Energy Analysts Deliver More Bad News for US Fracking Industry's Business Model

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This month,ย the energy consulting firm Wood MacKenzie gave an online presentation that basically debunked the whole business model of the shaleย industry.

In this webinar, which explored theย declining productionย rates of oil wells in the Permian region,ย research director Ben Shattuck noted how it was impossible to accurately forecast how much oil a shale play held based on estimates from existingย wells.

โ€œOver the years of us doing this, as analysts, weโ€™ve learned that you really have to do it well by well,โ€ Shattuck explained of analyzing well performance. โ€œYou cannot take anything forย granted.โ€

For an industry that has raised hundreds of billions of dollars promisingย future performance based on the production of a fewย wells,ย this is not good news. And particularly for the Permian, the nation’s most productive shale play, located inย Texas and Newย Mexico.

Up until now, the basic premise of the fracking business modelย has been for a companyย to lease some land, drill until finding a high-volume well, hype to the press this wellย and the many others itย plans to drill on the rest of its acreage, and promise a bright future, allย while borrowing huge sums of money to drill and frack theย wells.

Throughout the seminar, Wood MacKenzie analysts emphasized that companies can’t reliably predict future oil production by โ€œclusteringโ€ wells, that is, estimating volumes of many future wells based on the performance of a small number of nearby existing wells,ย and described the practice as potentiallyย โ€œmisleading.โ€

Shattuck called out how the old business model of firms borrowing money from investors while hoping for future payouts on record-breaking wellsย no longer works. Heย summed up theย situation:

โ€œWeโ€™re transitioning to a point in time, where the investment community was enamored of the next well and how big it might be. That has changed for a variety of reasons. One very important reason is the next well might not be bigger. It might beย smaller.โ€

The fracking industry is now being asked to produce positive financial results โ€” not just promises of new super wells, or cube development, or artificial intelligence. And yet the industry couldnโ€™t deliver profitsย while drilling all the best acreage over the last decade. Now, shale companiesย needย to do that with oil wells that may not produce asย much.

Seven years ago, Rolling Stone referred to the fracking industry as a โ€œscamโ€ while profiling theย โ€œShale Kingโ€ย Aubrey McClendon, the man generally credited with inventing the business model the shale industry has used the past decade.ย Today, McClendon’s old company Chesapeake Energy is in danger of going bankrupt.

Perhapsย investors are finallyย catchingย on.

Are Child Wells the Newย Normal?

Last year I covered the issue of child wells, or secondary wells drilled close to an existing โ€œparentโ€ well, and the risk they posed to the fracking industry. Child wellsย often cannibalize or damageย parent wells, leading to anย overall drop in oilย production.

At the time,ย I cited a warning about this situation from Wood MacKenzie, which said, โ€œClosely spaced child well performance presents not only a risk to the viability of the ongoing drilling recovery but also to the industryโ€™s long-termย prospects.โ€

Over a year later, has the shale oil industry abandoned this approach or are child wells still anย issue?

During this month’s webinar, Ben Shattuck answered that question, making a statement that should strike fear in the heart of shale investors and the owners of allย this shaleย acreage:

โ€œWe know weโ€™re on the cusp of a child-wellย world.โ€

One of the biggest problems with fracked oil well production is child wells, and according to Shattuck,ย that looks likeย the new normal. When the bug in an unprofitable business becomes the main feature of the business model, its future is definitely atย โ€œrisk.โ€

Frackingโ€™s Fatalย Catch-22

As long as shale firms could keep borrowing and losing money to drill new wells,ย producingย more oil was simple. When profits werenโ€™t a concern, the debt-heavy business model worked. But similar to the dot com boom and bust, the fracking industry is learning that if you want to stay in business, you need to make aย profit.

Without a doubt, drilling and fracking shaleย can produce a lot of oil and gas in the right geological regions. It just usually costs more to get the oil and gas out of the rockย thanย the fossil fuels are worth on the free market. Now, however, the much-lauded โ€œshale revolutionโ€ is facing two big issues โ€” the best rockย has been drilled and few are eager toย loanย money to drill the remainingย acreage.

E&E News recently highlighted what this reality means for Texas’sย Eagle Ford shale play, where production is now 20 percentย lower than at itsย peak in early 2015. For an oil basin that’s only been producing oil via frackingย for just over a decade,ย that is a pretty grim number. However, an analyst quoted by E&E Newsย highlights the secret to making money whileย fracking for oil: Simply stopย fracking.

โ€œGenerating free cash is easy: Stop spending on new wells,โ€ said Raoul LeBlanc, vice president for North American unconventionals atย IHS Markit. โ€œThe catch is that production will immediately move into steep decline in manyย cases.โ€

Ah, the catch. To generate cash while fracking requires companies to stop fracking and sell whatever oil they have left fromย rapidly declining wells. Becauseย fracked wells declineย quickly even when everything goes perfectly, if a producerย isn’t constantly drilling new wells, then the oil production of a field drops off very quickly โ€”ย the โ€œsteep declineโ€ noted byย LeBlanc.ย 

That’s exactly what happened in the Eagle Ford shale, an early darlingย of the fracking industry, and most of the top acreage in the Bakken shale play in North Dakota and Montanaย has already been drilled, andย will likely see similarย declines.

LeBlanc emphasizes this point again inย the Journal of Petroleum Technology, where he is recently quoted sayingย that the decline rates in the Permianย region have โ€œincreased dramaticallyโ€ for new frackedย wells.ย 

A year and a half ago, DeSmog launched a specialย series exploring the finances of the fracking industry, putting a spotlight on itsย financial failings. At the time, optimism about the future of fracking was still filling the pages of the financialย press.

The initial articleย kicking off theย series closed with a quote from David Hughes, a geoscientist and fellow specializing in shale gas and oil production at the Post Carbon Institute. For years, Hughesย has been warning aboutย the optimistic estimates for shale oil andย gas.

Hughes told DeSmog that with the finances of fracking, โ€œUltimately, you hit the wall. It’s just a question ofย time.โ€

With the industryย on the cusp of a โ€œchild-well world,โ€ that wall appears to be approaching quickly โ€” unless you still believe the industry promises that fracking’s big moneyย isย right around theย corner.

Main image: Oil fields near Stanton, Texas. Credit: Formulanone,ย CC BYSAย 2.0

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Justin Mikulka is a research fellow at New Consensus. Prior to joining New Consensus in October 2021, Justin reported for DeSmog, where he began in 2014. Justin has a degree in Civil and Environmental Engineering from Cornell University.

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