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Shale Companies, Adding Ever More Wells, Threaten Future of U.S. Oil Boom

The Wall Street Journal. logo The Wall Street Journal. 3/3/2019 Christopher M. Matthews, Rebecca Elliott, Bradley Olson
© James Durbin/Associated Press

Newer wells drilled close to older wells are generally pumping less oil and gas and could permanently hurt output, leading frackers to cut back on the number of sites planned and forecasts on overall production to be trimmed.

Shale companies’ strategy to supercharge oil and gas production by drilling thousands of new wells more closely together is turning out to be a bust. What’s more, the approach is hurting the performance of older existing wells, threatening the U.S. oil boom and forcing the maturing industry to rethink its future.

To maintain America’s status as an energy powerhouse, shale companies in recent years have touted bunching wells in close proximity, greatly increasing the number of wells drawing on a promising reservoir. The added wells would produce as much as older ones, many drillers believed, allowing them to extract more oil overall while maintaining strong returns from each well.

Those rosy forecasts helped fuel investor interest in shale companies, which raised nearly $57 billion from equity and debt financing in 2016, according to Dealogic, even as oil prices dipped below $30 a barrel. That was up from nearly $34 billion five years earlier, when oil topped $110 a barrel.

Now the results are coming in, and they are disappointing.

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Newer shale wells drilled close to older wells are generally pumping less oil and gas than the older wells, according to early corporate results. Engineers warn the new wells could produce as much as 50% less in some circumstances.

The newer shale wells often interfere with the output of older wells, because blasting too many holes in dense rock formations can damage nearby wells and lower the overall pressure, making it harder for oil to seep out. The moves could potentially cause permanent damage and lower the overall amount recovered from a reservoir.

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Known in the industry as the “parent-child” well problem, the issue is surfacing in shale hot spots across the U.S. as companies ramp up production. Most of the tens of thousands of planned new wells will be child wells—wells drilled close to an already producing well.

It is one of the primary reasons why thousands of shale wells drilled in the past five years are producing less oil and gas than companies forecast to investors, a Wall Street Journal examination of drilling data has found.

Shale producers across the country are finding “you can get a lot of interference, one well to the other,” said billionaire Harold Hamm, who founded shale driller Continental Resources Inc., in an interview last year. “Laying out a whole lot of wells can get you in trouble,” he said. Mr. Hamm was discussing other companies, not Continental.

Many of the largest shale producers, including Devon Energy Corp., EOG Resources Inc. and Concho Resources Inc., have disclosed they are facing the problem. Some have begun drilling wells farther apart to get around it, which means they have fewer total wells to drill on their land.

Shale companies face the equivalent of an industrywide write-down if they are forced to downsize the estimates of drill sites they have touted to investors, some of which promised decades’ worth of choice spots. That raises questions about the high costs shale companies paid to secure drilling sites from Texas to North Dakota, and the true worth of their land positions, one of the primary ways they are valued.

Companies continue to test the balance between making a single well as productive as possible and maximizing returns from a cluster of wells. Some say it still makes sense in many cases to place wells closer together to extract as much oil as possible from a reservoir and realize the best returns per acre. Others have acknowledged wells should be drilled farther apart.

Two years ago, Laredo Petroleum Inc. had a market value of more than $3 billion and was thought to have some of the best land in the epicenter of U.S. drilling, the Permian Basin in West Texas and New Mexico. It was also a strong proponent of packing wells close together to wring more oil out of its land and make logistics more efficient, reducing costs.

Founder and Chief Executive Randy Foutch said a year ago that Laredo could likely drill 32 wells per drilling unit, usually about 2 square miles or more, with each well likely producing an average of 1.3 million barrels of oil and gas. Such spacing had scarcely been attempted before in the area on a large scale. Mr. Foutch said that gave Laredo at least 25 years’ worth of wells to drill.

In November, Laredo disclosed that wells it fracked in 2018 were producing 11% less oil than projected, in part due to parent-child issues. It now plans to space wells farther apart, to 16 to 24 wells per unit. One of its biggest investors, SailingStone Capital Partners LLC, argued in a letter last month that Laredo’s decision to drill too closely, among other choices, had “come at a significant cost to shareholders.”

Laredo’s market value has fallen more than 75% to about $800 million since the end of 2016.

“We tightened spacing during 2017 and 2018 to increase location inventory and resource recovery in our highest-return formations, and we achieved this goal,” said Laredo spokesman Ron Hagood. He said the company moved to wider spacing to increase individual well rates of return.

Shale companies are learning as they rapidly roll out thousands of wells, using fracking and horizontal drilling techniques that have only been deployed on a wide scale over the past decade. The technology has helped raise American oil production to all-time highs of about 12 million barrels a day, according to the Energy Department.

The problems that have been revealed so far mean some of the more optimistic projections for production from shale regions may have to be lowered. In the Permian Basin, parent-child issues threaten more than 1.5 million barrels a day of projected growth, according to a 2018 study by energy consulting firm Wood Mackenzie. That’s more than the daily output of Libya, and the equivalent of more than $30.55 billion annually at current prices.

“Unless there is a massive technological breakthrough, those child wells are going to be smaller,” said Robert Clarke, research director at Wood Mackenzie.

The number of child wells in the Permian now makes up 50% of all wells there and will grow steadily, according to Schlumberger Ltd., the world’s largest oil field services company. In other basins there are already more child wells than parent wells, Schlumberger estimates.

