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The Coming Gas Deliverability Crisis Given today’s politically charged atmosphere of hardball politics on nearly every issue, I often wonder if policymakers believe that saying something often enough it will make it true – no matter how absurd the statement. Does anyone really believe the budget projections given the state of the economy? Financial market participants are also known to issue inane statements from time to time. My favorite is something along the lines of, “The US has a multi-decade supply of natural gas and Washington should encourage new uses of the fuel since it will create jobs and reduce our dependence on foreign oil.” One study that is often cited is the Potential Gas Committee’s biennial assessment of US natural gas resources. The Committee’s most recent assessment, released in June 2009, concluded that as of the end of 2008, the US had 1,836 trillion cubic feet (tcf) of natural gas resources. The new report showed a 39% increase in total potential gas resources over its 2006 study. (It should be noted that the Committee reported natural gas resources in addition to the 237 tcf of proved reserves identified by the Energy Information Agency (EIA.)) While reports like the Potential Gas Committee’s report are valuable for identifying potential future resources, they are often taken out of context. In the Committee’s press release, they caution that their findings provide no timeline, cost or gas price required to access the potential resources (75% of which fall into the “possible or speculative” categories). Unfortunately, none of those cautions are typically included in articles that discuss future gas supplies. While I agree that the US has significant potential natural gas resources and reserves of natural gas, I could not disagree more with the view that gas production will grow and we should be searching for new uses for the fuel. The steepening decline curve of our existing production base indicates we should reduce our usage and focus our available resources on higher value added uses of gas since our reserves will take far longer to produce than most market observers realize. In other words, the US is heading towards a gas deliverability crisis that will be very damaging to the economy. Today’s conventional wisdom will only make the crisis worse. As an example, let’s consider shale plays, which represent a growing percentage of US reserves and resources. The field that best exemplifies the coming natural gas deliverability problem is the Barnett Shale field in the Fort Worth basin. The field, which is the largest in the US, recently hit its peak at 4.5 billion cubic feet a day (bcf/d) and has an estimated 26 tcf of gas left to produce according to the US Geological Survey. The two most important factors in the production profile of a play are its decline curve and its reserve life. Until recently I was unable to find the reserve life used by the play’s largest operators. During Chesapeake Energy’s Q2 2009 conference call, CEO Aubrey McClendon had the following to say about the reserve life of shale plays in response to an analyst’s question regarding reserve bookings: “…That is 65 years. I believe that is our standard across all shale plays, which is a pretty interesting point to talk about. I have seen a number of other EUR’s (estimated ultimate recovery) from companies that are at 40 or 45 or 50 years and that actually means our curves are more conservative. If somebody is at 6.5 bcf at 50 years (Mr. McClendon is discussing Haynesville wells) then it means that we probably have some upside in our EUR over time if they are getting there in 50 years and our curves take 65 and get there.” For anyone confused by the above statement, Mr. McClendon is saying that Chesapeake assumes they will produce less gas per year than others for a similar type of play. As a result, they will be producing for a longer time frame. While I knew Barnett Shale wells had long production tails, I was surprised to hear just how long they are. The below table show the typical production profile and tail for Barnett Shale wells: Source: Chesapeake Energy Using the information that accompanied Chesapeake’s Q2 conference call, I was able to determine the production profile for the first five years of an average Barnett Shale well. According to the presentation, the wells have an initial production rate of 2.5 million cubic feet per day (mmcf/d), have a first year decline of 70% and an EUR of 2.65 bcf. Using these figures I was able to construct the production profile for a typical well’s first five years:
