Producers Playing Gas Supply 'Hole Card'

Abstract: Drilling deeper wells in shallow Gulf of Mexico waters has the potential for adding up to 20 tcf of gas/condensate to the reserve base, particularly if a new royalty relief proposal is approved.

Analysis: In light of what’s been covered so thoroughly and insightfully recently by other Oil and Gas Advisory analysts vis-à-vis North America's natural gas supply situation, it might be appropriate to pay heed to a developing trend in brand-new domestic gas supply. And while this "hole card" probably won’t provide a long-term solution to meeting U.S. demand, it could help considerably in the short run.

This ace in the hole is the deep gas that's being found in shallow offshore areas of the Gulf of Mexico.

Taking a tip from 10 or more years of deep gas development in South Texas and related gas plays along the Alabama-Mississippi-Louisiana inshore region, a growing number of offshore operators are returning to the vast submerged lands of the Gulf's Outer Continental Shelf (OCS) area both to drill new deep wells and deepen existing ones. Their goal is to find the offshore counterparts of the prolific deep onshore gas plays, and they're having more than modest success in so doing, particularly with the higher average wellhead prices seen during the past couple of years.

Hip-high in that deep OCS drilling are a growing number of small and mid-size independent producers, some working their own leases and others earning equity by drilling those held by larger counterparts. In either case, new gas is being found at deeper horizons in even the shallowest of Gulf Coast bays and sounds, most of whose upper-level oil and gas reservoirs were developed originally as far back as a half-century ago.

For the record, deep gas on the OCS is defined as both natural gas and condensate production found at drilled depths greater than 15,000 ft below sea level in water depths of 650 ft or less. Currently, the action is taking place in water depths much, much shallower than that. The "rebirth" of the Gulf's OCS has been widely discussed, both in these pages and elsewhere; however, the increased publicity now being given to perceived domestic natural gas shortfalls gives that rebirth added meaning.

Houston-based El Paso Corp., the overall management of which is being contested currently and which could be caught up in a particularly nasty proxy fight in the near future, has been involved in a number of noteworthy strikes in deep Gulf OCS drilling. El Paso has deepwater operations, as well, but its ownership of newly productive shallow-water leases is what has dominated the news--at least, until the threatened proxy fight issue arose.

Two years ago, El Paso's production business unit, which applied its onshore South Texas deep gas experience in the Gulf, drilled a discovery well at South Timbalier Block 204 (ST-104), located in about 150 ft. of water about 50 miles south-southwest of Morgan City, LA. The well bottomed at below 18,000 ft. measured depth, and was completed as a prolific gas well. In fact, the company said it could be the biggest OCS discovery in a decade, though they didn't give test rates.

Subsequent development of the ST-104 field revealed it to be just so, with proved reserves listed by McMoRan as 400 to 600 bcf of gas equivalent (bcf/e) from a series of wells ranging in depth from 17,600 ft to 19,000 ft. And since the field is located in comparatively hip boot-deep water, the company was able to install a relatively inexpensive fixed platform jacket before development wells were drilled, and then install a used deck section for handling production. Because the area already was strewn with existing gas transmission infrastructure, the field went on production only three months after the discovery well was completed. El Paso Chairman Rod Erskine has said the discovery well cost $16 million to drill and paid out in only 60 days. The subsequent wells--all reportedly prolific gas and condensate producers--apparently were even less expensive to drill, so payout for them was even quicker. Compared to deepwater drilling/production, the costs for developing deep OCS' gas seem to be decidedly less, even with the added expense associated with greater well depths, including larger-diameter casing and drill pipe and larger, more sophisticated drilling fluid systems.

But the ST-104 discovery wasn't all for El Paso in terms of deep OCS gas drilling.

New Orleans-based McMoRan Exploration Co. also has made some sizable deep gas discoveries on the OCS, two of which were announced this year alone. The wells were drilled as part of a joint venture exploration program it formed with El Paso. That joint program, announced only a year ago (June 7, 2002), covered four shallow-water, deep gas prospects on 100,000 acres held by McMoRan. Under the program, El Paso agreed to fund all exploration drilling and development costs for 100% interest in the four prospects until aggregate production reaches 100 bcf/e, after which 50% interest would revert to McMoRan.

McMoRan, created in 1994 out of the liquidation of a joint venture that operated an offshore sulfur mine, has since become an active driller on the Gulf OCS.

