The $100 Million Dry Hole Cost of Shale Fields

People have said that there is no such thing as a dry hole in the new generation of resource plays. I'd argue just the opposite; the dry hole costs are much greater than before the revolution.

The notion of dry hole costs, as remembered by those with more than about 10 years of history in the industry, consists of those dollars lost if the well or prospect turns out not to be productive. A friend of mine once had to face his board of directors to justify his drilling of a dry hole for a cool $100 million. Twenty-five years ago, that was a heck of a dry hole, but he knew exactly the risk he was taking as he approved the location. Now the ante has systematically increased in the industry, and the perspective on risk seems to have become distorted.

Dry hole costs more abstractly represent the money placed at-risk in order to find out whether or not more money can be made. Practically all individual shale wells produce some kind of hydrocarbons, and this fact has made people believe that, really, less money is placed at risk drilling in resource plays. In fact, as an exploration/development program, the at-risk money is much, much higher than in millidarcy reservoirs.

Plenty of wells drilled for sandstone or limestone targets were plugged without being completed. Drilling results showed clearly that there was no hope of making enough money to justify completion. Even completed, those vertical, conventional wells would usually run $1 million or less as little as 10 years ago.

In today's world, a driller must bear the full cost, commonly $5 million or more including completion, to begin to understand how the well will produce. The transients in production are long and slow, recommending a year or more of data (depending upon the engineering method) to estimate recovery with practical reliability. And the natural, (so far) irreducible variation in shale well results means that about 50 wells are required in the same geologic area to estimate well the average well results. Moreover, the similar geologic areas are often not apparent before drilling, meaning that the area must be delineated by multi-million datapoints. And, of course, all this occurs on large acreage blocks often acquired for thousands or tens of thousands of dollars per acre.

The result is that a company can easily spend $100 million, or several hundred million, before they can begin to identify a geologically similar area and begin to quantify its average productivity. And that doesn't count the cost or complication of a learning curve.

Of the years, many companies have lost very large sums in shales without drilling a single "dry hole." Silently they exit the inglorious plays and retreat from the wide uneconomic fringes of the name-brand plays. The impressive, extravagant successes deceive observers by survival bias.

It is too bad that the cautionary tales do not garner more attention because it would benefit many companies to understand the risk truly involved as they enter a shale play. And, as the G.I. Joe cartoon used to remind me, "Knowing is half the battle."

(For a more quantitative treatment of shale exploration strategies, the SPE Distinguished Lecture in 2013-14 by Brad Berg of Anadarko Petroleum is one of the best resources. SPEE's Monograph 3 is also quite useful.)

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