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Dream of U.S. Oil Independence Slams Against Shale Costs

Dream of U.S. Oil Independence Slams Against Shale Costs thumbnail

The path toward U.S. energy independence, made possible by a boom in shale oil, will be much harder than it seems.

Just a few of the roadblocks: Independent producers will spend $1.50 drilling this year for every dollar they get back. Shale output drops faster than production from conventional methods. It will take 2,500 new wells a year just to sustain output of 1 million barrels a day in North Dakota’s Bakken shale, according to the Paris-based International Energy Agency. Iraq could do the same with 60.

Consider Sanchez Energy Corp. The Houston-based company plans to spend as much as $600 million this year, almost double its estimated 2013 revenue, on the Eagle Ford shale formation in south Texas, which along with North Dakota is one of the hotbeds of a drilling frenzy that’s pushed U.S. crude output to the highest in almost 26 years. Its Sante North 1H oil well pumped five times more water than crude, Sanchez Energy said in a Feb. 17 regulatory filing. Shares sank 7 percent.

Rethinking the Ban on Exporting U.S. Oil

“We are beginning to live in a different world where getting more oil takes more energy, more effort and will be more expensive,” said Tad Patzek, chairman of the Department of Petroleum and Geosystems Engineering at the University of Texas at Austin.

Photographer: Matthew Staver/Bloomberg

An oil drilling rig stands on the Bakken formation in Watford City, North Dakota.

Drillers are pushing to maintain the pace of the unprecedented 39 percent gain in U.S. oil production since the end of 2011. Yet achieving U.S. energy self-sufficiency depends on easy credit and oil prices high enough to cover well costs. Even with crude above $100 a barrel, shale producers are spending money faster than they make it.

Missed Forecasts

Companies are showing the strain. Chesapeake Energy Corp., the Oklahoma City-based company founded by Aubrey McClendon, reported profit yesterday that missed analysts’ forecasts by the widest margin in almost two years. Shares declined 4.9 percent. Fort Worth, Texas-based Range Resources Corp. fell 2.3 percent after announcing Feb. 25 that fourth-quarter profit dropped 47 percent. QEP Resources Inc., a Denver-based driller, slid 10 percent after fourth-quarter earnings reported Feb. 25 fell short of analysts’ predictions.

The U.S. oil industry must sprint simply to stay in place. U.S. drillers are expected to spend more than $2.8 trillion by 2035 even though production will peak a decade earlier, the IEA said. The Middle East will spend less than a third of that for three times more crude.

Photographer: Eddie Seal/Bloomberg

Tony Sanchez, chief executive officer for Sanchez Energy Corp., left, speaks at the… Read More

Bulls Crow

Shale wells can vary in price. Chesapeake will spend an average of $6.4 million each this year, according an investor presentation last updated yesterday. Houston-based Goodrich Petroleum Corp. will spend up to $13 million on some of its wells, Robert Turnham, president and chief operating officer, said in a Feb. 20 earnings call.

Bullish analysts and oil executives have reason to crow. While drilling in Iraq could break even at about $20 a barrel, output will be limited by political risks, Ed Morse, global head of commodities research at Citigroup Inc. in New York, said in a January report. By contrast, the break-even price in U.S. shale is estimated at $60 to $80 a barrel, according to the IEA. The price of a barrel hasn’t dipped below $80 since 2012 and has stayed above $90 since May. Costs in the U.S. will continue to fall as drillers get faster and improve results, Morse said.

Crude Exports

“The U.S. oil and natural gas renaissance is receiving significant investment because return on investment is good and competitive with other opportunities,” Rick Bott, president and chief operating officer of Oklahoma City-based Continental Resources Inc., a pioneer of shale drilling, said in an e-mail. “We’re confident that continued technological advancements will keep the Bakken and other plays at the forefront of investment for the foreseeable future.”

Harold Hamm, the chairman and chief executive officer of Continental Resources who became a billionaire drilling in North Dakota, told U.S. lawmakers Jan. 30 that the country, which U.S. Energy Information Administration data show supplied 86 percent of its own energy last year, can drill its way to energy independence by 2020. Hamm is leading an effort to get Congress to allow crude exports for the first time since the 1970s.

