Tuesday, April 14, 2009

Haynesville Sizzle Might Fizzle

Despite lower natural gas prices, the Haynesville Shale is the hottest onshore play in North America. Production is more than 150 MMcfd from recently drilled horizontal wells, and single-well Initial Production (IP) rates are as high as 24 MMcfd.

I used standard rate-versus-time methods to determine estimated ultimately recoverable reserves (EUR) for 14 horizontally drilled wells that had sufficient production history to project a decline rate. Production was extrapolated using a hyperbolic decline, and an economic limit of 1.0 MMcf/month. The wells had an average EUR of 1.5 Bcf, and 67% (10 wells) had reserves less than 1.5 Bcf. This is an early evaluation, and does not include several recently completed wells because of insufficient production data. Reserves were, with one exception (5.3 Bcf), considerably lower than the 6.5 Bcfe most-likely per well reserves, and 4.5-8.5 Bcfe range, claimed by leading operators in the play Chesapeake Energy Corporations and Petrohawk Energy Corporation.

Problems with the Haynesville Shale include high decline rates and costs. Average monthly decline for the wells that I analyzed is 20–30%, and projected annual decline rates average 80−90%. Rapid decline makes IP rates unreliable indicators of well productivity. The average production history of wells used in this analysis is less than five months; current production rates already average only 48% of IP.

Drilling and completion (D&C) costs are about $7.5 million per well, although Petrohawk recently revised its D&C costs upward to $8.5–9.5 million. Average true vertical depth of wells in this study is 11,500 ft, and average measured depth is 15,250 ft. Five- to ten-stage hydraulic fracturing is typical with 600–750 lb sand/lateral foot in horizontal boreholes, which average 4,500 ft long. Leasing costs in active areas during 2008 were $10,000–30,000/acre, increasing capital expenditures for an 80-acre spacing unit $0.8-2.4 million above D&C costs.

Operating costs average $2.25/Mcf, based on US SEC 10-K filings and annual reports. After gathering and transportation costs, netback gas prices for early March 2009 were less than $2.50/Mcf (RBC Richardson Barr). Net revenue interest, after royalties, is typically 75%, and Louisiana severance tax is $0.27/Mcf (included in operating cost) . While current prices are the lowest in many years, and hedging has helped careful operators, it cost many operators a $7.25/Mcf or more to produce gas during the fourth quarter of 2008.

Clearly, most Haynesville Shale wells will not approach a commercial threshold until both gas prices and per-well reserves increase. To quantify that reserve and price threshold, I ran a basic NPV10 model using the cost information already mentioned. I used decline rates from the Barnett Shale (65%—Year1, 40%—Year 2, 30%—Year 3, 25%—Year 4, and 20% thereafter) instead of the higher decline rates projected from Haynesville production to date.

The break-even (NPV10= 0), minimum per-well reserve volume is 2.5 Bcf with a netback gas price of $8/Mcf (~$9/MMBtu Henry Hub spot). This means that the play would have been marginally commercial in 2009 dollars during only 15 months (12.5%) over the past decade—and over the past 20 years since the advent of the natural gas commodity market in 1989—if an average well had reserves of 2.5 Bcf instead of only 1.5 Bcf. At 1.5 Bcf/well, $12/Mcf netback gas price is needed to break even.

Chesapeake CE O Aubrey McClendon recently said, “We only need gas prices to be ‘good’ for three to six months out of every two-year period.” (Houston Chronicle, February 11, 2009). If ‘good’ means to break even in the Haynesville Shale, it looks like he will meet costs no more than 12.5% of the time, and lose money the other 87.5%, assuming that per-well reserves can be doubled. That business model is difficult to understand, although successful hedging might change those percentages. But that’s not the entire business model.

“We believe in volatility...You can sell volatility. Volatility has value,” McClendon continued. “Our company makes additional money when we sell those calls.” What McClendon means is that his company can make money by selling deals to other companies that fear they will be left behind during brief periods of rising prices. For example, in 2008 Chesapeake sold interests in its shale plays to Plains, BP and StatoilHydro. Chesapeake made $10.3 billion on those transactions.

Why do I reach different conclusions about the Haynesville and other shale plays than some industry analysts? First, they are not industry insiders and, therefore, many do not incorporate true operational costs including interest expense for debt service, or netback gas prices into their evaluations. Second, investment company analysts are marketing a product and make a commission on stock that they sell to clients—their analyses cannot be truly objective. Third, they do little investigative research, and generally accept information on rates, reserves, and declines provided by the companies that promote these plays. They cannot have done independent decline analysis on the Haynesville Shale or they would have recognized the obvious reserve discrepancy (1.5 vs. 6.5 Bcf/well).

I expect shale plays to be part of the natural gas landscape for awhile, despite the fact that they are marginally commercial at best. Most companies in these plays have a lot of debt, and the only way to service the debt is to generate cash by drilling wells to produce gas.

The Haynesville Shale play appeared at a time when gas prices were rising. Companies rushed to pay great sums to obtain positions based on the irrational belief that prices would continue to rise. This is the same thinking that brought us the global financial crisis. The magnitude of capital expenditure for leasing and drilling illustrates a profound breakdown of due diligence by the financial and E&P industries.

It is difficult to imagine that the Haynesville Shale can become commercial when per-well reserves are similar to those of the Barnett Shale at more than twice the cost. Maybe the most recently completed wells will tell a different story; otherwise the Haynesville Shale play will likely be replaced by other shale plays that lose less money.

24 comments:

Jim Krow said...

Your post goes against the facts presented at the DUG Confrence in Ft. Worth last week. Until you post a list of the wells you evaluated for this blog and for your article in Oil World, I don't think you have much credibility.

