Escolar Documentos
Profissional Documentos
Cultura Documentos
We covered so much ground in our visit with Peter, well publish two
reports. In this first one, we cover the broad impact of the Shale
Revolution, which he calls, the greatest evolution of the American
industrial space since 1970. We hope you enjoy the discussion.
American energy system to a globe-changing revolution. Understand those changes and you can
understand just how transformative shale is about to become.
The best place to start is probably about what's changed in the shale oil industry. The general
technology, fracking, where you drill down, then go laterally, and then put in water and sand at high
pressure and crack it apart that's nothing new. Everybody talks about the horizontal drilling and the
pressurized fracking as what made it possible. And I don't mean to suggest that that is not true, but
what really allows shale to be something more than a big boondoggle is seismic technology. Now,
seismic has been around in the industry since the late 1970s. It's not new, either. But the old seismic
is a radically different creature from what we have today. It's like comparing a Toyota hybrid to an 18-
wheeler from the 1950s. Yes, technically, they're of the same technological tree, but they're so
radically different. With the old seismic you have these giant bulbs of oil-saturated rock that didn't
require much of a sonar cross-section to show up when you would do your seismic. The new ones
can pick up deposits about the size of a 500 ml water bottle.
GC: Does most oil sit in such an environment, under a cap rock?
PZ: No. It's easier to think of it as a pool of liquid, but it's not actually a big chasm full of liquid. It's
porous rock that happens to have a lot of oil saturated through it. The difference about shale rock is
it's not as porous to the same degree that the conventional reservoirs are. So, if you have a high-
porous rock, the liquid, the oil, the gas can migrate through it until it hits a barrier that it can't pass
through. At this point it builds up pressure and when you tap those, you get a gusher. Shale is porous
at the micro level but not the macro level, so the oil can form in it but then it can't get out. If you have
a shale rock versus another oil-bearing rock, the shale rock is much heavier. It's super-dense, and you
can't squeeze it; you have to shatter it. With the conventional reservoir, you drill down into it and you
don't even have to crack it. The water, which would be the liquid, will seep out on its own in most
circumstances. With shale, you have to beat the hell out of it to get it to give up the crude. Micro-
seismic allows you to get a more accurate picture of all of that, and micro-seismic is so new it 2
Ad Hoc Report
February 15, 2017 Capture the Knowledge Effect in your portfolio
did not exist 30 months ago. More than four-fifths of the petroleum in North America is trapped
within the source rock, and most of those source rock are shales. The shale industry is all about
developing technologies that make it possible to access the oil that isnt perfectly packaged. The
only way to get shale rock to give up appreciable amounts of petroleum is to turn conventional
drilling techniques on their ear literally. Instead of drilling vertically down through the formation,
you instead drill horizontally along the formation. Total reservoir contact between the wellshaft
and the shale layer would be but a few dozen feet per well with vertical drilling, but by going
horizontally you can now establish over two miles of contact.
GC: Are technologies like micro-seismic allowing drillers to access this trapped oil
that was inaccessible before?
PZ: Right. Seismic technology has been around for a while and that's gotten better and better,
and we would've never had the shale revolution without it, but micro-seismic has changed the
approach by sending a series of geophones down an existing well shaft and detecting noise
across the entire cross-section. Then, as people are doing other drilling around it, it's listening to
how those much smaller sound vibrations, ergo micro, are bouncing around within the formation.
They can now map out the formation as they're doing other drilling. And there's dozens of
variations on this that are still coalescing around whatever the new tool is going to be, and each
company excels at a different piece of this. It's disseminating far more rapidly than any other
technology in the energy sector ever has. The geophone is basically a big wire that has dozens of
sensors going all the way down to the bottom of the well shaft, and they leave that in place as
long as theyre doing operations. Now that we're getting into things like re-fracking and going
back to fields for the second, third, and fourth time, you basically can leave that installed. So, in
places like the Permian, where we've been doing conventional operations for decades, they'll go
into a depleted area where the conventional oil's gone, they'll run the geophones down an old
well, and then they'll frack in new wells all around it. The more layers you have, the thicker the
petroleum bearing layer is, the more economically viable it is. It is a massively disruptive
technology that alone can lower the break-even price by at least $15 a barrel. Remember, it's an
emerging technology and the pace it is moving is lightning fast. You could say that some bits of
this book are already out of date, because it's moving so fast and we are at a stage that not
everybody is even using it yet. I would say it was probably used in just 5% to 10% of the wells
that were drilled last month (December 2016). A year before that, it was probably only used in 1%
to 2% of the wells. Now that oil prices have rebounded a little bit, and you've got a broader array
of companies that can make profit at this margin, you might not see that percentage creep up
very quickly because there's a little bit more breathing space in terms of breakeven costs. But the
companies that know how to do it are the ones that are going to grow the fastest.
water tanks. So, you don't have to worry about site set up, you don't have to worry about site
breakdown, you don't have to worry about land reclamation or rehabilitation. The water is all in a tank.
