GULF OF MEXICO End of El Niño, new marketing options spur on gas drilling

James Dodson James K. Dodson Co. Leonard LeBlanc Editor This regression curve shows the average ft per day drilled by 25 selected operators versus the average total depth of wells for the 1990-1994 period. (Copyright 1995 by James K. Dodson Co.; Tel: 800-275-0439).

Rig shortage caps positive 1996 US Gulf drilling outlook
3D surveys reviving shallow water, transition zone

James Dodson
James K. Dodson Co.
Leonard LeBlanc
Editor

The 1996 outlook for the oil and gas industry in the US Gulf of Mexico is more positive than it has been in more than a decade: no El Niño to drag down natural gas prices; approaching parity in crude oil supply and demand; the first true shortages of drilling equipment; and assistance by the US government in costly deepwater development.

Despite encouraging signs of firm oil and gas prices and increasing upstream profitability in 1996, the expansion of drilling will be capped by two factors:

  1. The lack of suitable drilling rigs;

  2. The longer periods required to drill and complete extended reach, subsalt, and deepwater wells.

A total of 940 exploratory and development wells are projected to be drilled in 1996, based heavily upon the two factors cited above. However, the number of wells drilled in 1996 easily could have exceeded 1,000, based upon the number of drilling plans filed and permits approved during the late months of 1995. The 940 wells projected for 1996 is only 40 more than the projected number drilled in 1995, but 15 less than the number drilled in 1994.

Oil, gas prices

The disappearance of El Niño should provide the industry with a projected $2/Mcf average gas price for 1996. Colder and longer winters will cut deeply into storage volumes and result in a longer refilling period next summer in preparation for the following winter. The presence of normal winter temperatures will also reduce the popular focus on global warming, which has spurred new congressional and regulatory relief measures.

Current oil prices should hold up during 1996. Non-OPEC oil production is expected to peak during late 1996 or early 1997 and oil demand should begin absorbing surplus production capacity as the global economic condition improves. The restraining factor on increasing capacity in future years for both non-OPEC and OPEC producers is the lack of suitable drilling units.

Deepwater drilling in the US Gulf continues to offer the best new opportunities to add new oil and gas production to the market, but the critical shortage of deepwater rigs limits the pace at which these new supplies can be brought onstream. Ironically, it occurs just as the US government is preparing to relax deepwater royalty payment until minimum production is established.

Gas drilling constant

Despite the wide swings of spot gas prices ($1.03-2.30/Mcf ), average gas prices during the past eight years have moved little from the $1.73/Mcf average for all eight. In 1992, the average dropped to $1.47, and the next year it surged to $2.09/Mcf.

Gas producers target these averages to determine cash flow and project viability, not the seasonal peaks and valleys. Most fields produce long enough to take advantage of the annual averages.

Interestingly, gas drilling in the US Gulf has dropped only once in the past eight years - when gas prices surged to an average of $2.09/Mcf in 1993. Thus, gas drilling in the US Gulf is not price elastic. The business is driven by factors that have little to do with how far prices move.

  • Quick depletion: The average life cycle of gas fields - 3-4 years - and mobile rig and customer contract commitments force gas producers to continue drilling whether or not market prices are profitable.

  • Two-way profitability: Nearly 80% of all gas drilling in the US Gulf is funded, via independents, by gas utilities and other end users. Their profits are derived from the margin spread during power conversion and energy packaging when gas prices are low, and alternately from gas producers when prices are high. They cannot lose.

  • Geology: Major operators are continuing to pursue oil reserves in deepwater and must get rid of the associated gas. Re-injection is an expensive choice, given the already high cost of deepwater development. In most cases, that gas will be piped to shallow water gathering lines.

With regard to participation by gas utilities in the US Gulf, majors and large independent producers have taken a lesson from the marketing arrangements set up these utilities and other end users. A number of majors have set up their own downstream marketing arms, with associated price hedging mechanisms. Larger independents, still largely self-funded, are forming cooperatives to obtain similar marketing flexibility and price protection in the market.

Over two-thirds of the BOE (bbl oil equivalent) produced in the US Gulf is gas, so even the largest operators must continue to pursue arrangements that maximize profitability in gas drilling and development.

Rig numbers

Will day rates for mobile drilling units continue to climb in 1996, reflecting producers' efforts to drill more leases before surrender? For most rig categories in the US Gulf, day rates peaked at the end of 1995 - perhaps only temporarily. In the face of some rate softness at the end of the year, rig contractors were working hard to increase lease periods and hold down day rates.

Firmer gas prices in 1996 could boost day rates further, but there are some indications that producers may step back and assess their position and profitability margins on prospects during the first quarter of 1996.

Currently, there is no net inflow of rigs into the US Gulf and there are 38-41 mobile rigs in storage along the US Gulf coastline, the same number as last year.

Most of the leasing action continues to be among the 3rd and 4th generation semisubmersibles with deepwater capability. The proposed government postponement of royalty take until minimal production flow is reached will allow some upside to day rates for these drilling units. In fact, most drilling contractors are pumping early earnings back into the upgrading of 2nd and 3rd generation semisubmersibles to meet the demand for suitable deepwater units.

Most of the 38-41 drilling units in storage are older shallow water jackups. Some of these units may be pulled out of storage later this year if drilling along the coastline where 3D seismic surveys have been run produce better-than-expected drilling results.

Transition zones (bays, passes, estuaries, oceanfront) in Louisiana and Texas are already experiencing increased leasing action as a result of 3D seismic, and increased utilization of submersibles is a likely situation in 1996. The presence of firmer gas prices should enhance these opportunities.

Rapid decline

If oil and gas producers are to attempt to replace produced reserves in the US Gulf, they will have to keep the drilling pace close to 1,000 wells annually. Two situations are driving this requirement:

(1) Most development drilling in the US Gulf is in pursuit of behind-the-pipe reserves and outlying accumulations of both oil and gas. These reserves have a production decline curve life averaging 2 - 3-1/2 years.

(2) The average life of new gas fields in the US Gulf is between three and four years. Decline curves can be very steep during the later stages unless the reservoirs are re-pressurized by injection programs.

With these short life spans for reserves production, producers must constantly scour old fields for new accumulations or expand exploration. During 1995, weak gas prices and average oil prices dictated that existing fields receive the bulk of attention. Despite improving gas and oil prices, producers remain attached to the profitable economics of chasing existing reserves. The projected ratio of development wells to exploratory wells in 1996 remains about the same as in previous years.

Technology impact

Despite the rapid decline of behind-the-pipe reserves, there appears to be no end to re-drilling and re-completion of older fields in the US Gulf. Projections of development well drilling in 1996, supported largely by re-drilling of mature fields, do not indicate any sizable switch to exploration.

Producers with mature fields, aided by many new 3D reservoir seismic, drilling, and completion technologies, consider investment in these fields to boost production flows more profitable than new conducting newfield exploration. Working with these oil and gas producers are manufacturers and developers of new seismic, drilling, and completion methods and equipment, who are enjoying solid returns on incremental developments.

All sectors of exploration and development in the US Gulf should begin benefiting from these new technologies, which combined with firming oil and gas prices in 1966, should provide a renaissance the US Gulf has not seen since the early 1980s.

Copyright 1996 Offshore. All Rights Reserved.

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