New Report: Demise of Shale ‘Greatly Exaggerated’

According to a report by Cowen & Co., the producer price index for frac sand rose 1 percent in October, following a 1 percent gain in September. At the end of October, it was at its highest level since the end of 2012.

The overall decline in the price of oil and, until recently, a natural gas price stuck below $4/Mcf, is going to provide the frac sand market with a significant test, however, prospects for the market are bullish in almost every way, according to the report.

“Sand demand is outpacing supply,” the report said. “Coarse grades of Northern White sand still remain the premium, most sought-after products. Tightening demand is leading to price increases and other grades/types of sand are being used to fill the gap.”

According to FMI’s recently released Oil and Gas Advisor report, the demise of the shale revolution in the U.S. is being greatly exaggerated.

From July 28 to Oct. 20, spot WTI oil prices declined from $105.91/bbl to $82.76/bbl, a drop of nearly 22 percent. This price movement has driven headlines suggesting that the U.S. oil and gas renaissance, driven by exploration and production of shale resources, could be in jeopardy. While the oil and gas market is no stranger to hysteria, the issue could benefit from logical analysis, the report stated.

The economics of oil and gas exploration and production are simple: If projected return on investment (ROI) is high enough, exploration and production companies E&Ps will continue their capital expenditures on drilling programs. If they are too low, E&Ps will slow down their drilling programs or look elsewhere for greater returns. Determining ROI can be a complex analysis, utilizing prices, pricing differentials, infrastructure/transportation availability, lease rates, rig rates and multiple other input variables.

However, one aspect of the equation that is often overlooked is the ability for E&Ps to improve their ability to pull more hydrocarbons out of a given well. Over time, E&Ps learn the “code” that allows them to maximize production within wells in a particular area. Drilling efficiency has such a strong effect on well economics that the Energy Information Agency (EIA) began estimating it late last year.

Drillers in the Bakken, Eagle Ford and Niobrara formations have dramatically increased the amount of oil they can generate from an individual well over the past three years. In the Bakken, for example, drillers are producing approximately 524 barrels of oil production per day per rig today versus 324 bbl/d/rig five years ago, an efficiency increase of over 60 percent. The Eagle Ford’s figures are even more staggering, with an increase of over 900 percent during that same time period.

This increase in efficiency allows us to perform a very high-level analysis of how durable the U.S. oil market is in the face of potential pricing headwinds. For example, the last time WTI oil fell into the low $80 range was in June of 2012 when the price averaged $82.30/bbl for the month. At that time, E&P companies in the Bakken shale could expect about 281bbl/d/rig or, all things being equal (including the ability to get WTI pricing in the Bakken), projected revenues of $23,126/d/rig. Today, that same producer can expect 524 bbl/d/rig due to increased drilling efficiencies. Assuming equal costs, that same producer would earn $42,968/d/rig at $82.00 WTI oil. More importantly, an E&P company could drill for oil at approximately $44.14/bbl (WTI) in the Bakken and generate the same revenue per day. (524 bbl/d/rig $44.135/bbl = $23,126/d/rig.)

This analysis does not look at well costs, which have grown substantially as E&P companies drill longer horizontal wells. The break-even price of wells in the Bakken has been calculated by Wood Mackenzie and others to be somewhere closer to $55 or $60 per well, but the analysis demonstrates a key point often lost in today’s headlines: U.S. oil and gas producers are driving enormous technological advancements that are making shale development increasingly profitable and increasingly resilient to pricing headwinds.

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