From Peak Oil to Glut: How innovation is helping the U.S. oil industry cope with its biggest downturn in decades
By Jérôme Taillard, Assistant Professor of Finance, Babson College
Fracking is the common term used for hydraulic fracturing, which combines horizontal drilling with high-pressure fluid injection to fracture shale rock deep underground and extract previously untapped oil and gas deposits.
The practice of
high grading is exemplified by Continental Resources’ focused drilling on their best acreage positions in the Bakken as prices declined (see
In February 2016, responding to an oversupply of approximately two million barrels a day, oil prices hit a multiyear low of $26.14 a barrel (WTI benchmark ,Figure 1, April 2016) forecast one-year oil prices ranging from a low of $20 to a high of $80, a range that reflects the inherent uncertainty of trying to predict future price movements. Media reports often claim that U.S. oil producers, driven at times by greed and the need to repay their ballooning debt, have continued to overproduce during this period of turmoil. The evidence, however, supports a very different picture of how the industry has reacted to lower oil prices.
Responding to the Glut
The fact that U.S. production has declined only slightly in spite of the sharp drop in prices (see
Figure 2) has less to do with oil men’s obsession with drilling than it does with a number of industry business practices—and especially with the significant impact of innovation in exploration and drilling technology. Many oil firms used financial derivatives (such as “futures” and “swaps”) to lock in prices, which guarantees a stream of revenue allowing them to continue drilling profitably for at least a period of time during a downturn. Rig count itself dropped dramatically: After increasing five-fold in three years to more than 1,600 active rigs in late 2014, it fell to fewer than 330 by April 2016. Partially offsetting the reduction in rig count has been the practice of “high grading” drilling activity on the most productive assets. By focusing on their best acreage, firms can extract a higher return from their drilling capital and reduce exploration risk by drilling where the prospects are more certain.
Innovation in the Oil Patch
While futures contracts and high grading are important measures to counter the impact of lower prices, they are limited by time: companies typically hedge prices only a few years out, and at some point the most productive areas decline.1 Far more important to the long-term capacity of oil companies to drill profitably in the face of low prices has been the rapid technological advancements in drilling and hydraulic fracturing (fracking) technology.2 As a result of continuous improvements in technology, it is quite typical to see annual increases in well productivity as high as 30% (as depicted in
Figure 4 from EOG Resources). Such improvement has allowed Exploration and Production (E&P) firms to maintain their production guidance despite materially lower capital budgets.
Specific examples of technological improvements include new well design completion techniques and Enhanced Oil Recovery (EOR) efforts. For instance, Panel A of
Figure 5 shows how Pioneer Natural Resources has, in the last three years, significantly modified its completion techniques in fracking by using tighter stage spacing between each fracture stimulation of the shale rock, which allows for greater oil recovery per well. In Panel B, EOG Resources reports a very similar evolution toward a high-density completion technique during the past five years.
Enhanced Oil Recovery (EOR) efforts also are seeing significant benefits from technological advancements. In its latest quarterly results, EOG Resources announced it “cracked the code” in reinjecting natural gas in its Eagle Ford wells in Texas in order to extract 30 to 70% more oil than initially expected.3 Enhanced oil recovery from existing wells allows for increased oil production without the upfront capital costs and development risk associated with drilling new wells.
While these examples have focused on large industry leaders such as EOG Resources and Pioneer Natural Resources, it is important to note that the race for technological improvements in the oil and gas industry also includes many smaller, innovative companies. To illustrate this widespread phenomenon of technological advancement,
Figure 6 describes a broad array of new technologies that Lonestar Resources, a small exploration and production (E&P) firm based in Texas, is applying to its shale-drilling activities with its partner, Schlumberger, a drilling-services provider.4
Granite Oil, another smaller E&P firm based in Canada, has been applying with great success a gas reinjection system in the Bakken. The resulting production profile in
Figure 7 shows much shallower decline rates than typical shale drilling because the injection of natural gas maintains the pressure in the well for a longer duration.5 This innovative technology is another example of how production profiles can be sustained at a high level without having to invest significant additional capital. The firm claims that this approach allows it to sustain its current dividend policy even in a low price environment of $40 a barrel.
An additional example of technological progress in the industry is provided by Painted Pony Petroleum, an E&P firm active in British Columbia. The company has shown tremendous well productivity gains following (1) the switch to parallel drilling, an example of pad drilling in the industry whereby more wells are being drilled from a single drilling platform; and (2) a change in its completion technique from “plug and perf” to “ball-drop.”6 These two changes combined have led to a 72% increase in well productivity (see
The combination of these innovations helps explain why North American production numbers have not fallen as much as some observers had expected. But, more importantly, they illustrate the resiliency and capital discipline that this crisis has instilled in North American oil producers.
