The Road to Happy Valley

"There’s a fine line between a numerator and a denominator”, Yogi Berra 

As a Dutch boy, a country’s conscience ingrained the “Goedkoop-Duurkoop” rule in me: literally “buying cheap is expensive”, or “you get what you pay for”. The Dutch claim extensive expertise on being cheap, and the world can thank us for the invention of the copper wire. The invention is claimed by two Dutchmen fighting over a penny…

The Goedkoop-Duurkoop rule can help when buying a car or when you decide on buying a completion for your well. Thinking about the long-term for a car is to look at lifetime cost per mile ($/mile). If you are interested in comfort or performance, don’t read any further. I am strictly looking for the no-frills ability to travel from A to B.

In the plot below we show how the cost of a car generally rises more than linearly with the expected lifetime miles. Focus on cheap and you may buy a lemon for $5,000 that breaks down after 10,000 miles ($0.50/mile). A focus on comfort and performance may land you a new luxury car every two years, with a sales differential of $30,000 for say 30,000 driven miles ($1.00/mile). 

Yogi Berra was a smart guy: it is wrong to focus just on reducing the numerator or increasing the denominator in the $/mile ratio. Slightly increasing the numerator ($) can sometimes help to increase the denominator (mile) even more, resulting in an overall reduction in the $/mile ratio. 

I have two cars to test the $/mile concept. My kids have dreaded using a “very uncool” 1996 Toyota Camry. They drove it 100,000 miles in 15 years with minimal yearly maintenance: $0.12/mile for the car (and about $0.10/mile for gas). I am pushing a Chevy Suburban to 200,000 miles. Maintenance is slightly more expensive at about $0.16/mile (with $0.15/mile to be added for gas). Subby is little more expensive than Camry, but wins on a $/mile/passenger metric.

Adapt this concept to oil production, and a modified rule for the cost per produced barrel of oil ($/BO) or cost per produced barrel of oil equivalent ($/BOE) can be an effective metric to help you decide how to complete an oil well. Chris, Liberty’s CEO, calls the search for a minimum $/BO or $/BOE “the road to Happy Valley”. We love to help our customers get to Happy Valley.

The cheapest well possible would just comprise drilling cost. As the created fracture system generates almost all estimated ultimate recovery (EUR), $/BOE is very high for a small frac due to low production. A focus on just Yogi Berra’s numerator may deliver a cheaper well, but production response and NPV may suffer, thus keeping $/BOE relatively high. 

Well cost typically increases more than linearly as a function of EUR. Some of the cost in a completion are “wasted” due to out-of-zone frac growth, which cause fracture length in the reservoir to be less than proportional to treatment volume – frac half-length is generally proportional to something close to the square-root of job volume. If we make the simplification that EUR is proportional to fracture half-length (assuming fracs equally spread across a lateral), the cost to create half-length therefore increases with something closer to the square of EUR.

The table below shows a summary of some of the major completion changes I discussed in my last post, with completion parameters averaged over 10 basins / formations. Between 2012 and 2016, liquid-rich shale operators have worked to reduce their $/BOE in three different ways:

• Push toward higher proppant mass and fluid volumes, higher stage intensity, higher injection rate, and a general move to lighter fluid systems. All these changes indicated that, in the graph above, Happy Valley is located farther to the right than we previously thought, and that our past efforts were likely too focused on cost reduction alone;
• Push the overall $/BOE curve down. The cost per barrel curve in the graph above is not static, but comes down over time through innovation and efficiency gains. The drilling industry has worked hard to cut drilling time, increase well intensity per pad and drill longer laterals. The pumping industry has dramatically increased pump time per day and increased proppant throughput, and has cut chemical additive requirements to place a pound proppant. As overall well completion costs have gradually increased again through most of 2017, the cost to place a pound of proppant has barely come up.
• Increase production. The combined effect of these completion changes has resulted in a 60% well production uplift, or about a 25% production uplift per lateral foot.

These production gains, shown for each individual shale basin and major formations in the graph below, are even more remarkable given the fact that newer wells now often represent infill drilling, which faces possible depletion or production interference from older wells.  

As a pumping services company, we do not have great visibility into total drilling cost reductions operators accomplish, but some information is available through investor presentations. For example, in their May 2017 Investor Update, CLR posts $/BOE reductions of 60-75% over the last four years, with about 40-50% of that reduction through cost savings through higher well intensity per pad, longer laterals and faster drilling, while pumping more fluid and proppant and increasing stage intensity and diversion efforts. As a result of these completion changes, the remainder of their $/BOE reductions came from higher production.

While shale operators and service companies benefit from innovation and efficiency gain, much of these benefits transfer to consumers – just like in any other market-driven business. The shale industry has made dramatic progress, triggered by the downturn, to become more competitive on the world stage.  Since the crash in crude prices in late 2014, shale operators are saving consumers around the world about $5 billion every day, helping them to get to their own Happy Valley with more abundant lower-cost energy.

More information

Liberty customers can request free access to our Frac Trends Viewers for various basins here.

Thank You

To Chris for teaching me the Happy Valley concept.