Ground-Eye View of the Bakken Shale

12/20/2012 9:00 am EST

Focus: COMMODITIES

John Mauldin

Chairman, Mauldin Economics

New technology is opening up shale fields, and there is a lot of opportunity waiting for people willing to work hard...and for smart investors, observes John Mauldin in Thoughts from the Frontline.

I have to take you back to Wise County, Texas, about 60 miles west of Fort Worth. A Greek goat herder named Savas Paraskivoupolis (who changed his name to Mitchell) came to Galveston in 1905.

His son George Mitchell worked his way through Texas A&M and got a degree in petroleum engineering. After the war, George teamed up with his brother Johnnie and Merlyn Christie. They drilled their first well in 1952, in what became known as the Boonesville Field in Wise County, near Bridgeport where I grew up.

They went on to drill hundreds of gas wells, but had to shut them down because they had no way to deliver the natural gas they found in abundance. The work was done at serious financial risk, but they just kept drilling and plugging those wells. Finally, a contract for a pipeline was financed by an Illinois utility, and those wells went into production.

What started as Christie, Mitchell, and Mitchell soon became a major employer in my little hometown and a powerful spur to the local economy. The future father-in-law of my childhood best friend was the first permanent North Texas employee, back in the early 1950s, and he was eventually joined by the fathers of many of my friends.

Over the coming years, Mitchell would drill over 10,000 wells, with over 1,000 of them being wildcat or exploratory wells. He is a legend. His story is reminiscent of Walt Disney, who also lived constantly on the edge of crisis in the early days of his business.

In the late 80s and early 90s, Mitchell pioneered a new drilling method called horizontal drilling. It is still hard for me to imagine that there is a small amount of flexibility in what seems like rigid steel pipe. Over hundreds of feet of drilling, they can turn a pipe inch by inch until it describes a 90-degree arc.

Everyone knew there was more gas deeper in the ground, but it was trapped in very tight shale formations. Mitchell and his engineers figured out how to put water under pressure back into the earth to create very minute fractures that allowed the gas and oil to be freed. This is the process known as hydraulic fracturing, or fracking.

In the 90s and especially the last decade, there has once again been an oil and gas boom in Wise County, in what is called the Barnett Shale. Except, the Barnett Shale is a far more massive formation than the original Boonesville field.

Once again, Texas was at the center of US energy production. The new technology opened up vast new reserves that were impossible to get to just a few years ago.

And then it turned out there were potentially even larger shale oil fields scattered throughout the United States-and, as we are learning, seemingly everywhere in the world. The first modern oil wells were drilled in Poland in 1854 at around 100 feet in depth, and now exploratory wells show that 11,000 to 13,000 feet below the surface there is considerably more oil and gas in Poland and the surrounding region.

In contrast to today's deep wells, the legendary Drake Well was drilled in Titusville, Pennsylvania, in 1859, at a depth of 69 feet. And there is evidence of ancient oil drilling using bamboo pipes in China. Marco Polo remarked on bubbling springs of oil in what is now Azerbaijan.

And that brings us to the Bakken shale oil and gas fields. I was invited to speak to the customers of BNC Bank in North Dakota by its president and CEO, Greg Cleveland, last week. He graciously offered to take me on a helicopter tour of the Bakken Field if I would come a day early, which I of course agreed to do.

As a special bonus, he arranged for Loren Kopseng to be our tour guide. Loren didn't drill the first well in the Bakken, but he was there by the time the third well went in, and he now owns a piece of about 20% of all the wells drilled in the region. (There are over 7,000 wells in the region and counting.)

Today the Bakken overshadows the Barnett. Notice in the graph below how rapid the growth has been. More recently, permits were granted for 904 wells in August, September, and October, with October being the record with 370 wells.

chart
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We flew the 50-odd miles from Bismarck to the edge of the Bakken, over the famous Badlands (which I found quietly beautiful) to what Loren called the line of death. On one side of the line, if you drilled you would get a dry hole. On the other side there is an amazing reported 99% success rate. The field stretches from western North Dakota and eastern Montana up into Saskatchewan, Canada.

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The Line of Death
Easy money, right? Just punch a hole in the ground and count your money. Today, perhaps, but not in the beginning.

As we were flying, Loren asked me what I knew about oil drilling. I had to admit I didn't know much, except that my best friend Randy Scroggins from elementary school wouldn't let me invest in his oil company in 1981. Loren laughed and said Randy was a very good friend indeed-and added that "1981 was the first time I went bankrupt."

While Loren grew up in Bismarck, he would have been at home in Texas. He is the quintessential wildcatter, straight out of central casting. There is a certain infectious enthusiasm that seems to emanate from that special breed of entrepreneur called an oil man.