As Winston Churchill famously said: “Never let a good crisis go to waste.” This article’s objective was to assess the actions of North American oil producers as they face one of their biggest crises in recent memory. The picture that emerges overall is one that would make the British Bulldog rather proud that his advice was well heeded. U.S. oil producers emerging from this crisis will be stronger. If one can draw some lessons from their actions, these lessons probably would be as follows: (1) Hedging matters greatly for commodity producers. Downside protection gives precious flexibility for firms to adapt their capital structure and expenditures in the wake of a commodity price crash. (2) Having a penchant for excess debt is dangerous in a business where the price of your main output is volatile and not fully in your control. (3) Firms should not wait for the next crisis to become nimble. In a highly competitive and cyclical industry with no product differentiation, having the lowest cost structure is key to thriving in both good and bad times.
While technological innovations are more often associated with clean energy (e.g., wind, solar or Tesla’s electric cars), this article highlights how traditional oil and gas firms also have embraced a culture of innovation. The oil industry might be on a slippery slope as it faces a multipronged assault ranging from lower prices to environmental activists; however, do not write them off just yet. In the race to lower energy costs, innovations in drilling technologies will keep the oil industry afloat by driving costs down for years to come.
Figure 1: Energy Information Agency (EIA) Forecast
This figure depicts the forecast for crude oil prices (WTI) from the Energy Information Agency (EIA).
Figure 2: U.S. Oil Production
This figure depicts the U.S. field production of crude oil over the last 95 years.
Figure 3: Example of High Grading in the Oil Industry
This figure depicts how oil and gas exploration and production firms (here Continental Resources) have focused their drilling efforts back onto their core acreage since the fall in oil prices. In 2014, Continental was drilling across its entire Bakken acreage in North Dakota. As of 2015, drilling concentrated mostly in the region with multiple (stacked) plays of the Bakken (MB) and Three Forks (TF) reservoir (two additional layers of oil deposits, TF1 and TF2). Its planned drilling for 2016 (right-hand side figure in green) concentrates only in the region where the firm has four stacked plays to drill from (MB, TF1, TF2, and TF3). This region is the most economical to drill.
Source: Left-hand side figure: Slide 16 of August 2015 Investor Presentation, Continental Resources. Right-hand side figure: Slide 13 of February 2016 Investor Presentation, Continental Resources.
Figure 4: Example of Increase in Well Productivity
This figure highlights the increase in average cumulative crude oil production from wells in the Eagle Ford shale play for EOG Resources of the period 2012–2015.
Source: Slide 4 of RW Baird 2015 Investor Presentation, EOG Resources.
Figure 5: Enhanced Completion Techniques
Panel A is taken from an investor presentation of Pioneer Natural Resources. This exploration and production (E&P) firm active in Texas (Permian) has gradually improved its completion techniques in fracking with tighter clusters, which allows for greater oil recovery per well. Panel B is taken from an investor presentation of EOG resources. It shows a very similar evolution toward a high-density completion technique during the past five years.
Source: Slide 11 of May 2016 Investor Presentation, Pioneer Natural Resources.
Source: Slide 32 of Q1 2016 Investor Presentation, EOG Resources.
Figure 6: Advances in Drilling Technology
This figure is taken from an investor presentation of Lonestar Resources. This exploration and production (E&P) firm active in Texas (Eagle Ford) has signed a drilling partnership with Schlumberger Inc. The slide highlights all the new technologies it will deploy going forward.
Source: Slide 23 of March 2016 Investor Presentation, Lonestar Resources.
Figure 7: Example of Enhanced Oil Recovery (EOR)
This figure stems from one of Granite Oil’s investor presentation. It shows how their enhanced oil recovery (EOR) system works based on a gas reinjection scheme in order to extract more oil from existing wells.
Source: Granite Oil investor presentation May 2016, p. 11.
Figure 8: Further Developments in Completion Techniques
Panels A and B of this figure stem from one of Painted Pony Petroleum’s investor presentations. It shows the increase in productivity (Panel B) following the new completion technique of parallel ball-drop fracturing technology (Panel A).
Source: Slide 25-26 of May 2016 Investor presentation, Painted Pony Petroleum.
- See short video summary at:
- It was George Mitchell and his small independent oil producer (Mitchell Energy) who first made hydraulic fracturing (fracking) profitable in the early 2000s (see Hinton (2012).
- See Q1 2016 conference call transcript:
- Disclaimer: The author is a shareholder of Lonestar Resources.
- See Granite Oil’s website:
- Plug and perf explanation:
https://www.youtube.com/watch?v=Z-vCBV1AhBs Open hole ball-drop explanation: