Lessons for U.S. oil production from the gas industry

John Kemp Reuters market analyst The United States produced a record 25.7 trillion cubic feet of natural gas in 2014 according to preliminary estimates published by the Energy Information Administration (EIA) on February 27. Gas production has risen 27 percent since 2008 even though the number of rigs employed drilling for gas has declined by more than 80 percent over the same period. Continued growth in output despite a sharp drop in rigs and depressed gas prices is often cited as a warning not to rely on rig counts to forecast future production. The gas industry’s experience is especially relevant now given the plunge in oil prices and new drilling since June 2014. But the real lessons from the gas industry are more complicated and underscore the complicated relationship between prices, drilling and production. Lessons for oil The gas industry’s experience holds two lessons for oil production. First, gas production would have fallen since 2008 in response to lower prices and drilling had it not been for the boom in crude production and high prices for natural gas. Second, it is the combined value of all the products from a well (dry gas, natural gas liquids and crude) that determine the profitability of a well. Continued growth in gas production has been, in large part, a by-product of the oil boom. Oil producers will not be so fortunate. They cannot rely on natural gas sales to improve the financial performance of their wells. Efficiency improvements and greater drilling selectivity will ensure the drop in oil production is proportionately smaller than the drop in rigs. But based on the gas industry’s experience there is every reason to believe oil output will level off, and maybe fall, unless oil prices and drilling pick up. Mixed hydrocarbons Rig counts published by oilfield services company Baker Hughes and others make a simple binary distinction between rigs drilling for oil or gas. Drillers and petroleum producers must classify their wells as oil or gas-producing depending on the primary output and inform state authorities so they are treated appropriately for tax and regulatory purposes. In reality, however, most wells produce a range of hydrocarbons from dry gas (methane) to natural gas liquids (ethane, propane, butane and natural gasoline) and crude oil (molecules heavier than pentane). Since 2009, most drilling has targeted rock formations and plays that yield more natural gas liquids (NGLs) and crude rather than dry gas because they have been more valuable. An increasing share of gas production has therefore come from wells which are either listed as crude wells or listed as gas wells but produce a substantial volume of natural gas liquids and crude as well which improves their profitability. Simple correlations between prices, drilling and production are therefore apt to mislead. Correlations between rigs and total gas output miss the growing amount of associated gas produced from crude oil wells. Correlations between prices and the number of wells miss the important role played by natural gas liquids and trace crude recoveries in making these wells profitable. Casinghead gas Total U.S. gas production increased by roughly 4.2 trillion cubic feet between 2008 and 2013. Of this increase, 3.5 trillion, or 83 percent, came from just three states: Pennsylvania, Texas and North Dakota. In Texas and North Dakota, increased gas production has been a by-product of the growing number of crude oil wells. In Texas, the amount of associated or casinghead gas produced from oil wells has tripled from 674 billion cubic feet in 2008 to almost 2 trillion cubic feet in 2014. Casinghead production has grown from less than 9 percent of the state’s gas output to almost 25 percent between 2008 and 2014, according to the Railroad Commission of Texas. Casinghead production has grown even as gas-well gas has fallen from 7 trillion cubic feet to 6.2 trillion. North Dakota’s output of casinghead gas has also surged with the Bakken oil boom and the state’s efforts to curb flaring of associated gas produced from crude wells. Wet gas wells In contrast to Texas and North Dakota, most of Pennsylvania’s increased gas production, which amounted to more than 3 trillion cubic feet between 2008 and 2013, has come from wells classified as gas producers. Pennsylvania’s shale gas wells drilled into the Marcellus formation have proved exceptionally productive. But those wells have also yielded a high and increasing proportion of natural gas liquids, helping them remain profitable despite depressed gas prices. The focus of drilling has gradually shifted from central Pennsylvania, where wells produce mostly dry gas, to more westerly counties, where the gas is wet and mixed with valuable NGLs and crude. Without high prices for NGLs and crude, the state’s gas boom would have been far smaller. Reuters