Tuesday, January 6, 2009

9. Why Europeans aren't the only ones who should worry about Natural Gas

The first of the Tech note posts dealt with the initial creation of coal, and so obviously I will be coming back to talk about that at some time in the near future. Most particularly I will be challenging some of the conclusions of Dave Rutledge, whose opinion on coal reserves has been publicized recently in WIRED. (Hat tip to Devin). However, some of that requires a bit of a foundation, which will continue to be built over the next few Sundays. Instead, what I want to begin to also develop are some posts about the natural gas situation in the United States (the situation in Europe is highlighted by the Russian:Ukrainian dispute).

The reason for some initial groundwork on this topic is that, at the present, the US has a surplus of natural gas, and this is driving the price down, even as demand rises. Sadly this is a relatively short-lived situation and going to start to have some significant unfortunate consequences probably within the next year to eighteen months. What I want to do is two different things – the first is to roughly identify the problem, as I see it, and then in some later posts to explain some of the technical problems that have led us to where we are today. Today’s post will, however just outline the problem, which begins with the current cost for a new gas well of around $5 million.

The reason that the country currently has a surplus of gas can be traced back to a couple of different causes, the development of a gas pipeline from Colorado to Ohio, and the more critical extraction of gas from the shale deposits around the country. These latter reserves were needed since, over time, the earlier supplies of natural gas from more traditional sources such as wells in the Gulf of Mexico and Texas have been declining. The problem is well illustrated by information that Gary Swindell has illustrated and from whose work I would like to take a couple of graphs. In Texas the overall production has been relatively stable at about 500,000 mmcfe a month for the past decade. However, in that time the average size of the wells that are being produced has declined.

Average size of wells being developed in Texas (from Swindell)

and the average decline rate, in the first year of production, has climbed to 60% of the initial production rate.

First year decline rate of Texas gas wells (from Swindell)

Notice that the decline rate reached this plateau in around 2000. This is when the first wells started being sunk into the Barnett Shale, which is a gas bearing rock that underlies Dallas and Fort Worth, among other places. It is currently being developed, and there are over 6,000 wells already drilled into the formation.

Now I will get into all the complexities of drilling and producing gas from the gas shales in a separate post on some future Sunday, but for now there are two things to note. The first is that with more than 60% of the wells initial production dropping off in the first year, new wells have to be drilled at an ever increasing rate (as the fields get smaller) in order to maintain production. Swindell notes that 18% of the production now has to come from new wells every year.

However drilling these wells is very expensive, as Comstock reported yesterday, these wells are now costing up to $5 million each. And the problem is that the relatively short life of the wells, and the levels of production that are achieved, are not giving an adequate rate of return.

Last year I noted (when the wells were costing $3 million), drawing from Arthur Berman’s analysis that only about a quarter of the wells were likely to be profitable. With the increased costs, this number, despite today’s rally in stock prices - driven by the Russian:Ukrainian debacle, when taken with the drop in natural gas market price means that there will be less incentive to drill new wells, and rig numbers will significantly fall.

Rig numbers are already falling rapidly. The concern is, that with the need for a continuing supply of new wells to sustain U.S. Natural Gas production, there will soon not be enough wells being drilled, or rigs drilling them, to meet the shortfall in supply as the current wells start to run dry within the year.

Oh, and Russia does not plan on exporting LNG to the United States.

And while I am talking about exports, there is useful information on fuel exports that can be found at the Energy Export Data Browser

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