Why You Shouldn’t Worry About Steep Decline Rates

In the new shale paradigm, it is common to point out that individual well declines are very rapid, approximately between 60% and 80% in the first year. This criticism, while initially appearing to be sound, makes the mistake of extrapolating what is true on the well-level to what is true on the field-wide development level.

To make a simple comparison, the effective decline rate of a coal mine is 100%. The instant on-going coal mining operation cease so does the flow of coal. In contrast, since oil and natural gas are fluids, they seem to flow “automatically” thanks to the accumulated pressure that expels these fluids. With coal and other solid mineral resources, their physical state prevents them from flowing to equalize pressure differences. Nonetheless, we don’t bemoan the unsustainability of coal or copper mining on account of their 100% decline rates. We recognize that each incremental amount of production requires an incremental “scoop” from the mining equipment.

Production from shale reservoirs falls somewhere between mining operations and traditional puncture-and-flow oil and gas reservoirs. As with mining operations, large pieces of capital equipment, such as drilling rigs and fracking equipment are needed for ongoing field development, with each new fracking operation comparable to a “scoop” of coal extracted by a large piece of mining equipment. However, after this initial “scoop,” there remains a pressure differential across the exposed reservoir that allows additional hydrocarbons to gradually be recovered (through the nanopore shale structure) over longer periods of time.

The important thing to focus on when anticipating what a field-wide decline rate will look like is the fundamental economics of an individual well, not its decline curve. Many producers are now focusing on increasing sand-loading during this difficult pricing environment specifically to generate more production in the early stages of a well--in other words, they are making the front-loaded production of the well even more extreme. Why? Because it still makes economic sense. By doing this, they can recover their initial cash expense in an even shorter time frame (typically slightly more or less than a year), recycling that cash back through the company to drill an additional well. Going back to the “scoop” analogy, we can think of each pay-back period as the initial scoop, and the residual production they get after that as the payout, or the dividends on the well. When these companies have developed a large inventory of these wells at later stages of their decline curves, they can sit back and collect all of these payments.

Consequently, if the wells themselves are economic, they will continue to be drilled. As the prime locations are drilled up, and the drillers move on to the more marginal edges in each play, the incremental wells will have slightly lower peaks, and thus be slightly less able to offset the decline of the most recent well vintages. The next marginal set of wells after that will be slightly less productive, but they will in turn need to only offset the previous vintage, which was itself less than the vintage before that. This, however, is assuming stable oil prices. If there were a sudden decline in oil prices such that it actually undermined the fundamental economics on the individual well level, then yes, the sudden freezing of operations would lead to a more abrupt decline in production just as would be the case with coal or copper mining operations.

The point here is simply that there is nothing new or fundamentally flawed with the shale drilling model when we recognize it as lying somewhere between traditional oil and gas production and traditional physical commodity mining. It’s characteristics reflect a mix of these two other models, both of which are fundamentally sound in their own right. Consequently, there is no reason to expect some fundamental flaw within the model of shale itself to bring about its own downfall.