Why do gas companies drill in residential communities?

August 24, 2016

Colorado, oil and gas drilling

An oil and gas worker feeds pipe on a rig in Erie, Colorado on January 15, 2015. [Source: Denver Post]

An oil and gas worker feeds pipe on a rig in Erie, Colorado on January 15, 2015. [Source: Denver Post]

The simple answer is “because they can.”

Obviously there’s much more to it than that.

With the prices of oil & gas hovering at all-time lows, there’s a bigger question that must first be addressed.

Why are oil & gas operators still drilling?

I don’t want to get too buried in the numbers here, but the numbers do matter. The fact is natural gas prices have declined over 80% in the 8 years since President Obama was elected, from a peak of about $13.50 per MMBtu in 2008, to around $2.6 now.

How do operators continue to stay in business?

Some operators don’t. We’ve seen plenty of bankruptcies recently. Denver energy companies filing for bankruptcy this year include Warren Resources, Emerald Oil Co., St. Anselm Exploration Co., and Venoco Inc.

And we’ve seen our share of sell-offs. WPX Energy sold its Piceance Basin assets in western Colorado to private equity backed Terra Energy Partners. Investor partnerships have the funds to wait out low gas prices and still pay the debt on their investment.

But that’s hardly even a drop in the bucket. The COGCC reports hundreds of active operators still in business across the state as of this month.

To understand how the gas companies stay in business we need to look at how the oil & gas business works. In order to keep up with the huge production demands during the boom years, the oil & gas industries built massive infrastructure to cover all aspects of production: upstream, midstream, and downstream.

O&G production stream
From well pads to pipelines to compressor stations to processing plants to distribution, all streams are co-dependent on one another to survive. Together they are like a multi-headed Hydra that must be fed. Just to maintain domestic production the oil and gas monster requires increasing levels of input in terms of the number of wells drilled, the footage drilled, and the capital investments required.

That’s right. Gas production increases during a declining market.

Here’s how it works. When Last Gasp gas company enters a new shale play, if they want to get their gas to market they must sign a contract with a natural gas pipeline company. Last Gasp promises to provide a specific amount of gas per day and the pipeline company provides the transmission capacity.

Let’s say Last Gasp drills fifty wells during their first year. They contract with a pipeline company who transmits that gas to market. One year after these wells are drilled their production rate falls by 60%. So, to meet the amount of gas promised to the pipeline company, Last Gasp must drill at least 30 to 40 new wells to make up for the drop in production. At the end of the second year the company has first year production drops on all of its new wells and second year production drops on all of the wells drilled in the first year. This forces the oil and gas company to drill-drill-drill to keep up its contract with the pipeline company.

In the oil and gas industry this is known as the “Red Queen Effect,” named after the character in Lewis Carroll’s Through the Looking-Glass. The Red Queen lectures Alice: “Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!”

Yup. Sheer madness.

In some cases, companies might have no other choice but to keep producing. Most mineral leases, for example, include “hold by production clauses” and operators are required to begin producing gas within a specified amount of time or risk forfeiting the contract.

Where do the gas companies get the money to keep drilling?

They borrow from investors.

Bob Arrington, P.E., describes it this way: “When the wells do not produce on a straight line and have asymptotic rapid decline and a trickle of long term very low production (even requiring pumping), that means the investment companies have bought into a pig-in-the-poke and the loss goes to all the hapless investors. In other words, the public bites the bullet of another Ponzi scheme of investment and the oil gas people are long gone.”

If Last Gasp is drilling a lot of wells on borrowed money, it stands to reason that in order to stay afloat they would have to cut costs — drastically. While it’s true that overall production costs have declined by as much as 30%, it’s not enough to make up for the huge deficits piling up. Drilling is expensive.

The Piceance Basin is one of the more expensive areas to drill because of tight shale formations. According to Porter Bennett, an energy analyst and president of Ponderosa Advisors in Denver, the Piceance Basin has traditionally had high drilling costs.

Bob Arrington explains: “Any company coming into the Piceance Basin is faced with a treadmill of drilling to keep production numbers up, but always on the cuff in debt and must eventually bail or their investors will take the fall.”

That’s the reason why, as gas prices plummeted over the past two years, operators moved rigs out of more expensive shale plays like the Piceance to less costly regions like the DJ Basin along the Front Range.