A January 2018 study published by the Society of Petroleum Engineers found there is a 70% to 80% chance that a child well will produce less than a parent well per foot drilled. A September 2018 study published by the group found child wells could produce between 15% and 50% less in the Permian basin, depending on how close the wells are and other factors.

Child wells also frequently cannibalize parent wells as they compete for the same resources and deplete the pressure of reservoirs more quickly. A 2018 study by Rystad Energy AS, an energy consulting firm, found that parent wells in the Permian basin will produce 10% to 12% less oil and gas on average when a child well is drilled nearby.

In the early days of the shale boom, producers drilled single wells widely to test the potential of different areas and lock down land leases. After companies identified sweet spots, many told investors they could repeat their promising results by using advances in technology to drill many more wells around them, packing them into tighter spaces.

Chesapeake Energy Corp. began aggressively testing tighter spacing in the Eagle Ford region in South Texas more than five years ago. On a call with investors in 2013, Chesapeake said it had begun drilling wells 350 feet apart, down from 500 feet, a practice known as downspacing.

More than a dozen large drillers in the Eagle Ford were downspacing by 2015 to 350 feet between wells or less. That same year the number of child wells surpassed parent wells in the Eagle Ford, according to Schlumberger, and oil production there reached an all-time high, topping 1.7 million barrels a day, federal data show.

But in a 2017 technical paper, two researchers for Norwegian oil giant Statoil ASA, now called Equinor ASA, found in a simulation that as wells in the Eagle Ford got closer together, they interfered with one another. One well’s fracking, or fracturing of rock formations deep underground to help release trapped oil and gas, could affect the productivity of the one next to it.

For wells spaced 375 feet apart, the interference could cause a 28% loss in production over the well’s life, compared with wells spaced 600 feet apart. For wells spaced 275 feet it could be as much as 40%, according to the study. In some cases, water and chemicals used to frack a child well could flood the parent through connected fractures, significantly impacting oil production in the older well.

By the end of 2017, Chesapeake was discussing “upspacing” as the best way to maximize a well’s value, even though doing so meant recovering less oil and gas overall. The company later cut its production forecast by 327 million barrels of oil and gas in part due to spacing issues in the Eagle Ford, regulatory filings show.

Chesapeake declined to comment. Tim Beard, a Chesapeake vice president, said in a December interview that the company was quick to respond when problems surfaced by increasing the space between its wells. “You’ve seen a lot of people destroy a lot of value in plays across the U.S.,” Mr. Beard said, referring to other companies.

Across U.S. shale basins, producers have begun drilling wells farther apart to solve the parent-child riddle. But it comes at a cost: It means they have fewer wells to drill. Many companies haven’t publicly adjusted their inventory estimates as they revise their well spacing assumptions, but many have stopped touting how many potential wells they have. Analysts say new investments may have to be made to purchase new land.

Oil currently trades around $55 a barrel, forcing shale companies to pay closer attention to how much it costs to extract resources.

Some companies and industry analysts believe that shale drillers will innovate their way out of the parent-child problem. Many producers have drilled longer child wells and pumped more sand and water into them in response. Such techniques can help child wells extract as much oil as the parent, but come at a higher financial cost. Some companies are also fracking wells simultaneously, which they say avoids the pressure drops seen when drilling a parent well and subsequently adding child wells.

Some shale executives privately admit that if they can’t fix the parent-child problem or turn out to have far fewer wells to drill, their companies will likely be worth far less. Wall Street has already lowered its valuation of some companies’ assets.

In 2018, shale companies paid $40,000 or more per acre to lease land for drilling in the Permian Basin. Oil and gas data firm Drillinginfo recently analyzed 11 Permian-focused shale companies and found the untapped portion of their acreage was now worth only around $10,000 per acre, on average. Based on production so far, the land’s value should only have declined 10%, according to Drillinginfo.

RSP Permian Inc. grew from an upstart to one of the largest drillers in West Texas, and it consistently touted thousands of “high-return” well locations in the Midland area of the Permian basin.

The company said in February 2016 it had at least 2,591 drilling spots there, and could have 67% more, or 4,328 wells, according to an investor presentation. Zane Arrott, the company’s co-founder and chief operating officer, told investors on a call that month that it had “a lot of confidence” in its midlevel projection of 3,392 wells.

In February 2018, RSP lowered its estimate of drilling spots in the area to 2,440 wells. The company said it had found that spacing wells closer than 400 feet hurt production, and it had come to believe that 450 feet was the optimum spacing in the Midland area.

A month later, in March 2018, Concho Resources acquired RSP for $9.5 billion, or about $75,000 per acre, creating a Permian giant. In a presentation announcing the deal to investors, Concho estimated RSP’s total inventory of drilling sites, which includes areas outside Midland, was about 30% lower than RSP’s previous estimate.

A Concho spokeswoman declined to comment. The company has previously said it would drill wells 660 feet apart in the Midland area and that synergies created by the merger will save money and allow it to go into a “manufacturing mode” of large-scale drilling projects.

When the deal closed in July, the combined market cap of Concho and RSP was nearly $30 billion. The current value of the combined company is $22 billion.

Write to Christopher M. Matthews at christopher.matthews@wsj.com, Rebecca Elliott at rebecca.elliott@wsj.com and Bradley Olson at Bradley.Olson@wsj.com

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