Taylor said...

It is very hard for me to believe that you can understand the hyperbolic nature of the production profile with only an average of 5 months of production. Everyone in the industry is assuming an 80-90% 1st year decline already. It seems that you are discounting the possibility of significant matrix contribution after the fractures are drained that could contribute to a high b factor. While this is not given, it is also a strong possibility based on what the Barnett has produced.

Richard said...

Mr. Berman, I found your article for Oil World very interesting. You bring up very valid points about leverage and overpaying for acreage as this can significantly add to production costs. I am an electrical engineer by training and do not understand the science behind producing shale gas. However, it appears to me that your finding of 1.5 BCF EUR per well presents an ethical question for the engineering profession. Engineering research has been one of the main justifications for investments in the Haynesville and your finding contradicts this investment thesis. I hope that you can provide further analysis of the Haynesville along with interpretations of new well results in the region so that the economic potential of this shale play is better understood. I am concerned about the ethical implications of companies using 6.5 BCF EUR while an independent geologist finds only a 1.5 EUR. These companies have used core samples and their expertise in horizontal drilling to come to these estimates; investors have given a good deal of credence to this analysis. Open discourse is key to maintaining the integrity of the engineering profession (and the financial profession, as we have seen what a lack transparency can do) and I encourage you to continue to develop your analysis and provide more details on this blog.

hellinvest said...

I agree with Jim Krow - if you're going to make such a dramatic statement, let's support it with more information. Some of the wells in the Haynesville have already produced close to a 1bcf.
- wells
- b factor
- EUR time

Anonymous said...

This is a ridiculous article. It is obvious to me that Arthur Berman knows essentially nothing about decline curve analysis. He indicates that he uses decline rates from the Barnett shale (with the special Berman terminology of % decline for each year) and then just for good measures a 20% terminal decline. HELLO, if you are using the same decline rates from the Barnett Shale and the IP in the Haynesville is higher you pretty much have to have a higher EUR in the Haynesville. Berman seems oblivious to this little fact of reservoir engineering. He has to work for a magazine because if he worked for an O&G company he would never buy a property because he would dramatically under value them and anything he sold he would be willing to give away. Then to prove his complete lack of knowledge of anything oil and gas related he gives his special insightful explanation of what is meant by selling calls. The sad part is that some people will believe his well-written load of hog wash.

Registed Petroleum Engineer said...

Sorry, but Mr Berman is way out of his league - his forecasts "doth smelleth of excrement". I am a Reservoir Engineer working the Barnett Shale, and the 20% final decline that he uses is way too high (160 nanodarcy permeability shale: that is verrrrry tight stuff). Many of our wells will be in linear flow for many years to come (n>1). His previous article on the Barnett was chock full of errors, and my impression is that he likes to hear himself talk. I am truly amazed that Perry Fischer (the VERY intelligent Editor of World Oil) allows him to publish this kind of poorly researched dribble. His obvious delight in showing how he is an "industry insider" and knows so much more than investment company anaysts, makes me cringe. Reminds me of those that try to make themselves look good at the expense of others. Oil & Gas companies do not foolishly invest billions, at least our's doesn't.

Richard said...

Mr. Berman, I took a look at the Louisiana Department of Natural Resources Haynesville website and downloaded the well data. http://dnr.louisiana.gov/haynesvilleshale/haynesville.xls

The first 20 or so wells are not very good and tend to support your analysis. Unfortunately, there is only production data out to January 2009. None of the early wells look like 6.5 BCF EUR. I have read companies limited production in the beginning for competitive purposes and this appears to be supported by more recent wells which have produced nearly 1 BCF in their first months of operation and look like much higher EUR wells. It looks like the newer wells are quite a bit better than the older ones but it is odd that the first wells appear to have such poor production if these are 6.5 BCF EUR wells. There may be an issue with data collection. However, I did notice very low IP rates on many of the wells.

Anonymous said...

I have done about 40 declines from various areas of the Fayetteville. Outside 2 wells near Bee Branch, I don't see sensible amounts of reserves to justify the cost of the wells. The most telling of the wells are the oldest wells where declines have augered straight into oblivion. One well clearly is on the road to making .04 BCF...shallow but still a million bucks. Makes no economic sense when gas is below $7...and Chesapeake's geologists who were laid off are now saying the economics was based on $9 gas...sour grapes? maybe...maybe not.

geophil said...

I saw Art's presentation to SIPES New Orleans this week and was very impressed with the work he has done. He is well aware of the criticisms that have been leveled against his conclusions and his methodology and has gone to considerable lengths to answer them. He certainly has strong evidence for his position and I, for one, accept them as a valid study and likely correct conclusions. What, it appears to me, has happened to this play is that the financial guys have taken it over for mainly political reasons. These shales exist all over the U.S., including the anti-oil-company NE where there has been considerable glee in jumping on the bandwagon. This over promotion may actually work against O&G interests in the long run if it produces a Super-ENRON collapse and debacle. Right now Art is a voice crying in the wilderness but more power to him.

Cyrill Joseph Landau said...

when routine bites hard and ambitions are low and resentment rides high but emotions won't grow.

Drill for gas.

Allen Gilmer said...

Mr. Berman, your approach is somewhat challenged, or in any case a radically different approach is taken in this particular article:

http://openchoke.blogs.com/

In particular, it looks at and quantifies improvements in Haynesville production over the last 3 biannii(?, along with an EUR estimate for the average for latest wells that is materially better than your averaged prognosis. Of course, it has the benefit of lookback that your articlae here doesn't have.

Anonymous said...

Mr. Berman,

a year has passed.

Does your analysis still stand or have you changed your view?

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