The following is a copy of an overly long response to comments following my own comment on a shale gas meeting in London between the government ministers and the large gas producers. Smaller producers were excluded. I considered this to be because only the “big boys” have what it takes to seriously “do” shale gas. At the same time I made points about the expectations and public promise of shale gas was not the reality, especially that shale gas will increase energy costs because it is fundamentally a more difficult and expensive resource to exploit than former conventional sources. Some of the readers were perplexed. So I answered
Go to Arthur Berman formerly a writer for World Oil, Shale Gas (various: an early one, http://www.aspousa.org/index.php/2009/11/facts-are-stubborn-things-arthur-e-berman-november-2009/) if you want some good info. He was terminated from World Oil for publicly saying what all of us in the industry knew: with shale gas, what you hear is not what is or will be. (Unless the stars align, to give gas companies an out.)
Other than that ….
I’ve had a look at the responses to my comments, and they are dead on – if you look at shale gas the way companies and our governments want us to. Fact is, unless you peer very closely at the words, what you think you are reading, isn’t quite what you are reading.
Fundamentally, the difference between what I’m saying and what you are hearing is that I refer to the overall project, the overall cost and the overall results of a shale gas project. The words you read – like Mr. Axel’s reference to “Two trillion cuft of gas online” (Kung Fu, 22-05-2012 @ 2:00 pm)and Caudrilla’s Bowland 200+ BCF Gas Initially In Place (anonym, 21-05-2012 @ 8:21 PM), is about gas volumes in the ground, not the gas that is available to go down the pipelines to your homes. See below for the Recovery Factor comments. Elsewhere, gas prices that collapsed (Lord Beaverbrook, 21-05-2012 @ 8:13 PM) are referring to the prices paid by consumers for the gas they use, not the COST of the gas to the producers: you’d think they would be similar, but in an oversupply situation, they are not, not by a longshot. Also see below. High costs that involve local labour and equipment (first, it’s mostly large corporations anyway, so the profit leaves your town except for field maintenance) (RobL 21-05-2112 @ 7:52 PM, you still pay the high prices though your neighbour is employed, and that dollar from you pocket is still the dollar that your butcher doesn’t get. Finally (Latimer Alder 21-05-2012 @ 6:59 PM), the US is not different from Britain except that taxes are less in the States, access is easier and reserve volumes are greater.
See below for details. But note I make no specific comments about any particular company or field. My comments are general and generally true. There is the press and there is the profit. Not the same. The overall theme is this: what we have now is more expensive and more difficult to get than what came before, and those costs will be, must be, passed on to the consumer. The oil and gas companies are not going to be hurt individually, though as a group they can be pushed away: the field that is unavailable to everyone hurts none of them. Selective discrimination is a problem, not a collective one. You can’t tax a company into not producing a resource if the company can increase its price to the consumers: only regulation or a price freeze will keep a marketable product from being produced. Whatever you might hear about shale gas being a green boom is overrated, and will, has to, cannot be otherwise than, requiring more money out of your pocket, regardless of carbon based taxes.
Below I have some background for y’all. I’ve loaded this on my own website, a rarely used thing, as blogging with technical details is a full job in itself which my career in the oil and gas business has NOT enabled me to do, any more than someone running a corner store.
1. Economics of Shale Gas
You read numbers a lot. Economic thresholds for shale gas plays to go forward. Before you can really understand them, though, you have to know what they are talking about, for there are various types of economic assessments. Essentially all are time-related, but within that time-frame come, necessarily, costs as well as revenues.
1. Long-term. This might be called “full-cycle”. In a “play”, as the general project is called in the oil and gas industry, you have mineral right acquisition costs, surface access costs, drilling, completion and equipping costs, facilities and pipeline costs, operating costs, remedial surface repair and abandonment costs. You also have land taxes. To offset these costs you have production sales. Production is highest in the beginning and then falls either exponentially or, if you are lucky, hyperbolically, in which declines almost level out after a few years. Conventional and unconventional productions decline similarly at first, but the resource plays such as shale gas, are supposed to decline hyperbolically. Hyperbolic declines give you long-term production. Shale gas and coal-bed methane are both supposed to have reserve lives in the 40 year range.
