Byron King

I recently spent a couple of days in Austin, at the University of Texas (UT), attending a conference on oil, natural gas and energy issues.

Incidentally, though, the first thing that grabbed my attention was gold!

That is, UT’s endowment holds 664,300 ounces of solid, physical gold…

According to Kyle Bass, one of the directors of the UT endowment fund, “Central banks are printing more money than they ever have, so what’s the value of money in terms of purchases of goods and services? I look at gold as just another currency that they can’t print any more of.”

Indeed. Good academic governance starts at the top, right? What’s not to like?

It’s a delightful place. Founded in 1883, UT today has about 50,000 undergraduate and graduate students, including over 5,000 in engineering. Overall, the school awards about 12,000 degrees per year, across many fields — arts and sciences, engineering, medicine, law, etc.

UT boasts a beautiful campus — spotless, actually — nicely laid out. The architecture has roots in Spanish Mission style, and there’s a thoughtful, consistent mix of old and new. I’m compelled to note, however, that the campus-dominating Darrell Royal Memorial Stadium sort of reminds me of the giant alien spaceship from the movie District 9.

The UT locale is right down Congress Street, a few blocks from the impressive Texas state capitol building. Everything seems to be close to everything else at UT. The overall school ambience is pleasant. The place is filled with friendly, smiling young people who walk tall, look you in the eye and say hello.

“The kids enjoy it here,” said one faculty member with whom I spoke. “You can sort of see it in the delayed graduation rates. Maybe it’s a sign of the times, but we have students who slow down toward the end. They just don’t want to leave. And then? When we finally push them out the door? Well, Austin has some of the best educated taxi drivers you’ll ever find.”

According to a senior faculty member from the Department of Engineering, UT has about 1,200 students majoring in mechanical engineering alone. Another faculty member told me that there are about 600 students majoring in geology. In recent years, these students have had little trouble finding great jobs. It was music to my ears.

All in all, it was a nice visit to a great school — truly a national asset. Oh, and the energy conference was fabulous too…

About That Energy Conference…

The conference took place in the UT Alumni Center, which is right across the street from the aforementioned Darrell Royal Memorial Stadium. Makes sense, right? Keep the football fans near and happy.

The first thing that happened when I walked into the main event room was that I (almost literally) bumped into Scott Tinker, the state geologist of Texas. I met Scott a few years back, at an energy conference in Cape Town.

Among other things, Scott is a third-generation oil guy. He worked in the oil industry before moving into academe. He’s on the geoscience faculty at UT. He’s a past president of the American Association of Petroleum Geologists (AAPG). He sits on the National Petroleum Council. And Scott is a wealth of information about all things having to do with hydrocarbons.

In his talk to the meeting, Scott started out with a very basic point. He showed a graph of global population growth and rising energy use. The image showed an astonishing correlation. “Energy is about people,” he noted, to lay the foundation point, which was/is that rising energy demand is a fact of life and will remain so for a long time to come. The question is where will the world get all that energy?

Then Scott moved to the technical side of things. He discussed recovering hydrocarbon molecules from “tight” formations like shales via hydraulic fracturing — “fracking.” The presentation touched an area known as “petrophysics,” or how fluids behave inside rocks. Scott’s talk included a series of slides taken at superhigh magnification, just to illustrate the literal size — or, better, lack of size — of the pores in those tight rocks.

When you frack a formation and attempt to recover gas or oil from shale, for example, you’re dealing with ultra-small pore volumes inside rocks — volumes that make the width of a human hair look like the Golden Gate Bridge. As a matter of chemistry and physics, shale oil/gas moves at scales where hydrocarbon molecules behave in odd ways, because they’re acting at just slightly over an atomic level.

The behavior of hydrocarbon molecules at near-atomic scales kicks up an entirely new set of questions. Basically, do the old, classical rules of oil and gas engineering still apply?

In other words, is Darcy’s law – describing the flow of a fluid through a porous medium – still valid? Hey, you can’t drift away during these technical points. This last item, about Darcy’s law, is key to understanding what’s happening out in the oil biz these days. It’s critical to understanding where things are headed — micro and macro.

Indeed, “This is not your father’s energy business,” said Scott Tinker, the state geologist of Texas, who knows a few things about the energy business. “Heck, it’s not the energy business that you and I grew up in,” he added — to a crowd of mostly… umm… older people.

“Here at the University of Texas, even among the faculty,” added Scott, “we don’t understand a lot of what’s happening in these tight rocks a whole lot better than our students. We’re figuring it out too.”

Which is not to say that a lot of people aren’t drilling and fracking a lot of wells in a lot of formations across the country and producing a lot of oil and gas. It’s just to say that the state of the art — even at a fabulous, historic, energy-focused legacy institution like UT — is still finding its learning curve.

It also means that “we” — as in the U.S. and the rest of the energy-consuming world — are a long way from being able to make clearheaded, long-term energy policy and investment decisions based on true understanding of the fracking technology upheaval.

The Drilling Treadmill

Recently, I described the complexity of drilling a new type of well and fracking the reservoir rock. I discussed fracking and the cost and complexity of these new wells and production techniques.

Back in October, I stated, “Even the ‘good’ case for fracking ought to make you stop and think. Fracked wells tend to cost five times what wells used to cost, and then your well depletes twice as fast. That makes for a factor of 10 in terms of reduced investment efficiency.”

