Counting DUCs: Sometimes, it makes economic sense just to leave it in the ground

There is some possibility, though it is too early to say how likely it is, that market forces will cause some Pennsylvania natural gas wells to be capped without ever producing gas, and some leased sites never to be drilled at all. This post explores the growth of one indicator (the number of drilled but uncompleted wells) as a possible harbinger of trends to come.  Of course, if natural gas isn’t produced, then neither are natural gas liquids (NGLs: ethane, propane, and butane), which are the products that the Dragonpipe (Mariner East 2 pipeline) is designed for.

The story starts with the fracking process itself. In today’s shale-drilling industry, there are two stages in the process. First, you drill the well. Second, you pump in a mixture of water, sand, and fracking chemicals to break apart the shale and release the oil and gas. Both phases are expensive, but the second is apparently the most costly part. It can involve hundreds of thousands of gallons of water, which must first be injected and then disposed of in a way that doesn’t damage the environment. (In fact, some wells produce far more waste water than the amount injected, and it must all be disposed of.) Even the sand, which must be brought to the well in hundreds of truckloads, is not cheap.

Under the terms of their leases, developers are often required to drill within a certain period (three years, say) or lose the lease. But they aren’t required to frac the well immediately. So depending on the price of oil and gas, as well as other economic factors, the driller may decide to leave a well drilled but not fracked for a period of time.

These wells are known as “DUCs” (drilled but uncompleted wells) in the industry.

The federal Energy Information Administration (EIA) keeps a running count of DUCs. The counts include both oil and gas wells, because it is hard to differentiate them. In some shale formations and at some depths, you get almost all oil from the wells. In others (like the Marcellus here in Pennsylvania), you get almost all gas. In many places, you get both.

Why so many DUCs? Whatever the intended product, DUCs are increasing very rapidly. In August 2018, the EIA counted 8,269 DUCs (up by 238 from the previous month).  There was a period in 2015 and 2016 when lots of wells were completed and DUCs dropped to a low of around 5,000, but they have been increasing ever since.

There seem to be two reasons for wells to be left uncompleted. One is that, in some locations, insufficient pipeline capacity exists to take away the product. Because the first companies to arrive can often get the best leases on the best terms, drillers tend to run headlong into a new region (a “play”) far ahead of the pipelines required to accommodate the output of the wells. They drill wells but don’t complete them (by fracking) until the pipelines come. Eventually, they reason, pipelines will catch up and the wells can be completed then.

The other reason depends on the driller’s view of future price levels. The driller may be waiting for the market to improve before completing the well. Why spend the money to complete a well now if the oil and gas will probably be worth more in a year or two?

Can exports absorb the glut? Right now, there is a glut of both natural gas and crude oil in the US, so the industry is focused on building export volumes. In the case of natural gas, relatively little can be exported to Mexico or Canada by pipeline, so most of the extra gas will have go somewhere by ship. That will not only require more pipelines to get the gas to the port, it will also require more ports with facilities that can liquefy natural gas (the existing ones are currently at capacity). So until the infrastructure catches up, there is a glut in the US market that is depressing prices.

The final ingredient that is required for exports is a willing overseas customer. For years, it has been assumed that China would be the main one for natural gas. Now, with a trade war starting and a big pipeline from Russia to China under construction, it is not so clear that China will take much gas from the US. So far, only one US company has struck a deal for gas deliveries to China, and the volumes being shipped are relatively small.

What about NGLs? There is also a glut of NGLs, and producers are banking on exports to absorb it, just as they are for other petroleum products. Again, the hope is that developing economies (especially China) will provide a market. Ethane is used almost exclusively to make plastic, and the NGL producers reason that an improving Chinese standard of living will require lots more plastic. Similarly, a compressed butane/propane mixture (called “liquefied petroleum gas”, LPG) is becoming widely used in developing countries as a replacement for wood and charcoal in cooking.

But the immediate specter of a major trade war means that exports are uncertain. And in the longer term, the markets for NGLs may not live up to expectations, because of factors like the increasing recognition of the environmental damage from plastic and the rapidly-increasing use of locally-generated solar electricity for cooking in the developing world.

Pennsylvania’s disadvantage. Even if a sizeable export market for natural gas and NGLs does develop, the business here in Pennsylvania may not be profitable. In Texas’ Permian Basin, which is now the world’s most prolific source of oil, vast quantities of gas are produced along with the oil.  If drillers want the oil (which is currently the more valuable commodity), they have to sell the “associated gas” at whatever price they can get. That means that a gas glut, and low prices for gas, may be with us for a long time.

A gas glut and low gas prices in Texas will depress prices everywhere and make drilling in Pennsylvania less profitable, and that will help ensure that many more DUCs are generated here. If Texas prices continue at low levels for several years, fewer leases will be signed and fewer wells will be drilled in Pennsylvania in the first place. And profits are already hard to come by here. Remarkably, given all the hoopla about the potential of the Marcellus shale, the Marcellus has never been profitable for drillers on average. Hundreds of them have gone out of business here. The remaining ones just keep drilling based on the hope that things will get better.

Could it be that the market, not the environmental movement, will be what ultimately causes our hydrocarbons to be left in the ground? Maybe the DUCs will eventually come home to roost.