Operators recycle it as they go and mix the frack fluid on site. The footprint of a well is 5% of what it
was two years ago. You also need a lot fewer rigs. Instead of going down a mile and over 6,000 feet,
down a mile, over 6,000 feet, now you hit the same well but at every vertical layer. By hitting the next
layer again and again, you're getting up to 50 miles of horizontal contact out of one well. Thats why I
ignore the rig count now and view it as basically a meaningless number.
GC: You've also seen a 60% jump in rig count off the bottom too.
PZ: That's some of the older rigs that are coming back. I would not read into that too much because
last year most of the rigs that were in operation were the multilateral rigs. Now that prices have come
up, some of the older single spike rigs are coming back. They can work at $50 per barrel, but they can't
work at $40 or $30. So, I would caution you that a lot of the companies that might be seeing really big
growth right now will not be able to sustain it. If you take these technologies and you compress them
down to a nice little package, the companies that can do that are going be able to ride out any price
shock, and the companies that can't do that will make money only when the prices are higher.
The only area where the volume of inputs has not dropped is sand. Everything else has become more
efficient. They are actually using more sand per foot of well stage. The general areas where efficiency
has improved is with stronger pumps and cramming more sand to create bigger fractures. The good
news is sand is cheap and they've also discovered that the fancy designer sands that are made out of
artificial materials really don't do much for you. You could just buy the absolute cheapest brown sand
that Texas puts together and you're good. So, we've seen a bit of a sand recession, if that's even a
thing, in Wisconsin. It wasn't as bad as what happened in the rest of the energy sector because
everybody still needs some sand, but then they started experimenting with cheaper and cheaper sand,
and they discovered it didn't make much of a difference. So, all the good sand out of Wisconsin is kind
of falling by the way side, now they're just using that for glass. Instead they are using cheap sand from
wherever you can dig it up. And they're using two, three, sometimes even five times as much per foot
of well stage. The length of the fracks is much shorter now. It's now 20 to 80 feet; an 80-foot one is
really a long one.
They've gotten good enough with the precision application that the industry is now fracking stage-by-
stage. Those cracks might technically go a couple hundred feet, but they are so tiny that the sand only
goes a quarter of that distance and the water maybe half. The cracks are so thin you dont have to
worry about seepage nearly as much as you used to so that problem has gone away, and the Obama
administration even signed off on it. The EPA report on water quality finally came out in 2016, and it
basically said, "Yeah, fracking, don't worry about it." There have been instances of contamination, but
they're not statistically significant and thats according to the Obama administrations EPA.
4
Ad Hoc Report
February 15, 2017 Capture the Knowledge Effect in your portfolio
GC: With all the new techniques, productivity and cost savings, where do you see
production going? Do you see a repeat of almost a doubling of production over five years?
PZ: I think that a million barrels per day added in calendar year 2017 is just baked in now, and that even
assumes a certain price giveback from where we are at right now. The break-even price in the big four
fields is now $40. And what you're seeing now is this initial spike from relatively new players coming in
with relatively old technology because the numbers make sense and they don't have the debt
overburden. It's easy to get a little bit of money to start something fresh right now. It's when the players
who survived this get their fresh funding which is happening right now, that probably by the end of the
first quarter that output will really increase. So one million barrels per day of new output I think is a very
conservative estimate, but a very safe one. Two million is possible. 5
Ad Hoc Report
February 15, 2017 Capture the Knowledge Effect in your portfolio
GC: You describe an environment of consolidation from June 2014 to June 2016, during
which experimental technologies were shared much like techs open source culture,
driving output rates higher even while they drove per-barrel product costs lower. Was this
a result of the Saudi price war?
PZ: Exactly. Saudi Arabias price war inadvertently created a dream scenario for American innovation.
