Andreoli on Oil and Fuel: Outrunning the Red Queen in the shale oil fields

In Lewis Carroll’s hallucinogenic novella, Through the Looking Glass, the Red Queen explains to Alice that she too can become a queen by reaching the opposite side of the playing board. But Alice, who has been running as fast as she can, finds that, despite her efforts, she remains in the same spot.

The Red Queen explains that in Wonderland, “it takes all the running you can do to stay in the same place, and if you want to get somewhere else, you must run at least twice as fast as that.”

Critics of the shale oil boom have compared oil production in the Bakken and other shale oil fields to Alice’s race with the Red Queen. The average new well produces fewer than 500 barrels of oil per day in the first month. By the end of the first year of production, output has typically fallen to slightly less than half of the initial flow rate. By the end of the second year, daily output from the average well declines to just over 15 percent of the initial flow rate.

Consequently, a significant and growing amount of new oil production is required to cover declining output from the many thousands of legacy fields that have been drilled over the last few years.

As a consequence of low average production and high decline rates, shale oil critics draw an analogy to the Red Queen race, arguing that as time goes on, the amount of drilling will have to increase exponentially just to keep production from declining. Sooner than later, oil production from the shale fields will reach a plateau and inevitably fall into decline despite the significant size of proved shale oil reserves.

It’s difficult to refute this line of reasoning precisely because rising production means that the Red Queen problem is becoming ever more pronounced—as production rates go up every year, so too do the legacy decline rates.

Toward the end of 2013, the Energy Information Agency (EIA) began publishing a monthly Drilling Productivity Report that suggests trouble looms on the horizon.

There are three primary shale oil fields: the Bakken in North Dakota and the Eagle Ford and Permian in East Texas and West Texas, respectively. On a daily oil output basis, the Permian is the largest, producing nearly 1.4 million barrels per day (mbpd). Output from the Eagle Ford has climbed to approximately 1.3 mbpd, and production from the Bakken has recently risen above 1.0 mbpd.

Collectively, oil production from these three fields in December 2013 was nearly double the December 2012 volumes. With such strong growth, there seems little reason for concern that oil production will soon become, like Alice, trapped on the Red Queen’s treadmill—but decline rates from legacy fields have been climbing faster than net production.

New wells drilled in the Permian field are expected to add 42,000 barrels per day (bpd) to total production between January and February 2014. On a net basis, however, oil output is expected to rise by only 3,000 bpd because output from legacy fields is declining at a rate of 39,000 bpd, and is increasing more rapidly than new well productivity.

In January 2011, the legacy decline rate was estimated by the EIA to be just 25,000 bpd, but has since then increased at a compound annual rate of 16 percent. By contrast, new well productivity in this field has remained flat. Consequently, in order for oil production to remain flat, the number of wells drilled every month must increase.

New wells drilled in the Eagle Ford field are expected to add 127,000 bpd between January and February 2014, but on a net basis, output is expected to increase by just 34,000 bpd as production from legacy wells is expected to decline by 93,000 bpd. Since January 2011, the legacy decline rate has increased eight-fold, and decline rates continue to accelerate.

The legacy production decline problem in the Bakken is similarly troublesome. The newly-drilled wells there are expected to bring 86,000 bpd of new oil online between January and February 2014, but 61,000 bpd will be lost to declining production from legacy fields. The legacy decline rate in the Bakken has more than tripled over the last three years, and decline rates are accelerating there as well.

To a large degree, legacy declines have been offset by rising new well productivity, but gains are not distributed evenly across all fields. Well productivity has been flat in the Permian, but since 2011 the oil output per well has been growing at a compound annual rate of 43 percent in the Eagle Ford and 36 percent in the Bakken.

Assuming new well productivity continues to increase at these rates, and the number of rigs in operation remains the same in each of these fields, production from new wells in the Eagle Ford would be expected to grow from 127,000 bpd to 181,500 bpd, as the decline in legacy production grows from 93,000 bpd to 167,000 bpd. Consequently, net new production, which increased by 34,000 bpd in January 2014, would be expected to increase by just 14,000 bpd in January 2015.

Though still positive, the rate of growth in net new oil production from the Eagle Ford will fall to less than half of what it is today over the course of the coming year.

A similar process is unfolding in the Bakken, but a different story prevails there. Assuming the recent trends continue, production from new wells in the Bakken would be expected to grow from 86,000 bpd to 117,000 bpd, while the decline in legacy production would be expected to grow from 61,000 bpd to 92,000 bpd. Consequently, net new production would be expected to grow by 25,000 bpd in January 2015, which is exactly how much it grew in January 2014.

It may be concluded that the rate of growth of shale oil production is likely to slow markedly over the next 12 months. For now, the industry continues to outpace the Red Queen, but the exponential growth of legacy decline rates suggest that sooner than later the industry will have to “run twice as fast” if output from these fields is to grow.

What this means for oil and fuel prices is difficult to discern so far in advance because there are so many interconnected moving parts. I don’t see the Red Queen problem as a looming catastrophe, but rather as a challenge—a serious and growing challenge that shippers and carriers need to monitor.