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Tech Miracle In U.S. Shale Is A Media Myth

Midland Oil

I am tired of hearing about the unbelievable impact of technology on collapsing U.S. shale production costs. The truth is that these claims are unbelievable. The savings are real but only about 10 percent is from advances in technology. About 90 percent is because the oil industry is in a depression and oil field service companies have slashed prices to survive.

Zero Hedge posted an article yesterday called How OPEC Lost The War Against Shale, In One Chart that featured the chart shown below from a Goldman Sachs note.

(Click to enlarge)

Figure 1. Short-cycle shale has engendered a structural deflationary cycle. Source: Zero Hedge and Labyrinth Consulting Services, Inc.

Zero Hedge (and/or Goldman Sachs) erroneously states that “the cost curve has massively flattened and extended as a result of shale productivity.” If I read the chart correctly, the flat portion attributed to “shale” represents ~ 10 mmb/d but tight oil only produces ~3 mmb/d.

This little arithmetic problem and the fact that the entire 2017 cost curve has shifted downward ~$15/barrel from the 2014 curve indicates that the true point and message of the graph is that break-even costs for all producers have fallen almost 25 percent.

My business is working with clients who drill onshore U.S. oil and gas wells. Rig rates have fallen 40 percent since the oil-price collapse. One client had a bid for a drilling rig in September 2014 for $27,000 per day. By the time he signed the contract in March 2015, the rate was only $17,000 per day. Another client recently ran a special high-tech log in a well whose list price was $75,000 but he only paid $15,000 after discounts were applied. Related: Busting A Myth: U.S. Dollar Impact On WTI

Most of the celebration of efficiency and productivity is really about a depression in the oil industry that has resulted in massive price deflation. I estimate that only about 10-12% of the cost reduction is because of technology and most of that was a one-time benefit in the first year or so it was used. Going forward, efficiency gains are a few percent at most.

Our forecast assumes that productivity declines 8% by the end of 2018…We believe a significant portion of the productivity gains being experienced by the sector outside of the Permian are the result of high grading and will revert in future years. Cost pressures are already surfacing in the Permian, which will dampen capital efficiency going forward.

—Bernstein E&Ps ( 10 March 2017)

Break-even price is mostly a function of well cost, flow rate and EUR.

I have already addressed well cost. Most companies and analysts routinely exclude G&A (General and Administrative costs or overhead), royalty payments, federal income taxes, depreciation and amortization (“EBITDAX”) from their costs. Excluding cost is an excellent way to reduce break-even price except that it does not accurately represent break-even price.

Even if we accept these break-even prices, does anyone knowingly invest in things that don’t make any money? Sorry, I forgot about negative interest rate European bonds.

The EUR used for break-even prices in charts like Goldman Sachs’ are largely unknown but bigger EUR means lower break-even prices.

Companies routinely report EUR in barrels of oil equivalent (BOE) that use a natural gas-to-BOE conversion of 6:1 based on energy content but a value-based conversion including natural gas liquids is 15:1.

For gassy plays like the Eagle Ford and Permian basin, this conversion sleight-of-hand produces ~35 percent inflation in EUR. It is perfectly legal for reserve reporting but it is a dishonest way to represent break-even price since companies are getting ~$2.50/mmBtu for gas and not the $6.25/mmBtu implied by the 6:1 conversion. Related: OPEC Out Of Moves As Goldman Sachs Expects Another Oil Glut In 2018

Advances in technology have resulted in higher early production rates increasing net present value. In many cases, however, these are accompanied by increased decline rates and lower EUR. Figure 2 shows an example from the Bakken Shale play.

(Click to enlarge)

Figure 2. Comparison of 20-mMonth cumulative production and normalized decline rates for the Bakken Shale play. Source: North Dakota Pipeline Authority, Drilling Info and Labyrinth Consulting Services, Inc.