Whats happening now is a leaner, meaner, greener set of technologies that is allowing shale to tackle
what detractors rightly see as its greatest Achilles heel: high upfront production costs. Such tech
advances comprise the bulk of shales recent price advantage. In 2012, before any of those
technologies had been operationalized full-cycle costs were about $90/barrel. In November 2014,
when the Saudis launched their price war, the full-cycle break-even cost across the shale patch was
probably about $75 by August 2015 that figure had plunged to $50 in the Big4 fields. As operators
started to redesign wells with the entire lifecycle of production in mind, that per-barrel production cost
for new wells dipped to the vicinity of $40 in November 2016. North American shale already is more
cost-competitive than the global average. As these technologies continue to mature and play off on
another, a price structure of around $25 sometime in 2019 seems within reach.
Your average well involves inputs from more than 100 companies from start to finish. With the
technology that exists now, each well now likely can be relied upon to at least triple its long-term
output compared to 2014 norms for on average less than a 50-percent increase in cost, with less
surface infrastructure. By my math, all in, North America is less than 0.8M barrels per day from being a
net energy exporter.
Ad Hoc Report
February 15, 2017 Capture the Knowledge Effect in your portfolio
GC: And from a refining standpoint, is condensate easier and cheaper to work with?
PZ: Exactly. Condensate is basically a super light, super sweet crude. It's still crude, but because it
doesn't fall on that four-point matrix, it's usually considered a different category, and because so few
places produce it, it's not in the data in most places. But it is now our number one crude grade. That's
why I include condensate. Because the US now produces more condensate than the rest of the planet
put together and it only comes from shale deposits for the most part. The US produces about nine
million barrels of conventional crude oil and another five million barrels a day of condensate.
Remember the condensate is the best quality oil out there.
The ironic part is that our refineries were designed to work on sludge. So we are now in a situation
where we're loading the lightest, sweetest, most pollutant-free crude grade in human history into
refineries that are designed to process asphalt. We have to add 2% to 10% of contaminates to it so
that the refinery can handle it. So stuff that we won't even use to pave a road is now a premium
product in the American refining sector because refiners can then load it into the refinery to dirty up
the crude blend enough that the refineries can stomach it. It's hilarious.
hesitant to do that. This is why the refiners were okay with getting rid of the oil export ban because
that meant they could export the light sweet stuff and import the crappy stuff and not have to change
the refining metrics. And that blend is going to determine how internationalized the United States is
five, 10 years from now. The crude stream continues to get cleaner in the United States, and the
refineries are hesitant to match their throughput capacity to match the crude stream because they
don't know how permanent this is.
GC: So politically if we eliminate the export ban, you would expect then that we begin
exporting a lot of that light sweet shale oil?
PZ: We're starting to.
GC: Because they didn't make all those investments over all those years?
PZ: Right. So they're importing American refined product or American condensate to fuel their systems
while we're exporting the best crude that humanity has ever produced.
GC: The environmentalists claim the shale revolution is adding greenhouse gases due to
drillers allowing too much natural gas to escape. Do you have an estimate for the amount
of natural gas that's just being wasted that could be captured?
PZ: There are a lot of estimates, but a lot of people have a vested interest in lying about that number.
As of two years ago, the best estimate I saw was about two BCF, which comes out to about 2.5% of
total US natural gas output. And then another 1% to 3% leaks out of the pipes, which is going away as
the tech improves. If the leakage from natural gas is above 3.4%, I think that is the number, then
shifting from coal to natural gas power generation is a wash. But if you're down below that, it's a net
gain in terms of GHG impact. The real number of the leakage percent is probably in the 1.5% to 2%,
and we have the technology, easy fixes, cheap fixes, to get that down to 0.8% if we want to, and I
don't know anyone in the industry that doesn't want to. The question is the speed at which you do
that.
GC: There were election promises about bringing jobs back to West Virginia. Doesnt sound
like that will happen?
PZ: No way. All the Appalachian coal will be off the market within five years, maybe less, and that 8
Ad Hoc Report
February 15, 2017 Capture the Knowledge Effect in your portfolio
assumes no new regulation. Rocky Mountain coal, specifically Powder River Basin coal, will linger on
because its caloric content is so much higher than Appalachian coal, it's about triple Appalachian Coal.
That Montana-to-Arizona stretch that uses that coal will probably persist until regulation kicks it out.
But keep in mind that the coalition that has kept coal in the fuel mix is gone. That coalition came from
Texas and Pennsylvania, and they're gone now. So the number of states that are using it right now is
about 40% less than what it was seven years ago, and within two years the Midwest will be gone
from that coalition as well.
