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.
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.
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.
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.
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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