October 10, 2012 7:07 pm

‘Fracking’ to preserve US gas glut

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Operations At An Orion Drilling Co. Oil Platform©Bloomberg

In 2008, at the height of the commodity price boom, Devon Energy was running 40 rigs drilling into the Barnett Shale beneath the rolling green countryside of north Texas. Today it has just 10.

Squeezed by the collapse in US natural gas prices, which hit a 10-year low earlier this year, Devon has been cutting back its activity and redirecting the rigs it still operates away from “dry” gas wells and towards natural gas liquids, such as ethane and propane, that command higher prices.

US oil & gas data

US oil & gas data

Yet Devon, an Oklahoma-based independent oil and gas company, is producing as much from the Barnett Shale as ever – about 1.32bn cubic feet of gas equivalent per day.

For Devon, read the rest of the industry. While the number of rigs drilling for gas in the US has plunged, dropping 53 per cent in the past year, according to Baker Hughes, an oil services group, gas production has continued to grow.

This production boom has sent prices tumbling

Marketed dry gas production was 2,024bn cu ft in July, according to the government’s Energy Information Administration, not far off the record 2,042bn cu ft recorded in January.

Traditionally, the link between rig activity and production has been reasonably predictable. If the number of rigs drilling for gas fell below about 600-700, then gas production would start to fall.

Last week there were just 437 rigs drilling for gas in the US. But the EIA said on Wednesday it expected gas production to average 69.8bn cu ft per day in 2012, up 5 per cent from 2011, and to slip back by just 0.2 per cent next year.

One explanation is that there is a lag between drilling and production, and the full impact of the declining rig count has yet to be felt. Bob Ineson, senior director for gas at IHS, the research group, says that “other things being equal”, he would expect US gas production to drop in the fourth quarter.

Another factor is the increase in “associated” gas that comes off as a byproduct from wells drilled for oil or natural gas liquids.

As the number of gas-targeted wells being drilled has dropped, the number aimed at oil has soared, as companies seek refuge from low North American gas prices in more lucrative crude and other liquids. The number of oil-directed rigs working in the US has risen fourfold since the start of 2009, and by 31 per cent in the past year, according to Baker Hughes.

Simmons & Co, the investment bank, estimates that associated gas production from the “lower 48” states excluding Alaska will average 8.7bn cu ft per day this year, or about 13 per cent of total US production.

It argues: “The oil price is the critical production variable to watch for in 2013” with respect to gas supply. If prices stay high enough to sustain drilling for oil, then associated gas output will continue to grow.

More important for some industry executives and analysts is a structural reason for strong gas output: improvements in production techniques.

The shale revolution was made possible by advances in hydraulic fracturing and horizontal drilling, and both techniques have continued to evolve.

Five years ago, horizontal wells would typically extend 1,000ft-2,000ft sideways from the well head. Now they regularly run for 5,000ft.

Continental Resources, another independent company that specialises in shale oil production, has extended wells more than 15,000ft

Fracking, using a mixture of water, sand and chemicals pumped into a well at high pressure to crack rock, releasing oil and gas, has also become much more sophisticated.

“You can open up the reservoir more to produce more gas,” says Matt Jurecky at GlobalData, a consultancy. “It’s more efficient and lower cost.”

His conclusion is that unless there is some fundamental change, such as a decision to allow large-scale liquefied natural gas exports, US gas prices will stay at about their current level of about $3.50 per million British thermal units for the Henry Hub benchmark.

There is one other factor, however, that casts doubt on that analysis. Another reason for the decoupling on rig counts and production is that there is still a large backlog of shale gas wells that have been drilled but not yet brought into production.

As those wells are completed, they add additional production.

Arthur Berman, a consultant, points out that in the Haynesille shale in east Texas and Louisiana, the rig count peaked in the spring of 2010, but the number of wells in production was still rising two years later.

In his view, once that backlog of uncompleted wells is worked off, the shale gas industry will need an average price that is about double present levels to sustain production.

Mr Ineson at IHS, however, still believes prices can remain at close to current levels.

“I would expect to see periods above and below it,” he says. “But I would think that $3.50-$4 is a long-term cost base equilibrium.”

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