Musings: Natural Gas Is So 2010; Now It's All About Liquids-rich Shale

Musings: Natural Gas Is So 2010; Now It's All About Liquids-rich Shale

Tuesday, April 26, 2011

Parks Paton Hoepfl & Brown

by G. Allen Brooks

Last week the Baker Hughes U.S. active drilling rig count hit 1,800, up 1.6% from the prior week and up 21.5% over the past year. These were notable achievements. The increases reflect the exploration and development fever that is gripping oil and gas companies. This should be good news for the country's oilfield service industry, but maybe even better news for consumers as the increased drilling should lead to higher oil and gas production, and maybe lower fuel prices. More production means the nation's economy need not import as much oil and gas from abroad, which could have a significant impact on our balance of trade and payments, and the value of the dollar.

The most notable bit of data about last week's rig count was that for the first time in nearly 16 years, the oil and gas industry is employing more rigs targeting crude oil prospects (913 rigs) than drilling for natural gas wells (878 rigs). Analysts and investors, keen to see higher natural gas prices, have seized on this switch in drilling focus as a signal that future gas production will soon stop climbing. Assuming that the nation's natural gas consumption continues to rise, the drilling switch portends a shrinking of the oversupply of natural gas. That should mean higher natural gas prices – the only question is when.

Those E&P companies that are leading the charge into the gas shale plays around the country will be happy to see higher natural gas prices. They continue to claim that they can be profitable drilling these gas shale plays at natural gas prices in the $4.00 to $5.00 per thousand cubic feet (Mcf) of gas. Their financial results suggest something different. They still proclaim the success of the gas shale revolution, a movement that is beginning to spread globally.

Slightly over two weeks ago, the Energy Information Administration (EIA) released an analysis of gas shale resources around the world. It was clear from the report that the EIA believes the domestic gas shale revolution will be embraced globally. The EIA report estimates that 32 countries with known gas shale resources have added 5,760 trillion cubic feet (Tcf) of technically recoverable natural gas to the world's resources. With the addition of the U.S. gas shale resources, the global total would swell to 6,622Tcf. For comparison purposes, the world's proven natural gas reserves as of January 1, 2010, were 6,609Tcf. The world's total technically recoverable gas resources were 16,000Tcf as of the beginning of 2010, so with the new gas shale resources added in, the world now has over 22,000Tcf of gas resources.

The 32 countries with gas shale resources span the world and are likely to become energy-headline locations before long. Most people are familiar with the gas shale drilling underway in Poland and China, but those are only two of the 32 countries that span the globe. China leads the world with an estimated 1,275Tcf of gas shale resources. In Europe, Poland is in first place with an estimated 1,867Tcf of potential reserves, followed closely by France with 180Tcf. Interestingly, France has announced it is considering banning the drilling of gas shale wells until a study of possible water pollution problems associated with hydraulic fracturing are investigated and proven false. Equally surprisingly is that Norway has nearly half the gas shale resources of Poland and France.

Exhibit 1.  Gas Shales Located Around The World

Source:  EIA

In South America, Argentina is highly prospective with nearly 90% of the total gas shale resources estimated to be in the United States. Brazil has about a third of the resources of Argentina with most of the potential resources located in the area close to some of the key manufacturing sites in the country. Surprisingly, Mexico has a huge potential with almost 80% of the estimated United States gas shale resources.

In Africa, the greatest potential source of natural gas from shales lies in South Africa, which has an estimated 485Tcf of resources. Libya, the site of the current civil war involving the country's crude oil reserves and production, has an estimated 290Tcf of gas shale resources. Algeria follows with nearly 80% of Libya's estimate.

While the world has lots of gas shale resource potential, it is in North America, and primarily the United States, where the gas shale revolution is in high gear producing substantial volumes of new gas production. According to the EIA, 2010's 4.87Tcf of gas shale production represents about 23% of total U.S. output, but it is projected to account for 45% of the nation's gas supply by 2035. The huge potential of gas shales in this country was first highlighted by the 2009 report of the Potential Gas Committee (PGC) at the Colorado School of Mines. In that report, the PGC estimated that there was about 616Tcf of gas shale resource, or about a third of the country's total resource potential.

