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Musings: Are The Shale Resource Estimates Realistic Or...

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    Musings: Are The Shale Resource Estimates Realistic Or Fantasy?
    Parks Paton Hoepfl & Brown 3/29/2011
    URL: http://www.rigzone.com/news/article.asp?a_id=105581
    Maybe you've seen the advertisements from various financial newsletters touting the investment potential of
    companies involved in developing the Bakken oil shale formation that spreads across North Dakota and
    Montana and into the neighboring Canadian provinces of Saskatchewan and Manitoba. The claims, which
    several years ago appeared outrageous, of the Bakken containing eight times the amount of oil as in Saudi
    Arabia or 21-times the reserves held by Kuwait seem less than fantasy today.
    These newsletters began trumpeting the financial impact of the Bakken for various oil exploration companies
    active in the formation following the 2008 U.S. Geological Service (USGS) revised estimate for the basin's
    reserve potential suggesting it might contain between 3.0-4.3 billion barrels, a 25-fold increase over the
    organization's prior estimate made in 1995, which said the field might contain 151 million barrels. The USGS
    stated that the Bakken formation is estimated to be larger than all other current USGS oil field assessments in
    the Lower 48. The agency called it the largest "continuous" oil accumulation ever assessed. This means the
    oil is spread rather evenly across the basin as opposed to being located in discrete deposits. The next largest
    continuous oil deposit is the Austin Chalk trend stretching from Louisiana to central Texas that is estimated to
    contain 1.0 billion barrels. Jeff Hume, president and chief operating officer of Continental Resources was
    quoted in an article not long ago suggesting that there could be as much as 24 billion barrels of reserves in
    the Bakken formation.
    Exhibit 1. Bakken Is U.S. Largest Continuous Oil Field
    Source: EIA
    The success the domestic exploration and production companies have had in the Bakken has been partially
    responsible for U.S. oil production growing over the past two years to the highest level in over a decade.
    Exhibit 2. Domestic Oil Production Up Last Two Years
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    Source: EIA
    North Dakota's oil production reached a peak last November at 356,697 barrels per day from 5,099 producing
    wells. Over the past three years, monthly oil production in North Dakota has grown by more than 2.5 times.
    Production is off slightly in January to 342,088 barrels per day from 5,061 wells. While we can't be certain, we
    suspect the traditionally harsh winter in that region of the country impacts oil production efforts, especially
    since the infrastructure to produce much of this additional oil has not kept pace with the rising production.
    There have been media stories about the dramatic increase in the number of railroad tanker cars hauling
    Bakken production to refineries. We are also aware of some of the oil making its way by truck across the USCanadian
    border to shipping facilities there. All of that will change as new pipelines are constructed.
    Exhibit 3. North Dakota's Oil Production Soaring
    Source: North Dakota Natural Resource Department
    More important is the growth in drilling, which will be critical for boosting the state's oil and gas production in
    the future. The most recent Baker Hughes rig count showed 153 working rigs in North Dakota, more than
    double the count merely 14 months earlier. According to Mark Williams, senior vice president of exploration
    and development for Whiting Petroleum, "All current and planned projects could take us up to 1.1 million
    barrels a day."
    The most important factor in the growth of Bakken oil production has been the application of drilling and well
    completion techniques learned from drilling the gas shales ? horizontal wells with longer lateral sections and a
    greater number of hydraulic fracturing treatments. Estimates are that by applying these technologies, Bakken
    wells that were drilled only a few years ago might produce 100,000-200,000 barrels over their lifetime but are
    now getting 400,000-700,000 barrels out of the deposits. Even though the cost to drill and complete these
    newer wells is greater than for the older wells, the economics of greater production, especially at today's $100
    per barrel oil price, are extremely attractive.
    But back to the question we posed in the headline for this article. Just how realistic are reserve estimates? As
    we have commented on many times in our career, the biggest challenge for assessing the value of oil and gas
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    companies is the realization that virtually all their assets lie underground. Because of that we never will know
    exactly how much oil and gas a company owns. Moreover, the amount of oil and gas a company can recover
    from the reservoir will have a huge impact on its potential value. We were intrigued by a presentation at the
    Ohio Oil & Gas Association Winter Meeting by Chief Larry Wickstrom of the Ohio Department of Natural
    Resources' Ohio Geological Survey. Mr. Wickstrom's presentation was on the Marcellus and Utica Shale
    plays in Ohio, the latest hot spot in the business. The Ohio Marcellus and Utica shale formation is the
    westernmost part of that regional play that extends from Ohio and West Virginia through Pennsylvania and
    New York State and on into Canada.
    There is much speculation about the potential reserves in the Utica shale in Ohio, which is responsible for the
    land rush that has been underway in the state recently. Even though there have been only a few Marcellus
    wells drilled in the state and virtually no Utica shale wells, its potential is believed to be significant. Mr.
