Tuesday, January 15, 2013

Eagle Ford: An unconventional fantasy.

            In the aftermath of the initial panic that occurred after 2006, when conventional petroleum resources plateaued, perhaps permanently according to the IEA 2010 report, (p124), more and more people started to question the viability of our global economy in its current form.  There were a few contrarian voices, which said that there is plenty of oil in the ground, we just have to get to it.  At first they were ridiculed by many who saw them as eternal optimists.  Some people argued that the global economy cannot sustain the price level needed to support the long-term production of expensive sources of oil, such as oil sands, shale oil, and deep water fields.  We have been living with crude oil prices in the $100 range for almost half a decade now, and while it may not be pleasant, given that many decades worth of infrastructure were built for $20 oil, we are still kicking around.  Others argued that given the low rate of energy return on energy invested unconventional sources will not support the global economy.  Once again, it is a pain that we are faced with an industry which for a century now has been marching towards lower returns on energy invested, but as long as there is a significant net gain, it will be done. We are benefitting, even when we achieve a 4/1 ratio, which is what we get out of oil sands, and shale oil.  It is quite pathetic compared to the 100/1 ratio that some of the great conventional fields in Saudi Arabia and in Texas yielded early on, during the initial process of tapping some of the world's biggest and easiest to produce fields, but unconventional fields help us stay afloat.  There is of course also the question whether there is a long-term net benefit to us, given the environmental degradation involved in the production process.  I believe society as a collective already decided a long time ago to assume that we are getting a net benefit out of it, so environmental concerns will not be an impediment to producing unconventional oil.

            As a result of proving the immediate concerns of the peak oil advocates to be irrelevant at least given the current circumstances, the new mainstream consensus is now that we are not looking at energy constraints on the economy in the near future, instead, we are witnessing the transition to a new era, based on bringing online huge new resource deposits.  There is more and more talk of many trillions of barrels in potentially recoverable resources, in the form shale oil deposits, as well as kerogen, which is often mistakenly talked of as shale oil, probably done on purpose to give people the false impression that the resource is within technical reach.  So, increasingly people are given the impression that the new era of unconventional resources is giving us a chance to reset the oil age back to the early days, when we were just starting to tap the world’s great fields, and we are back to looking ahead at decades of plenty.  To put things into perspective, the world’s entire official proven oil reserve stemming from conventional fields is estimated at somewhere between 1.3 and 1.5 trillion barrels.  This number is itself under question given reserve inflation that seems to be occurring due to OPEC politics, which encourages members to seek influence within by inflating their reserve estimates.  So the bottom line is that the new perception that currently dominates is that in the US alone, there is now more oil waiting to be recovered than in the entire world.  All that needs to be done according to some talking heads, pushing their own agendas, is remove the environmental and other policy barriers and the prize is ours to take.

            Before I go to the analysis of the Eagle Ford oil and gas deposit in order to try to shed more light on this issue, I want to point out a few facts in regards to the prospects for these US unconventional resources.  First of all, it is estimated that there is a 2-3 trillion barrel shale oil resource base, part of which is already being developed in the form of shale oil.  Of that immense resource base, it is estimated by the USGS that about 1-2% will be recoverable given current technology and recent price levels.  Many people jumped to assume that technological innovation just unlocked that 1-2%, so given the fast paced change in technology we are witnessing currently, much more will be ultimately recovered, perhaps as much as 10-20%, or somewhere around 500 billion barrels.  My response to that is that anything is possible, but at the moment we have to take a step back and recognize that not technological innovation made these resources available, but a five fold leap in average yearly oil prices that happened in the last decade.  The fracking technology and even horizontal drilling have been around for a long time now, so no new major innovation was involved.  Given technical economic reasons, which in my view are now fully demonstrated by recent history, it is unreasonable to expect that we can successfully overcome another major permanent rise in oil prices any time soon to give us another boost in the form of the addition of more reserves.  Perhaps many decades from now, who knows, but certainly not within my lifetime.  So, in the absence of some innovation at current price levels, the 25-50 billion barrel addition to US recoverable resources is all that the US will get out of this resource.  It is a huge resource for sure, but put into global perspective, it is only one to two years worth of consumption.

