Connect the Energy Dots

 | Feb 15, 2013 | 6:00 PM EST  | Comments
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Stock quotes in this article:

chk

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cog

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eqt

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wmb

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sep

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kmi

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wprt

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clne

When it comes to natural gas, the news is good. But today it's not as good as first reported. Early estimates suggested that shale gas was almost everywhere and easy to produce. The gas is still there, but the production picture has changed and continues to change. The issue is production. For a typical shale gas well, natural gas production declines at a rapid rate. It turns out that decline rates are huge, as seen in this graph.

In the first 18 months, a typical shale gas well will lose approximately 80% of its production. Why so much? Because only the natural gas clinging near the surface of newly fractured rock is released into the well. This helps explain why only a small amount of natural gas is released by the fracturing process. Some experts believe current practices yield less than 20% of the available natural gas. The remaining 80% remains locked underground.

This is the basis for the apparent confusion about how much shale gas is technically recoverable. The Department of Energy's (DOE) Energy Information Administration (EIA) adjusts its forecasts as the scientists and the industry learn how to recover shale gas. Here is EIA's latest forecast:

"Estimates of technically recoverable shale gas are certain to change over time as new information is gained through drilling, production, and technological and managerial development. Over the past decade, as more shale formations have gone into commercial production, the estimate of technically and economically recoverable shale gas resources has skyrocketed. However, the increases in recoverable shale gas resources embody many assumptions that might prove to be incorrect over the long term."

Decline rates and yields are challenges for producers, pipeline owners and policymakers. For producers such as Chesapeake Energy (CHK), decline rates bias its internal rate-of-return calculations toward the front end of production. Beyond 24 months, returns are less attractive.

But as unattractive as out-year returns may be, their underlying assets could be more valuable than many expect. After a well is depleted, it really isn't depleted. Old wells can be expanded, and there are growing opportunities for secondary recoveries.

The big game-changer is technology. Geologists, engineers and scientists are already considering new technologies that will likely change the landscape. New technologies are more about reality than hope.

Many are unaware DOE is the nation's custodian of naval reactors, experimental reactors, nuclear bombs, nuclear weapons and explosion technologies. Remember that the next time you hear a politician claim they want to shut down DOE. To see where the future is heading for shale oil and gas, focus on DOE's explosion technology capabilities. They are extensive and advanced.

Sandia National Laboratory is part of DOE. Sandia runs a Geomechanics Laboratory in New Mexico that researches and develops technologies in rock properties including underground mining, oil and gas production. Next door to the Geomechanics is the Explosive Components Facility, which houses a state-of-the-art facility to research and develop explosive technologies.

Lawrence Livermore National Laboratory (LLNL), also part of DOE, runs the National Ignition Facility, which has expertise in life sciences, engineering, computation, and weapons and complex integration disciplines. Several months ago, LLNL made a presentation before the U.S. Energy Association that suggested water might not be needed for future fracking operations. Research and development is also underway in other DOE laboratories. Of course, most research is focused on national defense initiatives. But some development is transferrable to the oil and natural gas industries.

While current accounting methodologies define the limits of "technically recoverable shale gas," we can see a brighter future. When we connect the dots, we understand that 70% to 80% of the shale gas remains locked underground, we can see new technologies are emerging and we can conclude there are huge possibilities of unlocking massive amounts of technically unrecoverable natural gas.

We can see opportunities up and down the value chain. On the supply side, existing wells offer options to producers. Producers Chesapeake and Cabot Oil & Gas (COG) have the option of returning to older wells, re-fracturing and stimulating new production. As new technologies are introduced to break rock into smaller pieces, production returns will likely improve.

For processing, gathering and transmission companies, the future appears strong. With the potential of more gas from existing sources, companies like EQT Corp. (EQT) Williams Cos. (WMB), Spectra Energy (SEP) and Kinder Morgan (KMI) can earn longer returns on existing assets.

More gas also helps the demand side. Companies like Westport Innovations (WPRT) and Clean Energy Fuels (CLNE) have stronger opportunities and more sustainable futures.

Finally, connecting the dots also means more investments in research and development. Without new technologies, the nation's gas tank can hit the low mark in as little as 24 months.

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