By John Kemp
LONDON, June 27 (Reuters) - The success of the shale revolution will be slow to replicate outside the United States because of limited access to drilling equipment and skilled personnel, according to influential oil analyst Leonardo Maugeri.
Maugeri has produced a thoughtful assessment of the U.S. oil industry. But he is too pessimistic about the potential for shale production in the rest of the world and its role in restraining medium-term and long-term oil prices.
“The drilling-intense nature of the shale business is a factor that will make the expansion of the shale phenomenon in other parts of the world improbable - at least in this decade,” according to Maugeri, a former executive at oil company ENI and now a scholar at Harvard University’s Belfer Center for Science and International Affairs.
“No other country can likely match even a fraction of the U.S. drilling and fracking power,” Maugeri explains in a report published on Thursday. “No other country ... has the specialised crews, tools and capabilities to perform intensive fracking activity.”
Citing Baker Hughes, Maugeri notes that more than half of the world’s drilling rigs are employed in the United States. Ninety percent of them are equipped to drill horizontal wells, and almost all oil and gas wells in the United States are now fractured to stimulate production. In the rest of the world, by contrast, fracturing is used on fewer than one well in 10.
This leads him to conclude that shale is likely to remain a uniquely U.S. phenomenon for a while.
“Near-term discoveries of shale resources outside of North America likely will prove short-lived, because shale’s increasing cumulative production involves drilling hundreds, even thousands, of new wells per year,” Maugeri claims.
The report’s main shortcoming is treating the global drilling fleet as fixed. That may be true in the very short term, but over a five-year or 10-year horizon the rig fleet will respond to changes in industry practices and price incentives.
At present, the fleet is configured to target oil and gas accumulations in conventional reservoirs. It is designed to drill a small number of highly productive wells. The risk of failure is great and costs are high, especially for wells drilled offshore and other challenging environments, which is why the industry spends so much money on seismic and other surveys designed to “de-risk” the drilling process.
Shale transforms the process profoundly. Instead of targeting discrete pools of oil and gas that have migrated and accumulated in reservoirs, horizontal drilling and hydraulic fracturing go straight to the source rock. Rather than hunting for discrete pools and risking missing them, shale oil and gas are distributed continuously throughout the source formation.
Developing shale is much less risky and capital-intensive than a conventional field, but far more wells must be drilled and far more rigs are needed. The productivity of individual wells varies tremendously, even across quite short distances. Big returns still come from finding the most productive “sweet spots” in the formation.
Conventional is customised. Every well is different and individually planned before drilling starts. In fracking, the aim is to standardise as much as possible to minimise the time and cost involved in drilling hundreds or even thousands of wells across a formation. Leading exploration and oil service firms talk about “factory fracking” as an assembly-line process.
Therefore, if shale is going to account for a large share of global production in the coming decades, the global rig fleet will have to change. The industry will need a much larger fleet of smaller and cheaper rigs for drilling on land.
The crucial questions are how high oil and gas prices need to be encourage the expansion and how quickly it can be accomplished.
Maugeri is correct that the rig fleet cannot be expanded overnight. But five years is a long time (five years ago the world was still worrying about peaking oil and gas supplies). Ten years is an eternity. Over the 5 to 10 year horizon, the rig fleet is almost infinitely flexible.
Oilfield service firms may be cautious about expansion, given the risk of a cyclical downturn in oil prices and drilling demand, but new rivals from China and other countries with substantial shale gas resources could quickly scale up the fleet.
“China has shown ... an incredible capacity to develop in a few years whatever it needs to ensure the development of strategic sectors,” Maugeri admits. “If China really discovers major shale gas formations on its territory, it once again could surprise the world through the production of an adequate fleet of drilling rigs.”
Shale deposits need not be in China. Giant Chinese oil and gas companies have become major investors and developers of resources abroad, and China has a fast-growing engineering and oilfield services sector of its own. It is already one of the world’s largest exporters of rigs, oilfield supplies and pressure-pumping equipment.
Experienced crews to conduct and interpret seismic surveys, plan field development, and drill and fracture wells are in shorter supply than rigs. Senior toolpushers, drillers and derrickmen with 15 to 25 years of experience in the field and able to lead operations, as well as petroleum geologists and engineers, have been in particularly short supply after many were laid off during the long period of low prices in the 1990s.
But the oil and gas boom is already five to 10 years old, and within another five to 10 years the workforce bottleneck should ease. China is graduating hundreds of thousands of engineers every year and should be able to scale up its production effort without too much difficulty, at least for the simpler shale formations.
It all comes down to price. There is some threshold price for oil and gas that will provide both the incentive and the cash flow to expand the rig fleet and the total volume of drilling and fracturing.
The exact threshold remains uncertain but is probably below $100 per barrel. At current prices exploration and production companies plan to invest a record $678 billion this year on exploration and production.
Maugeri estimates the breakeven for shale oil is $85 per barrel, but this does not take into account revenues from associated methane and natural gas liquids production, which reduce costs, and it could be as low as $40 in sweet spots.
Breakeven rates outside the United States would probably be higher but would fall over time as drillers and pressure pumpers gain experience.
As long as oil prices remain above the threshold, the global drilling fleet and drilling activity will grow.
There are “above ground” obstacles to the expansion of shale production overseas, including mineral ownership, unstable political and legal frameworks, and objections from environmentalists. Maugeri’s report suggests they cannot or will not be overcome. But once again it is a question of defining the price threshold.
“So long as technology and better understanding of shale formations do not further revolutionise the shale sector,” Maugeri writes, “the overall increase of U.S. shale oil production critically will depend on the continuation of a highly intensive drilling activity and on a relatively high oil price”. Maugeri believes this intensity will be “impossible for other countries to achieve”.
But the lesson of the shale boom is that technology is not static. It is wrong to assume the global drilling fleet and techniques are fixed. Both are almost infinitely variable, given prices high enough for long enough.
If oil remains above $100 per barrel, there is no doubt the shale revolution will spread beyond America’s shores, it is only a matter of how fast.
In the past decade, analysts have repeatedly underestimated the oil and gas industry’s capacity for rapid innovation. It would be a pity to make the same mistake again.
“The Shale Oil Boom: A U.S. Phenomenon” by Leonardo Maugeri is available from the internet at: