition of opportunities varies as well. The possibilities for future natural gas and natural gas liquids additions are highly promising. Crude oil additions, though still at healthy rates, are exhibiting modest depletion effects. Most, if not all, of these negative effects are the consequence of prohibitions on exploration in some of the areas with the most potential for new oil discoveries, such as offshore California and the Sec. 1002A area of the Arctic National Wildlife Refuge.

Historic drilling effort

Reserve additions, as indicated earlier, are a consequence of industry effort. Levels of effort vary substantially over time. Thus the full significance of recent reserve additions only becomes apparent when they are compared to industry efforts.

The most common measure of industry effort is drilling activity. Fig. 2 [78,493 bytes] shows returns to drilling in the U.S. since the end of World War II. Two measures of returns to drilling are used: BOE of reserve additions per well drilled, and BOE of reserve additions per foot drilled.

The drilling statistics used are for all wells drilled, whether productive and dry, exploratory and development. Three-year averages are used to smooth out the inherent lumpiness of reserve additions. Because it is such a major statistical anomaly, the Prudhoe Bay reserve addition of 1970 was excluded from the calculation.

In little more than a decade, a productivity revolution of staggering proportions in the U.S. upstream industry has occurred. Reserve additions per well drilled have quadrupled from less than 75,000 BOE/well in 1981-84 to 300,000 BOE/well in 1995-97. Even at an anemic price of $12/BOE, this entails undiscounted average revenue of $3.6 million/well. Reserves added per foot drilled more than tripled from 17 BOE/ft to 54 BOE/ft. In the history of the modern industrial economy, such a pronounced and rapid turnaround in productivity in a mature industry is unprecedented.

The years from 1981-84 are generally considered the period of the last great upstream boom in the U.S. During these 4 years the industry drilled 336,800 wells, adding 25.24 billion BOE in reserves.

During the past 4 years (1994-97) the industry has added 25.62 billion BOE in new reserves, 1.5% more than was added in these so-called boom years. Yet it did so by drilling only 87,800 wells, just 26% of the number drilled during 1981-84.

Because of the human tendency to place more emphasis on effort than on results, we are now going through a boom that few have recognized. In answer to the bumper sticker's prayer, the results also indicate that this is one boom that the industry is not messing up.

The magnitude of this achievement becomes even more pronounced when compared to past predictions of industry performance. In the late 1980s and early 1990s, a few academic analysts asserted that drilling oil and gas wells in the U.S. would not even make economic sense by the year 2000. Forgetting that where human ingenuity is involved, trends rarely equal destiny, they extrapolated the pronounced downward trend in returns to drilling from the late 1960s to the early 1980s to predict that returns to drilling in the U.S. would be approaching zero by the middle to late 1990s.

In the sharpest possible refutation of these predictions, the latest reserve additions per well drilled were 50% higher than those achieved during the previous post-war high of 1965-67. Recent reserve additions per foot drilled exceed the record levels achieved in the immediate post-war boom of 1946-48. For the time being, the upstream productivity revolution has totally trashed the negative effects of resource depletion.

Geography of additions

The growth in reserve additions in the U.S. during the 1990s might be explained by the rejoinder that this increase occurred only because of a substantial increase in reserve additions in Alaska and the OCS. The point of this argument would be that remaining opportunities in the U.S. are geographically limited to Alaska and the Gulf of Mexico (particularly deep water) and that substantial opportunities onshore, if they still exist, are rapidly declining.

The composition by area of recent gross reserve additions does not support this argument (Fig. 3 [81,722 bytes]). Onshore additions are still the great majority of U.S. reserve additions, accounting for 67.2% of all reserve additions from 1990 through 1997. Even during the past 3 years, when major deepwater reserves have been booked and major reserve additions occurred in Alaska, onshore reserve additions were still 66.5% of the national total.

Admittedly, reserve additions from Alaska and the OCS are gradually becoming more important. In the 8 years preceding this decade they averaged 28.4% of the national total, compared with 32.8% for the past 8 years and 33.5 % for the past 3 years. But given the growing de-emphasis on onshore possibilities by the majors and the corresponding refocusing of their domestic efforts on Alaska and the OCS during the 1990s, the surprising fact is that this rate of change was so small, not that it occurred. Companies that have limited their U.S. efforts to only Alaska and the OCS have thus effectively eliminated two-thirds of the opportunities for domestic reserve additions from their portfolios.

Next: Opportunities in the specific.

End-Part 1 of 2

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