Shale Decline Rate Investing
It's not as if we didn't see this coming.
In fact, we've been writing about it for years now.
And just last week, it became official...
China has now become the world's largest importer of oil.
According to the most recent EIA data, oil consumption in China has overtaken production by 6.3 million barrels per day.
Couple that with a weakening demand in the U.S. for imports, and you have the recipe for a bitter pill that China must swallow: the Middle Kingdom's addiction to imported oil is becoming greater — and as a consequence, makes it weaker as a nation.
Of course, we're familiar with their plight. The U.S. has long been vulnerable to the dangers of foreign oil addiction.
And while that vulnerability hasn't completely disappeared, it has subsided a bit thanks to the domestic oil and gas boom that's now underway...
In fact, the International Energy Agency (IEA) announced last Friday that the United States is now set to overtake Russia as the world's biggest oil producer — this, by the way, just 40 years after the infamous OPEC oil embargo of 1973.
Here's what the IEA had to say:
With output of more than 10 million barrels per day for the last two quarters, its highest in decades, the nation is set to become the largest non OPEC liquids producer by the second quarter of 2014, overtaking Russia. And that's not even counting biofuels and refinery gains.
Of course, even with a wealth of new oil and gas getting fracked, sucked, and pumped out of U.S. soil, the question remains...
How long can it last?
A Lightning-Quick Shale Boom
Last year, I discussed the controversial issue of shale gas and rapid decline rates, noting that there are a number of very smart analysts who agree that the expedited decline rates of shale oil and gas production could result in a lightning-quick shale boom.
Investment guru Bill Powers wrote:
There is production decline in the Haynesville and Barnett Shales. Output is declining in the Woodford Shale in Oklahoma. Some of the older shale plays, such as the Fayetteville Shale, are starting to roll over. As these shale plays reverse direction and the Marcellus Shale slows down its production growth, overall U.S. production will fall.
At the same time, Canadian production is falling. And Canada has historically been the main natural gas import source for the U.S. In fact, Canada has already experienced a significant decline in gas production — about 25%, since a peak in 2002 — and has dramatically slowed its exports to the United States.
And energy and oil expert Chris Nelder published the following segment in 2012.
... the decline rates of shale gas wells are steep. They vary widely from play to play, but the output of shale gas wells commonly falls by 50% to 60% or more in the first year of production. This is why I have called it a treadmill: you have to keep drilling furiously to maintain flat output.
In the U.S., the aggregate decline of natural gas production from both conventional and unconventional sources is now 32% per year, so 22 bcf/d of new production must be added every year to keep overall production flat, according to Canadian geologist David Hughes. That's close to the total output of U.S. shale gas, after nearly a decade of its development. It will require thousands more shale gas and tight oil wells to keep domestic gas production flat.
If Powers and Nelder are right, this does not bode well for “dirt-cheap” natural gas as far as the eye can see.
And the outlook for oil may be worse...
The Red Queen
In a recent Bloomberg piece, analyst Asjylyn Loder wrote the following:
Chesapeake Energy’s Serenity 1-3H well near Oklahoma City came in as a gusher in 2009, pumping more than 1,200 barrels of oil a day and kicking off a rush to drill that extended into Kansas. Now the well produces less than 100 barrels a day, state records show. Serenity’s swift decline sheds light on a dirty secret of the oil boom: It may not last. Shale wells start strong and fade fast, and producers are drilling at a breakneck pace to hold output steady. In the fields, this incessant need to drill is known as the Red Queen, after the character in Through the Looking-Glass who tells Alice, “It takes all the running you can do, to keep in the same place.”
In North Dakota’s Bakken Shale, a well formally known as Robert Heuer 1-17R put out 2,358 barrels in May 2004, when it went live. The output proved there was money to be made drilling in the Bakken and kicked off an oil rush in North Dakota. Continental Resources, the well’s operator, built a monument to it. Production declined 69 percent in the first year.
According to geoscientist David Hughes, the U.S. must drill 6,000 new wells per year at a cost of $35 billion to maintain current production. He also notes that the newest wells aren't as productive as previous well drilled in the same locations during the first few years of the shale boom.
Hughes believes production will peak in 2017 and fall back down to 2012 levels two years later.
Of course, I'm no geologist. I can't say with 100% certainty if Hughes is right or wrong. What I do know is that it is absolutely accurate that decline rates for shale production are very steep, and they come very quickly.
And that's why I remain bullish on North American oil and gas, loading up on the best producers in the Bakken, well-funded LNG players up in Canada, and even the latest drilling technologies that producers are using to get the most bang for their drilling buck...
All in all, no matter how this plays out, there is no better time to stake your claim to the domestic shale boom that is now underway.
To a new way of life and a new generation of wealth...
@JeffSiegel on Twitter
Jeff is the founder and managing editor of Green Chip Stocks, a private investment community that capitalizes on opportunities in alternative energy, organic food markets, legal cannabis, and socially responsible investing. He has been a featured guest on Fox, CNBC, and Bloomberg Asia, and is the author of the best-selling book, Investing in Renewable Energy: Making Money on Green Chip Stocks. For more on Jeff, go to his editor's page.
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