Repeating the US's shale revolution – simply a case of moving up the learning curve?
The question of which country will be the next big shale producer is one that is asked frequently in the industry. The US has managed to move up the learning curve (or down the cost curve) to become the only country in the world so far to produce both shale gas and tight oil economically. US operators have achieved this with significantly reduced, but better focused and managed drilling activity in the best areas, even with oil prices in the $60/barrel region, defying initial speculation that OPEC's decision in November 2014 to maintain production would result in the ruin of the US shale industry.
The ability to produce tight oil and shale gas economically has come about in the US as a result of major cost cutting initiatives. Foremost among these has been the adoption of a lean manufacturing approach to field development. Hess Corporation reduced its drilling and completion cost reduction by 47% in the Bakken between 2012 and 2014 by applying these principles; the same approach has been used by companies like EOG and SouthWestern Energy to reduce the costs of their operations significantly, despite doubling the lateral reach of their wells.
Efficiency is not only gained through direct operator experience though. Every time a shale oil or gas well is drilled and completed, the operator, driller and supporting service companies gain experience. This experience leads to an efficiency improvement in the drilling of subsequent wells. Initially the learning curve is very steep – the lessons learnt from drilling the first few wells in a play will be far more instructive in relative terms than, say, the thousandth and beyond. Over time, as the play operators gain more experience and knowledge, greater economies of scale and better logistics further improve efficiencies. These improvements include (among others):
- Infrastructure development, such as play-centric gas processing and more extensive pipeline networks
- Maturing regulations based on better knowledge – both for the operators and local population
- Local skills and labour development
- Efficient water supply, perhaps through pipelines reducing the impact and reliance on roads
The learning curve therefore extends to the whole local economy, resulting in decreasing costs over time. The figure below shows the relative levels of development of some of the most prominent countries in the shale industry. The chart shows simply the number of horizontal wells drilled – this is taken as an indicator of how advanced a country's shale industry is. The US is the clear leader, with Canada following close behind. China and Argentina are the two next contenders. Both of these are in an early growth phase and have ambitious goals for shale over the remainder of this decade. In 2013, YPF (owner of 80% of Argentina's shale plays at the time) announced its intention to drill 2,500 shale wells by 2017, and China's Ministry of Land and Resources has set a target of 30 billion cubic meters of output by 2020 (about 10% of the US's 2014 shale gas production). Behind them are a number of other countries all with various indications of activity coming from their respective industries.
Figure 1: National stage of development (sources: EIA, company reports, industry journal reports)
The second thing to note is that the scale on the well count is logarithmic: in this model, each stage of development ("Pre-development", "Testing", "Emerging", "Growth", and "Established") represents an order of magnitude increase in the number of horizontal wells drilled.
Relating the stage of development to an industry level learning curve, Figure 2 below illustrates this effect at a play level. The cost per well is the reported average from all operators in the play and there is a clear correlation between this and the number of wells drilled. There are also a number of outliers. This analysis does not take account of play-specific factors such as well depth, lateral length, number of fracture stages for instance. What it does show is the macro level trend for costs to reduce in line with experience – an indication of a local industry's learning curve.
More difficult or unsuitable physical conditions are often cited as reasons why shale will never take off in foreign countries. Shale technology as it exists today, however, was designed for US fields, so the "ideal" geophysical conditions will of course need to match those found in the US. There is no doubt that technology development is needed to adapt to new environments, but it is the economic factors mentioned above that present a much greater challenge.
New technology has, however, played its role in cutting costs. For example, the use of rotary steerable systems for drilling the curve (as well as horizontal) sections of wells has enabled operators like PGE to cut drilling time by 64%, and switching to synthetic oil-based mud, despite being more expensive than the alternative, has resulted in a reduction in stick slip issues lowering overall drilling time. Baker Hughes's "Simul-Frac" technology and ExxonMobil's "Simops" allow much greater efficiencies in performing stimulation jobs on multiple wells from the same pad, eliminating stimulation crew down-time when working effectively. These advances, dating back to 2012/2013 are now considered old news in the highly innovative world of unconventionals. It should be noted that these technology advances are made in support of the overall drive to adopt a more factory drilling approach to shale development, a worthy case study of technology development following industry needs.
Figure 2: Shale industry cost curve (sources: EIA, company reports, industry journal reports)
Other innovations are likely to achieve cost reductions outside of the factory drilling approach. For example, water management is becoming less costly due to advances in recycling techniques which increase the amount of flowback water that can be re-used rather than simply disposed of. In support of this, the US state of Texas is considering introducing regulations to incentivise the re-use of water. This is a break from the more common command and control nature of US regulations, and an example of another source of innovation in the US, the regulatory bodies themselves.
The US had a number of benefits when starting on its learning curve that other countries lack either altogether or in some part. Four principle ones are mentioned here. The first was high energy prices and availability of finance – a gas price between 5-9 $/MMBtu during the mid-2000s when the "shale gale" first hit the US, and oil rising above $80/bbl from 2010 as tight oil took off in the Bakken, Eagle Ford and Permian. Ready finance enabled the exploitation of these price regimes (although recent reports of highly debt laden operators facing increasing cash flow problems threaten the health of the industry in the short term). The second benefit was the existence of a well-developed conventional oil and gas industry. The majority of the plays had already experienced extensive drilling activity over many years, providing a wealth of data for the shale explorers to use. Supply chains were already well established and US rigs were quick to adapt to the new horizontal drilling demand. The third benefit afforded to the US was the fact that resources in the country are owned by the landowners who live on top of them, providing incentives for the local population to allow development activities. Fourth, the operators that succeeded in shale developments were small to mid-sized independent oil companies. They lacked the corporate overhead of the IOCs (International Oil Companies) which meant that individual projects were much more profitable. Indeed, a competing IOC business unit would have to add its share of the corporate overhead to its local operating costs. In addition to these factors, the local economy specific factors mentioned at the start of this article were already at least partially established, giving the US a head start on the learning curve.
If shale projects are to have a real impact outside North America, the next generation of shale players will have to make their way up the learning curve without many of the benefits that enabled the US to take the lead.
The next generation of shale players, if shale projects are to have a real impact outside North America, will have to make their way up the learning curve without many of the benefits that enabled US players to take the lead. The US operators succeeded because they embraced local in the field innovation, they chose the right time economically, and they benefited from a well-established industry. Recently there have been talks of the industry facing a crisis as financial hedges against low oil prices run their course and new investment is predicted to dry up. The remarkable innovative ability of this new industry is such that it is entirely possible that new sources of finance or further cost reductions will be achieved. . Already, operators are finding ways to cut costs yet further through the focusing of efforts on only the most promising sweet spots, turning to refracking instead of drilling new wells and making better use of data to optimise fracture stage planning. These are a few among many further innovations that may well see the industry not only survive the current downturn, but come out leaner than ever.
Transferring this success overseas is not a simple matter, not least because the supply chain, lacking the entrepreneurial spark of the US firms, is unlikely to feel the same incentive to “learn” the new plays. China, Argentina and others will have to provide some economic innovations of their own, just as new shale operators there will have to provide some technical ones. However, the benefits and impact on energy supply are likely, over time, to be just as great as in the US, if they can get it right.
Henry St. Aubyn