    Wickstrom demonstrated this potential by discussing the following information. A typical conventional gas well
    in the Appalachian Basin will produce 100,000-500,000 cubic feet per day and 200-500 million cubic feet
    (MMCF) over its producing life. In contrast, a Marcellus well (and possibly a Utica well) produces 2-10 MMCF
    per day or four billion cubic feet over its lifetime. If one does the math of multiplying the lifetime production of
    each of these wells by $4 per thousand cubic feet, the current price for natural gas, there is an eight-fold
    increase in value for a Marcellus well compared to a conventional gas well ($16 million versus $2 million in
    gross revenues). Of course, this simple calculation ignores the greater cost to drill the Marcellus well (possibly
    $3-$5 million) and possibly other costs, too, but the magnitude of increased economic returns from the shale
    wells underlies the industry's excitement and aggressive behavior.
    Mr. Wickstrom decided to use his presentation to not only educate his audience about the geology and
    challenges of drilling and developing the Utica shale, but also to help people understand how speculative
    much of the chatter about the formation's potential is given the lack of production data. He began this mission
    by explaining the formula for estimating the resource potential for a field, which was developed by two
    geologists in 1989. The formula is: Qt = V x D x TOC x C x %R. The volume of hydrocarbons contained in the
    field is a function of the volume of rock, the density of that rock, the amount of carbon content in the rock, the
    percent of carbon converted into hydrocarbons and the percent of reservoir space containing the
    hydrocarbons. While the formula sounds straightforward, it requires estimating five important variables.
    Drilling core samples and analyzing the formation's rock composition helps in making these estimates. By
    correlating the rocks from this reservoir with those from other similar basins where production history has
    been established further improves the accuracy of the estimates. But in the end, the estimates can be subject
    to wide degrees of error. Just how much? Maybe that depends on which side of the debate about the
    economic performance of gas shales one is on. At the present time, it is much like that old beer commercial ?
    "less filling" versus "tastes great" both positive qualities but impossible to quantify.
    Exhibit 4. How To Forecast Basin Reserves
    Source: Ohio Dept. of Natural Resources
    To further help the audience understand the challenge of estimating the potential size of the Utica shale
    formation in Ohio, Mr. Wickstrom presented data from a study of the entire Appalachian Basin's Utica/Point
    Pleasant formation prepared in 1989. That study concluded the formation had migrated 13.26 billion barrels of
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    oil to conventional reservoirs in the basin. Remember, the shale formation is the source of the oil and gas that
    migrates into a basin's various conventional traps.
    Exhibit 5. Utica Shale Contribution To Appalachian Reserves
    Source: Ohio Dept. of Natural Resources
    It was at this point that Mr. Wickstrom suggested the audience should have some fun and make up the
    numbers to manufacture an estimate of the Utica's potential. He started with the variables used in the 1989
    study of the Utica formation for the entire Appalachian Basin. He suggested that based on more recent
    knowledge, we could increase the total organic content to 2.50% from the prior estimate of 1.34%. Then came
    the fun part. What should be the percent of reservoir space containing hydrocarbons that can be recovered?
    Mr. Wickstrom suggested we should start with the percentage used in the various studies for the Bakken
    formation ? 1.2%. Plugging that number into the equation, we arrive at an estimate of 1.96 billion barrels of oil
    or its equivalent for the Utica formation.
    Exhibit 6. Widely Different Forecasts From Minor Changes
    Source: Ohio Dept. of Natural Resources
    What happens, however, if you change the recovery factor? Mr. Wickstrom boosted that number to 5%, and
    suddenly the Utica may contain 8.2 billion barrels of oil or its equivalent. That's more than a fourfold increase.
    What could this mean to our crude oil and natural gas reserves?
    Exhibit 7. The Fantasy World Of Projections
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    Source: Ohio Dept. of Natural Resources
    By assuming that the hydrocarbon volume is split 1/3rd natural gas and 2/3rds crude oil, we have the basin
    containing either 3.75 TCF of gas and 1.31 billion barrels of oil on the low side, or 15.7 TCF of gas and 5.5
    billion barrels of oil on the high. Given these oil estimates, the Utica formation in Ohio contains less than half
    the oil in the Bakken formation or it contains one and a half times more! For natural gas, the Utica shale
    represents either two-tenths of one percent of the nation's potential conventional gas reserves as estimated
    by the Potential Gas Committee in its 2008 study, or it accounts for 9.4% - quite a difference in magnitude.
    Once you go through this analysis, it becomes easy to understand the hype surrounding the Ohio Utica play.
    The optimistic estimates, based on reasonable assumptions about the geology and recoverability of the
    hydrocarbons, will certainly get the attention of industry players and especially Wall Street that loves to create
    overly optimistic scenarios. But as Mr. Wickstrom cautioned, without drilling wells and developing a production
    record, these estimates are all fantasy.
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