Offshore staff

CAMBIDGE, Massachusetts -- Cambridge Energy Research Associates (CERA) says despite record high natural gas prices in recent years, fewer reserves are being added for every dollar of E&P activity. Furthermore, higher costs are undermining the economics of an increasing number of wells. These are the findings of CERA's first-ever analysis of full-cycle cost data. The analysis includes data for 2005.

The study also identifies the dramatic shift toward "unconventional" gas production, which now accounts for a quarter of total output.

Diminishing Returns, a multi-client analysis by CERA and IHS, looks at cost and production data for the 48,000 wells completed in all 50 North American natural gas basins (232 individual plays) in 2005, and finds that capital costs alone (excluding operating costs, royalties and return) ranged from $1 per thousand cubic feet (Mcf) of reserves to over $6/Mcf.

The weighted average all-in cost ranged from below $4.00/Mcf to over $12.00/Mcf. Judged against the record prices of 2005, which averaged $8.80/Mcf at Henry Hub, over 6% of the basins had high enough costs that they would fail to achieve a 10% rate of return-on-investment.

"Record prices in 2005 triggered a tremendous response in drilling by gas producers, leading to nearly decade-high reserve additions of 26.4 tcf and added production of 14.7 bcf that year," says J. Michael Bodell, CERA director of upstream gas strategies. "Nevertheless, despite a nearly threefold increase in the number of rigs deployed to drill natural gas wells over the past decade, North American gas production has remained stubbornly flat, and the cost of new gas supply has risen substantially due to higher drilling and operating costs and, most significantly, declining average well productivity and initial production rates."

Declining productivity
The study found that E&P companies are developing smaller resources and facing higher costs, with the inevitable result that unit costs have moved to a much higher range. However, within this overall trend, many regions, by contrast, have very strong margins and provide returns on equity well beyond 10%. "The E&P companies that have shifted their portfolios to include these lower-cost resources, particularly the early movers, are recognizing substantial cost advantages," Bodell says.

The CERA/IHS analysis found that a combination of higher prices and improved drilling and rock fracture technology has accelerated the development of unconventional resources, which accounted for 23% of total North American gas production in 2005 compared to 11% in 1995.

Unconventional resources are broad accumulated deposits in organic-rich rocks, typically in coal beds, gas shale, and tight sandstones with very little rock permeability and porosity. Because these resources have lower per-well flow rates and require more wells in a given area to maintain a given supply level, gas production rates for wells added in 2005 were about half that of wells drilled ten years earlier.

However, because unconventional wells access larger deposits than their conventional counterparts, they accelerate reserve base growth and provide higher production over a 20-year productive life.

"On the question of whether unconventional gas is cheaper or more expensive than conventional resources, we found there is no consistent answer. Unconventional production basins are distributed throughout the cost spectrum among the lowest and the highest cost resources and are not overweighted on either the low or high end," Bodell says. "This means that the industry is investing heavily in unconventional resources moving from the easier plays and basins to resources that represent more challenging opportunities. These more challenging resources may come at a cost that has the potential to put them in direct competition with imported LNG," he says.

2/5/2007