The chart above shows 20-month cumulative production data suggesting that well performance has improved every year. The chart on the right shows decline rates for the same years of production. It shows that, in fact, well performance is decreasing from 2014 through 2016 because of higher decline rates.

Technology does not create energy. The effect of better technology is a bigger spigot that produces the energy faster. The downside of the technology is that it increases the rate of resource depletion.

Costs have come down for all oil and gas producers since the oil-price collapse in 2014. Most of the savings are because of lower oil field service costs and not so much because of improved technology.

By Art Berman for Oilprice.com

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  • Lee James on March 22 2017 said:
    Maybe accelerated drilling and pumping rates give the appearance that somebody's in the money. Sometimes I think that investors do not look all that hard at extraction cost ... that we by now must have reached market bottom; profitable days are here.

    Trouble is, there's nothing cheap or easy about bringing in diffusely-held oil in source rock deep underground where the best indicator of what's in store for you is how well the guy next to you did with his expensive deep and long well.

    We may need a better energy railroad. Is there a transition that we need to be looking at?
  • Shabahat on March 22 2017 said:
    what difference it makes if tech has caused 80 or 20 % ; bottomline is how much thw break even cost has been lowered; do you have an answer for that.

    thanks
  • NickSJ on March 22 2017 said:
    "Technology does not create energy. The effect of better technology is a bigger spigot that produces the energy faster. The downside of the technology is that it increases the rate of resource depletion."

    This is obviously incorrect. It is technology which has made possible every energy source in the last couple of hundred years. At one point we were running out of whales for oil. Then drilling for shallow petroleum deposits was invented.

    A hundred years ago it was thought we would run out of petroleum within the next couple of decades, but advances in technology have opened up new energy sources on land, under the ocean, in oil sands, and now in shale, so reserves have continued to grow after many decades of production at higher and higher levels. As has been said, we don't just find resources, we invent them using technology.
  • zorro6204 on March 22 2017 said:
    And yet the majors are piling into shale, saying things how they can drill sixteen wells per rig per year rather than six in 2013, and how much knowledge they've gained into how much sand to use and when. Chevron says they have 3,000 wells that work at $40, and 5,000 at $50. Guess they're all doing their sums wrong. Or . . .
  • Rick on March 23 2017 said:
    Oil drilling business forced to become lean and mean? Too bad so sad. Welcome to the modern economy this shows how much fat was marbled into this overpriced commodity.
    In my business (abrasives) this has been going on for thirty years.
  • Teddy on March 23 2017 said:
    At the end of the day these companies will say anything to get more money from Wall Street to fund their ridiculous ideas. And as long as John Smith running your local Edward Jones keeps buying CLR and DVN and stuffing it into some poor guys portfolio these shale plays will go on for years. Had I guy from Apache drop off his resume at our office last week. I asked him about the big Alpine High discovery their company has been touting. Let's just say most in the company think the whole thing is a big reach, save for a few guys out in the San Antonio office who are getting paid to rave about it's potential. It's mostly just another gas play and everyone has known about the gas there for years, but also know it's not economical to develop at these prices either.
  • Matthew Biddick on March 23 2017 said:
    Great article, Art. I think Nick needs to understand that the statement on technology was narrowly focused on the economics of horizontal wells, particularly in the Bakken in 2016.

    Many of us have long said that the the old "BOE" measurement was very misleading. You are dead-on with that analysis. Many, many of these horizontals, even some with impressive initial potentials, are never going to payout.
  • DanielP on March 23 2017 said:
    Not a single commenter has the hands on experience that Art Berman does working in the oil business for 36 years. Art Berman is using data backed conclusions demonstrating that we are not making money with shale oil production. But no one wants to hear that America is NOT winning the crude oil price war with OPEC countries.

    Arts information, again, is from an expert professional Geologist that is still working as well as giving presentations to numerous Geological Societies and other groups associated with the oil & gas business. His work is on par, and no one wants to hear his answers. Our country needs to wake up because what wall street is telling folks in order to get more equity to give to the shale oil producers is absolutely wrong. Art doesn't deal in opinions, he deals in factual data. Regards.
  • Steve on March 23 2017 said:
    @DanielP - Art has been shouting that the sky is falling for several years now, all the way back to the Peak Oil days.

