Strategies Are Changing for Unconventional Gas (and Oil) Development

Natural gas drilling and development is facing new challenges this year. How will this impact E&P drilling?

Online PR News – 14-September-2010 – – HOUSTON, Texas Natural gas drilling and development is facing new challenges this year, according to Don Warlick, President of Warlick International.

Even with challenging price and supply conditions for natural gas, E&P companies are drilling ahead in all significant unconventional gas plays, with focus on gas shales. For example, 195 wells were drilled in the Marcellus in 2008, but this year that number could easily exceed 1,000 wells.

There is an ocean of cash going into plays like this, coming from several sources that provide a powerful monetary driving force to support unconventional drilling:

- Credit Suisse estimates that natural gas-focused producers have been reinvesting about 165% of cash flow so far in 2010
- Acquisitions add momentum -- Shell E&P is spending $4.7 billion in their acquisition of East Resources, Inc. in the Marcellus Shale
- Joint ventures are adding fuel to the fire -- two JVs in April and May in the Marcellus (BG Group/EXCO Resources and Reliance Industries/Atlas Energy) totaled almost $2.7 billion

The level of drilling activity continues to surprise the forecasters by remaining high in the leading unconventional plays -- all in the face of high natural gas supply and low gas prices.

What about North American natural gas demand? Will there be any improvement to help relieve some of the overhang in natural gas supply?

- The US economy was improved until recently, but is essentially moving sideways and remains anemic
- Low gas prices can typically spur demand (and even discourage drilling) but there's little change here
- Mid-term elections and related campaign rhetoric is no help, and in fact are lending some hesitation to business decision-making
- A plus: The EIA is anticipating US natural gas consumption to increase by 4% this year with a major share occurring in electric power generation

The current level of natural gas supply has flattened somewhat, due in part to some tightening of frac service capacity, pipeline completions, etc. which are probably somewhat temporary. But we still have a very busy rig fleet that is drilling ahead, especially in high-potential unconventional plays across the US and Canada.
As a result, we are facing challenging price situations today and into the future. In 2009 Henry Hub gas prices averaged $3.96/MCF. Three forecasters (Raymond James, Energy Directions and Bloomberg) are estimating average gas prices this year to range from $4.54 to $4.89. Their estimates diverge in 2011 in a range of $4.25 to $5.52. A less-than-cold winter heating season could easily move the needle to the left and the industry could be faced with near-$4 gas prices next year.

There are no easy answers or clear strategies for domestic drillers on land in the US and Canada. For those focused on unconventional gas their typical strategies in the past have been to:

1. Get big in real estate and drilling, block up sizable acreage and develop as fast as possible
2. Discover, define and develop sweet spots and then drill quickly in order to ramp up production to pay for their investment
3. Later in the process, engineer every efficiency possible to reduce all field and development expense to join the club of the lowest-cost producers.

It’s a much more complicated and a dynamic business environment with flat gas prices, more competition but steady crude oil and liquids prices. Some of the innovative operators are going forward with variant strategies that could improve their situation this year and into 2011.

First, a principal focus for all right now is the #3 strategy from above -- impose engineered processes and efficiencies to squeeze all drilling, development and production costs in these huge unconventional fields. One operator, EnCana, is employing what they call their “Gas Factory” approach in all of their big-play campaigns whereby they turn over every rock, look at every function and see how efficiencies and cost reductions can play out in the big picture, all the while with focus on improved production and attention to safety.
Another strategy, a big trend which started in mid-late 2009 is to redirect resources into more oil and liquids production. The approach is to apply unconventional gas drilling and development technologies in shale oil or wet gas/liquids plays. Two examples:

- Pioneer Natural Resources completed a well in DeWitt County, Texas in the Eagle Ford that had initial production of 11.6 M. MCFD of gas and 680 BD of condensate -- which ultimately translated to an equivalent 15.7 M. MCFE of dry gas production
- Two Granite Wash wells completed in April 2010 by Forest Oil had an average initial production of 11.4 MMCFD of natural gas, 1,862 BD of natural gas liquids and 1,956 and BD of oil and condensate
The trend to more crude oil and liquids continues, especially among those companies who have solid unconventional development experience in natural gas -- like EOG, Range Resources, Newfield, Chesapeake and others – all of whom wish to spread their portfolios and risks across a broader spectrum of opportunity.
Chesapeake Energy is going forward with another strategy. They are leveraging their presence across multiple gas shale plays with their gas gathering enterprise, Chesapeake Midstream Partners. Chesapeake’s system is made up of around 2,800 miles of gathering pipelines that serve about 4,000 natural gas wells. It will involve gathering directly from the wellhead through transportation to third-party takeaway pipelines. A big plus: Gathering agreements provide more stable and visible cash flow opportunities.

In summary, when situations become challenging -- even difficult -- adept managements that plan for the long term can revise their strategies to accommodate challenges in the path forward.

Warlick International is a Houston-based oil & gas intelligence firm that is a leader in evaluating unconventional oil & gas resource markets. The company has provided business information, marketing counsel, litigation services and strategic solutions to oil & gas, oilfield services and financial sector clients for more than 35 years, with emphasis on upstream energy. For more information, please visit Warlick International’s website.

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