Once again, Q1 earnings calls, in particular the Q&A, has provided one (mostly overlooked) emerging oil and gas development that should be thought about by every oil investor. It wasn’t a transaction, or an earnings surprise, or change in outlook. Rather it was Core Laboratories (CLB) outlining their view of “four major industry trends that will shape tomorrow’s oil field”, in particular its “second major trend is the interest in using finer proppants in the initial procedures in a hydraulic frac program”. The implication of broader success with finer proppants is that there US oil production could surprise to the upside in 2018, which should keep investor attention and capital allocation on US and Canadian shale/tight oil, condensate rich and natural gas plays that win with new technology tweaks and are proving to work at lower and lower prices.
The major oil market negative has been US oil production continuing to surprise to the upside. Its driven by technology being applied in increasingly better and more effective ways. US and Canadian shale/tight oil wells have been getting better from a series of completion improvements – more fracks per well, bigger fracks, more proppant per well, and longer horizontal well length. Each of these completion advancements has helped on a step by step basis to increase well rates and recovery. But CLB’s comments seem to imply that moving to a finer proppant may end up having the biggest incremental impact.
What is CLB talking about? CLB did not include their views of major industry trends in the Q1 earnings release [LINK]. But in the Q1 earnings call [LINK], CLB management’s prepared remarks described this finer proppants trend “Core via our industry wide profit consortia with a 30 plus year history and consisting of over 40 companies is boosting its evaluation of 100, 200 and 400 non-API mesh sand. These micro proppants are thoughts to open secondary and tertiary fracture patterns significantly increasing stimulated reservoir volume. Therefore, increasing initial flow rates as well as the estimated ultimate recovery. Micro proppants pumped during the placement of the track pad could potentially boost type curves by tens of thousands of barrels with very little added cost. Afterwards pumping 70 and 40 mesh sand late in the frac process also appears to be critical for success.”
It seems like a relatively clear concept that just makes sense. When a shale or tight zone is fracked, it opens flow paths for the oil or natural gas. But these fracked flow paths will end up closing unless proppant is inserted to keep the fractures open. Using smaller sized proppants will keep more of the smaller flow paths (secondary and tertiary fracture patterns) open. It seems logical, and applicable on a broad basis.
CLB’s comments in the Q&A suggest why this is potentially material. In the Q&A, mgmt. gave a much more detailed commentary on the use of finer sands and how this is a relatively low cost item to materially increase recovery. In the Q&A, mgmt. was asked “What do think simulated reservoir volume was say in 2014 versus today, versus where you think that might go?” Mgmt replied “Yes, I think, Rob actually on the conference calls back then, we talked to the amount of simulated reservoir volume was probably in the low 20 percentile range, now with the use of finer and micro proppants we think that that is expanding rapidly and the reason for that is the use of 400, 200 and a 100 mesh sand in the pumping the pad stage or opening up tertiary and secondary fracture systems to the exposure of surface area. That has never happened before so it is significantly increasing the amount of stimulated reservoir volume, read that the amount of surface area in reservoir that is open to a micro fracture. So I would put that right now probably in the 50% range, so we’ve significantly increased it since 2014, you can see that in the production in the production figures and also in the type curves, you can plot that pretty much right alongside of that. How much further it can go, we’ve just now entered looking at 200 and 400 mesh sand, so we’ll give you an update over the next couple of quarters on the effectiveness of using those micro proppants.”
Encana plans to increase its Montney type curves this summer in part from the switch to finer sand. In the Q&A from the Q1 call [LINK], mgmt. was asked for trends in Montney completions and replied “It’s a similar story to our Eagle Ford experience. We’ve been reducing the cluster spacing, going to thinner fluids – (38:39) is the fluid that we’ve been testing of late – and going to finer grain sands, and we’re seeing significant uplifts in our productivity both in Pipestone and Tower. So, again, really encouraged by that. And I did mention in my review that we’re looking at updating the type curves and inventory later this summer with respect to the Montney. So not a lot more to add on that, though.” Encana also noted in the Q&A, they have moved this completion to the Montney at Cutbank Ridge and Duvernay.
We believe the finer proppant early indications may be the most significant oil and gas development to emerge from Q1 earnings calls. The CLB comments certainly caught our attention. Using finer proppants is still at the early stages, and as CLB notes, industry is still just trying out how fine they can and should go. Finer proppant is not proprietary and completion tweaks can be adopted quickly by all. The logistical issue will be on availability. Proppant is already an issue on a broader sense, but it will bring up the additional logistical issue of how much finer sand (200 mesh or at least >100 mesh) is available. It will likely be the key question this summer and could be the reason why a broader use of finer sand is limited and the impact on US shale oil not as great as it could be. Look for the big US shale guys to lock up supply.
For Canada, it is good news for the deeper, higher pressure shale/tight oil and natural gas plays like the Montney, Duvernay, and Horn River. Using finer proppant isn’t proprietary and, If Encana’s positive results to date in the Montney at Pipestone and Tower are any indication, then there will be many other Cdn producers that can win from the move to finer proppant. These Canadian plays are showing to work at lower and lower oil and natural gas prices, and this will help push breakeven prices even lower.
However, the key wildcard for global oil prices remains how long the US can keep growing its US shale/tight oil at strong rates. US oil production continues to surprise to the upside. Given the early stages of finer proppant and the big companies controlling much of the key shale and tight oil, we believe increasing fine proppant use and success could provide the next completion tweak that leads to US shale oil surprising to the upside in 2018. And if so, it also means that it will be increasingly difficult for OPEC to reach and sustain its target of 5 year range for global oil inventories before the normal seasonal oil demand decease that happens every winter, which would lead to the need for OPEC/non-OPEC cuts past 2017. We have been bullish on oil to hit and sustain $60 in the next year, but that could be at risk if finer proppant success is real (it seems to be) and its use expands.
It may not be obvious, but the net impact on the high quality US and Canada shale/tight oil, condensate rich and natural gas is a positive. These plays are proving to be the best plays outside of OPEC to grow under $50 oil, or lower. They are attracting capital because they are proving they can be successful at low oil and gas prices, are continuing to achieve lower and lower break even prices, and generate higher IRRs at modest oil and gas prices. There is oil growth in North America at $50 oil. Increasing the amount of the reservoir being opened up by fractures and held by micro proppants will only lower that price level.