    He's knowledgeable for sure, but his analyses should be taken with a grain of salt.
  • DanielP on March 23 2017 said:
    @Steve - In years past I ignored Art Bermans work myself. I am a Geologist (LPG) the same age as Berman. His work on Peak Oil is correct as we ran out of economic cheap conventional oil, and now we must pay a much higher price for the unconventional crude oil that the world needs to meet demand. The price of the unconventional oil is something that the world economies cannot sustain. Peak Oil was all about economic conventional oil, and Art has been on the mark regarding Peak Oil. It took me a while to buy into Arts work, but realizing that his work is based on data driven analysis, I eventually realized his work was right, but most folks do not want to believe it since it is not giving them the answer that they want or like. Regards.
  • Robert on March 24 2017 said:
    There are not very many independent exploration companies left. Most are investor financed wall street speculation.
    Return on investment is the ultimate demand, to the point that no one person or service company is no expendable.
    There is a physical limit to all technologies, eventually it becomes counter productive to "BEAT THE CURVE" and places serious safety implications on performance.
    The service contractors will eventually say "Enough" and as they have done in the past, refuse work which is losing money. This goes full circle with all "Contractors".
    Then what happens? Skyrocketing production cost. Feast or famine.
    The Petroleum industry is the worst ran industry in the world, that is fact. People whine of D.C Cronyism, they ain't seen anything like the oilfield "Buddy System" kick backs galore, old as prostituiton...well almost......
  • Bob on March 24 2017 said:
    @DanielP - Like you I’ve followed Art for years, sometimes with healthy skepticism, but nevertheless some years back I read his article (World Oil, August 2009) regarding unconventional plays and using immense data from the Barnett as a qualifier. Since then I’ve studied with great interest Art’s perspective and found the veracity of his analysis uncanny, particularly in hindsight (isn’t that ultimate validation?). I’ve been in the oil and gas business and a practicing petroleum geologist for 40 years. Over the years, through direct involvement, I have evaluated, and continue to evaluate, numerous unconventional plays (e.g., the northern Oklahoma Mississippi Lime - that worked well - and the venerable STACK play), and constantly find myself ashamed of some in the “industry” for disregarding any semblance of candid, honest assessment and moving the goalpost every time the data isn’t convenient. I’ve heard (off-the-record setting) an active operator in some of the “hot” plays comment about their short-term exit (monetization) strategy and how their agenda compares to the sub-prime mortgage debacle of bygone days - they actually used those terms!! I also read where an industry executive responded to a Dallas Federal Reserve Bank questionnaire regarding economics of the Permian, and compared it to a Ponzi scheme (Dec 29, 2016 survey; source: Financial Times). So we’re not alone in our thinking. Art, where there is light darkness cannot dwell; so keep the torch bright!
  • MerLynn on March 25 2017 said:
    Miracle... a technology above that which you understand.
    Oil Tech Miracle?
    At magneticwaterscience.com you can ask nicely and be given the password to videos showing water being turned into oil and burnt. Its so pure it doesnt need refined to pour into a VW Golf Diesel car's tank. Apparatus: water, 12V car battery and some stainless steel pipes.
    All we did/do is understand the Earth's magnetic Fields and duplicate its Field interaction with underground water. If left to dry out our 'oil' becomes 'coal'.
    Its unfortunate the alphabet agencies have a vested interest in fossil geology for stealing your hard earned work. The above fake shale oil tech proves it.
  • JC on April 06 2017 said:
    zorro6204 - the oil majors often 'pile' into things they later regret.
    Shabahat - you might have read the article, but you didn't understand it. 80% of the savings have come from lower rig/service co' rates. As things improve and rates go up, that saving will disappear.

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