24/7 Wall St. Guide to Fracking

Like many technological advancements, hydraulic fracturing of oil and gas wells — better known as fracking — had been essentially sitting on a shelf waiting for the right moment to make itself known. That moment came in the early 1980s when Texas oilman George Mitchell went searching for a new source of natural gas in the shale formations deep under the earth in the Dallas-Fort Worth area.

The geology in the area had already produced natural gas both from above and below the shale layer. Mitchell figured there was plenty of gas trapped in the shale if he could just get it out. Over a period of about 15 years, Mitchell’s company worked to prove that hydraulic fracturing could economically extract natural gas.

By 1997 Mitchell had proved the idea to the satisfaction of his larger oil company brethren, and he sold his company to Devon Energy Corp. (NYSE: DVN) for $3.5 billion in 2002. Combined with the horizontal drilling techniques pioneered at another natural gas producer, EOG Resources Inc. (NYSE: EOG), the two technologies beefed up U.S. natural gas discoveries by trillions of cubic feet.

Horizontal drilling and hydraulic fracturing made it possible to extract natural gas — and later oil — from geologic formations that lacked the permeability of the rock accessed by conventional wells. The conventional wells flowed on their own for a time because there was sufficient pressure from the oil or gas reservoir to force the hydrocarbons to the surface. Once the pressure declined, producers use enhanced recovery techniques like water-flooding and CO2 flooding to force more hydrocarbons out of the reservoir.

But in the nearly impermeable rock, the wells had to be “stimulated” before even the first drop flowed. The reservoir was made up of dense rock shot through with minute cracks and fissures that were too small to allow gas or oil to flow. Wells had to be stimulated, and that’s what Mitchell and his crew figured out how to do economically.

ALSO READ: The 10 Most Oil-Rich States

Fracking is an extraction technique, not a drilling technique. The distinction is important because the connotation of the term “fracking” is much more negative than just the term “drilling.” Horizontal drilling has been a part of oil and gas production since the 1920s, and the whole rationale for horizontal drilling is to produce more hydrocarbons from a single well, whether or not the well is fracked.

In U.S. shale plays, horizontal drilling techniques enlarge the area around the vertical well bore that will later be fractured. The process of drilling and fracking a well typically begins by drilling a vertical hole hundreds or thousands of feet below the surface into an oil- or gas-bearing layer of rock and then rotating the drill bit roughly 90 degrees along a horizontal route that follows the hydrocarbon-bearing layer.

The development of horizontal drilling may be the technological pinnacle of the U.S. shale boom. The current technology is so precise that a horizontal well can hit a target a few inches in diameter that is 10,000 vertical feet below the surface and more than a mile away from the vertical well bore. In some horizontal wells, a single central wellbore may dispatch several horizontal spokes running out in different directions, all similarly precisely aimed.

Once the horizontal bore has reached its destination, things begin to get interesting. A production casing is inserted into the horizontal borehole and cement is pumped through the borehole to surround the inserted casing. Next a wire-guided perforating gun is inserted into the cased horizontal bore and an electrical signal sent down the wire blasts small holes through the casing and the cement into the surrounding rock.

At this point the fracking fluid is injected into the well under very high pressure. The fluid is a mixture of chemicals, water and, usually, sand. As the fluid is pumped into the borehole, it is forced out through the holes in the casing and cement into the surrounding rock. The fluid is then forced into the minuscule cracks and fissures in the rock where the hydrocarbons have been trapped for millennia and the pressure causes the rock to fracture and widen the fissures. The cracks and fissures are propped open by the sand or some other proppant that is injected along with the fracking fluid.

The produced gas or oil drains into the horizontal wellbore and is then pumped out with the fracking fluid. The fluid is either recovered and reused or it is hauled away and injected in another location back under ground. The water is often pumped into storage ponds where it is allowed to evaporate and the remaining sludge is hauled away and buried. Recent advances in recovering the water for reuse have cut down on the amount of water needed to frack a well.

ALSO READ: 10 States Where Manufacturing Still Matters

The bad rap that fracking gets comes from a relatively small number of issues. First, when the vertical wellbore is drilled it typically passes through the groundwater table on its way to its destination. Although the bore is typically encased in two layers of pipe and two layers of cement, there is a suspicion that the seal is not as tight as drillers say and that hydrocarbons can enter drinking and irrigation supplies. Studies in Pennsylvania and Texas found that the poor well integrity led to contamination of the groundwater. Fracking was not determined to be responsible.

A related concern is that the fracturing of the hydrocarbon-laden rock has unintended consequences that include letting the gas escape on its own up through fissures in the rock and thus contaminate groundwater supplies. It would be nearly impossible to prove definitively that this does not occur, but because groundwater is typically a few hundred feet at most from the surface it is highly unlikely that gas could wend its way through thousands of feet of rock that usually include an impermeable layer or two.

