- US shale gas production has grown from around 4 billion cubic feet (bcf) per day in 2007 to around 26 bcf/day in 2012
- US gross natural gas production has grown from a plateau of 2 trillion cubic feet (tcf) per month in the period 1995 to 2002 to 2.5 tcf per month in 2012
- Some believe this is marching the USA towards energy independence while others believe, owing to costs and decline rates, that this may be an energy bubble
- At the end of 2011, shale gas accounted for 32% of total US natural gas production (EIA data)
- Pre 2008 financial crash, there were roughly 400 rigs drilling oil in the USA and 1600 drilling gas. Today it is roughly 1400 drilling oil and 400 drilling gas
- The fall in US prices to <$2 in 2012 has created the illusion that shale gas is cheap while in fact over-production caused a crash in the price in US natural gas to below the level where it was possible for companies to make a profit
- What is the real cost of shale gas? “Some wells are profitable at $2.65 per thousand cubic feet, others need $8.10…the median is $4.85,” attributed to Ken Medlock, Senior Director of Rice University’s Baker Institute Center for Energy Studies
Figure 1 The astonishing evolution of global annual average natural gas prices according to BP. Shale gas development in N America, The Fukushima nuclear disaster and a shortage of LNG explains much of what is going on. The grey bar to the right shows minimum, maximum and median break even prices required for US shale gas according to Ken Medlock of The Baker Institute. These shale gas prices would be really cheap in Japan but are expensive for the USA and still mainly above US spot prices today ($3.85 / mmbtu). Click on all exhibits to get a larger version that will open in a new browser window.
In this second part of three in this mini series on “Shale gas myths and realities” I want to address one of the central questions surrounding this new bounty: is shale gas cheap or expensive? Last week in a bruising exchange on Andrew Montford’s Bishop Hill Blog I made the assertion that shale gas was expensive and not cheap. This produced a tirade of incredulous opposition.
Euan, shale gas is cheap. Really, really cheap. It isn’t just the gas. It is all the steel pipe needed for drilling and distribution. And all the jobs making the steel pipe.
At that point I had already made some enquiries into the cost of shale gas and made the assertion that break even price was likely between $4 and $8 ($ per thousand cubic feet are roughly equal to $ per million btu and are used throughout). It is extremely important to observe that $4 to $8 is currently cheap if you are in Europe, really cheap if you are in Japan but actually quite expensive if you are in North America (Figure 1) and making relative assertions about life cycle production costs is not a sensible way to proceed.
Before taking a more detailed look at published estimates of the life cycle break even costs of shale gas I first provide an overview of the very brief history and stunning growth rate of shale gas in the USA, since it is only through understanding the past that we may begin to understand the present and perhaps get a glimpse of the future.
US shale gas production to date
Figure 2 shows the history of US shale gas production produced by David Hughes . It shows that production is dominated by 4 plays, The Haynesville, Barnett, Marcellus and Fayetteville (Figures 2 & 3). Production has grown from around 4 billion cubic feet (bcf) per day in 2007 to around 26 bcf/day in 2012! The expansion of shale gas production has had material impact upon US gross production that has grown from a plateau of 2 trillion cubic feet (tcf) per month in the period 1995 to 2002 to 2.5 tcf per month in 2012 (Figure 4). Some believe this is marching the USA towards energy independence while others believe, owing to costs and decline rates, that this may be an energy bubble. Where does the truth lie?
Figure 2 Stack of US shale gas production from a presentation by David Hughes . From a standing start in 2000, production has grown to an astonishing 25 bcf per day.
Figure 3 Map showing the main shale gas and oil plays of the USA and Canada from the EIA.
Figure 4 The evolution of US gas production by type since 1993 based on data from the US Energy Information Agency (EIA). The dislocation in the data series in 2006 comes with the introduction of shale gas reporting. Prior to that shale gas was reported together with conventional dry gas production. At the end of 2011, shale gas accounted for 32% of total US natural gas production. According to David Hughes, by the end of 2012 that figure had risen to 40% (Figure 2).
