The downward price pressure on U.S. natural gas “should be sustained for many years,” according to the global energy research chief for Credit Suisse.
Ed Westlake. who heads global energy research for the financial group, and a Credit Suisse team of commodity analysts earlier this month discussed their outlook of the U.S. oil and natural gas landscape, in particular their view of what’s ahead for unconventionals. Westlake’s takeaway: domestic natural gas prices should remain relatively low, while the price of U.S. oil may find a comfortably “high” floor ($90/bbl Brent, $80/bbl West Texas Intermediate) for at least the next couple of years. Beyond 2015, however, the oil price risks are forecast further to the downside.
For U.S. natural gas to gain some traction, “we’re going to need a hell of a lot more demand,” said Westlake. “An abundance of natural gas and the high cost to liquefy suggests low U.S. gas prices are here for a while.” However, King Coal’s overthrow by gas “looks increasingly inevitable from 2020 onwards.”
North America’s ability to achieve gas independence is without question. Achieving complete oil independence is another matter. If Brent oil prices were to stay high, it’s possible for North America “as a whole to become more oil independent,” said Westlake. “This would require success in matching our forecast improvements in well recoveries, efficiency, high oil prices, safe operations and supportive policies at the federal and state levels.
“But global decline is still an issue. Indeed, shale helps at the margin but it does not flood markets…” Credit Suisse is “less convinced” that abundant U.S. shale oil “will derail oil markets this decade.” Oil is not as low cost to develop as natural gas, even in the most efficient exploration and production (E&P) plays. “Shale oil sweet spots work in the $75.00/bbl Brent range, but marginal acreage could require $90.00/bbl-plus,” said Westlake.
U.S. explorers took about a decade to claim and begin producing the huge onshore unconventional bounty. Now that they’ve got their rocks of plenty in hand, the task today is determining what to keep and what to toss, according to U.S. E&P research analyst Arun Jayaram. This new era is “not about volumes, but value.”
It’s now the “efficiency era” for unconventional producers, which have moved from the harried “acreage capture and production growth” mode. There’s so much natural gas, and it appears that there’s going to be a lot of U.S. oil produced as well. Culling the resources ensures there’s enough capital and that it makes a return, Jayaram said. Since nearly all U.S. E&Ps remain weighted to natural gas by 60-65%, according to Credit Suisse, operators have to be able to earn or even outperform, even with low commodity prices.
Using a “positive rate of change,” and differentiating from the pile, “good rocks can outperform gas prices.”
A big focus today for E&Ps is to remain on top of numbers in their “franchise assets,” said Jayaram. An operator can have a long list of acreage holdings, like Chesapeake Energy Corp. But the “franchise” has to be “the” play that makes the numbers day in and day out. It may have been a franchise at one time and/or remains so today in one form or another. Devon Energy Corp. had the original gas shale “franchise,” the Barnett. Today it’s an oil/liquids franchise. For EOG Resources Inc., it’s the Eagle Ford. Range Resources Inc.’s is the Marcellus. Apache Corp. has been in the Permian Basin for decades, and it’s become the renewed onshore franchise. Southwestern Energy Co. still hearts the Fayetteville Shale.
It’s not just the unconventional acreage that a company may hold. It’s the quality of the assets, which provide value through capital efficiencies.
Where wells are “getting better, where costs are lower,” producers can make money, said Jayaram. And that’s important because Credit Suisse doesn’t think there are any new onshore fields left to discover. “That strategy appears to be long in the tooth…We have been pretty skeptical about new venture strategies, and skeptical on finding another Eagle Ford, for instance.”
Returns on the “best shale can be superior to the available returns in deepwater projects,” according to Westlake. “Costs are still rising in the offshore, but they are flat or falling in shale. The sweet spots are already held in the best basins.” However, there are “emerging contenders” in the “super-rich Marcellus, core Delaware Basin and Utica/Upper Midland” of Michigan.<
With no new discoveries to be had, “it’s better to focus on the rate of change story,” said Jayaram. Everybody concentrates on the prices, but “little has been written about the potential impact to E&P valuations” from the potential uplift of unconventional assets in hand still to develop. “It’s a much bigger pie.” Some of the value “will accrete to the majors, government through royalties and the privates, but the bulk of the value should be captured by public E&Ps…The E&P pie is poised to get significantly larger…And this assumes no value creation from natural gas, which we view as conservative.”
As an example, the rate of change in the Marcellus Shale “trumps a low gas price…because it’s at the low end of the cost curve…Since operators started horizontal drilling in ’08 and ’09, the well results have continually gotten better. And we still think it’s in the early innings. Producers have shifted to development mode from acreage-capture mode. Now they are focused on increasing lateral lengths, completions. There’s still upside on the rate of change in the Marcellus…”
Using four years of production data, Credit Suisse determined that gross estimated ultimate recoveries (EUR) from northeastern Pennsylvania “are significantly higher than even the most bullish estimates…We estimate the average well is 9.0 Bcf or higher gross in four key northeastern counties. This compares to the average U.S. gas well of 1.3 Bcf. Our model assumes EURs of only 5.7 Bcf/d on a blended basis.”
Marcellus operators are increasing the lateral lengths and using reaction control system completions, said Jayaram. Range has increased its lateral lengths to 3,900 feet from 3,700 feet, while the fractured stages have risen to 18 from 14. The “three Marcellus Musketeers,” Range, Cabot Oil & Gas Corp., and EQT Corp. “have been off-the-chart performers. The positive rate of change has trumped the decline in natural gas prices” because the play is at the low end of the cost curve.
Producers also are scrambling to the Permian Basin, where several formerly drilled formations like the Midland and Delaware basins are reporting huge initial production (IP) rates and EURs, said Westlake. From 2012 to 2019, Credit Suisse is “assuming a 25-30% increase in the horizontal rig count. The IP rates also are expected to rise 25% versus the currently observed rates.”
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