Can America Overcome This Challenge?

Source: Chesapeake Energy

I have some good news and some bad news. According to the International Energy Agency, the U.S. is poised to become the world's top oil producer in 2015. Surging shale oil production will push America past both Saudi Arabia and Russia. Unfortunately, that dominance won't last as by 2020 American oil production will peak and then begin to decline. That will put the Middle East back on top.

The problem is the rapid decline rates of America's shale oil wells. A newly drilled well produces at a very high initial rate, but the rate of production drops significantly as time passes. While the initial rate of production is great for delivering high returns for drillers, it's not great for the sustainability of America's oil boom.

As an example, consider the following slide from a recent investor presentation by Devon Energy .

Source: Devon Energy

The graph at the bottom shows that an average well that Devon Energy drills into the Permian Basin will see a production decline of more than 60% in the first year. So, if a Bone Spring well initially produces 600 barrels of oil equivalent per day, or BOE/d, in its first month, that well will likely only be producing 360 BOE/d one year later. After a few years that well is just trickling out oil.

That said, over the well's lifetime it will produce more than half a million barrels of oil equivalent. Even then Devon Energy will still have left millions of barrels of oil underground that simply isn't yet accessible with current technology.

These decline rates, as well as leaving so much oil underground, are a real challenge for oil and gas producers and for the continuation of America's energy boom. The IEA believes that by 2020 productive oil fields like Texas' Permian Basin and Eagle Ford Shale, along with North Dakota's Bakken, will be past their prime. Even The U.S. Energy Information Administration is worried about production withering.

The EIA produces a monthly report on the productivity of each shale play. One of the most interesting aspects of that report is the effect that declining legacy production has on overall production growth. For example, take a look at the following chart on the Eagle Ford Shale:

Source: EIA

The industry is currently operating about 260 rigs, which are projected to add 116,000 barrels of oil production to the Eagle Ford's daily total. However, at the same time legacy wells are projected to have declined by 86,000 barrels of oil. That leaves a net gain of about 33,000 barrels of oil. But the decline from legacy production will someday be too much for new wells to overcome. 

To put those numbers into a rough context, let's take a look at an example. Chesapeake Energy  has 788 producing wells in the Eagle Ford. Those wells produced 95,000 BOE/d last quarter. That means that each well is producing an average of about 120 BOE/d. However, Chesapeake put 100 Eagle Ford Shale wells into production just last quarter at an average rate of 930 BOE/d. Within a few years these new wells will be producing at a much lower rate, meaning this lost output will also have to be replaced by more new wells. It's a vicious cycle. 

The problem is that there are only so many future drilling locations. EOG Resources , for example, only has about 12 more years' worth of drilling inventory in the Eagle Ford Shale. At some point its production declines from legacy wells will overtake the production gains it sees from drilling new wells. While it does have other options, including scaling up growth in the Permian Basin, this is a big future challenge.

All of this, however, assumes that oil companies don't figure out ways to enhance the recovery of wells that have been drilled. Current techniques to enhance the recovery of conventional oil wells include water-flooding and carbon dioxide injection. This increases the recovery factor from less than 20% of the oil in place to more than 50% in some cases. Shale wells are different so these techniques might not work to unlock more oil. 

This is why America's biggest challenge here could prove to be its greatest opportunity. Producers like EOG Resources are already figuring out strategies for extracting more oil out by extending the length of the wells, placing wells closer together, and employing new technologies. Enhancing the recovery of America's shale resources could prove to be the next phase of our great energy boom.

In the end, America's oil boom could outlast even the most bullish of predictions, because let's face it, no one saw this coming boom to begin with. In predicting its demise we could miss its next boom.

How you can invest in America's energy boom
Record oil and natural gas production is revolutionizing the United States' energy position. It comes with both challenges and opportunities. The Motley Fool has uncovered three stocks that are profiting from both the opportunities of the boom as well as its challenges. To find out how you can invest in America's energy boom check out the special free report, "3 Stocks for the American Energy Bonanza." Don't miss out on this timely opportunity; click here to access your report -- it's absolutely free. 


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Fool contributor Matt DiLallo has no position in any stocks mentioned. The Motley Fool owns shares of Devon Energy and 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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