Six months after the El Paso deal was cut, McMoRan announced a discovery on the JB Mountain prospect in South Marsh Island Block 223--one of the aforementioned El Paso prospects. The well flow-tested at a rate of 14.3 mmcf/d of gas and 1,056 b/d of condensate, with no water production, on a 14/64-in. choke. Flowing tubing pressure was a whopping 13,300 psi, hitting the red line for the gas testing equipment used. Engineering analysis indicated the well had the potential to produce 61 mmcf/d of gas and 4,900 b/d of condensate. Initial production is expected any day now, and offset wells are being staked and drilled.

Then, this past April, McMoRan announced that another of the prospects it's testing under the El Paso program also had significant potential hydrocarbon pay intervals. This well, drilled on Louisiana State Lease 340 (and called the Mound Point Offset) is located about six miles northeast of the JB Mountain discovery, though McMoRan says the potential pay zones are located at shallower depths than those found in the JP Mountain well. Earlier in the year, McMoRan drilled a well in the state block that reportedly flowed at various rates from 10 to 20 mmcf/d of gas (during January 2003) before mechanical problems prompted temporary abandonment.

Both prospects are located in about 10 ft of water, and were drilled with posted barge rigs, an offshore rig type once considered virtually obsolete, since much shallow water drilling in the Gulf gave way years ago to exploration in deeper water, hastening the predominance in the offshore fleet of deepwater jackups, semisubmersibles, and drill ships. Meanwhile, McMoRan is drilling or planning to drill deep tests on the two other prospects in the El Paso program, each in relatively shallow water.

There are other deep Gulf OCS gas discoveries, of course. But the U.S. Minerals Management Service (MMS) said the specific wells mentioned above prompted them to update a 2001 report, "The Promise of Deep Gas in the Gulf of Mexico (OCS Report MMS 2001-037)," and release it in May at the Offshore Technology Conference in Houston.

In the update, the agency describes production from deep wells on existing leases in the shallow-water Gulf as "one of the most attractive sources of additional natural gas" needed to help meet the nation's near- and mid-term energy needs.

According to the MMS update, while deep OCS gas production actually declined about 29 percent from 4.76 tcf per year in 1997 to an estimated 3.36 tcf per year in 2002, well data reveal that higher production rates can be expected on the OCS when drilling targets formations deeper than 16,000 ft true vertical depth subsea. It estimated that the potential of undiscovered recoverable resources for shallow-water Gulf deep gas falls somewhere in the range of 5 to 20 tcf, with the mean estimated at 10.5 tcf.

According to MMS records, operators drilled 75 wells deeper than 15,000 ft during 2001. Of that total, 40 were drilled deeper than 16,000 ft, 27 deeper than 17,000 ft, and 16 deeper than 18,000 ft. Of the 75 wells, 45 were completed, four were temporarily abandoned, five were sidetracked, and 21 were plugged and abandoned. In 2002, operators drilled 64 sub-15,000-ft. wells. Of that total, 39 went below 16,000 ft, 27 were deeper than 17,000 ft, and 18 went beyond 18,000 ft. Of the 64 wells, 32 were completed, 10 were temporarily abandoned, nine were sidetracked, and 13 were plugged and abandoned.

The indicative success rates of the 77 deep OCS completions (with average well statistics listed in the update), combined with sharp rises in natural gas prices this past winter and declining gas production in other Gulf of Mexico areas, was instrumental in bringing MMS to draft a proposal in March that would provide royalty suspension incentives when companies risk drilling for deep gas on already-leased OCS acreage. The proposal would cover some 2,400 existing OCS leases. After time for public comment, MMS would introduce the proposal for formal action and draft legislation under existing rules.

There is a precedent for the proposal. The agency has included a deep gas royalty incentive for new leases in deepwater (more than 5,000 ft.) since March 2001. That rule is thought to have at least marginally influenced an increase in wells drilled in the deepwater Gulf.

All this would indicate that with such a deep OCS gas royalty relief rule in place, Gulf of Mexico operators likely would enhance deep drilling activity there, hopefully adding some potentially significant new natural gas and condensate supplies to the country's dwindling reserve base.

It also might help stimulate construction of any number of new posted barge and shallow-water jackup rigs equipped with state-of-the-art deep drilling equipment, since many of the existing ones--most of them 20 years old or more--are only barely geared up to drill below the 15,000-ft mark. With many of the current wells going to total depths below 19,000 ft, it won't be long before merely upgrading older rigs simply won't fill the bill.