U.S. shale drillers are facing a serious problem: Their wells are not producing as much oil and gas as they had anticipated.
When facing shareholder scrutiny, shale drillers have countlessly hyped the litany of technological breakthroughs, efficiency gains and innovative drilling techniques. Indeed, production from U.S. E&Ps has skyrocketed over the past decade, save for interruption during the 2014-2016 bust. But even then, shale executives argued that the downturn made them lean and mean, and that they would use their newfound frugality to ramp up production and profits.
But the hype has slammed into reality on a few fronts. First, after years of bankrolling the shale industry in hopes of juicy profits, Wall Street is starting to lose patience. Some companies turn a profit, but the industry on the whole has been losing money since its inception in the mid-2000s. Executives are once again promising that enormous profits are just around the corner, but you could forgive the skeptics for questioning whether that will turn out to be the case.
A second – and no less damning – development is starting to occur on the operational side of things. Shale companies are finding that the returns on pushing their drilling practices to evermore intense frontiers are beginning to fizzle. For years, drillers increased the length of their laterals, injected more and more sand and water underground, and packed wells closer and closer together. These techniques of intensification promised to produce more oil and gas for less money.
Suddenly, there is evidence that the industry is running into a wall. The Wall Street Journal reportedthat shale wells placed too close together are starting to report unexpectedly disappointing results. The thinking is that the wells are interfering with each other. Adding more wells seems to be reducing the productivity of all the wells situated in close proximity. This so-called “parent-child” well problem, in which additional wells (the “child” wells) undercut the performance of the original well (the “parent”), may be the beginning of a larger problem with the shale industry.
The WSJ says that some of the newer wells are producing as much as 50 percent less than the parent wells. Ultimately, when all is said and done, adding more wells may actually result in less oil and gas recovered since the pressure drops and the reservoir suffers damage. Not only are child wells less productive than the parent, but they actually cannibalize production from the parent wells by sapping reservoir pressure and in some cases flooding the parent well with fracking fluids from the child well.
For instance, wells placed 375 feet apart may produce 28 percent less than wells produced 600 feet apart, the WSJ analysis finds. The figures grow worse the more the wells are packed tightly together – placing them only 275 feet apart results in a 40 percent decline in output relative to those placed 600 feet apart.
But companies can’t simply space out the wells and still achieve the same production targets. They have finite acreage, sometimes carved up in a patchwork, so it’s not always possible to simply stretch out the same number of planned wells over longer distances.
In other words, the parent-child well problem may mean that companies will have to drill fewer wells than they had anticipated. That means that they could be facing “an industrywide write-down if they are forced to downsize the estimates of drill sites they have touted to investors, some of which promised decades’ worth of choice spots,” the WSJ concluded.
There are enormous ramifications for this problem. The valuation of shale E&Ps is based on forecasts for long-term production. As the WSJ reported in January, many of the rosy production forecasts from shale drillers over the past few years have not come to fruition.
But the implications stretch beyond the share prices of individual companies. Medium- and long-term oil market forecasts depend very heavily on robust U.S. shale growth. In other words, global supply 5 and 10 years from now will be affected by the parent-child well problems. A study by Wood Mackenzie found that the Permian could undershoot expected growth by 1.5 million barrels per day. A revealing exchange occurred in late February on a fourth quarter earnings call for Centennial Resource Development. When asked why the company’s production guidance disappointed Wall Street estimates, Mark Papa, formerly of EOG Resources and now CEO at Centennial, testily dismissed the premise of the question. “Let me just make a simple statement here. All those expectations for production growth emanated from Wall Street expectations. None of those expectations came from Centennial guidance,” Papa said. He added that Centennial’s guidance “was very accurate and we’re just simply not responsible for guidance that’s created by Wall Street.”
The discrepancy points to a larger problem – after years of buying into the promise of shale, Wall Street still hasn’t exactly woken up to the full scale of the parent-child well problem. Some companies are undershooting expected production growth because they are spacing wells too closely together. “The issue for the entire Permian Basin relates to parent-child wells. Every year, every company is drilling a higher percentage of child wells and those wells are simply not as powerful as the parent wells,” Papa said.
Papa said that one reason that Wall Street may be confused as that so much M&A activity makes it hard to compare apples to apples. Companies have been growing, in some cases, because of consolidation rather than impressive operational results.
Papa cut to the chase and issued a stark warning. He said that Centennial was like every other shale company in the Permian. “[W]e have some of the best acreage in the Delaware Basin and what we are seeing is the increasing impact of the child wells,” he said.
“[B]ut that is just what I have been talking about really for a couple of years is that although the whole shale revolution appears to be quite powerful…If you look just under the hood, you see that every company has to run faster and faster to achieve growth because you’re seeing the effect of geology and well interference that is taking a toll.”