So there you have it. To stay in business and feed the domestic production stream monster, the gas companies must keep drilling, and to keep drilling they have to borrow money, and to keep the investors happy they need to cut costs. They have to drill “on the cheap,” or as we locals call it — dirty drilling.

If operators must keep drilling but they need to cut costs where do they turn?

At the COGCC rulemaking hearing last November, industry representatives predicted that future well pads will be constructed closer to municipal boundaries, and that low prices are forcing operators to use larger well pads. Anadarko Petroleum expects 40% of future wells will be near or within municipal boundaries.

Consider this. The number of active oil and gas wells in Colorado has more than doubled from 22,228 in 2000, to 53,651 as of July 2016. During roughly the same period Colorado’s population has swelled by more than one million. In 2000, state population was 4.3 million (4,301,261). As of July 2015, Colorado’s population is almost 5.5 million (5,456,574).

Therefore, it should be no surprise to anyone that humans and the monster have been on a collision course in this state for more than a decade — especially on the Front Range.

Where do people and oil and gas development overlap?

CO_WellPop_Overlap4

According to the Center for Biological Diversity:

A 2013 review by of active and prospective well data in Adams, Boulder, Broomfield and Weld counties found nearly 200 wells within 2,000 feet of a public school. 87 active and proposed oil and gas wells were within 1,000 feet of a public school. Likewise, a 2014 COGCC Staff Report revealed that statewide at least 10 buildings were less than 150 feet from a well spot, 230 were 150 to 300 feet from a well spot, 383 were 350 to 500 feet from a well spot, and 1,211 were within 500 to 1000 feet of a well spot — large portions of which were in Weld County. The report also showed that at least two residences were less than two hundred feet from wells in Weld County. Notably, Red Hawk Elementary school in Erie, Colorado (part of the Boulder metropolitan area) hosts over 400 students and is located within a 2-mile radius of 66 well pads including 8 which were drilled within 600 yards of the school.

And with the COGCC approving permits for large urban mitigation facilities and infrastructure in increasing numbers, the situation is only going to get worse.

Wait a minute …

What about directional (or horizontal) drilling?

Directional drilling has been around for a hundred years. Operators have the  technology and ability to control the direction and deviation of a wellbore to a specific underground location. They can drill and frack from remote locations outside residential areas.

Wells are drilled directionally for a variety of purposes:

  • Increasing the exposed section length through the reservoir by drilling through the reservoir at an angle
  • Drilling into the reservoir where vertical access is difficult or not possible. For instance a gasfield under a town, under a lake, or underneath a difficult-to-drill formation
  • Allowing more wellheads to be grouped together on one surface location can allow fewer rig moves, less surface area disturbance, and make it easier and cheaper to complete and produce the wells. For instance, on an oil platform or jacket offshore, 40 or more wells can be grouped together. The wells will fan out from the platform into the reservoir(s) below. This concept is being applied to land wells, allowing multiple subsurface locations to be reached from one pad, reducing costs.
  • Drilling along the underside of a reservoir-constraining fault allows multiple productive sands to be completed at the highest stratigraphic points.
  • Drilling a “relief well” to relieve the pressure of a well producing without restraint (a “blowout”). In this scenario, another well could be drilled starting at a safe distance away from the blowout, but intersecting the troubled wellbore. Then, heavy fluid (kill fluid) is pumped into the relief wellbore to suppress the high pressure in the original wellbore causing the blowout.

The answer seems so simple. To avoid drilling in residential areas, the state should require operators to build remote well pad facilities outside residential areas and use directional drilling techniques to access the gas underneath communities.

In a publication titled “Typical Questions from the Public about Oil and Gas Development in Colorado” the COGCC addresses the question of directional drilling:

Question 2.b.: Why doesn’t the COGCC prevent or mitigate environmental impacts by requiring companies to spend more money for special equipment and technology such as directional drilling or pitless drilling systems?

