Don't Knock Talk of Energy Independence


There is a real concern that America's energy boom will fizzle out. A recent article in Bloomberg Businessweek pointed out that production at wells that are horizontally drilled and then hydraulically fractured tends to run out really fast. These high decline rates have called into question whether energy independence is just a mirage

A prime example of this is a well that Chesapeake Energy drilled in Oklahoma in 2009. The Serenity 1-3H, which is referenced in the Bloomberg article, had impressive initial production of 1,200 barrels of oil per day. However, just a few years later that Chesapeake Energy well is trickling out about 100 barrels of oil per day. The article also references a Bakken shale well that Continental Resources drilled in North Dakota in 2004. Its initial production was 2,358 barrels of oil per day. Unfortunately, the well's production declined by 69% in its first year.

Some see the very high initial decline rates of shale wells suggesting that energy independence is simply unattainable. We need to drill an increasing number of wells just to make up for production losses. One estimate figures that the U.S. needs to spend $35 billion to drill 6,000 new wells each year just to maintain current production. It's one reason why a company like Chesapeake Energy is now experiencing slower growth. Despite spending more than $7 billion this year to drill, Chesapeake Energy is just seeing that capital yield just a meager 2% increase in total production. Critics point to these numbers and see that the end is near.

The problem with these estimates is the fact that oil and gas producers are shifting gears. In Chesapeake Energy's case, production growth is being slowed by its transition to pad drilling, as well as low natural gas prices that hurt the company's ability to grow. However, an even bigger shift in the industry, and one that many miss, is that energy companies are getting really good at extracting more oil from these wells. A great example of this is found on the following slide from an investor presentation by EOG Resources .

Source: EOG Resources Investor Presentation (Link opens a pdf)

The right side of the slide shows how EOG Resources has steadily been increasing its horizontal laterals. That practice, in combination with better fracture stimulation techniques, is leading to more oil being recovered per well. In just four years EOG Resources has nearly tripled the amount of oil and gas each well will recover in its lifetime. This is because there is more oil trapped in the rocks and producers such as EOG are still trying to figure out the best ways to recover it.

Another great visual example of this is in an investor presentation by Marathon Oil .

Source: Marathon Oil Investor Presentation (Link opens a PDF)

By employing new hydraulic fracturing technology, Marathon Oil has been steadily improving its performance. The graph in the middle really tells the whole story: the company is continually improving performance, with the new stage completions clearly outperforming what the company had been doing. These improvements have fueled a rise in initial production rates by 500% while the estimated ultimate recoveries per well have more than doubled.

Extracting more oil and gas out of these shale plays is critical. As it stands, current technology is only able to get a small portion of the oil that's actually there. Improving the recovery factor is a key factor that could make energy independence a reality.

For example, in the Eagle Ford shale EOG Resources currently is only able to recover about 6% of the oil present in each section it drills. However, by moving to tighter spacing and drilling more wells per section, it's moving to increase its recovery factor to 8%.

That's just part of the story. The industry is finding additional production zones that can now be unlocked. In North Dakota the industry has begun to unlock the oil beneath the Bakken in the Three Forks formation. It has increased the amount of technically recoverable oil from 20 billion barrels to 32 billion barrels. What's incredible about those numbers is that both represent just a 3.5% recovery factor. That means 96.5% of the original oil is still being left behind because current technology is limiting.

Continental Resource CEO Harold Hamm seems to think that future industry technological advances could one day boost Bakken recovery to 5% of the oil that's there. That means Continental and its peers could eventually pull 45 billion barrels of oil from those shale formations.

The industry has a very long way to go, but it has been making steady progress. It's figuring out the best ways to get more of the oil out of these tight resource plays. That's why I wouldn't knock the talk of energy independence. It's not like the oil isn't there, it's just that we haven't figured out the best way to get it all .. yet.

How you can invest in energy independence
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Fool contributor Matt DiLallo has no position in any stocks mentioned. The Motley Fool owns shares of EOG Resources. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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