The water contamination found in the town of Pavillion, Wyo., could have been caused by fracking. What makes this case unique is that the fracking was done within 1,000 feet of the surface near water wells that had been drilled as deep as 750 feet. The state of Wyoming is now conducting three studies on the contamination in Pavillion’s water supply: one is looking at well integrity, a second is looking at possible seepage from above ground disposal pits and a third is investigating water quality.

ALSO READ: 5 Reasons Oil Is Not Rising

A more likely consequence of fracking is also unrelated to the fracking itself but to the handling of the waste fluids after they have been pumped to the surface. Rather than let the stuff just sit in a lined pond until the water evaporates, some areas allow producers to transport the used fluids to a location where it can be pumped back into the ground. Rules governing these so-called injection wells differ, but in general the wells are required to be below the groundwater table and to be separated from it by an impermeable layer of rock.

It’s not contamination that’s the concern here, it is earthquakes. In October 2008, a number of small earthquakes were recorded near the Dallas-Fort Worth airport in an area where no earthquakes had ever before been recorded. At the time there were more than 200 disposal injection wells in use in the area. The best evidence that injection wells were responsible for the temblors is that when two nearby injection wells were shut-down the quakes stopped. In 2011 the area around Youngstown, Ohio, in the Utica shale play, was hit with 109 earthquakes, the first ever recorded since record-keeping began in 1776. A swarm of mild quakes also struck in the Fayetteville, Ark., shale region in 2011. Many of the quakes are believed to have been caused by injection wells located near or on existing faults.

Absent horizontal drilling and fracking, only a very small amount of the hydrocarbons in these tight formations may have been recovered. As demand for oil — especially — grows, meeting that demand without fracking could easily have driven the cost of crude above $150 a barrel and set it on course for $200.

As it now stands, horizontal drilling and fracturing costs are said to range between $40 and $85 a barrel. Partially that’s due to all the moving parts of actually doing the work, but costs are also driven higher by the nature of the wells. A conventional well builds its flow gradually to a peak about a year or two after the well has been completed, then produces at a plateau level for a number of years, finally tailing off slowly for another 10 years or more. A fracked well reaches its peak flow within a few months and the drop off is almost equally rapid, with little or no intervening plateau of production.

ALSO READ: America’s Most Polluted Housing Markets

That means more drilling, more fracking and more expensive oil. When crude oil prices first jumped to around a $100 a barrel in late 2007, the table was set for a feast. The major integrated U.S. oil companies posted enormous profits as their cheaper, mostly conventional wells pumped out crude that cost about $25 a barrel to produce. The oil companies used some of the windfall to invest in major exploration projects in areas where oil was known to be present, but no one knew for sure how much was there and how much it would cost to get it out. Ultra-deepwater and Arctic projects appeared to be profitable at crude prices north of $100 a barrel.

Horizontal drilling and fracking produced more oil too, though more of the costs were higher and the selling price for the crude was discounted due to the lack of transportation out of the principle shale plays. As the transportation situation improved, mostly due to increased use of railroads, crude oil produced by fracking still made a tidy profit at a discounted price of around $90 to $95 a barrel.

At $75 to $85 a barrel the economics get tighter for many producers, especially the smaller ones. The U.S. oil rig count fell by 19 last week, the largest weekly drop in two months. If prices remain at around $80 a barrel for six months or so, the small producers very likely will be forced to slow down further exploration, if not production. Bloomberg recently said that these small producers spend $1.17 for every dollar they earned.

An analyst at IHS told the Houston Chronicle last week that tight oil production in the United States can remain profitable at crude prices as low as $45 a barrel. Another research analyst at Stratas Advisors puts costs in some basins even lower:

[T]he Bakken in North Dakota, Eagle Ford in South Texas and Niobrara centered in northeast Colorado, on average, remain economic with crude prices as low as $50 per barrel. Permian drilling in West Texas, on average, remains profitable at $40 while the Utica in the Northeast U.S. can be drilled for as low as $20 per barrel.

What that means is that Saudi Arabia’s recent threat to let crude oil prices fall further is essentially an empty threat. The Saudi’s cost to lift a barrel of oil is reportedly around $25 to $35 a barrel, not exactly parity with costs in the big U.S. shale plays, but close enough. Unfortunately for the Saudis, though, about 45% of their gross domestic product depends on oil, and fully 90% of the country’s export earnings come from oil. Collapsing oil prices will hit the kingdom’s economy much harder than they will the U.S. economy.

ALSO READ: The Best Economies in the World