The phenomenal growth in US shale gas production did not just happen. The US drilling industry went into overdrive beginning around 2003 that saw the total number of rigs more than double to 2000 units by the summer of 2008 (Figure 5). The majority of rigs were drilling for gas and, putting Figure 5 together with Figures 2 and 4, it is apparent they were increasingly targeting shale gas at the expense of conventional gas production that began to decline after many years on plateau (Figure 4). Then, in August 2008 came the financial crash followed by a sharp decline in drilling activity as everyone pondered the future of the global financial system. US drilling activity picked up quickly in 2009 and 2010. But then began a great migration from drilling shale gas to shale oil plays (Figure 4). Pre crash, there were roughly 400 rigs drilling oil and 1600 drilling gas. Today it is roughly 1400 drilling oil and 400 drilling gas.
Figure 5 US drilling rig count from Baker Hughes compared with natural gas production (gross withdrawals) from the EIA. Since 1995, the size of the US drilling fleet has grown from about 700 rigs to 2000 rigs. For a long while, the increased drilling effort was only sufficient to combat declines until the attention turned to shale. New shale plays clearly provided better production returns than pursuing the very mature conventional gas targets. It remains to be seen if shale provides similar economic returns. There is evidence that gross gas production has plateaued during the past 24 months.
The migration from gas to oil is quite simple to explain. Overproduction of shale gas dumped the price from over $13 in June 2008 to below $2 in April 2012 (Figure 6). In the same time frame the oil price has been much more robust prompting the great migration from shale gas to shale oil drilling. Natural gas below $2 was fantastic for US consumers and economic growth but led ExxonMobil chief executive Rex Tillerson to famously proclaim:
“We are all losing our shirts today.” Mr. Tillerson said in a talk before the Council on Foreign Relations in New York. “We’re making no money. It’s all in the red.”
Figure 6 Henry Hub natural gas spot prices from the EIA.
European and Asian governments have looked on with envy as a shortage of natural gas on international markets, caused by the combined impact of the Fukushima reactor tragedy and a fall in LNG supply during 2012, sent prices soaring ever higher, creating enormous disparity in price (Figure 1). The fall in US prices to <$2 has created the illusion that shale gas is cheap while in fact over-production caused a crash in the price in US natural gas to below the level where it was possible for companies to make a profit. This is not good for society who without realising it, is dependent upon profitable energy industries for its survival.
What is the real cost of shale gas?
So what is the actual life cycle production cost of shale gas in North America? There is no single and simple answer. There are a large number of variables that need to be taken into account:
- The ultimate gas recovery from a well (EUR)
- The sunk costs drilling a well
- The land costs
- The cost of pipelines, process facilities and transport to market
- Tax and royalties
- Interest paid and interest rates
- Corporate overhead
There can be enormous variations in some of these variables from State to State, e.g. tax regime, and even bigger variance between N America and Europe. In the various estimates given below it is not clear in some cases if full life cycle or point-forwad economics are used (see caption to Figure 8). The estimate below is attributed to Ken Medlock, Senior Director of Rice University’s Baker Institute Center for Energy Studies:
“Some wells are profitable at $2.65 per thousand cubic feet, others need $8.10…the median is $4.85,”
These are the prices I have indicated on Figure 1. Figure 7 is lifted from an academic study  which seems to indicate minimum costs in the range $4 to $6 / mcf.
Figure 7 Ruud Weijermars  in an academic article estimates minimum prices of between $4 and $6 / mcf for various US shale plays.
In a 2012 presentation, shale gas analyst and critic Arthur Berman  pointed towards full cycle costs for shale gas in the Barnett, Fayetteville and Haynesville in excess of $8 applying an 8% discount rate (Figure 8). Berman argues that companies consistently over estimate well ultimate recovery and hence relative costs are actually higher than declared.
