Dr. Nathan Meehan, Vice President of Reservoir Technologies, Baker Hughes Inc.
In the movie Pirates of the Caribbean: The Curse of the Black Pearl, Captain Barbossa appears to violate the “Pirate’s Code” when he doesn’t release Elizabeth Swann, but he defends his action by saying, “The code is more what you’d call ‘guidelines’ than actual rules.” Shocking everyone, the laws of supply and demand continue to prove that they are not merely “guidelines” but are, in fact, hard rules.
Just two years ago, readers of these December columns would have concluded that all of the authors thought the petroleum industry’s greatest need would be people, pure and simple. We spoke of the impending Big Crew Change and lamented the erratic hiring of the past, the industry’s tendency to lay off tens of thousands of qualified professionals with each downturn and low enrollments in US petroleum engineering, geology and geophysics departments. Little would change that view as crude oil prices peaked above $135/bbl and natural gas prices peaked at about $11/Mcf in the summer of 2008. Although many people suggested that these high prices were a result of “speculators,” few were suggesting that catastrophic price drops were imminent.
The rules kick in. By the time these columns were (over-) due in November 2008, crude oil prices had dropped below $50/bbl, and they would continue to fall to less than $40/bbl by the time most readers saw the magazine. Meanwhile, US gas prices had just dropped below $6/Mcf and were heading to half that. December 2008 readers could easily detect the concern of the authors, who generally predicted slow recoveries as the US economy was collapsing around us. I was optimistic about 2009 for reasons that now seem simplistic. In the year since, we have seen many changes, few of them hoped for.
Virtually every aspect of the US economy was hit hard in 2009; much of the damage had been initiated in prior years. Ready access to credit and programs designed to encourage home ownership had allowed millions to buy more expensive homes than they could actually afford in the long run. Investments that now appear to be better described as speculation, overheated home prices and many other factors drove a weak economy into a global recession.
I suppose many people thought that the laws of economics were more what you’d call “guidelines” than actual rules. Yet, as dictated by actual rules, when demand for oil and gas dropped in the US, oil and gas prices followed.
Many E&P companies repeated prior patterns when the price crash hit, and laid off well-trained professionals. However, the likelihood of that Big Crew Change remains. There were essentially no wholesale “early retirement” actions, and those that occurred were more subtle than in the past, such as raising the effective discount rate for those who could retire, encouraging many to retire earlier than they had planned.
The gas picture. The recovery in industrial and heating demand for natural gas is difficult to forecast. However, predicting the supply response is not so difficult. I spent most of my 34-year (and counting) career working for a producing company that was exceptional at finding gas. Our executives were never optimistic that significant onshore crude oil discoveries would be made in the United States—at least not so significant that they would really reverse the climbing US dependency on crude oil imports. But they believed that natural gas was abundant and that the creative energy of the domestic E&P industry could keep the US supplied with natural gas for generations rather than a few decades. In retrospect, the reasons for this optimism were simple. They found natural gas almost everywhere they looked. Yes, that gas was primarily in low-permeability rocks where massive hydraulic fracturing was required to extract it, but infill drilling in old fields seemed to add reserves at every turn. Coalbed methane held enormous promise. And then the commercialization of shale gas resources completely changed the game.
While some people have questioned the impact and potential of shale gas, their doubts appear to be founded on fairly weak arguments. Simplistic reliance on curve-fitting techniques using decline curves (and ignoring the integration of reservoir engineering and earth sciences as well as flowing pressures, operating conditions, etc.) might over- or underestimate recoveries based on the skills and luck of the estimator. We do not yet fully understand the nature of hydraulic fracturing in many shales, much less have the ability to estimate the gas in place and optimal recoveries and spacing. But advanced logging techniques allow geologists to analyze more clay types, natural fractures and variations in lithologies than ever before. Microseismic monitoring of created fracture networks is being integrated with reservoir engineering analysis to give a picture of the real potential for shales and to map what portions (and total volumes) of the reservoirs are being drained.
Hydraulic fracturing of horizontal wells with dozens of individual frac jobs is now routinely possible, leading to the potential for larger drainage volumes from individual wells and better optimized placement. Advanced geomechanical modeling has greatly improved our understanding of shale behavior. In the early days of horizontal wells, there were similar questions about well placement, optimal lengths and incremental recoveries. As the industry’s experience grows, operators who invest in understanding these reservoirs will inevitably outperform the rest.
So, if we cannot precisely predict when gas demand will recover, what can we predict about supply? We have a great deal of storage, but far more pent-up opportunities for supply growth. As gas prices rise, supply will flood in. Shale operators remain under leasing pressure to evaluate and develop large leaseholds in a reasonable period of time, and cannot wait until gas prices fully recover. While it may take a while to get North American rigs better utilized, strong gas prices would drive very strong drilling activity. This potential will, in fact, moderate prices and North American gas activity.
Oil prices are another story. For almost my entire career, the ratio of oil prices to gas prices ranged from about 6 to 10 ($/bbl over $/Mcf). Variations from this general range tended to be temporary and were explained by the fact that North America could neither import nor export material gas volumes. But recently, that oil-to-gas price ratio has risen to numbers in excess of 20, and it currently remains well above 15. Is oil too expensive? Gas too cheap? Or is US gas less coupled than ever to global oil supply and demand? I think the answer to all three questions is yes. 
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THE AUTHOR
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Dr. Nathan Meehan is Vice President of Reservoir Technologies for Baker Hughes Inc. He has more than 30 years’ experience in reservoir engineering, reserve estimation, hydraulic fracturing and horizontal well production. Previously, he served as president of independent consultancy CMG Petroleum Consulting. He also was Vice President of Engineering for Occidental Oil & Gas and General Manager of Exploration & Production Services for Union Pacific Resources. Dr. Meehan earned his BSc degree in physics from Georgia Institute of Technology, his MSc degree in petroleum engineering from the University of Oklahoma, and his PhD degree in petroleum engineering from Stanford University. He has served as a Director of the Society of Petroleum Engineers.
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