Last March, we ran a blog post we titled “Kill the drill” commenting on a front-page New York Times story on the steep drop in drilling activity that accompanied plunging oil prices and gas prices in early 2009. The Times declared that, “The great American drilling boom is over,” and concluded that with prices plummeting, “the result for companies is that it is becoming unprofitable to drill.” The Times quoted Oklahoma’s Devon Energy as Exhibit A of the drilling hangover era:
“The big bonanza is over,” said Jay Ewing, the completion and construction manager for Devon Energy in the Barnett Shale field here, where so far this year his company has brought its rig count from 35 to 8. “Everyone is really shocked how fast everything has turned.”
Energy experts and company executives warn that oil and gas companies now cutting back on investments will be unable to respond quickly to a future economic recovery. John Richels, Devon’s president, said that if the slump lasted two years, it could then take 18 to 24 months for companies to reassemble rig crews.
We reproduced the Times’ chart showing “a precipitous decline in oil and gas drilling”:
Well, I recently went to update a chart on annual oil and gas production for the June edition of our Numbers You Need bulletin. My faith in the New York Times, Devon Energy and the OK Policy blog as heralds of economic trends led me to expect to find a steep drop in production in 2009, especially for natural gas, which has not enjoyed the rebound in prices seen in the oil market over the past year. And yet I discovered that natural gas production fell by just 2.6 percent in Oklahoma in 2009. Nationally, production actually rose by 1.6 percent in 2009 and has now reached its highest ever levels.
According to the latest analysis by the U.S. Energy Industry Association, continued strong production of natural gas and record levels of storage capacity are serving to keep natural gas prices low. But what is less clear is why lower prices are having little, if any, impact on production? What happened to the “precipitous decline in drilling”? What happened to “it’s becoming unprofitable to drill”?
I don’t have any particular expertise as an energy sector analyst, but a bit of research and a few conversations have led me to conclude that there are two things going on. The first is that the New York Times, and others, mistakenly equated the number of rigs in operation with production. As this chart posted by Bill Francis at seekingalpha.com shows, rig counts and production levels have deviated significantly in recent months:
Steady or rising production with fewer rigs seems to reflect a shift from conventional drilling to horizontal drilling, which yields much higher production per rig.
As to why low prices have not led production todecline, several explanations have been suggested: producers are drilling as a way to hold their leases, which will expire if acreages are left undrilled; new production techniques have brought down the cost curve of the industry and made more drilling profitable at lower prices; some producers are still taking advantage of hedged contracts negotiated when prices were higher; and companies are willing to accept smaller profit margins to stay in the game until prices improve.
But again, I’m no expert. If any of you readers have thoughts or theories about what’s going on, I hope you’ll feel free to share them as comments below.