Not only do you have to put up with the potential for drilling a dry hole, whereupon you lose all your money, you have to contend with the ups and downs in oil prices. While the major oil companies have become more conservative players, the real cutting edge is among smaller independents. And Loren is at the knife point of the cutting edge.

Flying into the heart of the field reminded me of my roots in Bridgeport. Drilling for oil is not pretty; it is actually fairly messy, although I must say there is seemingly much greater care taken to keep things neater than what I remember as a kid. Flying over completed wells, when it was just the pump and storage containers, showed a relatively small footprint, with the land being farmed right to the edge of the pad.

In my experience, oil wells were drilled pretty densely across the land, as you could only drill straight down. You basically got only the oil that was right underneath your well. In fracking shale oil, there is less need to put wells so close together. There is typically only one drilling pad for one section of land, that is, 640 acres or one square mile. Current technology is improving even on that, as a well can go down two miles and then turn horizontally another two miles.

I took the picture below my with my iPad as we were flying into this well for a tour. That drilling pad will be cleaned up and once again become part of the farmland that surrounds it today. That is a pretty massive rig, but it can be torn down, moved, and set back up in seven days.

A quick tutorial on shale oil: Global shale oil reserves are currently estimated at over 3 trillion barrels recoverable under current technology. The US has well over 2 trillion of those barrels. (Average estimates from numerous sources.)

The illustration below shows the typical construction of a shale oil or gas well. Note that the drill holes are "cemented" in around the pipes so that nothing can leak into the surrounding earth.

Shale oil and gas lie very deep under very nonporous layers of rock. There are very serious environmental rules about drilling and fracking (as there should be). A large portion of the drilling rig is containment for the water and other fluids that come from the drilling. The waste fluids are not dumped onto the local ground.

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No serious person would allow fracking near the water table. That does not mean there is not oil and gas in the water table already. Stockton, California lighted its county courthouse in 1854 with natural gas from a local water well. California has thousands of naturally occurring seeps.

In the Gulf of Mexico, there are more than 600 natural oil seeps that leak between 500,000 and 1 million barrels of oil per year. When a petroleum seep develops underwater, it may form a peculiar type of volcano known as an asphalt volcano. The ecological system has evolved certain bacteria that thrive on the oil seeps.

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One of the interesting things about the BP (BP) oil-spill disaster in the Gulf of Mexico was the disappearance of the oil over a few years. While it was a true disaster, it is theorized that the bacteria multiplied to deal with the crisis. But it took a long time. There is no excuse for what BP did.

As far as I can research from true experts, when properly done horizontal drilling and fracking pose no danger to the environment. (That is different from saying that burning gas in our cars has no impact. Different topic. I'm all for my electric car powered by nuclear energy.)

Notice in the illustration the small gray areas in the horizontal pipe. Loren took me to a pile of what he called "jewelry." These are about four-foot-long marvels of technology encased in beautiful stainless steel, looking like shiny gems along the dark string of iron pipe.

The first wells drilled in the Bakken had just one "jewel." While there is some debate about how many jewels to use to maximize fracking effectiveness in a two-mile pipe, I think I remember Loren saying that they are using up to 37. (It might have been 23, but oddly, I do remember it was definitely a prime number.)

Loren simply went into raptures describing the technology in each of those jewels. Since it was 9 degrees out, with the wind chill taking it down to about minus-15 and I was not appropriately dressed, I might have missed a point or two.

The US Energy Information Administration (EIA) reports that over 750 trillion cubic feet of technically recoverable shale gas and 24 billion barrels of technically recoverable shale oil have been discovered in shale plays. Except that they are reportedly having to update their update. Just five days ago they announced new projections that suggest US energy imports (as a share of production) will fall in half in the next 30 years. (This does not include any new sources of non-carbon-based energy-new technology can make estimates turn out quite wrong.)

Harold Hamm and Continental Resources drilled the first horizontal well to use fracking in the Bakken in 2004. He knows something about the region. He is now telling us that there may be four more layers (which are called benches) of shale oil and gas below the Upper Bakken formation, including the promising Three Forks stratum.

Just a week ago (on December 3), Continental announced they had completed a well in the "third bench." The Three Forks could be a bigger story than the Upper Bakken formation, as it is much thicker. Hamm is projecting almost a trillion barrels of reserves in the area.

What Loren thinks will happen is that the new drilling rigs that can move themselves will soon drill as many as 16 holes from one pad, into all the various levels and in different directions. Punch a hole in the ground, complete the well, move the rig over a bit and start the process again. That really helps keep down the cost of drilling, as does each bit of new technology.

Read more Thoughts from the Frontline here...

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