            As far as the often cited huge potential of the kerogen deposits, it is something that has been contemplated for decades now, but it seems market price mechanisms are not enough to unlock this resource, because pilot projects have yet to demonstrate that it is possible to get a significant net energy return on energy invested out of it.  All the talk about government policy being the main obstacle in this particular case is hot air and nothing more.  Here we truly have a technical challenge, and at the moment, there is no indication yet that it is about to be overcome, so no use even spending time discussing it. (link here for those who want to read more about recent attempts to find a way to produce this resource)

Eagle Ford:

            Given the current rush to proclaim the permanent defeat of peak oil, courtesy of unconventional oil and gas, I chose to look at one such field and analyze to the best of my abilities its future, based on currently available information.

Basic Facts:

-Eagle Ford contains the equivalent of about 7.3 billion barrels of oil according to the US Department of Energy, made up of crude oil, NGL’s and natural gas, which are technically recoverable. 

-Crude + NGL’s make up 3.3 billion barrels of the resource.
-Natural gas makes up the rest, which is about 4 billion barrels.
-At current market prices, the entire recoverable resource is worth about $330 billion, Asuming a price of $90 per barrel for crude oil, and a much lower $60 per barrel price for NGL's and $20 per barrel for natural gas.

-Current estimates put liquids production at about 900,000 barrels per day by 2020, which would mean that by that time, about 2/3 of the recoverable liquid hydrocarbons in place will be depleted.  There are some more outlandish estimates ( such as this one) that put oil and gas production from the field at 1.4 billion barrels for the year 2020, or 4 million barrels per day.

Net collective profit for the field:

            Many upbeat reports have been trumpeting the surge in investment in this field, and the resulting benefit to the local economy.  Recent analysis puts yearly investment into the field at about $30 billion between the years 2012-15.  That projected investment alone ads up to $120 billion, which many were eager to proudly point out that it adds up to more than the entire investment in Kazakhstan’s Kashagan field development, which contains about 15 billion barrels of oil.  Another $30 billion or so have already been spent up to 2012.  Money will have to be spent after 2015 on developing and maintaining production.  According to current production estimates, of the 7.3 billion barrels of recoverable oil equivalent, by the end of 2015, only an estimated 1.3 billion barrels will have been produced, which means that much more drilling and infrastructure building will still be needed going forward to drain the entire estimated recoverable resource.  It is reasonable to assume that it will take up to 2030 to recover most of the reserves, with small scale production afterwards going after what is left.

            Given that $150 billion will be cumulatively spent by the end of 2015, it is hard to understand how the recovery of the currently estimated recoverable resources can be ultimately profitable.  Assuming that between 2015-20, the yearly average investment will decline to $20 billion, and then decline to $10 billion per year between 2020-30, we already end up with total spending at $350 billion, which is more or less equal to the estimated value of the resource at current prices. 

We should remember however that by 2030, the field will not be entirely drained, so assuming that 90% of the estimated reserves will be produced by then, we get about $350 billion in expenditures and about $300 billion in revenue.  These results are just a rough estimation, based on many unknowns, including actual level of yearly expenditures going beyond 2015, long-term commodity market prices, company management, unforeseen environmental costs, royalties owed to government, technological changes, unforeseen geological challenges, and other unforeseen factors.  The bottom line is that it is clear that there is a good chance that the development of this field will not lead to a net collective profit for the developers.

Something has to give:

            In the absence of a large increase in the ultimate level of recoverable resources, it is hard to see how even the 7.3 billion barrels of oil equivalent will be extracted in the end.  Some may argue that surely technological innovation will come to the rescue of this situation, and provide with much cheaper and more effective modes of extraction, which will help yield more hydrocarbons at a lower price.  I should point out again that the current rush to shale oil and gas is the result of market price mechanisms, while the main technological innovations employed predate this rush.  There is always a possibility of technological breakthroughs, but there is currently absolutely no reason to expect this to happen.  In the absence of much lower extraction costs, much larger ultimate recovery volumes than currently estimated, or much better average prices than we have currently for these hydrocarbons, it is reasonable to expect that soon after the most profitable spots within the field will be developed; the rest will be left unexploited.  This of course means that the opposite of what is widely expected currently will happen, which is that a large portion of what has been deemed recoverable will be left in the ground, so Eagle Ford will ultimately produce less than 7.3 billion barrels, not more.

            Some may argue that the market will come to the rescue with higher prices.  Many people who adhere to the peak oil theory, initially believed that we are headed towards $200 a barrel or more for petroleum.  That initial reaction, as a response to the plateau in conventional crude production in 2006, including the prediction coming from renowned Canadian economist Jeff Rubin, was obviously flawed.  As I pointed out in an article written a few months back entitled “The Ceiling”, the current economy shows strong signs that it cannot stomach prices much higher than $110 a barrel.  Demand destruction seems to set in, every time the market pushes for those price levels for a sustained period of time, which then leads to lower prices again.


