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US gas powers on

The US shale sector is continuing to shift from shale-gas drilling to the more economical shale-oil drilling

One of the defining characteristics of the US shale sector over the past few years has been the shift in investment from shale-gas focused drilling to shale-oil drilling. In mid-2009, 80% of rigs drilling in the US were targeting gasfields, while 20% were targeting oilfields. That ratio has now flipped as rigs and dollars have flowed from shale gas plays such as the Haynesville and Barnett into the more profitable Bakken and Eagle Ford oilfields.

There is no mystery as to what has been driving the trend. The economics of drilling shale-oil plays became far more attractive than shale-gas plays after a prolonged slide in US natural gas prices, which fell to a decade-low $1.90 per million British thermal units (Btu) in April last year, while oil prices have remained relatively high.

But natural gas prices have bounced back this year, rising to as high as $4.40/ million Btu in April, more than double the price from the same time a year earlier. Prices have slipped since April to around $3.60/ million Btu, but natural gas has still been one of the strongest performing commodities in 2013. Analysts expect gas prices to trade between $3.50/ million Btu and $4/ million Btu over the next six months.

So does that mean the economics of drilling are shifting back into the favour of shale-gas plays? Analysts at Barclays took that question on in a research note last week, revisiting a 2011 analysis it did of the economics of drilling in various shale-gas plays versus the oil-rich Bakken play.

For the most part, the answer they came up with was no. Assuming a natural gas price of $4.15/ million Btu and a WTI crude price of $93 a barrel, the wells drilled at the Marcellus shale-gas play are the only ones that comes close to competing economically with the average Bakken well. The Fayetteville, Barnett and Haynesville shale-gas plays, meanwhile, would require either a significantly lower WTI oil price or higher natural gas price to draw investment back from the oil patch.

But gas wells are becoming more competitive. Analysts at Barclays found that “significantly lower gas prices are needed today for a gas well to compete with an oil well than in 2011”. There are a number of reasons why that is: as oil drilling and production has increased, WTI crude prices have fallen from 2011; many of the best shale-oil wells have been drilled since 2011, meaning that the average well is now more challenging; and there have been significant improvements in the efficiency of shale-gas drilling and hydraulic fracturing.

That last point has been a key reason why, in spite of the sharp fall in shale-gas drilling activity, output has continued to rise, to the surprise of many. Analysts at BofA Merrill Lynch had predicted a fall in output this year because of lower prices and reduced rig activity, but after a strong first half of the year now reckon production will rise again this year. “The relationship between US nat gas production and the gas rig count now seems completely broken. The gas rig count dropped to 18-year lows... with no discernable effect on output.”

BofA Merrill Lynch wrote in a recent research note: “Domestic gas production has failed to show any declines at all and has been growing at a monthly rate of 0.3 billion cubic feet a day (cf/d) since April. Much of the gain comes on the back of continued improvements in drilling efficiency that have caused the relationship between output and rig count to break... We raise our production growth forecasts from a 0.2 billion cf/d decline to 0.04 billion cf/d growth for 2013.”

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