With natural gas prices for CME NYMEX Henry Hub futures averaging $3.69/MMBtu so far this year, you might think that the internal rate of return (IRR) for dry natural gas wells in the Haynesville would be under water. But in fact, wells are still being drilled with IRRs in the low teens. Granted these wells don’t look nearly as good as liquids plays in other shale basins, but the wells are profitable. How could this be when the cost of a typical deep, multistage horizontal well in the Haynesville can run $9 million? Today we take you through the math in our production economics model and provide a downloadable spreadsheet.
In the first episode in this series (see Drilling) we discussed “unconventional resources” and conventional hydrocarbon drilling then reviewed the technologies developed by the late George Mitchell and his team to produce unconventional shale resources. In the second episode (see Shale Production Economics – Part 2 – Drilling and Completion Costs) we introduced the eight input factors for our model of production economics and provided example values for drilling and completion costs. In part 3 we explained four techniques to forecast initial production (IP), decline rate and estimated ultimate recovery (EUR) for a shale gas well (see Shale Production Economics Part 3 – Estimating Well Production). These production parameters determine the rate of return for a well. Unconventional shale wells are characterized by high IP rates and rapid decline rates but the high early production rate provides drillers with a rapid return on their investment, which makes these plays so attractive. In episode four we looked at variable production costs for a shale gas well – including lease operations, transportation to market, royalties and taxes (see Variable Cost and Net Present Value).
In this series we are modeling the economics of shale production with reference to a specific example – the Haynesville Shale. We use the Haynesville because it is a dry gas formation, meaning that only natural gas (“mostly methane”) is produced. That allows us to model the production economics without having to delve into the complexities associated with wet gas (including NGL) or combined crude and gas liquids. These liquid hydrocarbons are, of course very important to many US shale plays today, but once you understand the economic returns on a dry gas well then the liquids produced from wet gas or oil wells can be viewed as an additional uplift dimension to the basic model.
This time we take you through the variables in our model well. In the next episode we will cover the model outputs. This time we provide a downloadable Excel spreadsheet that you can use to test out the sensitivities of the production and cost variables for a Haynesville shale gas well.
The Production Economics Model
We are going to walk through a model that can be used to calculate the Internal Rate of Return (IRR), the Discounted Cash Flow (DCF) and the Break Even price of natural gas, depending on the inputs provided and the form of evaluation. We provide an Excel file version of the model as an attachment to this blog that you can download here. [To download the file, you must be logged in as a registered RBN Backstage Pass subscriber. If you are not yet a subscriber, you can sign up here.] If you are a subscriber and you have trouble downloading the file (usually some firewall issue), then let us know at email@example.com and we will send you a copy. You can play with the variables in the spreadsheet model and adapt it to your own data, but please note that it is provided as an example, not a definitive well economics predictor. Don’t call us up if your production well does not achieve the rate of return you expected.
Before we discuss how the model works, we will go through the inputs. Table 1 below is a copy of the spreadsheet model input cells, with colored boxes added so that you can identify which input cell we are talking about. We also labeled input columns and rows on the table to help you find the right cell. The cell references that we use in this description should match the cell references in the spreadsheet.