Beware of Bottlenecks

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Oil companies that have slashed the break-even cost of producing oil from shale plays now must figure out how to hold on to those hard-won gains.

US producers can profitably produce oil from these difficult formations at prices that are 50% lower than they were during the boom, according to Rystad Energy. But roughly half of those gains are at risk as drilling activity rises.

“Lower unit prices of service com­panies are a major reason for the drop,” said Jon Duesund, senior project manager for Rystad, during a recent briefing in Houston.

Discounts squeezed out of suppliers are considered “nonsustainable” because prices will rise as demand rises, allowing service companies to raise prices.

An early example of that is the sand used to prop open fractures. Prices have risen this year by 25% as companies use significantly more proppant per well, according to a Bloomberg story quoting IHS.

“We can potentially surpass the amount of proppant used in 2014 already in 2017,” when more than 100 billion pounds were pumped, he said.

Rystad’s analysis roughly breaks down the savings that have reduced the break-even price for unconventional producers into three categories:

Rising demand will test how durable those cost reductions really will be.

“Some of the efficiencies we see disappearing,” Duesund said. “We will not see the [break-even cost] level in 2014, but it will be higher than current levels.”

Costs will rise because “future efficiency and productivity gains are not expected to counter the cost inflation,” he said. For example, the drilling rigs still working can drill far more feet per day than the average rig working before the downturn. But the cost per day will rise as the demand goes up; and as many more rigs go into service, less efficient equipment and crews will be working.

In the next 2 or 3 years a significant increase in demand will allow price increases, and “we will run into some bottlenecks,” Duesund said.

The severity of the problem will depend on the level of activity in the shale business. Rystad’s optimistic price outlook, with the price of oil rising USD 10/bbl per year over the next 4 years, makes it more of an issue. While the onshore conventional business is expected to produce more, global production will be affected by deep spending cuts in high-cost areas such as deep water.

Increased demand for services and supplies will result in shortages of equipment, supplies, and labor in some areas, and these bottlenecks will not be evenly distributed.

More efficient drilling rigs drilling longer horizontal wells in fewer days mean the available equipment should be able to keep up with the demand.

“About 1,000 horizontal rigs could be enough to get back to same number of horizontal well spuds as seen in 2014,” Duesund said. Three years ago, the Baker Hughes rig counts showed more than 1,500 rigs drilling horizontal or directional wells, which is about three times the current level.

When it comes to completing those wells, though, the risk of bottlenecks rises due to the growing demand for horsepower to pump fracturing jobs. The size of the current active fracture fleet is not big enough to meet the growing demand from more wells and larger completion.

“We saw in 2010–2011 that pressure pumpers’ margins went up about 10 percentage points when the industry ran into bottlenecks, which probably equates to somewhere around a 20% price increase for the operators,” he said.

Three years from now, finding the skilled labor needed to gear up operations could also be a problem, Duesund said. Low unemployment rates are allowing laid off workers to find jobs in other sectors. When demand rebounds, the job market may look different from the last drilling boom that began in 2009, when unemployment rates were high as a result of the Great Recession.The bottleneck can also be overcome, but at a cost. He said that workers who have been out of the oil business for years during the slowdown “may be reluctant to return unless they get good salaries.”

Beware of Bottlenecks

Stephen Rassenfoss, JPT Emerging Technology Senior Editor

04 December 2016

Volume: 69 | Issue: 1