Source: Chesapeake Energy Using my estimates, based on Chesapeake’s graph for well decline rates, it becomes clear that less than half of a well’s reserves are produced in the first five years of production and it takes approximately 45 more years to produce the remaining reserves. Why is this important? I believe we are about to experience a big mismatch between US reserves and gas deliverability due in large part to long-lived shale gas reserves. Consider the following. According to the US Energy Information Agency, the US has proved reserves of 237 tcf of reserves as of year-end 2007 and produced 21.4 tcf in 2008. Some observers may jump to the conclusion that the US will be able to continue at its current rate of production for the next 11 years. I disagree. Given that an increasing percentage of US reserves are in US shale plays which have very long reserve lives, we are headed for much lower production in the near future. How did we get ourselves into such a bind and why has it gone unnoticed by most market observers? There are several reasons. First, shale gas reserves are booked very differently than reserves from conventional reservoirs. For example, when an operator drills a conventional well, he is able to book maybe two or three locations as proven undeveloped reserves. The reservoir engineers, whether they are in-house or third party, permit the booking of only a small number of locations. This is prudent since every conventional reservoir is different. Booked reserves are often increased as more wells are drilled and more information is gathered. However, the method for booking shale reserves is markedly different. Once an operator can prove that a shale formation is homogenous over a certain aerial extent through drilling, reservoir engineers are far more generous in their reserve bookings since they are more confident the EUR of each well will be similar. While I could not find a reliable percentage of total US reserves that come from shale plays, I am confident that a very large percentage of the increase in overall US gas reserves (from 186.9 tcf in 2002 to 237.7 tcf in 2007) came via shale plays. Recent industry activity also indicates that shale gas is becoming a larger percentage of total US gas reserves. The vicious downturn in gas prices over the last year, which led to the dropping of over 900 gas rigs in recent months, has forced operators to concentrate nearly all of their current drilling activity on shale plays. This situation will only increase reliance on shale resources for a larger portion of our gas needs and sharpen the production decline curve. Another reason the coming gas deliverability crisis is not widely recognized is that it is being overshadowed by the recent success of several unconventional gas plays. The biggest success story amongst the shale plays is the granddaddy of them all, the Barnett Shale. According to the Texas Railroad Commission, the Barnett Shale, which produces 70% of all shale gas in the US, was producing only 1.04 bcf/d in 2004 compared to its nearly 4.5 bcf/d currently. I believe that most market observers are once again extrapolating the large growth in production and reserves of the recent past into the distant future. We have seen this movie before – several times, actually. It was about 15 years ago that observers predicted that offshore production would make gas prices so cheap it would put onshore producers out of business. Obviously this has not happened and offshore gas production is in steep decline. Even though large untapped deposits remain in the Gulf, it will take at least a decade, political agreement and substantial financial expenditures to access those resources. It was about 10 years ago we heard that coal bed methane (CBM) from large deposits in Colorado, Wyoming and elsewhere would supply increasing amounts of cheap gas for decades. Due to water disposal and land access issues among other things, CBM production has peaked and is now in decline. Possibly my favorite prognostication of future gas supplies is the notion that the US would be hit by a tsunami of liquefied natural gas (LNG). As discussed in previous updates, significant LNG imports have yet to materialize and with other countries turning to LNG as their only reliable source of gas, major reliance on this delivery mechanism for the US is unlikely. The final reason the coming supply crunch has evaded many is that the flurry of large shale play discoveries over the past two years has led many market observers to think that technology will make many more shale plays economic. While it is difficult to make predictions regarding future discoveries, I tend to believe that progress is made in fits and starts. It took nearly 20 years for the Mitchell Energy to make the Barnett Shale commercially viable and that technology has been applied to every known shale in the US – sometimes it works, sometimes it doesn’t. Therefore, I believe it will take advances in technology, which may be around the corner or years in the future, for the next wave of shale plays to become commercially viable. In conclusion, the natural gas deliverability crisis that I am predicting is not years away, we have already seen signs that it has started. The last two EIA 914 reports (the monthly report that details US natural gas production) have shown a downtrend in US production. However, the crisis will not really come to pass until the first half of next year when US production declines accelerate. The deliverability crisis will be front-page news one year from now when an uptick in drilling activity does nothing to slow the current production decline. Be prepared.
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Bill Powers | Editor | Powers Energy Investor |
