Cost Reduction or Productivity, What Strategy Should Operators Choose?

• We’ve focussed on cost reduction because we don’t understand what drives revenue (and profit).

• The best design for any well is the one that is the most profitable allocation of capital.

• Investing in new technologies can be an immensely profitable allocation of capital.

In the twelve months following the 2014 price crash, the industry responded by slashing budgets, squeezing oil field servicing companies and seeking cost reductions and productivity improvements through horizontal drilling and hydraulic fracturing design optimizations. This resulted in a 70% productivity improvement.

In the 12 months before the 2019 pandemic, DOE data showed that the per well productivity in major U.S shale plays only grew by about 10%. A far cry from the 70% productivity improvement that was witnessed following the 2014 price crash. The technologies of horizontal drilling and hydraulic fracturing are now mature and while there are still opportunities to generate productivity improvements, the industry has become facetted on cost reduction.

The reason was made clear to me from an excellent presentation given by David Anderson and as he so eloquently put it and I’m paraphrasing here “There is a disparity between how well the industry understands costs and revenue. The industry has a pretty good understanding of cost but has a hard time understanding revenue, i.e. if we spend money on x, is it going to lead to well performance y.” Understanding this is critical to optimize capital allocation and ultimately profit. I’m going to take this a step further and say that the same disparity exists within the market, where investors also understand cost but don’t know how decisions at the asset level relate to well performance. The only common language between the operators and the market is cost and so it becomes a focal point. Tying in the fact that fiscal responsibility has finally become a priority, it makes sense, it’s the metric that investors use to understand and measure performance in the industry.

But what should we be focussing our efforts on? The answer again was made clear by Dustin Anderson, we need to focus on whatever is the most profitable allocation of capital.

Fortunately, new technologies are emerging that can be an extremely profitable allocation of capital by lowering production decline rates and increasing EUR in unconventional shale plays. DEEPROP® is a breakthrough in proppant technology that allows operators to place proppant in smaller fractures, further from the wellbore and it has been shown to lower decline rates and increase EUR. DEEPROP® has been generating a huge return on investment in multi-year trials in several major U.S shale plays on the order of between 20-40% uplift in total production.

How much more valuable is a productivity improvement versus cost reduction? We’ll explore a modest 25% uplift in total production in the next blog post and see if its worth spending an extra $100,000 - $300,000 per well versus trying to cut costs by an equivalent amount.

We’ll see you in the next blog post!

25% more production out of every well? Well, with Deeprop® let's look at what that would look like.

How could this be achieved? What is the potential upside? What is the potential downside? Who are the winners and who are the losers? In this blog series, I am going to take a look at some of the industry trends and how we can reduce our costs and achieve some upside by improving our production per well in unconventional shale plays.

Since mid-November 2014 when Saudi Arabia, Mexico and Russia could not agree on production cuts, the shale players in the oil and gas industry have had to adjust to lower commodity pricing. Initially by slashing budgets and over time by gaining a better understanding of the geology, innovating, and becoming more efficient with drilling and completion practices. Over the last 7-years the industry has focussed primarily on efficiency and particularly on cost-cutting to improve the economics of shale plays. We’ve gotten used to the term “short-cycle” where it’s possible to drill a well and put it on production in less than two weeks through enhanced drilling efficiency. Short cycle development costs less and it allows operators to be more reactive to sharp changes in commodity pricing. The problem with short cycle development is the rapid production decline associated with producing from very low permeability rock. where production typically declines by about 60% in the first year. While we have seen an increase in IP’s (initial production rates), we haven’t seen an increase in EUR (expected ultimate recovery) of these wells. This implies that we are accelerating our recovery, but our technologies and innovations are not improving the total amount of petroleum we’re recovering in each well. With demand destruction caused by the recent covid-19 pandemic and the historic halt in drilling, we have seen a dramatic decline in shale operator’s base production. This, combined with investor fatigue from pumping in a huge amount of equity for very little return, ESG requirements and perception of an energy transition could hamper the industries ability to quickly supply the market as countries begin to recover.

Ali Al-Naimi -The Oil Market Will Stabilize Itself (2014)

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So the industry is in a situation where the North American hydrocarbon supply is on a downward trend but where there could be a dramatic recovery in hydrocarbon demand post-pandemic. In fact, Exxon predicts that the world will need to add an additional 7% to oil supply per-year when production declines are factored in with demand growth. The issue is that over the last 7-years, due to poor return on investment, there is limited access to equity which drives production growth. The focus of the industry is no longer on growth at any cost but on maximizing free cash flow, paying down debt and reducing greenhouse gas emissions. However, there are opportunities to leverage new technologies that can allow operators to reduce cost per barrel, increase efficiency, profitability and production. The most promising of these technologies is DEEPROP®, a tiny microproppant material that has been shown to increase well productivity by between 20-40% in multi-year trials, in over 250 wells in 6 major U.S shale plays. If you’d like to skip ahead of the blog and learn more about how DEEPROP® can help your company produce cheaper, more profitable oil or gas (and make you look like a Rockstar while you do it) please get in touch!

Investors have Fled the Oil and Gas Industry in Recent Years.

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Summary

• Investors have Fled the Industry

• Oil Production is on a Flat or Downward Trend

• Current Completion Technologies are Accelerating Recovery but not Improving Incremental Reserves

• How can the Industry become more Profitable?