Full-cycle economics is what it all is really about. You put a buck in and when it is all over, interim costs considered, how much did you get out? Full-cycle has the full revenue and the full costs, but there are a couple of big assumptions. First and foremost is the production decline: will it really last 40 years? Second is the price forecast, and this is where an individual company can make or break the apparent worthiness of the project: is the commodity price going to 6 bucks in two years or will it stay at 2? And 10 years out, what will it be? The discount factor (DCF) for the project is important, too: while the dollar may rise, what about the purchasing price of the dollar, so you are comparing apples to apples?
Shale gas (like CBM) is generally presented as the volume you get over 40 years, with a 40 year price forecast. Costs are recovered first, profits last. So the real profits are at the second half of production life. If there isn’t any production, or if the prices are low, your economics are either low or negative, regardless of what the project was “supposed” to be like. The money is made in the future.
2. Short-term. This is how you and I generally think about the economics of a project when we ask, does it make money.
a. Short-cycle. Generally less than 6 years. The idea is that you want to get your money back within 6 years. Because of the DCF, money spent today must have a certain rate of growth to be have the same purchasing power later. And that is before profit. And because of the rapid decline of these new resource plays, getting twice as much for the product later doesn’t do you much good if the production rate is one-quarter of its original. If you don’t at least get your money back (value neutral) in 6 years, you might have been better to put your effort into a toothpaste factory.
Shale gas doesn’t do well on the short-cycle because the upfront costs and decline rates are very high. You need good commodity prices to get a positive short-term economic forecast. This is why resource plays, like shale gas, typically give the 40-year picture. There is more wiggle room.
3. Finding and Development. Known as F & D. This is the upfront costs to getting the well or field on production. $/mcfd, or dollar per volume of gas produced per day. Long-term costs are not considered. Peak production is the rate you use. As you can imagine, a very high rate, which shale gas has, gives a positive number relative to a conventional source, but the number doesn’t necessarily represent the profitability or even the total profit you might get.
4. Drilling, Completion and Equipping. D,C & E. This number gives you the project cost but doesn’t include facilities, pipelines, land, etc. It gives you the costs to production once you have the legal right to go after it. This number lets you determine if you can afford the discovery and/or the development of the project. Shale gas drilling and completing is a multi-million dollar operation. It is a scale enterprise: decline rates demand a lot of locations and a lot of replacement locations as the field declines rapidly.
5. Operating. This is the net-back view. All the money is spent, water (cash) under the bridge. You have operating costs, not including future abandonment and reclamation costs or equipment sales, and you have production revenue. Each day you make a buck and you spend less than a buck, if you are going forward, and the reverse, if you are going in the whole.
The economic assessment you read about, which is relevant to how much gas has to be sold for to be worthwhile, is one of the above five types. Corporate discussions always give you the numbers that sound the best or are perceived as representing the best scenario for the company. If the gas prices are in the toilet, then short-term is not what you will hear. F & D is helpful for knowing how much muscle you need to bring to get the thing going. Operating is good once the thing is established and maintenance is all you need to worry about for a few years. If you want to sell a project on its future merits, then full-cycle is what you use. It is in the differences between these economic assessment types that the devil lives.
What is the true economic costs of shale gas? Now we have to be even more specific. There is the core area, and there are fringe areas. The core area is the high productivity, high reserve portion. Like everything in life, there is the best part and the not-so-best part and finally the poor part. All rolled in you may think that you have a field that requires $5/mcf to make money, but what you really have is a core that requires $2, a surround that requires $4 and a fringe that requires $7. Why would you drill the fringe, then, when prices are, say $4/mcf? Well, companies need volume to maintain image and production in-place to take advantage of positive price spikes.
I’ve seen this personally. Areas that clearly do not make money are brought developed because, rolled into other areas that make more money, the whole enterprise makes a ton of money. Plus, if prices spike, then suddenly the no-profit areas become profitable. Finally, money to large corporations, not just oil and gas, is like water in a river. There is more coming tomorrow, and all that money today doesn’t really have a place to go (not all the time). You could dividend, but, no. So you plow it into things that tomorrow may be good, even though today they are not good. Regardless, in a year or two the moneybags are full again. (Obviously if you do this too many times you go bankrupt – witness Detroit. But if you only do it a few times, the future wins at least make up for the current losses. At least that is the strategy.)
