Musings: Is The Oilfield Service Industry Staring At The Up Escalator?

Musings: Is The Oilfield Service Industry Staring At The Up Escalator?

As shown in Exhibit 4, Texas is the number one natural gas producing state in America. According to the Form 914 monthly natural gas production survey for August (latest data available), Texas produced 22.41 billion cubic feet of gas a day. Texas accounted for 29.3 percent of the nation's total gas output in August, 30.9 percent of Lower 48 gross gas output, but importantly 32.6 percent of Lower 48 land gas production. As shown in the chart, Texas has only recently been surpassed in natural gas output by the collective production of all the remaining states in the U.S. except for Oklahoma, New Mexico, Wyoming and Louisiana, and the volume of gas coming from the Federal waters of the Gulf of Mexico.

Exhibit 4. Texas Most Important Gas Producer

As the gas shale revolution has swept the U.S., one concern has been the sustainability of gas output from shale wells. Some analyses have shown that unless the petroleum industry continues to add producing gas wells in shale basins, production from existing wells drops rapidly. Recently, consulting geologist Art Berman examined the production of gas wells in Texas, home to several important shale plays. Mr. Berman prepared a chart (Exhibit 5 on the next page) showing the percentage of first half of 2012's gas output in Texas that came from wells drilled in the years since 2000. Since the column representing 2012 reflects only the output from the first half of the year, it is not surprising that it is only a fraction of the height of the column representing production from 2011 and 2010. As the chart shows, almost 30 percent of current Texas gas production comes from wells that first produced in 2011. Generally, what the chart demonstrates is an upward sloping curve of well contribution to current production as we move closer to the present. We decided to add a line (red) showing the annual number of natural gas wells drilled as reported by the Texas Railroad Commission web site. The peak in gas wells drilled occurred in 2008 while the peak in current gas output contribution was in 2011. This lag reflects the timing between drilling of wells and their completion and production. During 2008-2011 there was generally a shortage of hydraulic fracturing equipment meaning that wells typically had long waits between drilling and completion and production.

Exhibit 5. Importance Of Recent Texas Gas Wells

Another way of looking at the data is by the cumulative percent by year of production that is represented in the first half of 2012 gas production volumes. (Exhibit 6.) The significance of this analysis is that 56 percent of current Texas natural gas production comes from wells drilled in the last 30 months. Fully 75 percent of total gas output comes from wells drilled in the last 54 months, and less than 20 percent comes from wells drilled before 2008. Increasingly, we are relying on gas output from new wells as older wells have declined to such low volumes that collectively they are becoming marginal contributors.

The significance of Mr. Berman's recent Texas gas production analysis, which he has supported with a similar analysis of the production performance of Barnett shale wells, is that it confirms observations he made two and a half years ago in a presentation. Not only does it confirm those projections, but the data shows the current situation to be worse than projected. We suspect what has made the current situation worse is that producers have embraced using more hydraulic fracture stages per well, which drains reserves faster leading to sharply lower future production volumes.

Exhibit 6. Gas Production Declines Without New Wells

In Exhibit 7, we show a slide from Mr. Berman's SPEE presentation made in February 2010. We could have selected several of his well production graphs, but this chart summarizes his questions for the bullish view of gas shale production. A principle assumption is the long life of producing wells, even though they add little production and, based on the time value of money, little economic value for the play. As the notes on Mr. Berman's slide suggest, 70 percent of the value of gas shale wells is produced in the first five years with 85 percent is produced within ten years. As the Texas data suggests, more than 75 percent of the production has come in the first five years with over 85 percent of it delivered within the first six and a half years.

Exhibit 7. An Optimistic And Prescient Scenario

Based on this analysis, it is very likely that producers are facing the prospect they soon will have to step up their gas drilling efforts in order to sustain production levels. While they may not do that in the near term, opting instead to let production fall in order to drive up gas prices. The one bad thing for producers that has come from the American gas shale revolution is that consumers are beginning to institutionalize the concept of growing gas volumes with continued low gas prices. Allowing production to fall and prices to rise will be the only way to re-educate gas buyers as to the rules of supply and demand, which many people think have been overturned. The oilfield service industry is likely staring at the up escalator of future drilling and completion work, although they probably can't see it for the downward pressures of current activity declines and fierce price competition. Companies with liquefied natural gas (LNG) export terminal applications pending before the Federal Energy Regulatory Commission (FERC) may want to reconsider how much effort they spend on these soon-to-be white elephant facilities.

G. Allen Brooks works as the Managing Director at PPHB LP. Reprinted with permission of PPHB.


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Hallucigenia | Dec. 1, 2012
Its worth noting that even as of January 2009, 25-30% of US gas came from wells <12 months old, and nearly half came from wells drilled in the previous 3 years - see page 1 of htt*:// Since then the gas rig count has crashed, yet the headline price has also collapsed. Sure, delayed completions are part of the story - but the soaring oil rig count has also played a big role. Particularly in Texas, where youve got a lot of wells being drilled as "oil" wells to produce liquids in the Eagle Ford, which throw out a lot of gas as a byproduct. That shift to gas from oil wells means that you cant just look at wells classified as gas wells when predicting where the market will go in future, it will inevitably take time for a new equilibrium to establish. However once the market is relying on shale gas wells as the marginal producers, then yes prices will be considerably higher. Its worth reading that piece from Fortress (no affiliation) from September 2009, which uses similar logic to this article to predict soaring gas prices - of course it didnt happen. As for LNG exports - the companies are interested in the differential between US prices and world prices, not the absolute value of US prices....

cooilman | Nov. 26, 2012
As the managing director at PPHB, can you further explain the following statement from your article? "The peak in gas wells drilled occurred in 2008 while the peak in current gas output contribution was in 2011. This lag reflects the timing between drilling of wells and their completion and production." Because I have a hard time believing that you actually believe wells drilled in 2008 were completed in 2011. The increase in production is a result of the boom in horizontal drilling and advances in fracking. If you disagree, I would appreciate seeing examples of wells drilled, but not completed for 3+ years.

Doug Sheridan | Nov. 22, 2012
Its important to point out that although the shale the industry might be on a treadmill due to the high decline rates, the gas is in fact there. Low prices and healthy inventories for most of this year are evidence that both operators and service companies are up to the task when it comes to increasing their rates of investment and drilling activity. And remember, the high decline rates could only occur if large initial production is being observed. And since when is getting MORE gas from a well SOONER a bad thing?

Robert Green | Nov. 22, 2012
While I lament the use of terms like "...institutionalize the concept..." of lower priced gas, I think the study underlines the risks of investing in shale gas plays using current technology. The short-term thinkers in investment analysis who are undoubtedly looking at the various shale gas plays should look at the long-term consequences of diminishing product in terms of return on investment (ROI). The author is correct in warning about the media hype over the availability of the gas resource.


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