Recently, Ken Medlock, a professor at Rice University, delivered a presentation about the gas shale industry at the American Association of Petroleum Geologists (AAPG) annual meeting. In his presentation he listed a timeline of potential gas shale resource estimates beginning with the 2003 National Petroleum Council estimate of 38Tcf. Two years later the estimate was raised to 140 Tcf and then in 2008 Navigant, a consulting company, estimated there was 520Tcf of potential reserves. The next year came the PGC estimate of 616Tcf and last year, consultant ARI estimated gas shale resources of more than 1,000Tcf. Mr. Medlock said there is a Department of Energy study underway with a May release date that will contain an estimate greater than ARI's estimate, likely putting it close to China's estimated 1,275Tcf of potential reserves.

All this potential gas has led politicians, investment professionals and E&P company executives to announce that the United States has in excess of 100 years of natural gas supply. In his presentation at the AARP, Art Berman showed that by reading the PGC report it becomes clear that gas shale reserves will likely only supply about 20 years of demand at the current 23Tcf of annual consumption.

Mr. Berman's pricking of the gas shale 100-year supply bubble should be having a greater impact, but instead the air is barely slipping out of the balloon. In fact, President Barack Obama has endorsed the huge potential gas supply mantra. In a recent presentation about the nation's energy situation, President Obama said, "We have a lot of natural gas here in this county." In doing so, however, he touched on the key issue now swirling around the gas shale revolution, which is the use of hydraulic fracturing to release the trapped gas from the formation President Obama's observation was, "The problem is…extracting it [shale gas] from the ground. The technologies aren't as developed as we'd like and so there are some concerns that it might create pollution in our groundwater, for

Exhibit 2.  Gas Shale Reserves Less Than 100 Years

Source:  Art Berman

Musings: Are Prospects for Natural Gas Shifting to The Plus Column?

Musings: Are Prospects for Natural Gas Shifting to The Plus Column?

Wednesday, April 13, 2011
Parks Paton Hoepfl & Brown
by G. Allen Brooks

"In terms of new sources of energy, we have a few different options. The first is natural gas." These were the words of President Obama in his remarks entitled A Secure Energy Future, delivered on March 30th at Georgetown University. For being the first of various energy fuel options, however, natural gas received precious little additional mention during the President's comments other than his view that "recent innovations" have given the United States "the opportunity to tap large reserves – perhaps a century's worth." Even the leader of the country has bought into the mystique of the super abundance of natural gas from shale that appears to be ubiquitous throughout North America.

The President cautioned his listeners, though, that the government needs to make sure that the oil and gas industry is tapping these shale reserves "without polluting our water supply," a bone thrown in the direction of environmentalists who seem to be losing in their efforts to restrict the burning of fossil fuels. In his comments, President Obama said he was asking Secretary of Energy Steven Chu to work with other federal agencies, various state governments, environmental specialists and the natural gas industry to "improve the safety of this process [hydraulic fracturing of gas shale formations]." President Obama made a point of mentioning that Secretary Chu has a Nobel Prize for physics. According to the President, "He likes to tinker on this stuff in his garage on the weekend." We're not sure whether that comment was to compare Secretary Chu to Bill Hewlett and David Packer who created a technology and commercial powerhouse company or to Christopher Lloyd who played Dr. Emmett "Doc" Brown in the 1985 film, Back to the Future. We must say we haven't met many physicists tinkering in the domestic oil and gas industry.

There appears to be a sort of Dr. Jekyll and Mr. Hyde outlook for natural gas. Recognized as a lower carbon, i.e., cleaner, alternative fuel choice that possesses significant energy and provides consumption flexibility to meet the multiple energy demands of modern society, natural gas should be in high demand. That demand should be further boosted by its current low price – the product of significant new supplies of gas and declines in energy markets needing it. The problem is that the financial crisis of 2008 has produced one of the most anemic economic recoveries since the Great Depression. The economic downturn and weak recovery has reduced energy demand. This, coupled with government mandates for increased use of renewable fuels in the utility sector, has created increased fuel-on-fuel price competition, in particular for coal and natural gas. But the real culprit has been the growth in supplies of new natural gas.

Exhibit 1.  Oil Prices Boosted By Geopolitical Problems

Source:  EIA, PPHB

At the same time gas prices were collapsing, explosive oil demand in the developing economies of the world, principally in Asia/Pacific, combined with geopolitical turmoil have driven oil prices significantly higher than where they would likely be absent the civil unrest in the Middle East and North Africa. As it appears, the political problems in Libya, and now Syria and Yemen, are not improving quickly and, in fact, could actually spread to additional Middle Eastern countries. The upward pressure on global oil prices is likely to increase in the near-term.

