What’s lowering the break-even price of natural gas?

First, the stats:  The February 15 Baker Hughes rig count—the Bible of the industry—showed the gas rig count at 421, the fifth-lowest in the current run down—that’s down from 1,600 in 2008, or almost a 75% drop. Just this last year the gas rig count has dropped 41%.

(You can find this chart each week at http://intelligencepress.com/features/bakerhughes).

There are two obvious reasons for this—one is that there is more “associated gas” with oil production, especially in Texas (not so much in North Dakota on a per well basis, but overall the Bakken is up around 1 bcf/d in gas now).

But the big reason is drilling efficiency.  When I go to conferences, I tell the crowd—fracking isn’t improving every year.  It’s not improving every quarter.  It’s improving every month. That shows up in the reduced time it takes to drill a well now, thanks to improvements in horizontal drilling techniques, and in the amount of gas each well is able get out of the formation—thanks to improvements in hydraulic fracturing.

The problem is, few companies want to brag about how much they’re improving production, so hard statistics are hard to come by.

In one of his blog posts last year, industry expert Rusty Braziel of RBN Energy published some statistics from Southwestern Energy, which provided in-depth numbers on its drilling operations in the Fayetteville shale in Arkansas and Oklahoma.

Over the course of five years, the company’s average drilling time per well plunged from 17 days in 2007 to only 8 days in 2011, falling by more than half. In just one year from 2010 to 2011, drilling time dropped more than 27 percent. Over the same five-year period, the later length of wells grew by 82 percent, and initial production more than doubled, rising from 1.65 million cubic feet per day in 2007 to 3.3 million cubic feet per day in 2011.

All the while, the cost per well hovered around the same level, dipping 4 percent from 2007 levels.

So for the same costs, drilling rigs were producing more than twice as many wells, with more than double the initial production. That means the initial production additions per rig grew by 338 percent in half a decade. If the rest of the energy industry saw the same kinds of improvement over the same period, even while cutting rig counts by three-quarters from their 2008 peak, we would expect to see a modest rise in production from simple efficiency.

These changes are not just coming over the course of years, either. Southwestern reported huge swings in IP rates even from quarter to quarter. Between the first and second quarters of 2009, average IP rates at the company’s wells rose 20.7 percent, and eight quarters out of five years saw an increase of at least 13.4 percent.

And other companies have seen comparable improvements. As recently as the third quarter of 2012, exploration giant Anadarko reported a 14 percent year-over-year reduction in drilling costs, along with a 40 percent drop in completion time at its Marcellus operations.

Future of Oil and Gas Goes Through Efficiency

Others are not only pointing out drilling efficiencies, but say they will continue into the future. A report released last summer from Credit Suisse hinged its estimates of future American oil production on expected improvements in efficiency.

Credit Suisse estimates that that drilling and completion times will fall by around 40 percent within the next decade as exploration companies become more familiar with new technology and new geology. Some of the newest emerging plays, particularly in California, would come closer to a 50 percent reduction.

That amounts to a less dramatic improvement than that observed by Southwestern over the past five years, but it would still allow energy firms to increase well counts by 27 percent by 2016 with only an 11 percent rise in rig counts.

The report also assumes steadily improving initial production, a trend that has already been observed in shale developments in North Dakota. Credit Suisse sees IP rates rising 21 percent over the numbers seen at the end of 2011.

As positive as these numbers sound, Reuters reports that consulting firm Bernstein Research points out the obvious other side of the coin—efficiency is improving dramatically because fracking operations at present are highly inefficient.

The firm released research last year suggesting that as many as half of all fracking stages contribute no additional production from a given well. In turn, the vast majority of all production – 80 percent – comes from only 20 percent of all fracking stages; yet another example of the somewhat infamous Pareto principle, commonly known as the 80/20 rule.

Nansen Saleri, president and CEO of consulting firm Quantum Reservoir Impact, told the news source: “In a few years the techniques used today for fracking will be viewed as primitive.”

So as investors watch the gas rig count with a perplexed face, the industry has been steadily reducing the cost of drilling, lowering the break-even price of natural gas—and disappointing the bulls.

– Keith

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