Will falling oil prices kill the shale revolution?

About 20 miles from the iconic Pueblo Bonito in Chaco Culture National Historical Park, and just a couple away from the elephantine hills that artist Georgia O’Keeffe dubbed “The Black Place,” two rows of tanks and an assortment of pipes interrupt the high desert. They’re painted forest green, perhaps to blend in, though almost everything here is the color of ash or burnished clay.

This is Chaco 2408 32P #114H, one of dozens of oil wells drilled in the last few years in northern New Mexico’s Gallup Sandstone, one of the nation’s newest “tight oil” plays. Chaco #114H and thousands like it in North Dakota, northern Colorado and Texas exist because of high oil prices, driven by demand from China and the developing world. But now, thanks in part to slower growth in China and the flood of U.S. oil, crude prices are falling. Though the resulting drop in gasoline prices benefits most sectors of the economy (average gas prices in New Mexico dropped below $3 this fall), it may dampen or even crush the shale oil revolution.

Chaco #114H can help explain why. The San Juan Basin, home to some 40,000 oil and natural gas wells, was already one of the most prolific natural gas fields in the nation when, in the early 2000s, high prices made it economically feasible to combine horizontal drilling and hydraulic fracturing to drill in tight shale formations. The drilling frenzy that followed glutted the domestic market with gas, causing prices to crash. Rigs abandoned San Juan County for fields also rich with profitable oil. San Juan County’s economy faltered; tax revenues from oil and gas are today just one-third of what they were in 2009, when prices were high.

But there remained hope — oil, that is — in the Gallup Sandstone. Spurred by high oil prices, energy companies recently resurrected this old play, sparking a still small but growing boom.

Chaco #114 is one of the boom’s pioneers. In early 2013, WPX Energy drilled down about 5,400 feet, turned the bit 90 degrees, and ran it another 5,000 feet horizontally through the oil-bearing sandstone. At 10,000 feet “deep,” as drillers say, it’s still shallower than North Dakota’s wells, which average 20,000 feet. But it’s far deeper than its predecessors, which averaged about 4,000 feet deep.

And that helps make shale wells far more expensive, and therefore more sensitive to price drops. In reports to its investors, WPX Energy says its wells in the San Juan Basin cost $5.2 million on average to drill and frack; its Bakken wells run to a staggering $10 million. Old-school oil wells typically cost $500,000 or less to drill.

As much as a quarter of the cost stems from hydraulic fracturing. Chaco #114 was pumped full of nearly 1 million gallons of water and chemicals — everything from walnut hulls to Bactron K-87 Microbiocide — along with 3 million pounds of sand to hold the fractures open.

Chaco #114 responded in March of 2013, initially gushing as much as 272 barrels of oil per day. With oil selling for $108 per barrel on the global market, the well should have turned a tidy profit within its first year.

According to state records, however, each barrel of oil from Chaco #114 has yielded as much as $26 less than the global benchmark for crude, the “European Brent price.” Subtract royalties paid to operate on state land (12.5 percent in this case), other county and state production taxes (about 8 percent), and the costs of extracting hydrocarbons, transporting them to market, maintaining the well and disposing of the tens of thousands of gallons of wastewater, and the well becomes a lot less lucrative.

And there’s a bigger catch. Oil and gas wells produce heartily during their first months, and then wane. It’s called a decline curve, and it’s especially steep for most shale wells. Chaco #114’s production had dropped by half by the time it was six months old. A year after drilling was complete, it was producing just 50 barrels per day — a decline of over 80 percent. This phenomenon is repeated across the West’s shale oil and gas fields to varying degrees.

That means that, just to keep overall production levels stable, energy companies must drill new wells relentlessly. “It’s known as the Red Queen syndrome,” says Mark Haggerty, a policy analyst with Headwaters Economics, a nonprofit based in Bozeman, Montana. “They’ve got to drill faster and faster, just to stay still.” Collectively, the nation’s producers have stayed ahead of the curve, but only by operating 1,700 to 1,800 rigs at any one time, each drilling multimillion-dollar wells.

When prices are high, that might make sense. But when they crash by 20 percent, as they have since this summer, it puts companies in a tough spot. If they stop drilling, production and revenues will fall. If they finish drilling when prices are low, the well uses up that initial production bonus with less of a return, reducing the chances of ever recouping that multimillion-dollar investment. Had Chaco #114 been drilled this October, the company would have made about $82,000 less during the critical first month of production. That math may not stop drilling in the best spots if prices remain in the $80 per barrel range, says Haggerty, but it could result in a total shutdown in smaller, peripheral plays.

For the brand-new boomtowns of North Dakota, and for the reworked ones in the San Juan Basin, a long-term drop in oil prices is a mixed bag. The social and environmental impacts that accompany the drill rigs will dissipate if drilling slows, but so will the taxes paid by the companies to help mitigate some of those impacts. A 10 percent price drop from year to year could reduce North Dakota’s mean annual revenues by as much as $300 million, and the San Juan Basin could forget about recovering from the natural gas slump, at least for now.

This dynamic can be influenced by tighter regulations, which can raise drilling costs, or by technological advances, which can lower them. But whether Chaco #114 will ever pay for itself — or whether the regional boom will keep going or lose its steam — hinges primarily on the price of oil and the unpredictable global forces that determine it. 

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