            The people who are now capitalizing on the current trend of unconventional oil and gas production, in order to reinforce their argument that we will have plenty of hydrocarbons forever, therefore there is no need to change anything fundamentally in our direction forward, will get to say “I told you so” for perhaps just a little over a decade more, before they will start being faced with the need to backtrack a little on their fabulously inflated claims of many decades or even hundreds of years worth of hydrocarbon plenty.  This is unfortunate because total liquid fuel production will plateau, just as conventional crude did about six years ago, and we need to be prepared.  Preparing for that event can take decades, so it is a shame that we are failing to realize that all that these unconventional sources are giving us is a second chance on which we must jump as quicly as posible.

            Eagle Ford is perhaps the best example of what is ahead of us in the absence of a technological miracle which will unlock substantially more than the 1% of the crude oil currently in place in the field.  It does not sound like a huge task having to increase recovery rates in a field from 1% to 2%, or more.  Truth is however that there was no technological breakthrough involved in releasing that 1% either, so there is no reason to expect that much more will be produced, although, we have to admit that anything is possible, and we should never count out human ingenuity, which is by far our most important potential resource as I often stated. 

Given what we know about the field and its current development path, in the absence of a great change in one of the main variables, such as an increase in ultimate recovery, a great leap in prices, or a great technological breakthrough, which will decrease development costs, we should expect the peak in liquids production to happen around 2020, by most estimates at a rate of about 900,000 barrels per day.  By that time, 2/3 of the original recoverable liquids in place will have been produced, which means a very fast rate of production decline from that level, especially if by then many companies will realize that it is time to either cash in on having exploited the sweet spots, or as will be the case for some companies, cut their losses.

            Other similar fields, which are currently contributing to the hysteric swing towards optimistic euphoria, such as the Bakken will likely experience similar production schedules.  Collectively, in the absence of human ingenuity causing a real breakthrough, which does not seem to be currently imminent or even to be expected, the fracking revolution will cause a bump in production which started in 2008, and it will end sometimes between 2020 and 2030.  On the way down, it will be very painful, just as it will be a great boost to the US economy on the way up.  In fact it may be the only bright spot going forward, so we can enjoy it while it lasts.  We could enjoy it and worry later, or we could put some of our human ingenuity towards coming to a collective realization that, unconventional sources of oil and gas being tapped worldwide are only enough to cover the potential growth in demand coming from what seems to be a permanently anemic global economy for perhaps two decades.  If we fail to come up with better ways to manage the global economy by the time this bump in production ends, we will be left with nothing else except prayer for a technological miracle, because the market has already played its hand a decade ago.



  1. I'm sure the investment bank officials considering lending to these businesses know how to do these calculations, and have done them - they obviously don't take the business's word for it that it will be profitable.

    But consider the effect on the economy of continued investing in the "drill, baby, drill" program. Over-production lowers fuel costs at the pump, it employs people instead of them being on welfare, it boosts GDP, and it even allows politicians to deny Peak Oil and claim the US will be self-sufficient in oil in the future.

    And what does it really cost?
    The investment banks probably get their funds at low rates from the major banks, who get their funds at ultra-low rates from the Fed
    and then leverage it up 8-fold through fractional reserve banking, and the Fed creates the funds out of thin air and books the lot as solid assets.

    As long as the supply of money doesn't run out, it cannot fail - a Ponzi scheme. And Bernanke has said over and over again that he will always create money to avoid deflation.

    So with nods and winks along the chain, the entire unprofitable venture gets the go-ahead. It cannot be happening by accident.

    1. Thanks for your comment Dave. I largely agree with your comment, except for your stating of the belief that the investment banks know what they are doing. I'm sure they designated people to look into it, before lending out the money, but question is how diligently did those people do their jobs? Or perhaps they simply took the claims of industry at face value? And let us face it, industry has been making some very positive claims lately, including on ultimate recovery rates, and therefore profitability per well drilled. The society of petroleum engineers recently rebuked their claims, but do investment bankers read those reports? Other than that, you are right of course. With the bump in oil & gas production, there is a definite acompanying bump in economic activity, which will last for perhaps a decade or more, before the bill will come due, but untill then, we are likely looking at over a million direct jobs, and at least as many indirect jobs as a result of fracking, so if it will come at a slight net financial loss, who cares? Maybe a small bailout with some borrowed money will make it all better.

      Here is an article you might find interesting:

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