Shale production has transformed the economics of oil and gas production in the U.S. and is creating an era of lower cost energy. Yet drilling and completion costs are typically far higher for shale wells than they are for conventional drilling. Higher initial production and ultimate well recovery rates contribute to better economics for these unconventional wells. To understand how this works we need to get into the details of shale production costs and revenues. That is the objective of this series. Today we continue our rundown of shale production financial return calculations.
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. The long length of the laterals developed by horizontal drilling increase the surface area of the formation in contact with the well. This exposure typically increases the initial production (IP) rates and estimated ultimate recovery (EUR) compared to vertical drilling. We described the process of hydraulic fracturing to open up fractures in the shale that release hydrocarbons, which flow up the well bore to the surface. In this second episode we introduce the factors that impact production economics and then cover the specifics of drilling and completion costs.
Haynesville Dry Gas Example
We will model the economics of shale production with reference to a specific example – the Haynesville Shale. This is one of the best-known shale formations in the U.S. The play straddles the border between East Texas and Louisiana and saw a huge increase in production a few years ago. It is a sedimentary rock formation with a total area of nearly 9,000 square miles, which was deposited in the ocean more than 140 million years ago. It is found at a depth of 10,500 to 13,500 ft and has an average thickness of 250ft. The Haynesville shale has an estimated technically recoverable natural gas resource of 74.7 Tcf, which is huge. It is a dry gas formation, meaning that only natural gas (“mostly methane”) is produced.
The advantage of using the Haynesville for our example is that being a dry gas formation it allows us to model the economics of large shale gas wells 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.
Modeling Production Economics
The methodologies for calculating the economics of oil and gas producing wells are quite complex, requiring sophisticated models and technical experts. However, it is possible to approximate production economics using a relatively simple approach and only eight input factors. These factors are:
- Drilling and Completion Costs – what it costs to drill the well and ready it for production
- Operating Expenses – the ongoing cost of operating and maintaining the well
- Production Taxes- taxes due to government entities based on oil and gas production
- Royalty Rates – the amount owed to the owner of the ‘mineral rights’ where the well is located
- Initial Production Rate – the rate of flow for the well when it first goes into production
- Decline Curves – the rate of production decline over the life of the well
- Estimated Ultimate Recovery (EUR) – the volume of oil and gas that will eventually be recovered over the life of the well
- Commodity price – the price at which the gas is sold
We will look at each of these factors in detail, using representative Haynesville values in our example calculations. Note that these calculations are intended only as rough approximations. The cost factors we show are derived from examining source materials from producers in the area – primarily investor publications. We have averaged typical results from the play, so these numbers are not representative of any one producer or area within the Haynesville. Also, the numbers change periodically so these figures may not represent the most recent data being seen by producers in the area. However, they are generally representative of Haynesville economic inputs and thus can be used to understand the way the economic calculations work.
The cost of drilling a single unconventional well is chiefly a function of the depth of the formation and the lateral length drilled through it. For example, the typical Haynesville well has a vertical depth of 11,500 ft with an additional lateral (horizontal) length of up to 7,000ft. In 2012 drilling an unconventional well in the Haynesville shale cost an average of approximately $4.5 millioin. The following is a percent break down of the component costs of horizontal drilling.