2013 presented some pretty confusing lessons about the oil industry in Kansas.
On the one hand, SandRidge Energy, an Oklahoma City-based company that uses horizontal drilling, is on track to become the state’s top oil producer, overtaking all of the state’s longtime home-grown vertical drillers. That’s according to the latest production totals through October posted by the Kansas Geological Survey.
That could signal the arrival of horizontal drilling as a mainstream method in Kansas. Although SandRidge’s percentage was still less than 5 percent of the state’s production, according to the Kansas Geological Survey, it did help lead the state to its highest total oil production since the mid-1990s, with a projected finish of more than 46 million barrels.
Horizontal drilling involves using a specialized bit to angle the well bore so that it eventually runs more or less flat for several thousand feet through a layer of rock. A lot of expensive technology and expertise are required to drill down a mile into the ground and hit the right layer.
The well is completed by repeatedly pumping water, sand and chemicals under high pressure into the well to fracture the rock to open up oil flows. If the bore runs through the right layer, the results can be astounding – hundreds of barrels of oil a day – along with tons of saltwater that must be pumped back down a disposal well. SandRidge said its wells cost in the neighborhood of $3 million.
On the other hand, almost all of the other out-of-state companies that have tried horizontal drilling in Kansas have pulled up stakes and left. Shell Oil drilled 45 producing wells in 2012 and early 2013 before deciding that the payback just wasn’t high enough.
That could signal that horizontal drilling is just a fad for Kansas – that Kansas geology is just too complicated and the payoff too inconsistent to justify the cost of a horizontal well. That’s why the bulk of the Kansas oil industry continues to rely on vertical wells, which typically cost $400,000 to $600,000 to complete.
Wayne Woolsey of Woolsey Energy said he has drilled 11 horizontal wells. Two produced very well, three did poorly because of technical issues with the drilling, and he had high hopes for the last six. Instead, they have produced at a mediocre level that didn’t justify the cost. He said he would try two or three more horizontal wells this year, along with a program of 24 vertical wells, but he is clearly frustrated.
“When you have one horizontal well with contact with the source rock for 4,000 feet versus four vertical wells with 100 feet of contact each, it ought to work,” he said.
A more nuanced view, say some local oil men, is that Kansas is a marginal play for horizontal drilling that can be managed only if the costs are low enough and the geology and technology are good enough.
SandRidge has pushed hard to improve the efficiency of its drilling operations. The fact that it has spent so heavily on land leases and drilling rigs before seeing adequate return helped spark a shareholder revolt that drove CEO Tom Ward out. New CEO James Bennett has stressed efficiency, saying the company will focus efforts in just six counties in Kansas, including Harper, Barber and Comanche. It said it has lowered drilling costs, sped up the time it takes to drill a well and increased the density of wells so it can replace electrical generators and water trucks with electrical lines and water lines.
Robert Murdock, CEO of Osage Resources, a Hutchinson-based exploration company, said that he expects to complete seven horizontal wells in 2014, along with vertical wells.
Many of the out-of-state companies didn’t really understand Kansas geology when they entered the state, Murdock said.
They approached it as they did shale plays such as the Bakken in North Dakota, which are more expensive to drill but also offer stronger and more consistent flows of oil. The oil in those shale plays is evenly distributed in the rock. This is called a resource play.
Kansas’ Mississippian layer isn’t shale, it’s limestone, and that allows the oil to move and pool inside the rock layer. That makes it much less consistent in delivering oil. In some places, horizontal drilling pays off with a big flow, but in others it doesn’t, and only a lower cost of vertical is justified, he said. The trick is to know which is which.
“It is not a resource play and never was,” Murdock said. “That was the fundamental misunderstanding.”
Making oil pay
The good news, Murdock said, is that the cost of horizontal drilling is coming down as the technology and expertise improve. What cost $3.5 million a couple of years ago, he can now drill for closer to $2 million.
The oil doesn’t go away. It’s still there. If the price can get down to $1.5 million, the cost to drill becomes low enough for Kansas to become attractive to more horizontal drillers again, he said.
In their race to lock up oil leases in 2010-12, the well-funded out-of-state companies drove up land leases all over southern and western Kansas.
But as those companies figured out how much Kansas would pay off and some pulled out, lease prices started to fall, Murdock said. Shell paid up to $3,000 per acre for leases in 2011, Murdock said.
“We are currently seeing lease prices as low as 1/100th of that for comparable areas,” he said.
As the three-year lease period expires, most of those acres are, or will be, up for leases at much lower prices, he said. He expects Kansas to revert to its 2008 level of pricing within two years.
With prices again falling to $100 per acre and below for lease bonuses, he said, Kansas can better support an oil exploration industry. Those prices have been time tested.
“For the last 70 years,” he said.
The natural gas industry is a completely different animal. In recent decades, because of the Hugoton Field in southwest Kansas, the state’s industry has been much more important nationally. The state’s top producers are out-of-state companies – ExxonMobil is the state’s No. 2 producer.
But gas production has been dropping dramatically since the mid-1990s. In 2012, it produced 299 million cubic feet, just 40 percent of the production in 1995. Unlike oil production in the state, it didn’t start rebounding a decade ago
Aided by a lack of drilling because the price of natural gas remains low, production is on track for 295 million cubic feet, which would be a modern low for the state and the lowest production since the late 1940s.
But most expect substantial price hikes this year, especially with the bitterly cold winter, as gas in storage falls. The Energy Information Agency projects natural gas to rise from an average of $2.83 per million cubic feet in 2012 to $3.84 last year to $4.29 this year.