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.
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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.
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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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