The price divergence between crude oil and natural gas has produced a profoundly distorted relative valuation of these fuels. The energy content of natural gas to crude oil is 5.6 to 1.0, or six to one for ease of figuring. The current West Texas Intermediate (WTI)

Exhibit 2.  Oil Trading At 25-times Gas Value

Source:  EIA, PPHB

crude oil price of about $112 per barrel suggests that a thousand cubic feet (Mcf) of natural gas should be valued at roughly $20.  Instead, the ratio of the price of crude oil to natural gas has expanded to about 25-times. As can be seen in the chart in Exhibit 2, between 2005 and 2008, this ratio averaged around 10-times. Since the beginning of 2009, the ratio has increased to an average of about 20-times. Given the run-up in crude oil prices and the prospect of only modest increases in natural gas demand, the oil to gas ratio is now moving closer to an average of 25-times. At some point the ratio will reverse. The question is what will have to happen before that trend reverses?

Most natural gas industry observers have focused on two trends in trying to understand market sentiment – the gas-directed rig count and the monthly gas production figures. The gas rig count is reported weekly by several sources and is being sliced and diced regularly by analysts trying to discern early movements in activity that may foreshadow declines in gas production, which presumably would lead to higher natural gas prices in the future. The problem is trying to ascertain how long in the future before gas prices might rise.

Musings: Updated 2011 Hurricane Forecast Still Calls for Active Year

Musings: Updated 2011 Hurricane Forecast Still Calls for Active Year

Tuesday, April 12, 2011
Parks Paton Hoepfl & Brown
by G. Allen Brooks


The latest forecast update from Professors Philip Klotzbach and William Gray of the Department of Atmospheric Science at the Colorado State University (CSU) says the upcoming hurricane season is expected to see above-average activity. The April 6th forecast is slightly lower than their December 2010 forecast largely due to uncertainty about the sea surface temperatures in both the South Pacific and South Atlantic oceans that can assist or retard the development and strengthening of tropical storms.

The forecasting team has developed a new April methodology based on a data collected from 1982-2010. There are four predictors employed in the model with two of them based on sea surface temperatures in the Atlantic and Pacific oceans. The Pacific Ocean for most of the past year has been cooler than normal, which helped contribute to the Atlantic basin’s storm activity last year mostly turning north before reaching the U.S. In general, sea surface temperatures in the eastern and central tropical Pacific Ocean have been 0.50C-1.00C below average.

Exhibit 21.  Pacific Ocean Sea Surface Temperatures Low


Source:  Colorado State University

On the other side of the globe, Atlantic Ocean sea surface temperatures remain at or above average levels. They have cooled recently but most likely that has been caused by a shift from a negative phase for the North Atlantic Oscillation to a positive phase. Atmospheric conditions currently are conducive for an active hurricane season as wind shear, a force that can limit the development and strengthening of tropical storms, across the basin has been well below average over the past two months.

Exhibit 22.  Atlantic Ocean Temperatures Near Normal
   
Source:  Colorado State University

With these conditions, the CSU forecasting team began looking for analog years to help fine-tune their forecast. They were looking for years generally characterized by weak to moderate La Niña conditions and above-average tropical Atlantic and far North Atlantic sea surface temperatures during February and March. They found five seasons that met these conditions. Four of them had either neutral or La Niña conditions during the hurricane season and all four of them were very active years. Those four years were 1955, 1996, 1999 and 2008.

Exhibit 23.  Analog Years For Hurricane Forecast
   
Source:  Colorado State University, PPHB

The forecasters also found 2006, which had the same February-March conditions. That year, however, experienced an unexpected El Niño, which greatly reduced hurricane activity.

The CSU team anticipates 2011 to be slightly more active than what was experienced in the average of these five analog years due to the very active season predicted by their new statistical model. It is interesting that there were only two analog years that fit the parameters for both the December 2010 and April 2011 forecasts, and those years were 1999 and 2008.

Exhibit 24.  Latest Hurricane Forecast Down Slightly

Source:  Colorado State University, PPHB

The CSU forecast calls for a total of 16 named storms, down one from the December 2010 forecast total. It also expects there to be nine hurricanes and five major hurricanes. The total number of storm days will be down by five, from 85 to 80, with a similar reduction for each of the other storm categories.

