Author: Kent Moors, Ph.D.
Of all the oil and natural gas production areas I have been at in the past several decades, the Permian Basin stands out. Straddling Western Texas and Eastern New Mexico, the Permian is a primary focus of the US oil recovery.
Given the resurgence in oil prices, this has become the center of an American crude mini recovery. The increase in interest costs, however, has dragged that some. More than 80% percent of all production in the Permian is fueled by debt, most of that of the junk bond (i.e., high yield below investment grade) type.
That means a prolonged decline in market price will usher in another round of bankruptcy and mergers among operating companies in the basin. Even without a plunge, however, there are other matters arising.
The Permian contains enormous reserves, made accessible by advances in horizontal hydrofracking and resulting in a remarkable decline in average per barrel drilling costs. Nonetheless, several problems are emerging when considering the full impact of this largesse…and any extension of a recovery in US oil prospects.
One involves the availability of additional pipeline capacity to move extracted volumes out. This has resulted in bottlenecks and storage problems. That is easing somewhat with new pipeline spurs, especially to export availability down the coast from the Houston channel at Corpus Christi.
But the increase in transit is not keeping up with the volume of new production.
Another concern is the inflation in oil field service (OFS) prices. In a mirror reverse image of the situation that hit throughout 2015 and into 2016 – when a collapse in crude oil prices obliged substantial upstream discounts among drillers, seismic and field supply companies just so those folks could even stay in business, costs for OFS services are now escalating.
That is always the case when market improvements result in a noticeable rise on aggregate drilling volume. The advantage moves upstream to the service providers who can often extract the best contract bottom lines by playing fields against each other.
However, it is another problem that is looming as the most serious.
And it is all about water.
Despite advances in the use of other fluids, plasma, and carbon dioxide, fracking requires a lot of water. That water, in turn, creates concerns for the drilling process in three ways. Each one of these has the potential to add serious costs to overall drilling.
First, fracking requires a constant access of fresh water. That water is combined with chemicals and proppants and moved downhole under heavy pressure. A frack bursts open shale (or in the case of the broader category of tight oil/gas, other rock formations), with the proppants necessary in keeping those fissures open to allow product flow.
The chemicals are required to offset interruptions in that flow and to combat the rise of bacteria that will impede (and then end) the flow altogether.
As the gas or oil moves back up hole, the remaining two problems emerge.
Second, well depth, number of fracking stages, rock and fluid composition, and other factors determine what the flow looks like at the wellhead. But much of that is flowback water. As the amount of water increases (a rising difficulty these days) with the drilling technology that allows for multiple wells from the same pad, there are consequences. Increased utilization of water flooding as a secondary recovery technique in traditional vertical drilling, longer frack sequences, and increasing pressure considerations all lead to increased cost in separating the water from the product.
Currently in the Permian, the average well is yielding almost five barrels of water for each barrel of oil equivalent. That is much more than the average only two years ago and it likely to be increasing even further.
Of course, we also should put this in perspective. The advent of “King Shale” has catapulted the US into one of the largest oil producers in the world. Consistent American production should equal or better that in either Russia or Saudi Arabia until at least 2025. But it was a very different story until recently.
In the doldrums of US production (1990s through 2005), historically low production levels were requiring that the country become heavily dependent on imports to satisfy close to 70 percent of daily demand.
At the time, over 60 percent of total American domestic daily production came from “stripper” wells, each one producing less than 10 barrels of oil a day. Unfortunately, the average stripper well was also producing 16 or more barrels of water for each barrel of oil. The cost was prohibitive, making it much cheaper to import.
The Permian is hardly at such a level of water production. But with each increase in the water ratio, the rising cost of separation reduces profitability. That flowback water also introduces what is the major public problem.
Third, the water is also bringing back up the toxic chemicals initially sent down. Some of these are known carcinogens (in the early days of fracking, straight diesel fuel had been used instead). This water cannot be reintroduced into the environment. It must be segregated and injected into deep disposal wells.
These injection wells are becoming more difficult to come by. In addition, the governments of Texas and New Mexico have limited the licensing of new ones and have further limited the fracking of injected wells to increase disposal capacity (fracking such a well increases the area available for injection).
It is now not unusual for operators to haul by truck flowback water considerable distances to the remaining available injecting wells. This is accounting for the single fastest rise in production cost factors. I know one Texas-based company that resorted to hauling water to Utah! Until, that is, it went belly up and closed its operations.
As the Permian increases production, the water problem on all three of these levels increases as well. It certainly opens the door for some profitable possibilities for new water providers and disposal. Several projects are also treating water on site and reusing in subsequent fracks.
I am following developments on all of these fronts. There are likely to be investment targets surfacing in due course.
Unfortunately, the Permian water problem has generated a distinct political problem. Landowners no longer simply lease property for drilling or access. In many parts of the Permian, they also make money by monopolizing freshwater sourcing. In addition, area truckers are making a tidy income from hauling either freshwater to the drilling site or toxic water for disposal. None of these folks want the cash cows to be sacrificed. In response they have engineered local political roadblocks to both operating and OFS companies attempting to introduce new services to reduce costs.
All of that was well underway even before the Biden administration came in with its penchant for renewables and opposition to expanded drilling.
Recalls a famous phrase by former US Speaker of the House (and Texas good ole boy) Sam Rayburn: “It all depends on who’s ox is getting gored.”
Unless something is figured out on the water issue, everybody in the Permian may be the next to feel the pinch.
Dr. Kent Moors
This is an installment of Classified Intelligence Brief, your guide to what’s really happening behind the headlines… and how to profit from it. Dr. Kent Moors served the United States for 30 years as one of the most highly decorated intelligence operatives alive today (including THREE Presidential commendations).
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