Answer 2.b.: The law empowers the COGCC “to regulate oil and gas operations so as to prevent and mitigate significant adverse environmental impacts … resulting from oil and gas operations to the extent necessary to protect public health, safety and welfare, taking into consideration cost-effectiveness and technical feasibility.” Because of the statutory requirement that the COGCC take into consideration cost-effectiveness and technical feasibility the COGCC has to consider the costs of any condition imposed for environmental purposes. In some rare instances the COGCC has required directional drilling or pitless drilling systems. Generally, the COGCC does not impose these requirements because there has been no showing that the requested method is cost-effective, technically feasible, and necessary to protect the public health, safety and welfare. A surface owner may file an application for Commission hearing to make a showing that directional drilling or pitless drilling systems are necessary to protect the public health, safety and welfare taking into consideration cost-effectiveness and technical feasibility.

In that one short paragraph the term “cost-effective(ness)” was used four times. The fact is directional drilling can cost more than twice as much as vertical drilling. The Commissioners do not consider public health, safety, and welfare as a good enough reason to double the operators’ costs by requiring remote directional drilling over residential drilling.

There are plenty of cost-effective advantages for operators drilling in residential communities. Intangible drilling costs (IDCs) represent all expenses an operator incurs at the well pad facility that they are unable to recover once the wells are producing.

One of the biggest challenges and highest IDCs in a drilling program is getting the well pad facilities ready for drilling. Construction costs for large multi-well facilities number in the millions of dollars. Add to that the cost of road construction for a remote facility located outside of a community and costs can double, even triple when you take into account road maintenance during the lifespan of the facility.

Other IDCs include things like labor, supplies, renting drilling rigs, plus the actual drilling and fracking. Deeper and longer lateral wells are more costly to drill and frack. Drilling in residential areas puts the well pads closer to the minerals and the shorter drilling distances save money for the operators.

During the boom years, companies could afford to write off those IDCs because their profit margins on the gas were so high. Now those margins have evaporated.

It’s easy to see why residential drilling is so attractive to gas companies that need to keep drilling to keep their investors happy but at the same time need to cut costs.

Bob Arrington spells out the situation for operators in the Piceance Basin this way: “Newcomers like Ursa and Caerus must still get their holdings numbers up and new wells with good initial production quantities to show a sheet of worth more than they paid just to get their monies back in a sell. That would explain why Ursa wants the cheapest way of creating book value and will not consider the more expensive, longer directional drilling to access the gas under Battlement Mesa.”

Residential communities have roads and infrastructure, in some cases pipelines, already in place. In most communities, the operators don’t need to build much more than a driveway to their large urban mitigation facility, keeping well pad construction costs to a minimum. And with large multi-well facilities, they can drill dozens of wells from one location. During both construction and operations phases, the operators and their sub-contractors are free to use existing residential streets without any road use tax placed on them by the municipal governments to cover the costs of road damage caused by increased truck traffic. In return the operators instruct sub-contractors to buy water from the local municipality. Just one frack job requires at least 3 million gallons of water, or more depending on the length and depth of the hole. In residential communities the operators are blessed with an endless supply of water and the town councilors fill their coffers with cash in a win-win for both sides.

Public health, safety, and welfare be damned — as long as the gas company is operating cost-effectively and the local politicians have the funds to adorn street corners with flower pots.

This is not rocket science. It’s not even engineering. It’s economics. And it’s all about the operators slashing those unrecoverable IDCs. Drilling in residential communities is easier and cheaper than remote directional drilling and fracking.

And since the state of Colorado doesn’t prohibit residential drilling and fracking, for the oil & gas companies, it’s a no brainer — they do it because they can.

By allowing drilling in residential communities the state is forcing hundreds of thousands of citizens to sacrifice their health, safety, and welfare to keep the oil & gas industries in business.

A few years back when oil & gas prices were double what they are today, the industry didn’t subsidize citizens for the high costs of driving their vehicles, and heating and cooling their homes. Talk about unrecoverable costs.

We all know the costs of living and doing business in Colorado are high. We feel the pinch daily. The oil & gas companies chose to drill here. Nobody put a gun to their heads. The people are not obligated to surrender their communities to the oil & gas companies so they can drill on the cheap. They don’t even pay a dime to the state for their drilling permits. It’s time they own up and pay their fair share. The state is obligated to protect public health, safety, and welfare, and must force the industry to drill responsibly, outside of residential communities.

No matter what the cost.

If the state doesn’t put a stop to this madness, eventually the people will prevail.

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