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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Could This New Business Model Save Fracking?

Could This New Business Model Save Fracking?

The hallmark of the fracking revolution in the US has always been persistent technological progress. Fracking only became possible as a result of technology pioneered by U.S. companies like Continental and Whiting Petroleum. Those companies, and many others, have steadily pushed the bounds of energy extraction over the last decade to make fracking cheaper and more efficient.

Now the latest technological advance may be on the horizon. “Refracking” is the process of going back to old wells using new technology to extract more resources. Devon Energy and Chesapeake Energy are among the companies looking at refracking as a low cost way of extracting more resources from existing assets.

Related: Saudi Arabia Continues To Turn Screws On U.S. Shale

Refracking is technically feasible at any of the approximately 50,000 existing wells that were drilled across the U.S. when fracking technology was still in its infancy. The benefit of refracking is the cost. Drilling a new well costs roughly $8 million whereas refracking an old well only costs about $2 million. That level of cost savings is far in excess of what can be saved by even the most aggressive of negotiations with suppliers when drilling a new well. And in today’s low oil price environment, every penny counts. In addition, because refracking is being done in existing wells, it is less likely to cause problems with local residents or environmentalists. Related: Alberta Election Result Changes Little For Oil Industry

Not all companies are eager to embrace refracking, however. EOG for example is publicly skeptical about the process at this point in time. The problem, according to EOG, is that refracking is still too risky from an economic perspective, given how little is known about actual recovery rates. Of course, twenty years ago most oil company execs were publicly skeptical about the ability to efficiently pump oil from many of today’s most prolific shale fields, but times change and technology advances. Refracking will likely convince its skeptics as it proves itself. Indeed the CEO of Andarko Petroleum has said just that – as the technology behind refracking improves, it will become more attractive. Related: This Tiny Nation Could Have Huge Oil And Gas Potential

The problem with refracking is that not all wells will be productive a second time around. Some wells may have had the majority of their extractable resources drawn out when they were first drilled, while others still have a lot to give. It’s not easy to say which wells are valuable a second time through, but data analysis can help. Baker Hughes, Haliburton, and Schlumberger are all offering services to help oil companies pick the right wells for refracking. Indeed these oil field services companies are so confident in the value of refracking that Schlumberger, for instance, is offering to foot the entire bill for refracking upfront, and then get paid back later as the well produces. With this kind of guarantee, it is hard to see a downside in the business.

Eagle Ford Shale wells are producing roughly 500 barrels per day of oil on average by some estimates. Given the widely cited 70% decline rate over the first year of production in a new well, and an $8 million well cost, that makes the extraction cost roughly $40-50 per barrel of oil produced. If refracking a well allows a recovery of even half the amount of oil as the original well, then the price per barrel extracted falls to $20 per barrel. In the current price environment, and with the big servicers willing to take on the initial production risks, that business model makes tremendous sense.

By Michael McDonald of Oilprice.com

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