Is current shale production a decoy?

By Kate

While cynics would argue that the precipitous decline in the price of oil stems from yet a new chapter in geopolitical oil-driven politics, as Saudi Arabia and the OPEC oil cartel have driven prices down to destroy the US shale revolution, such tunnel vision causes many to miss the bigger picture. While significant US shale oil production will become uneconomic at an oil price of less than $80/barrel, too narrow focus on the cost of production would overlook a crucial fact: much of that resource potential remains nothing but potential, based on companies’ estimated recoveries, not on fact.

A few weeks ago, Mohammed analyzed the Monterey shale [here], a project that is but the canary in the fracking well: an omen for the future of the increasingly tenuous “US shale revolution”, a miracle borne out of erroneous estimates and an overly optimistic view on the potential for future US shale production.

Source: Bloomberg New Energy Finance

Undoubtedly, the growth of US shale gas production has been a game-changer in a natural gas supply picture, driving significant investment in new generation gas distribution infrastructure, a dramatic reversal in US trade balances, and the proclamation by politicians and pundits alike that it is time to usher in a new era of North American energy independence. This new paradigm of “North America as the new Middle East”, buoyed by production growth far exceeding expectations, has led analysts to predict a secular transformation in the US economy and oil politics. In the views of one analyst, new oil could create “billions of dollars of new output, three or four million new jobs, a current account deficit slashed by half or more, and a strengthened dollar firmly reasserted as the reserve currency of choice.”

Caveat emptor.

The EIA’s utopian view of future US shale production has engendered increasing cynicism: analysis at the firm level of shale drillers reserves reported to the SEC in regulatory filings, versus resources presented to investors, suggests a discrepancy of nearly five times (33bn barrels reported versus 163.5bn in resources). As the world has gained experience in drilling unconventional wells, it has become increasingly clear that past performance may not be a predictor of future results. While most shale plays have limited production histories, evidence has suggested that unconventional wells have decline rates far above others – and, as in the case of Monterey, where reserve estimates were slashed by an unbelievable 96%, greater technical challenges that may jeopardize the ability of firms to deliver promised results.

At the heart of the issue lies a debate over methodology and geology: the de facto analysis employed by firms to estimate potential reserves relies on a formula derived by a petroleum engineer in 1945, basing projections on decline analysis that can forecast a well’s future production rates and the estimated ultimate recovery. The decline rate, or the negative relative change of production over a time period, is thus the critical assumption that drives our expectations for potential reserves. Given that unconventional drilling represents such a paradigm shift versus conventional, it would appear highly dubious that such extrapolation would translate equally.












A recently published report, “Drilling Deeper,” attempts to unpack these issues through an in-depth critique of the EIA’s forecast, finding that barring new discoveries, production from the Bakken and Eagle Ford will underperform EIA estimates by 28%. More critically, while short-term production will be robust, the report finds that such production levels from the major shale plays is far from sustainable – calling into question the new utopian paradigm of “Saudi Arabia” espoused by so many analysts, politicians, and firms alike.

The implications are far-reaching. A myopic focus on price-driven geopolitics misses the point: if resource potential is indeed many times overstated, then the US shale revolution will far from fundamentally transforming the energy landscape. It may in fact be creating perverse incentives if firms chose not to pursue more sustainable alternatives as a result of the seemingly cheap and plentiful domestic available supply of oil and natural gas. As a result, it is incumbent on both policymakers and firms alike to focus on the implications of the Monterey Shale writ large: echoing Mohamed’s original post, what happens when the other operators in the US follow suit?







Citi GPS: Energy 2020 –North America, the New Middle East. 20 March 2012

J. David Hughes. “Drilling Deeper: a Reality Check on US Government Forecasts for a Lasting Tight Oil & Shale Gas Boom.” 2014


About macomberjohnd

HBS Finance faculty interested in sustainability in the built environment including devices, structures, townships, and cities.

3 Responses to “Is current shale production a decoy?”

  1. This is a complex issue with many contradictory or misleading available graphs and numbers without digging deeply into the underlying facts.

    In my view, it’s no surprise that these wells have steep decline curves; it has been a well-known fact from the first day these resources have been exploiting. The big disparity between reserves report to SEC and to investors most likely is the difference between the proved, probable, and possible reserves (which are related to the probability). SEC presumably requires higher levels of geological de-risking in order to report. These oil companies then have incentives to play up their lower-probably reserves to investors because it can have a positive impact on their share price…but this game is nothing new. Oil companies did this far before shale resources became commercially viable. And as for the Monterey shale in California, I had been deeply involved in unconventional and shale resources at the time everyone was talking about this, but none of the experts that I had talked to were ever terribly bullish on the Monterey.

    It is true that the shale revolution has slowly become scaled back to a more realistic level of optimism. The Polish shale resources, for example, fell flat due to its unfavorable and fragmented geological characteristics. Many other shale plays that were originally optimistic have since been shown to be less than ideal. Yet again, this is the game of oil and gas…this should be nothing new to anyone.

    What is being completely missed is the enormous potential that lies within the existing plays. Let me explain: once there was a realization that we could economically produce what was in these geological formations, there was a huge land-grab. Oil companies were quietly but aggressively pursuing wide-spread land rights in any region with even the smallest amount of potential. Because if it was shown to be a good area after some pilot wells were drilled, the cost for land rights would sky-rocket, seriously denting the NPV of developing the field for late entrants. Chesapeake, one could argue, was more of a land development company than a true oil company (consistent with Aubrey’s history as a land-man). But now all these oil companies have all these land rights, usually acquired on a section-by-section basis. If the land is good, they need to poke a hole in every section before their rights expire. If they do get a well on the land within this timeframe, then they can retain the rights. This first well is usually required within 3-5 years of acquiring the mineral rights.

    Let’s recap what we have so far: big land-rush, followed by a big rush to drill one hole in each mile-squared section to retain the land’s mineral rights. Now what? First is temporary over-production because the drilling is being driven by land retention first and economics second. But after everything has corrected activities levels out again. But now if I am an oil company, I have one well on each section while each section has enough reserves for 5-10 wells. So I have only exploited 10-20% of what I’m sitting on. And the best part is: I can probably do the rest of it cheaper by using multi-well pad drilling techniques (more than one well from a single location) with minimal geological risk , so my F&D costs start dropping. Meanwhile production optimization techniques will keep improving ultimate recoveries. This is the long farm-out period that we can expect to last ~20 years.

    Natural gas is just entering the farm-out cycle. They had the land-grab, the huge drilling activity for land retention, followed by a glut and massive price drop (down to ~$2/mmBTU). Then they stopped drilling for a while in gas while prices stabilized back up to $4, and now they are back at it in a more measured and efficient way. Oil is a few years behind the gas cycle: they’re just having the price crash. Rigs will move sit idle for a bit (which also will have benefits because lower rig utilization = lower rig day rates) while oil prices stabilize back to a healthy level, and then the long farm-out period begins. This is what makes shales unique to conventional fields, is the enormous resource size that has driven this land-grab followed by long farm-out timeframe. Oil companies have not put themselves in a bad place in the US, rather the smart ones have strategically pokes lots of holes in order to retain a long-term asset that will pay out of the next couple decades.


  1. Response: “Is current shale production a decoy?” | Innovation in Business, Energy, and Environment - December 2, 2014

    […] is a further response to the original post here and a comment here. It’s entered as a new post to preserve formatting and graphics – John […]

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