U.S. oil production will average 9.2 million barrels a day in 2015, up from 7.4 million last year, according to the EIA, the statistical arm of the U.S. Energy Department. Colorado boosted output by 11 percent in the first 11 months of last year, Wyoming was up 12 percent and Oklahoma added 24 percent.

“I don’t see the shale boom coming to an end,” said Andy Lipow, president of Lipow Oil Associates, an energy consulting firm in Houston. “We’re just getting started in places like Colorado, Wyoming and Oklahoma.”

Horizontal Wells

Sanchez Energy said in a Feb. 19 statement that Sante North 1H isn’t yet finished and the well will produce more oil than the early report suggested. The company said it has 120,000 acres in the Eagle Ford and plans to spend 90 percent of its exploration budget there this year. The company’s shares have risen 63 percent in the past year.

Traditional wells are bored straight down, like straws stuck into large deposits of crude. Shale is tapped by steering the drill horizontally through layers of oil-rich rock, sometimes for a mile or more. The formation is blasted apart with a high-pressure jet of water, sand and chemicals, a practice called hydraulic fracturing or fracking, to open up cracks that free pockets of trapped fuel. The complexity and materials needed to drill horizontally and blast the rock add to the cost.

Yield Little

The boom’s boosters have given rise to the misconception that wringing oil and gas from shale can be easily replicated throughout the country, Patzek said. That isn’t the case, he said. Every rock is different. The Bakken shale, along with the neighboring Three Forks formation, covers an area larger than France, according to the IEA. An oil-bearing formation that’s 400 feet (122 meters) thick in one spot may taper off to nothing just a mile away, Patzek said. What works for one well may yield little in a neighboring county.

The output of shale wells drops faster, too, falling by 60 to 70 percent in the first year alone, according to Austin, Texas-based Drillinginfo Inc. Traditional wells take two years to fall by about 55 percent before flattening out. That forces companies to keep drilling new wells to make up for lost productivity.

“You keep having to drill more and you keep having to spend more,” said Mark Young, an analyst with London-based Evaluate Energy, which tracks production and its costs.

Sweet Spots

A prolonged slide in prices below $85 a barrel may put pressure on operators that have struggled to contain costs or that don’t own acreage in the prolific “sweet spots” of the oil fields, said Leonardo Maugeri, a former manager at Rome-based energy company Eni SpA who’s researching the geopolitics of energy at Harvard University’s Belfer Center for Science and International Affairs.

Companies have boosted well productivity and will continue to whittle down the break-even price, he said. While the boom could survive a brief dip in oil prices, a long slump could slow drilling and cause production to fall swiftly, Maugeri said.

“To sustain in the short term, the U.S. needs prices at $65 a barrel,” Maugeri said. “That’s a critical level. Below that level, many opportunities will vanish.”

The U.S. benchmark oil contract for West Texas Intermediate crude for delivery in April 2016 is trading at about $85 a barrel, almost $18 a barrel less than today and still $20 above Maugeri’s threshold.

Net Debt

Even with crude prices above $100 a barrel, U.S. independent producers will spend $1.50 drilling this year for every dollar they get back from selling oil and gas and will carry debt that is twice as much as annual earnings, said Ryan Oatman, an energy analyst with SunTrust Robinson Humphrey Inc., an investment bank in Houston.

By contrast, the net debt of Exxon Mobil Corp., the world’s largest energy explorer by market value, is less than half of the cash earned from operations last year. The company will spend 68 cents for every dollar it gets back this year, according to company records and analyst forecasts compiled by Bloomberg.

So far, oil prices have been high enough to keep investors interested in the potential profits to be made in shale, Oatman said.

“There is a point at which investors become worried about debt levels and how that spending is going to be financed,” Oatman said. “How do you accelerate and drill without making investors worried about the balance sheet? That’s the key tension in this industry.”


17 Comments on "Dream of U.S. Oil Independence Slams Against Shale Costs"

  1. Davy, Hermann, MO on Thu, 27th Feb 2014 1:38 pm 

    Well, need Rock’s insider information.