GC: What new rules or regulations could Trump change that would either accelerate or
decelerate the pace of production?
PZ: That's the thing not much. Ninety-nine percent of the shale wells that have been drilled in the
last 10 years were done on private land. That makes it a state and a county legal prerogative, not a
national prerogative. If he were to bring some sort of harmonization between the rules for drilling on
federal lands with the rules that are on state lands that increase output somewhat. Remember, there's
a lot of federal land in the American West. Right now, it's not that that's technically off limits to drilling,
it's just that the permitting process is 300 days. The permitting process in Texas is 30 hours. So, you
bring the federal closer to that, you could see an explosion in activity on federal lands. There's no one
that's really chomping at the bit for that outside of a few local operators who are near the border of
these zones. But if you were looking for something that would actually make a change in the market,
that would be it. Anything else he does, the federal authorities really don't have authority. The EPA,
even under the Obama administration, where the EPA was basically given charge of traffic, didn't
expand their bailiwick to include a lot of shale stuff because it was so clearly a state prerogative. So,
you had the water question, eminently local where they basically just rubber-stamped. You had the
natural gas leakage out of the pipes, which was probably the biggest one that you could do something
with, but even that is a shared responsibility between the local, state and federal authorities. So,
there's not a lot that I would expect him to shift unless it comes on the federal land, and to be perfectly
blunt, the bureaucracy of that touches so many different agencies, that's not going to be a quick
turnaround. Certainly, not this year.
and fracking. There's earthquakes that come from the actual fracking. Those are a non-starter. The
strongest fracking-related earthquake we've ever had is 3.1, which is about the strength of what you
get when you use a sledgehammer. Those don't cause anything. Nobody can detect those. The real
ones, the ones you do need to worry about, are wastewater injection. Because you can only recycle
the water so many times, and some of these wells, particularly in Oklahoma, produce a lot of water
byproduct. When you frack it apart, you'll get these water deposits. They'll come up right with the
shale stuff. You have to separate the water out, do something with it, or re-inject it. When you frack,
you put in several million gallons of water to frack it, and then the water comes back out. It doesn't
stay. So you have adjusted the local micro-geology, but not hugely. With a wastewater well, you're
putting billions of barrels of water down there and you're leaving it. And that causes slippage and
actual earthquakes.
GC: Those wastewater wells, are those former oil wells that have been depleted, or are
they totally separate things?
PZ: They're separate. And they usually go down a lot deeper. If you're in an area where you don't have
a lot of wastewater production, or a lot of bi-water production, it's not nearly as much of an issue. So
in the Permian and the Bakken, there hasn't been a lot. But in the Barnett, and in SCOOP in Oklahoma,
there's been a fair amount. Oklahoma is the one, of course, where this is the biggest because their
local geology for disposal is seismically prone to react to this sort of activity. The volume of
wastewater and bi-water production they get out of their wells is much higher than it is anywhere else
in the country, so that's why Oklahoma has been ground zero for all that.
There's a lot of really interesting experimentation going on in Oklahoma to figure out how to deal with
it. You can't use it for drinking, you can't use it for irrigation. But if you run it through an evaporator and
condense it again, it's normal water again. You'll have this sludge you'll still have to dispose of. But it's
formerly dissolved solids. It's less than one-10th of 1% of the volume that it was before. All of a
sudden, you have a manageable issue even if all you do is re-dissolve it in water and re-inject it. You've
now injected 90% less water. They've discovered in places where they reduce the input, they reduce
the earthquakes.
The question is the cost because the good evaporation and condensation process adds like eight bucks
a barrel to your crude cost. That's not insignificant. But, that is the nature of the problem. It's not from
the production itself, it's from the aftermath. And it's not everywhere.
10
Ad Hoc Report
February 15, 2017 Capture the Knowledge Effect in your portfolio
GC: Where are the federal government rules with respect to import and export of various
crude products or refined products?
PZ: At present, the export oil ban has been rescinded, so you can export raw crude without a
presidential waiver now. However, as soon as we have any sort of energy shock
Stay tuned for part 2 of this interview, on the worlds geopolitical environment since the US
presidential election. Peter Zeihan is the best-selling author of The Accidental Superpower.
The report is for informational purposes only and should not be considered investment advice. The
views are expressly of Mr. Zeihan and are not necessarily the views of Gavekal Capital or its
investment professionals. Mr. Zeihan provides consulting and research to Gavekal and is compensated
for those services.
11
www.gavekalcapital.com