Not only is Christmas in the air this time of year, but talk is also swirling about energy independence for the U.S. The revolution in economically exploiting unconventional plays has produced a glut of natural gas and steadily rising oil production. Even the sober International Energy Agency forecasts that U.S. production will overtake Saudi Arabia in seven years, and that North America will be independent in 10. Before we pop the champagne, however, let's listen to an independence "bear." Just as with any great stock thesis, you should study the bear case in order to ensure your research is thorough.
Here is the challenge in North America: While there are far more reserves of hydrocarbons locked in the shales than there are in the depleting conventional plays, these reservoirs are smaller than the latter and begin declining far sooner than do large conventionals. That means the pace of drilling must accelerate in order to sustain production, let alone grow it. Industry consultant Arthur Berman, of Labyrinth Consulting Services, recently made the case that we won't be able to drill quite fast enough to offset rapid decline rates. He says that, while U.S. production will grow, independence is unlikely. His full presentation is here (PDF); I will share a few slides to illustrate his points.
Berman's first example is the prolific Eagle Ford shale in Texas. This play has ramped from essentially nothing in 2008 to production of more than 500,000 barrels of oil per day, with more than 3,000 producing wells. However, without an increase in wells, the play will start to decline at a 42% annual rate, based on the performance of current wells. Berman calculates the need for 800 new wells per year, which should cost about $8 billion annually. This is only to replace the 150,000 barrels per day that will deplete.
Similarly, the exciting Bakken shale is now producing 573,000 barrels a day from more than 4,800 wells, but it faces a 38% annual decline rate. The Bakken drillers must find 182,000 barrels per day of new supply, which Berman calculates will need nearly 1,500 new wells annually at a cost of $17 billion. He pointedly makes note of the Sanish-Parshall field, which is considered a "hot" play at the moment. That field started production in 2006, and is already declining at 15% per year despite the drilling of additional wells.
Berman's conclusion is that the laws of diminishing returns have not been repealed. The best plays will be discovered first, and then additional drilling will find progressively more marginal reservoirs. This is not to say the shale revolution is over by any means; it is a great source of new energy supply for years to come. Berman's point is that, based on the experience of current depletion rates, the completion of new wells will have to accelerate for years in order for U.S. production to actually overtake that of the Saudis.
My point is that this is excellent news for the oilfield service names, such as Halliburton (HAL), Schlumberger (SLB) and a host of others. Those stocks have had a lousy year as exploration activity has slowed in the face of low natural gas prices and an oil decline from the peak. However, the longer-term outlook is exceptionally bright. North American exploration activity will not diminish anytime soon. In fact, it will probably accelerate. For investors with a three-year outlook, now may be an ideal time to start building positions in these names.