Figure 8 From a 2012 presentation by Arthur Berman . In an email from Arthur today: “Point-forward economics do not include entry/land costs, overhead/G&A or debt service. The table is two years out-of-date so I wouldn’t use the break-even gas prices as other than a guide. The decline-curve analysis remains sound.”
I have this from the former CEO of a major oil company:
It is all a function of gas price. At $4-5/m, there is a ton.
In summary, it seems clear that below $2 the shale gas industry as a whole is unprofitable. The published evidence points to the estimates of Ken Medlock at the Baker Institute as providing a balanced picture. The profitability of individual companies will depend upon the quality of their overall portfolio. Only time will tell if the high end estimates of Weijermars and Berman come to pass as a result of wells producing less than currently assumed. But this is an extremely volatile and active industry with efficiency gains being made all the time, and making forecasts is incredibly difficult, especially about its future.
The future of shale gas in the USA
There are signs that the sharp slow down in shale gas drilling is beginning to feed through to a slowing of gas production rate (Figure 5) where a 24 month production plateau may be evident. One of the surprising things is that gas production continued to rise while the rate of drilling fell. This in part is due to a time lag between drilling wells and hook up to the distribution system. Wells need to wait for the pipelines to arrive and at any point in time there is a backlog inventory of new wells that are sitting idle waiting to be hooked up. But drilling efficiency has also improved, fracking and completions are improving and in some areas like the Marcellus of PA, production hot spots are being found and drilled. This excerpt from The Motley Fool:
With so many companies using pad drilling, it shouldn’t come as a surprise that the average North American active rig drilled 15% more wells during the third quarter of this year than in the first quarter of 2012, according to Baker Hughes data.
In North Dakota’s Bakken shale, each rig’s daily oil production from new wells is expected to nearly double this year, from slightly more than 250 barrels of oil per day last year to an estimated 496 barrels per day in December, according to the U.S. Energy Information Administration. Similarly, in Texas’ Eagle Ford shale, each rig’s production from new wells is projected to increase to 413 barrels per day, up from about 200 barrels per day last year.
It seems possible that an equilibrium point has been reached where 400 rigs are managing to provide sufficient volumes to offset gas declines. Demand for cheap gas has risen in the USA which still imports small volumes from Canada. It is difficult to envisage in current market conditions a fresh migration of drilling activity away from oil into gas. It seems reasonable to expect, therefore, that the rise in production may come to a halt or may even reverse in the medium term, a situation that will persist until natural gas prices have risen back to a level that attracts rigs away from The Bakken and Eagle Ford.
The spectacular efficiency gains made in drilling times and well productivity must inevitably slow down at some point. The longer term future will be determined by the number of production sweet spots and hot spots that are found. For so long as new wells continue to be better than the old, it will seem like the shale miracle will go on forever.
On the basis of the foregoing it seems likely that US natural gas prices may continue to rise to beyond $5 in the near term. Citizens may grumble but should also appreciate that at this level, the prosperity of the shale gas industry may be assured for a while at least, and that will be of major benefit to the US economy. At $5, companies with a good quality portfolio of cheap, productive wells may make a lot of money whilst those with low productivity, expensive wells may not.
Relevant posts on Energy Matters
The information presented here is done in good faith in an effort to provide an objective summary of the current state and near-term prospects of the US shale gas and shale oil industry. The author invests in oil and gas companies but does not hold any stock in US or Canadian listed energy producers.
- The “Shale Revolution” Myths and Realities” Energy Growth Conference First Energy Capital Toronto, Ontario November 19, 2013; J. David Hughes, Global Sustainability Research Inc., Post Carbon Institute
- Ruud Weijermars, Economic appraisal of shale gas plays in Continental Europe, Applied Energy 106 (2013) 100–115
- After The Gold Rush: A Perspective on Future U.S. Natural Gas Supply and Price, Arthur E. Berman Labyrinth Consulting Services, Inc. ASPO Conference 2012 Vienna, Austria May 30, 2012