Here’s another way of looking at it. Let’s graph out the rapid decline rates for new wells. Indeed, across a multitude of shale gas plays, fracked wells decline in the range of 40% during the first year of operation. Much of the estimated ultimate recovery (EUR) is upfront. Look at the production profiles in this image.

In other words, no sooner have you drilled your well than it’s instantly entering a phase of dramatic depletion. It’s Darcy’s law at work — or not, per Scott Tinker’s excellent points.

Now, if you’re an operator, suppose that your new well is producing all its product upfront, and it’s an era of historically low pricing. Whoops. You’ve drilled a well that needs $7 natural gas to pay off, but you’re collecting only $3.50 at the wellhead. There goes the whole economic case for what you’re doing.

And suppose you’re that operator, looking ahead to maintaining output. Your new well is fast depleting, so now you almost immediately must drill another well, with more wells to follow. Welcome to the drilling treadmill. What’s the capex? What’s the cash flow? Are you making money? Who’s your banker? What about those shareholders, eh?

Then looking ahead, by year five, you’ve got little more than a low-volume, high-maintenance “stripper” well. Great business model, right?

At a larger scale of thinking about it, is this kind of energy treadmill really the way to energize the national economy? What are the inputs versus what’s the value of the output? It gets into that “energy return on investment” (EROI) idea.

Just consider what it “costs” to drill and frack each well. Consider the geologic work, the geophysics, leasing, permitting, pre-drill engineering, site-construction, drilling, completion, fracking, operations and maintenance. Did I miss anything? Darn right I did… this is a SHORT list!

Now consider the externalities. Think of the land use issues. Think of the traffic from hauling stuff in and out, tearing up the roads and bridges. Think of the water use. Think of the pipeline grid that has to be built out. There’s a long list of other issues. All for wells that offer a quick pop of hydrocarbon and then decades of stripper status.

Yes, all of this makes for jobs for geologists, landmen, lawyers, bureaucrats, engineers, drillers, truck drivers, backhoe operators, well loggers and much more.

But long term, it tightens the economics of energy production. How investable is this? Good question.

That’s all for now. Thanks for reading.

Byron King

Original article posted on Daily Resource Hunter

Byron King

Byron King is the editor of Outstanding Investments, Byron King's Military-Tech Alert, and Real Wealth Trader. He is a Harvard-trained geologist who has traveled to every U.S. state and territory and six of the seven continents. He has conducted site visits to mineral deposits in 26 countries and deep-water oil fields in five oceans. This provides him with a unique perspective on the myriad of investment opportunities in energy and mineral exploration. He has been interviewed by dozens of major print and broadcast media outlets including The Financial Times, The Guardian, The Washington Post, MSN Money, MarketWatch, Fox Business News, and PBS Newshour.

  • Baby Makes3

    I guess the ultimate question is do we run out of fresh water or oil & gas first? Fracking requires around a half a million gallons of water for a single well. currently that water is waste and is injected back into deep wells.

    the current predictament is untennable on any but a relatively short time line. so the question should be what comes next? A world of dirty water and expensive energy in very short supply? That would certainly seem to be a reasonable extrapolation of our current trajectory.

    Then how does humanity support an expotentionaly growing population on a dwindling energy and clean water environment? Certainly does take an Einstein to see what happens next.

  • Pingback: Joshua Jacobi

Recent Articles

5 Min. Forecast
How to Profit On the Back of an “Activist Investor”

Dave Gonigam

Since the invention of the "shareholder rights plan" (i.e. the "poison pill"), most companies are relatively immune to hostile takeovers. But according to Dave Gonigam that could all change thanks to one activist investor. And if you're savvy enough, you may just be able to follow his lead for big gains. Read on...


Extra!
Why Americans Shouldn’t Worry About Income Inequality

Jim Mosquera

As the markets have continued to rally over the last several years, more and more people have touted the problem of "income inequality" in the US. But as Jim Mosquera explains, this perceived problem will likely sort itself out with the arrival of one specific market event. Read on...


One ETF to Play Asymmetric Warfare

Addison Wiggin

Almost one year ago, substation telephone cables were maliciously cut in San Jose, CA. In 20 minutes, 17 transformers were knocked out. A year on, similar threats have cropped up. Today, Addison Wiggin explains why these threats are so serious for the safety of the global economy... and shows you one way to play it...


What Small-Caps are Saying About the Current “Bubble”

Greg Guenthner

The big problem with declaring bubbles is that it really does you no good. Unless you're attempting to measure and time market moves, you're also blowing hot air. But if you keep watch for negative divergences, you have a much better shot at figuring out big market moves than the latest bubble-busters. Greg Guenthner explains...


A Simple Strategy for Investing in the US Energy Boom

Byron King

Too often investments are made in a vacuum. But as Byron King demonstrates, the global economic crash... easy money... and technological advancements are all interdependent. In particular, that connection has changed the investment calculus in the resource market. Read on to learn how...


How Gold Will Respond to Declining Discovery

Henry Bonner

Oil isn't the only resource to experience "peaks." Due to a major contraction in gold exploration over the past few years, the mining sector is no longer mining gold at its replacement rate. In other words, the amount of gold above ground is running out. And according to Henry Bonner, it will get worse before it gets better...