Why “Cheap” Oil Is Over, And More!

A reader emailed me recently with a question about the fast-growing oil output of U.S. oil shale plays, such as the Bakken play in North Dakota and the Eagle Ford play in Texas:

Byron, you’ve been talking about Peak Oil. You’re not one of those guys at the fringe who says, “We’re running out of oil and we’ll all freeze in the dark.” But you still talk like the oil industry won’t be able to meet world demand in the future. With all the new oil shale developments, like the Bakken and Eagle Ford, isn’t the U.S. on the right track? Is it time to move away from that Peak Oil way of looking at things?”

Well, I’m glad that I’m not “one of those guys at the fringe.” I think.

I should begin by saying that I met the late geologist M. King Hubbert back in 1977, when he gave a talk at Harvard. Hubbert developed the concept of Peak Oil back in the 1950s when he worked at Shell Oil.

Hubbert’s thesis was that mankind is using up a finite resource — oil — over time. At some point, the cost and technology for oil development will be so prohibitive as to cause the overall supply curve to “peak.” Then it’s a long back slide while the world figures out how to run itself on diminishing oil supply.

Hubbert was, of course, a creature of his times. He cut his teeth working in oil development during the 1930s and 1940s. By the 1950s, Hubbert was looking ahead and considering where the oil industry could go with the technology then available or foreseeable in the tech pipeline.

Hubbert’s view of oil reservoirs was what we today call “conventional,” such as sandstone or limestone reservoirs charged up with oil and gas, confined by structure and stratigraphy and “capped” by an impermeable top — like a tight shale or salt layer. Of course, Hubbert was aware that many shale formations contain significant oil and gas, but he didn’t foresee the modern “fracking” technology we have now.

Does New Tech Supplant Old Ideas?

Let’s get back to the reader’s question about how the idea of Peak Oil pertains to today. We live in a world where operators drill directional wells into shale and then fracture (“frack”) the rock by breaking up the shale, under pressure.

Downhole, we see what are called “multistage completions” that deliver significant volumes of hydrocarbon — at least at the beginning of the well’s life. The Bakken and Eagle Ford plays are excellent examples of new tech bringing out new oil supplies.

So with this in mind, has time passed up Hubbert? Are Hubbert’s ideas just intellectual relics of another age?

Actually, Hubbert’s ideas are as pertinent today as ever. In other words, Peak Oil is an analytical tool. The ideas behind Peak Oil require you to look at overall energy production with an eye toward the available technology and the costs of production. What’s the overall cost? What can you do? And what can you afford to do?

What’s the Return on Investment?

At the end of the day, here’s the key question: How much value of oil or gas do you get out of a well versus the value of the total inputs? Another way of asking the question is what’s the “energy return on energy invested” (EROEI)? This idea is rooted in basic Hubbert 101.

There are all sorts of accounting examples for the oil biz. People drill wells for all sorts of reasons. They drill to hold a lease, for example, and not lose it. Or they drill because a certain tax break is in effect. They drill to find oil and sell it at a profit.

One useful number is the “finding cost” within the oil industry for a barrel of oil. What does it cost to find a new barrel? Every company keeps its own set of books, of course, but a reasonable number for the industry wide finding cost for oil is $80 – 90 per barrel. Coincidentally, that’s about the current North American price.

Another consideration for this “finding cost” number is that many oil companies are undervalued in the stock market. Hence, right now, it’s generally cheaper to “drill for oil” on Wall Street than head out into the brush and shoot geophysics and drill wells.

Bakken and Eagle Ford, by the Numbers

But again, let’s get back to the reader’s question. What about the newly drilled wells in the Bakken and Eagle Ford? Are they changing the global energy game? Do these new plays negate the Peak Oil tool? Let’s get specific.

A new report from consulting firm IHS Herold — The IHS Herold Eagle Ford Regional Play Assessment — takes a hard look at actual well output. The most-frequent well result of an Eagle Ford well is 300 – 600 barrels per day, as a monthly average. By comparison, wells in the Bakken yield about 150 – 300 barrels per day.

The best — meaning the most prolific — wells in the Bakken have an average peak-month production rate of about 1,000 or more barrels per day. The top producers in the Eagle Ford see up to 1,500 barrels of oil equivalent (BOE) per day.

These numbers are splendid, by North American onshore standards. Wells that yield 500 or 1,000 barrels per day are great. But then the question rises of how long these wells can maintain that flow rate.

Sad to say, the decline rates for Bakken and Eagle Ford wells are relatively swift and severe. The 1,000-barrel-per-day well may be down to 500 barrels after six months, and 200 barrels after a year. Then it’s necessary to refrack, or drill new wells. At $10 million or so per pop, it gets expensive.

For all their output, the oil shale wells are small potatoes compared with the superwells of, say, Saudi Arabia, which deliver upward of 10,000 barrels per day, and more over a period of many years.

Or consider offshore, deep-water wells that yield 20,000 or more barrels per day, over significant time frames. (The Macondo well of BP which blew out in the Gulf of Mexico in 2010, spilled 25,000 barrels per day or more into the ocean. The blowout was a tragedy, but the reservoir is apparently excellent.)

Here’s the rub, and in a much-generalized manner. Looking back, an “old-fashioned,” conventional oil well cost about $1 million to drill (adjusted for inflation). Today, a modern directionally drilled, multistage-completion fracked well costs over $10 million. And the new well depletes much faster than the older well. Operators are spending much more money for, overall, much less oil.

Meanwhile, the volumes of oil from the new oil shale wells are in the hundreds of barrels per day range, and maybe a thousand or so for the best of them. Yet U.S. demand is still in the range of 16 million and more barrels of oil daily. And global demand is increasing into the 90 millions of barrels per day.

It’ll take a lot of “new technology” wells — tens of thousands, and immense levels of related capital investment for pipelines, pumps and more — to keep up with continuing oil demand. You have to drill dozens of “oil shale”-type wells to make the equivalent output of even one well in the most-prolific areas of, say, Saudi Arabia.

Thus, the answer to the reader’s question is that Peak Oil analysis is still relevant. We have to look at overall investments and costs compared with the output. If you still don’t like the term “Peak Oil,” I suggest that you use the term “Peak Cheap Oil,” because that’s the future into which we’re heading. Oil will be scarce, and expensive. “Cheap” is over.

Why “Cheap” Oil Is Over, And More! was originally featured in The Daily Resource Hunter. Check out the newest Daily Resource Hunter research video “The Price of Gas Explained”.

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