So what is the cost level for shale gas to make sense? The core-non-core ratio is the key. When corporations speak of the threshold, they speak to the better parts. The truth is generally worse because the best parts have to support the lesser parts. As for shale-gas vs conventional gas: a shale gas well is a closely spaced, horizontally drilled well with a large frac required. If a conventional well to that depth costs $1, a horizontal shale gas well can be $4 to $6 (or more). The production rate may be 4 – 10X in a shale gas well, but the volume received may be more of the 3X ratio. All these numbers mean that short-term, you get much more from a horizontal shale gas well, perhaps 10X, but long-term you get only 1.5X the volume, and at 2X the cost. The ratio is off: more gas, more expensive. And since the decline rates of shale gas wells are higher than for conventional wells, more expensive more often.
That’s the rub.
Breman noted this difference when he got into trouble at World Oil. The long-term could use a PRESENT low price because the price forecast increases and best-efforts volume forecast made up for the short-term deficiencies. These were assumptions which are not necessarily valid. But you have to realize that a corporation thinks far longer ahead than an individual, and so can do that. The average Joe and smaller company knows that the short-term, like for breathing, is where you live and die.
A price basis of $4 to more than $7/mcf is not unreasonable for what you need as a go-ahead business. At $10/mcf a great deal is worthwhile producing. Current prices in NAmerica are less than $2/mcf. (Before you consider what Europe and Britain are paying, you have to make sure that the taxes are similar. Which they are not.)
Operating profits don’t count when it comes to the overall scheme. And current sales prices don’t tell you anything, either, about the costs of exploration, development and production.
There is a supply glut of gas right now. If it weren’t for the recession, that would not be the case. And you don’t just shut-in a well. Most companies borrow the money they use, so have a need for constant cashflow. Even though the well you produce is getting little for its gas, you need the money to pay bills. You also don’t shut-in fields if you can help it, because often they cannot be turned back on, especially if there is co-production of water. Which a lot of shale gas wells do. But where does it go? It goes back into the ground in specially built salt-dissolved caverns, or in abandoned oil/gas fields. You produce out over here and dump it in, over there. Now you have a large supply ready to produce at a moment’s notice … whenever that is. Also an “asset” that costs money to be saved, and an asset that is not generating any revenue. So you drop your price to get as much as YOU can into the market without giving away the farm.
Notice this has nothing to do with the cost of production. The price of gas is now determined by how desperate you are to get cash in the front door.
Shale gas has driven market prices down while driving the cost of gas production up. In the short-term, producers are “losing money”, meaning that if the low prices continue until the field is depleted, there will have been more money spent on getting the gas to market than the market paid for the gas. In the short-term, consumers are happy with “cheap” gas. But once the gas “bubble” as they call it, is gone, prices will reflect the cost plus profit of what is being produced. That is why gas prices must go up if shale gas is to become a major part of our energy needs.
So, wwhat do I think of shale gas and its potential?
Shale gas is a “resource” play that is going to save our butts. It is everywhere. All you have to do is get permission to drill and your company’s and nation’s energy problems are solved.
Yeah, right. First, if it were that easy, it would already have been done. We’ve actually known about these reservoirs for decades – we drilled through them and had big problems with gas coming into the drilling fluids, reducing its weight, creating a danger at surface. (This is true of methane in coals, by the way.) We didn’t have the good technology to get the gas out of these shales before, however, and we didn’t have the prices for gas to justify the effort, either. Now we can get it out … but shale gas reservoirs are like conventional reservoirs: they have core good bits, lesser bits, bad bits and areas of no bits. The companies/countries may boast of their gas-in-place numbers, but what counts is their economically producible gas-in-the-pipeline volumes (and rates). This is often called the recoverable gas, with a recovery factor (RF) showing the percentage of gas you can get out. Not just at A price, but ANY price.
