High Oil and NGL Prices Drive U.S. Shale Drilling Decisions

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Written by John Egan for Industrial Info Resources (Sugar Land, Texas)--Sustained high prices for oil and natural gas liquids (NGLs) such as ethane, butane and propane are causing North American Oil & Gas developers to increasingly focus on drilling for oil and "wet gas," at the expense of "dry gas," even in shale formations, according to Don Warlick, president of privately held Warlick International (Houston, Texas), an oil & gas market intelligence firm.

"In the U.S., we have a large and growing supply of natural gas, and most people project prices will remain low, in the range of $4-$5 per thousand cubic feet (Mcf), for the next several years," Warlick told a conference organized in Denver, Colorado, last month by EUCI (Denver), an energy-events company. Gas production is increasing from shale formations, and the increased supply will tend to act as a cap on prices, he said. To remain competitive at those prices, oil & gas developers are increasingly drilling in tracts that contain higher proportions of oil and NGL-rich "wet" gas.

"Oil & gas developers have been going through a period of asset rotation, increasing their exposure to oil and gas properties that have a high concentration of NGLs, so they can operate profitably in a low-price gas environment," Warlick told Industrial Info in a subsequent interview. "Everyone's going crazy over NGLs right now," he said, in part because of rising global demand for petrochemicals, which use NGLs like ethane and butane as feedstocks.

Since bottoming out in late 2008, spot prices for some NGLs have risen by as much as 100% or more, according to industry benchmarks. For example, spot prices for normal butane at Mont Belvieu and Conway averaged about $1.40 per gallon in September 2010, up from an average of 60 cents per gallon in December 2008. Similarly, ethanes sold at 40-50 cents per gallon on the Mont Belvieu and Conway spot markets in September 2010, up from average prices of 25-30 cents per gallon in December 2008.

Even at these recent prices, NGL prices remain sharply lower than their recent peaks, reached in mid-2008. But as global demand for petrochemicals grows, Warlick sees NGL prices continuing to rise for the near future.

He sees the impact in domestic drilling trends: According to data he cited from Baker Hughes, about 45% of U.S. drilling rigs are now drilling for oil, up from about 20% in 2006. The percentage of rigs drilling for gas has fallen to about 55% today, down from 80% in 2006. Warlick said he expects this shift to continue in the next few years.

As evidence of this shift, more than 130 rigs are drilling in the oil-rich Williston Basin in North Dakota and Montana, he continued, adding that the number of rigs drilling in the NGL-rich Eagle Ford Shale formation more than doubled in 2010.

Most parts of the Barnett, Marcellus, Haynesville, and Fayetteville shales contain "dry" gas, which has comparatively little NGLs, Warlick explained. But parts of the Marcellus shale, notably in southwestern Pennsylvania, have high levels of NGLs, which drive up drillers' returns.

"Wet" gas fields have far higher pre-tax returns on investment compared to "dry" gas at current prices, Warlick told Industrial Info. For example, in early 2010, when gas sold for about $4 per Mcf, Seneca Resources Corporation (Williamsville, New York), a unit of National Fuel Gas Company (NYSE:NFG), had an ROI of 20-40% when it extracted "dry" gas from a well in the Marcellus Shale. But Range Resources Corporation (NYSE:RRC) (Fort Worth, Texas) reaped an ROI of 50%-60% for a well drilled in southwestern Pennsylvania that had a higher NGL content than the Seneca well. The wells had the same costs to drill, about $4 million.

Returns in the Eagle Ford Shale, in south Texas, may be even higher, as that formation is "very wet," Warlick said in an interview.

Despite sharp differences in ROIs from "wet" and "dry" gas fields, Warlick predicts U.S. shale gas production will continue soaring from 2009 production levels of about 9 billion cubic feet per day to more than 20 billion cubic feet per day by 2015. "It may be more, and it may be sooner," he added.

U.S. shale formations have attracted tens of billions of dollars of investment capital from around the world since mid-2008, Warlick noted. In one blockbuster deal struck in October 2010, the China National Offshore Oil Corporation (CNOOC) (Beijing) paid more than $1 billion to acquire a one-third interest in 600,000 acres of oil leases in the Eagle Ford Shale held by Chesapeake Energy Corporation (NYSE:CHK) (Oklahoma City, Oklahoma). The Marcellus Shale has drawn more than $8 billion in joint venture investments since mid-2008, Warlick told the EUCI conference. Foreign investment has topped $30 billion, including heavy investments by companies like Royal Dutch Shell plc (NYSE:RDS.A) (The Hague, Netherlands), BP plc (NYSE:BP) (London, England) and Statoil ASA (NTSE:STO) (Stavanger, Norway), to name a few.

With oil prices projected to range between $75 and $95 per barrel for the near future, Warlick says the economics of drilling for oil and "wet" gas are compelling. "Oil is a global transportation fuel. Strong demand for NGLs from petrochemicals companies serve as a floor for those feedstock products," he said.

The speed of the U.S. economic recovery, and continued economic growth from countries like China and India, will be the most important factors governing oil prices, demand for petrochemicals and NGL prices, he said. But another European debt crisis, or flattening global economic growth, would shrink potential profits in oil and NGLs.

"The history of the oil industry has been one of booms and busts," said Warlick, a 34-year veteran of the oil patch. "There may come a time in the future when the NGL prices collapse. This is not too big a concern right now, but there is that potential."

Industrial Info Resources (IIR) is the leading provider of global market intelligence specializing in the industrial process, heavy manufacturing and energy markets. IIR's quality-assurance philosophy, the Living Forward Reporting Principle™, provides up-to-the-minute intelligence on what's happening now, while constantly keeping track of future opportunities.