U.S. Shale Depletion Worries are Overblown

Note: Drilling in the Lower Tertiary over the last three years indicate an additional 15 billion barrels of recoverable oil remain in the Gulf of Mexico. To put this in perspective, the EIA estimates U.S. total oil reserves of 26 billion barrels. An additional 15 billion barrels of reserves will propel the U.S. from 14th to 10th in a global ranking of countries with the most recoverable oil reserves. Because of this, Wood Mckenzie projects oil production in the Gulf of Mexico to reach 2 million barrels/day by 2020–up from 1.3 million barrels/day to a record high. As we have mentioned, the days of U.S. energy independence–fueled by a renaissance in domestic production, as well as significant investments and breakthroughs in renewable energy–are inevitable. Drilling and production in the Lower Tertiary is simply another part of the energy independence equation.

Onto our main commentary: The worries over oil and gas well depletion rates are nothing new. During the 1970s, natural gas wells in Texas only averaged a 16% first-year decline rate. By the late 1990s, this hit an all-time high of 56%. As a young natural gas analyst in Houston, TX during 2000-01, I was stunned by these high depletion rates, and was convinced that domestic natural gas production would more than halve over the next decade.

TX Decline RatesSource: Oil & Gas Journal, Gary S. Swindell & Associates

At the very least, such depletion rates, even with flat demand growth, would require a substantial amount of Canadian and LNG imports. Obviously, this turned out to be a false assumption, courtesy of the adoption of horizontal drilling rigs and the commercialization of shale fracking. Here’s what I learned: Higher depletion rates were not a function of less productive wells; rather, they were a function of better extraction technologies, as well as investors’ demand for higher IRRs at the expense of higher long-term production if short-term production was capped (IRRs increase substantially if production, and thus monetization, is front-loaded). We simply turned into a culture where we could and did suck out the oil and gas faster than ever before.

Make no mistake: It is important to track and analyze depletion rates in the six most prolific shale areas–the Bakken, Eagle Ford, Haynesville, Marcellus, Niobrara, and Permian–as these six key fields accounted for nearly 90% of domestic oil production growth, and nearly 100% of all domestic natural gas production growth during 2011-12.

dpmapv3-wtitleTo that end, the Energy Information Administration (EIA) publishes a monthly “Drilling Productivity Report” that tracks depletion rates of legacy fields and initial production rates of new fields in these six key shale plays. As long as initial production on new fields outpaces the decline in production of legacy fields, the increase in oil and gas production in these six shale plays will continue. The latest evidence suggests this remains true. For example, early indications in the Eagle Ford Shale suggest that both oil and natural gas production rose to another new high this month, as production from new wells outpaces the decline in legacy production.

chart2eagleford

Finally, current rig counts and recent productivity gains in both the Bakken and Eagle Ford regions suggest new production growth should comfortably offset future decline rates. In addition, production growth actually accelerated in the Niobrara and Permian. In other words, there is ample evidence suggesting that shale oil and natural gas production in these six shale areas will continue to grow–and to drive U.S. energy independence–for months, if not years to come.

bakken&eaglefordrigs

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