What is the RF for shale gas? Obviously it is different for different places. 65%? In the core? 20%? over the field? Right now we don’t know. The fields are all still in their initial years, but some already don’t look like they were initially hoped/hyped to be (standard practice: optimism first, realism later).
What I can say, though, is that resource plays – actually any oil and gas idea these days – always appears more promising than it turns out to be. That is because it is not easy to find or easy to produce or easy to transport – those ones have already been exploited. One resource play was large coalbed methane fields in the States and Canada. The in-place “resource” is huge. The RF in the core might be 26%, but much of it is actually <9%. Overall, the RF might be 3%. This in-place vs producible situation is the same with shale gas said to be under half of Britain. Yes, the gas molecules are everywhere. No, you can’t get them out. (In theory, of course, you can. Gimme $200/mcf and I can deliver a great deal, not all, but more. And see what this does for energy costs?)
Shale gas is an excellent reserve of natural gas for the world. It is cleaner than oil, though not as useful and not as energy dense. It will add to our future, but not remove all our concerns. For individual companies or countries, check to see what practical reserves are being discussed, not how many molecules are in the ground. And don’t think it is cheaper than what you got before.
Your energy costs MUST rise if shale gas is an important component of your energy sources as it is harder to get out and goes away faster than our previous gas reservoirs. And the fringes cost more to get less than the core, just like with everything else. Shale gas will also – once supply gets in line with demand – raise the overall price for gas, to the benefit of the conventional producers, as gas at market has the same value regardless of its source. And since all the places where gas could substitute for oil have already been taken care of, gas prices will do nothing for oil prices, up or down.
2. I’m a shill for Big Oil. How weird is that?
Yeah, I’m a skeptic about CAGW, but I’ll tell you as I’ve told others: oil and gas businesses will flourish under carbon taxes because the costs will be pushed onto the consumer – you. The only way that the oil and gas companies will really be hurt is if the governments put a PRICE freeze on the commodities. To-the-consumer price reflects cost plus profit. And, for the government, which likes percentage taxes, the higher the cost, the more gross revenue it gets. Even if you were to put a tariff on foreign oil, this would hurt the consumer, but not the oil and gas companies. In fact, a tariff would increase the value of the internally produced oil.
The oil and gas companies do not stand to lose from carbon dioxide capture rules because they can pass on the costs. The consumer cannot. If the consumer cuts back on demand, AND production remains high, then prices will fall. So jobs will be lost while the oil and gas companies contract to preserve profitability, energy costs to the consumer will fall … and demand will go back up. If production is curtailed, so there is a shortage nation-wide, then prices will go back up, the oil and gas companies will make a lot of money again, and the consumer will still be paying through the nose, except this time it won’t end.
I’m a professional geologist. I’m not rich and never will be. But CAGW doesn’t really affect me as an o and g guy. It sure affects me as a person, though, and my non oil and gas friends. Every dollar that I have to pay for energy is one less dollar I can pay to my favourite bartender or musician or magazine writer. Personally, I’d like to keep paying them rather than the government (in taxes) or Chevron (because someone forced them to develop expensive oil and gas fields).
Shale gas is expensive to produce. The economic downturn globally has reduced demand below supply, but gas fields cannot just be shut down. Gas goes into storage underground, but the buyer now can chiesel away at the price as there is always someone with lower profit demands or more urgency to sell. So prices drop below cost, while producing companies try to hang on until demand exceeds supply. And then prices will rocket.
Production costs you hear refer to the better parts of the field. Improvements in costs come from shared infrastructure and improved results, not reduced costs. That never goes down except in very bad recessions when it is a dog-eat-dog business and things like rig maintenance become next year’s business.
Gas-in-place is not gas in your stove burner. The Recovery Factors for shale gas are still to be determined. If 65% is said to be that of a field, that will be the core and that will require a lot of infill drilling. More gas = more cost. If 1/4 of all the areas I have seen reported as the total resource were produced, I’d be shocked. GIP is only meaningful in comparison to someone else’s GIP. If Recoverable Gas were so impressive, that would be the number you hear.