In terms of landfall probabilities, the forecast calls for a 72% probability of a storm hitting the entire U.S. coastline compared to the 52% average for the past century. There is a 48% chance of a landing on the East Coast including the Florida peninsula compared to the historic 31% rate.  For the Gulf Coast from the Florida Panhandle to Brownsville, Texas, there is a 47% chance of a tropical storm landfall versus the historical average of 30%. Despite the higher probabilities, nature is such that it is impossible to forecast with any degree of accuracy until a storm is on its way whether it will reach land.  For the offshore energy industry, it will need to be on alert this hurricane season, although if the current pace of permitting continues, there won’t be too many offshore rigs to have to worry about this fall. Is that a backhanded positive?

Download the PDF Musings041211.pdf

Musings: Are The Shale Resource Estimates Realistic Or Fantasy?

Musings: Are The Shale Resource Estimates Realistic Or Fantasy?

Tuesday, March 29, 2011
Parks Paton Hoepfl & Brown

by  G. Allen Brooks

 

Maybe you've seen the advertisements from various financial newsletters touting the investment potential of companies involved in developing the Bakken oil shale formation that spreads across North Dakota and Montana and into the neighboring Canadian provinces of Saskatchewan and Manitoba. The claims, which several years ago appeared outrageous, of the Bakken containing eight times the amount of oil as in Saudi Arabia or 21-times the reserves held by Kuwait seem less than fantasy today.

These newsletters began trumpeting the financial impact of the Bakken for various oil exploration companies active in the formation following the 2008 U.S. Geological Service (USGS) revised estimate for the basin's reserve potential suggesting it might contain between 3.0-4.3 billion barrels, a 25-fold increase over the organization's prior estimate made in 1995, which said the field might contain 151 million barrels.

The USGS stated that the Bakken formation is estimated to be larger than all other current USGS oil field assessments in the Lower 48. The agency called it the largest "continuous" oil accumulation ever assessed. This means the oil is spread rather evenly across the basin as opposed to being located in discrete deposits. The next largest continuous oil deposit is the Austin Chalk trend stretching from Louisiana to central Texas that is estimated to contain 1.0 billion barrels.

Jeff Hume, president and chief operating officer of Continental Resources was quoted in an article not long ago suggesting that there could be as much as 24 billion barrels of reserves in the Bakken formation.

Exhibit 1.  Bakken Is U.S. Largest Continuous Oil Field

Source:  EIA

The success the domestic exploration and production companies have had in the Bakken has been partially responsible for U.S. oil production growing over the past two years to the highest level in over a decade.

Exhibit 2.  Domestic Oil Production Up Last Two Years

Source:  EIA

North Dakota's oil production reached a peak last November at 356,697 barrels per day from 5,099 producing wells. Over the past three years, monthly oil production in North Dakota has grown by more than 2.5 times. Production is off slightly in January to 342,088 barrels per day from 5,061 wells. While we can't be certain, we suspect the traditionally harsh winter in that region of the country impacts oil production efforts, especially since the infrastructure to produce much of this additional oil has not kept pace with the rising production.

There have been media stories about the dramatic increase in the number of railroad tanker cars hauling Bakken production to refineries. We are also aware of some of the oil making its way by truck across the US-Canadian border to shipping facilities there. All of that will change as new pipelines are constructed.

Exhibit 3.  North Dakota's Oil Production Soaring

Source:  North Dakota Natural Resource Department

More important is the growth in drilling, which will be critical for boosting the state's oil and gas production in the future. The most recent Baker Hughes rig count showed 153 working rigs in North Dakota, more than double the count merely 14 months earlier.

According to Mark Williams, senior vice president of exploration and development for Whiting Petroleum, "All current and planned projects could take us up to 1.1 million barrels a day."

The most important factor in the growth of Bakken oil production has been the application of drilling and well completion techniques learned from drilling the gas shales – horizontal wells with longer lateral sections and a greater number of hydraulic fracturing treatments.  Estimates are that by applying these technologies, Bakken wells that were drilled only a few years ago might produce 100,000-200,000 barrels over their lifetime but are now getting 400,000-700,000 barrels out of the deposits.  Even though the cost to drill and complete these newer wells is greater than for the older wells, the economics of greater production, especially at today's $100 per barrel oil price, are extremely attractive.