    I see this article and others as a rebuttal to the “Lobby of Plenty” who has been dominating the discussion up to now. Reality has a way of surfacing.

  2. Makati1 on Thu, 27th Feb 2014 2:25 pm 

    Reality is a bitch! ^_^

  3. shortonoil on Thu, 27th Feb 2014 2:41 pm 

    Based upon our calculations (data taken from “ND Monthly Bakken Oil Production Statistics”) the entropy production of these wells is 17.4 times greater than what is produced from average world conventional crude production.

    These wells are not net energy providers, and will be phased out long before conventional crude production is terminated.

  4. rockman on Thu, 27th Feb 2014 2:44 pm 

    Day – Since I’m not drilling the shales I can’t offer much specific insider poop. But I have hunted on Tony’s ranch in S Texas but we aren’t exactly drinking buds. LOL. But I do have my bias I’m always glad to share. Simplest and undeniable fact is that regardless of the net value of these trends the pubcos have no choice but to play them. I have ready access to $100+ million for conventional drilling projects and it’s just sitting there going nowhere. But my owner requires a very nice rate of return for what I spend so there’s a limit to how small my targets are. We participated in $400 million in conventional NG drilling projects before low prices killed that program. Haven’t drilled a single one since then.

    The shales plays/Bakken do make a profit in general. How good on average? No way to come up with a representative number IMHO. But that’s not the point. For the most part the profit level is unimportant to the American people. They just want to see the oil come out of the ground. So even if the companies were swapping $ for $ and making no serious profit everyone (employees, stock owners, management, the consumers) are doing OK. For now. One thing I’ve learned over 40 years in the oil patch: nothing (good or bad) lasts very long…3 to 7 years. Never has and I doubt that will ever change. So pick your fairy tale (or nightmare) as you wish. Either will come true eventually.

  5. Kenz300 on Thu, 27th Feb 2014 3:40 pm 

    Quote — ““We are beginning to live in a different world where getting more oil takes more energy, more effort and will be more expensive,” said Tad Patzek, chairman of the Department of Petroleum and Geosystems Engineering at the University of Texas at Austin.”

    The price of oil, coal and nuclear keeps rising and causing environmental damage.

    The price of wind, solar, wave energy, geothermal and second generation biofuels made from algae, cellulose and waste get cheaper every year.

    Oil companies will soon hit an economic wall. They need to change their business model and become “Energy Companies” and not just “oil companies”.

    Cheaper, safer and cleaner alternative energy sources will win in the end.

  6. GregT on Thu, 27th Feb 2014 3:59 pm 

    As long as we are bound to a fiat monetary system, that requires interest to be payed back on our moneys, we are bound to a system that requires infinite exponential growth. Eventually that system will meet the hard cold reality of environmental limits.

    We either crash that system, and reset to a monetary system by the people for the people, or the bankers will bleed us dry. If we do not voluntarily reset that system, the system will eventually crash by itself. The results of that, will be catastrophic.

    We can learn to live in an energy reduced society, but not as long as our financial and economic systems require infinite exponential growth.

  7. Dave Thompson on Thu, 27th Feb 2014 4:11 pm 

    “The price of wind, solar, wave energy, geothermal and second generation biofuels made from algae, cellulose and waste get cheaper every year.” Sorry Ken, none of the above listed are possible without fossil fuel energy inputs.

  8. Boat on Thu, 27th Feb 2014 5:19 pm 

    Meanwhile cummings engine and the gov have a semi truck that improved the mpg by 75%.

  9. shortonoil on Thu, 27th Feb 2014 6:11 pm 

    “Meanwhile cummings engine and the gov have a semi truck that improved the mpg by 75%”

    That does not change the fact that 60% of the world’s crude production comes from 1% of its fields, and those fields are growing older.

    It is those very few fields that powers the world’s economy, and without them there will be sparse demand for semi’s with improved mileage of even 95%. Attempting to paste over the situation with false prophecies like “shale” is certainly not contributing to the dilemma we face!

  10. DC on Thu, 27th Feb 2014 7:13 pm 

    Q/Meanwhile cummings engine and the gov have a semi truck that improved the mpg by 75%.

