One of the “sweet spots” for America’s domestic energy production has been the substantial growth in unconventional oil and gas production.  And while it offers plenty of opportunity it is not for the risk averse.

Today, weak natural gas prices especially compared to rising oil prices have combined with a shortage of hydraulic fracturing services due to higher demand is forcing the industry to quickly shift to higher profit oil drilling from lower profit natural gas drilling.  The payoff is America’s most promising new source of energy from unconventional oil and gas plays which offer the potential for billions of barrels of unconventional oil and equally large gas resource potential economically viable now because of innovative horizontal drilling and hydraulic fracturing technologies.

EOG Resources (EOG) is as good a proxy as you can find about what is happening in the unconventional oil and gas space.  In its November 3rd investor analyst call, EOG CEO Mark Papa told the analysts that his company was shifting its focus to oil production given the low current prices for natural gas because of the economy:

“We’ve reduced our full year 2010 growth guidance from 13% to 9%. About 70% of this reduction relates to North American natural gas volumes, where we’re now projecting minus 2% growth versus the previous estimate of plus 2%. Obviously, in this price environment, we’re not incented to grow gas volumes. Our conversion from a natural gas to an oil company is still on track. And we expect total crude, condensate and natural gas liquids to comprise approximately 67% of our 2011 North American revenues.

However, because of lower cash flows from weak gas prices, higher frac costs, delays in frac equipment availability and the pattern drilling used to maximize resource plays, we’ve also reduced our 2011 and 2012 liquids growth targets to better reflect real-world conditions. Even with these reductions, we expect to grow crude and condensate 36%, 53% and 30% in 2010, ’11 and ’12.”

In the real world of domestic oil and gas production stuff is happening and while much of it is good there are still plenty of scary risks out there.  Here’s is a quick summary of Mark Papa’s discussion of EOG’s efforts to manage those business risks in the field:

The Goldman Sachs analyst asked Mark Papa in the investors call to “provide more color” on how long it takes to drill complete and tie-in wells today compared to what EOG assumed when it began work in the Eagle Ford, Bakken and other plays in production.

Papa replied:

“We all knew that we wanted to complete these wells in bunches, four, five or six wells together. But what we assumed back in April 2010 was, if we called up a service company and say, we need you to frac a well in three weeks, that they’d show up in three weeks and we’d then frac five or six wells simultaneously. Now what we’re finding is you have to schedule this four or five months in advance. And production comes online months later than expected and as a result the gross volumes that were projected are going to be less. We’re still going to have pretty dramatic year-over-year production, but from a lower base than what we previously expected because we didn’t achieve our production goal this year.”

From the oil field services standpoint these are demanding times.  Higher natural gas prices would increase demand for the same horizontal drilling and fracing services that oil production now requires.  Companies like EOG have chosen to be in BOTH the oil and gas business because their technology, sites and skills work on both sides so they produce product based upon commodity prices, equipment availability and the strategies of retaining long term competitive advantage.

And then there is the reality that unconventional oil and gas plays are typically smaller and faster depleting than traditional drilling where wells were drilled vertically into giant pools of oil or reservoirs of natural gas.  To be in the unconventional oil and gas business to stay you must be in it many places and apply the lessons learned in the earlier unconventional plays to the work you plan for the future ones.

One lesson is the technology is good—so good—that the length of horizontal drilling is growing fast from the early well which might be 3,000 lateral feet to newer ones perhaps two or three times the length with many more wells tapped along these laterals adding time and cost to the drilling and fracing requirements.  But the payoff is huge since the reserves are also much larger from incremental cost increases in drilling and fracing.  This is what happened in Bakken and those lessons are now being transferred to Eagle Ford, Leonard Shale and hopefully Marcellus and others for the future.

So what?

So today America has a strategic competitive advantage in horizontal drilling and fracing because the technology was developed here and the American firms have the best expertise.  If America wants to retain that competitive advantage it must create an attractive market for the players to stay home and work to rebuild America’s domestic energy production.

Drilling moratoriums like the ones Interior Secretary Salazar imposed in the Gulf of Mexico and off the Atlantic and Pacific Coasts or that New York State imposed on Marcellus shale development send the message to the industry that it must look elsewhere for business.

There are plenty of elsewheres interested in taking America’s technological advantage and put it to their own use in China, India, Brazil, Russia and other places. The question is will we be foolish and short-sighted enough to let that happen?

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