1. Depletion rates steadily increased between 1980-2006 (see http://www.eia.doe.gov/oiaf/servicerpt/depletion/pdf/app_g.pdf and
http://gswindell.com/tx-depl.htm)
2. Average flow rates have been decreasing over the past 30 years (Figure 2)
3. Initial flow rates for shale gas are impressively high (anecdotal)
4. Depletion in shale wells is very high, particularly in the first few months of operation (Also anecdotal)
Figure 2
The only two years in the past decade when production per well increased were 1999 and 2007. These years featured relatively low prices in natural gas, so the increase in per well production may be due to producers:
1. Only drilling their best prospects that year
2. Reducing the number of existing wells since the low price did not justify the existence of marginal wells.
It is also clear that 1998-1999 represented a turning point in the production per well. This could be due to a number of different factors:
1. A decrease in the quality of available resource
2. A shift in the type of well being drilled (conventional versus unconventional)
3. An increase in the rate of drilling after 1999. Starting in 1999, there was an explosion in the rig count and the number of new wells drilled. The acceleration of drilling would more quickly change the demographic of total wells toward lesser quality or unconventional wells.
This is consistent with data on the number of operating drill rigs. Glancing at a graph of drill rigs, it is clear that there was a noticeable increase in rigs starting in 1999 (Figure 3).
Figure 3 (Source: Baker Hughes)
While supply stayed more or less constant from 1998, the number of existing wells increased dramatically, and the rig count exploded. This trend continued through 2007 when shale natural gas wells started changing the dynamics of the market.
Take a close look at Figure 3 and you will see that there have been 3 dramatic falls in rig counts in the past ten years: 1997-1999, 2001-2002, and 2008-current. These drops in drilling activity correspond to very low prices for natural gas (as the famous quip goes: low prices are the cure for low prices). In section 5 the rig drops in 1998 and 2001 are examined and used to model what might be expected in 2009. Speaking generally, as drilling activity slows, there is a point at which depletion of the total existing supply exceeds new marginal supply, and total supply starts to fall. Because the rig count falls below the maintenance level, supply continues to fall even after the rig count starts to climb. This is because it takes a period of time to activate the number of rigs necessary just to drill at the level necessary to maintain supply. In Figure 4, there is a graphical estimation to prove the point.
Figure 4 Rig count starts at exactly the level necessary to maintain supply. We assume an annual depletion rate of 25% and also assume a 40% decline in drill rigs from peak to trough that declines linearly over a period of 40 weeks. Finally we assume that once the rig count has bottomed, the rig count then has a linear increase back to the initial rig level in 25 weeks.
This figure gives a first approximation for how supply responds to decreased rig counts. In order to try to model the 2006-2009 period a little bit more accurately, some assumptions need to be made. First, it is pretty clear that we were expanding supply from 2006-2008 at a meaningful (some would say blistering) pace. Therefore, the drill level was above the level necessary to maintain supply, and this is confirmed by the increase in supply during 2008. Furthermore, the increase in rigs during this time period was particularly marked for horizontal rigs in shale deposits (footnote 5:The emergence of horizontal drilling for shale natural gas is probably the most significant development in the energy sector over the past 3 decades. Some market participants have noted the extremely fast depletion rates of shale natural gas wells. While a fast depletion rate will present a challenge after the supply of shale gas peaks, it actually makes the resource more flexible and responsive so long as the resource is increasing. While this paper generally holds the view that natural gas prices could spike in the next 12 months, shale natural gas and its high depletion rate will actually act as a damper on this price increase. Since initial flow rates are so high and a larger percentage of a shale well’s production occurs in the first few months, this decreases the amount of time necessary to increase supply by significant quantities) : the number of these rigs expanded by more than 100%. When the total number of drill rigs peaked in late 2008, producers could very well have been drilling 50% more wells then was necessary to maintain then-current levels of supply. That will be the baseline assumption in the estimate that follows.(footnote 6:Other assumptions include: horizontal rigs are modeled to drill twice as much gas per rig as other types of rigs to reflect the elevated initial flow rate of shale gas. Depletion rates are assumed: horizontal wells deplete at 70-80% per annum, and other wells deplete at 40-50% per annum. I am not suggesting that Figure 5 is a completely accurate depiction of reality; for one thing, it does not account for supply that was lost during Hurricanes Katrina, Rita, Gustav, and Ike. It also aggregates different types of wells, and makes assumptions about depletion rates that may or may not be accurate. But it will give a better broad view of supply then what is suggested in Figure 4. The red curve at the end of the graph reflects an estimate of what future supply would look like if rig counts started increasing next week and increased linearly at a rate of 30 rigs a week.)
Figure 5 Rig Data from Baker Hughes. Curve depends on depletion rates estimated by author
This figure is meant to illustrate the concept that supply will continue to fall even after rig counts start to recover. This is because we have now overshot the number of rigs necessary to maintain supply, and so supply will fall until we return to that number of rigs.
In conclusion, by comparing to past instances where rig counts fell below the level necessary to maintain supply, we can expect that supply will continue to fall for at least another month or two. If rig counts stay at current levels (or continue to fall) then the nadir in supply will be pushed out that much further. To relate this back to section 2, an expected reduction in supply would cause, everything else equal, the second derivative of natural gas storage (that is, the change in the flow rate) to be negative
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