    Hey Boat,ever hear the saying extraordinary claims require extraordinary evidence?, like I dont know, how about the SOURCE for your vague and nebulous claim? This is the interwebs after all, and a source is often times just a click away. And, like SoO says, a big so what even if it were true. Cummins isnt making anything like that and if they could-why didnt they decades ago, and how is ‘gov’ involved anyhow?

    ‘Semi’s’ aren’t the economy or civilization, so its not at all clear just what net benefit these magical semis would have, even if every single under-paid independent trucker(slave) hauling salad shooters for wall-mart own one.

    Here, let me try. I have a device that improves fuel economy by over 1000%!- except they are real. They are called my feet, and my bike.

  11. Others on Fri, 28th Feb 2014 3:20 am 

    Add to this the fact that Chinese sold 2.2 million vehicles last year.

    That’s 70,000 + vehicles / day and if you add Brazil, Russia, India and 100 other developing countries, some 120,000 – 150,000 vehicles were added every day to World’s roads.

    Expect Oil prices to keep going up.

  12. Boat on Fri, 28th Feb 2014 5:08 am 

    A link for ya.

    In a world of bad news I just thought I would share some good news. I don’t claim this is the silver bullet for the worlds problems.

  13. GregT on Fri, 28th Feb 2014 5:27 am 

    15.6 million vehicles sold in the US in 2013, and 1.7 million in Canada. The biggest selling vehicles in North America, were full sized pickup trucks.

    Brazil, Russia, India, China, and 100 other developing countries are not alone, and they are merely following the example set by the developed nations. They also deserve to have a life, every bit as good as everyone else.

    Hopefully oil prices skyrocket sooner than later. It is the one thing that will stop us from destroying the planet Earth. If it isn’t already too late.

  14. GregT on Fri, 28th Feb 2014 5:29 am 


    Ever heard of Jevon’s paradox? If not, it might be worth looking up.

  15. Boat on Fri, 28th Feb 2014 5:32 pm 

    GregT What is your point. You suggest we should only allow trucks that get less than 5 mph on the road? Or 2, or 1 mph. I don’t get what you want.

  16. Nony on Fri, 28th Feb 2014 5:49 pm 

    See the EOG latest conference call. They are not making poor investments. At 100/bbl, these plays are economical. The billions are not going in for no reason.

    Heck, the rapid decline makes it that much easier to know that your investment has paid off earlier, to spool down drilling (“mining”) if price drops. It’s an easier situation than deciding to invest in Arctic oil and waiting 10 years to see if you wasted money or minted it.

    It is definitely true that new oil is costing more. So…still better than cutting our throats.


    1. I think new players do have this issue of poor return. But people that already grabbed good acreage (e.g. EOG) are just developing it…low uncertainty and just more of a manufacturing environment. Still a lot of interesting science/engineering to optimize things, but not like wildcatting well. Perhaps there are also some issues of core competency. Yeah, shale horizontal fracks are not rocket science, but still some people might do them better, or have more experience, just a small advantage.

    2. I guess you have to think about where you want to go. There are still going to be some opportunities in the verticals (from price) and the shale train would have been a good one to get on a lot earlier than now. Still, there’s more going on there. I know you have your pride and know a lot, but it’s good to still keep learning even when you are an old salty dog. I think you should think about “becoming a shale slut”…not just for the money, but for the experience.

    Maybe talk Tom Ward (oops, whoever hires you) into going after some crazy shales. It’s not your money, right. 😉

    3. I might not be posting much any more. Got called for a couple consulting/program management gigs (not oil). 3 really, if you count an investment bank that wanted 2 weeks of hellish pressure.

    I actually feel like I just found out about this latest boom last DEC or so (reading the net). There’s a lot I like about it and I wish I had been involved in it. I’m nobody special and these oilers are ready to pay Goldman and McKinsey, but I still manage to find places that I can help people and I’m more honest than those types.

  17. GregT on Sat, 1st Mar 2014 1:20 am 


    My point was to for you to look up Jevon’s paradox. Fuel efficiency has been shown to result in only burning more fuel.

    Not a solution to our predicament.

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