Home > energy, The Economy and the Planet, Uncategorized > The Bakken Formation — hype or a new Saudi Arabia

The Bakken Formation — hype or a new Saudi Arabia

from Lewis L. Smith

A friend asked me to comment on some material which he had received, extolling the virtues of the Bakken Formation, which appears to have received considerable publicity among investors in the USA.

This is a large mass  of underground rock located mostly in Montana and Wyoming, running up to the Canadian border at least. According to a recent study by the US Geological Survey, this formation may contain large amounts of oil and gas which could be extracted using current technology. In fact, it is already being exploited successfully, and some people believe that it might even be another Saudi Arabia !

The Bakken Formation should not be confused with the  now famous, gas-bearing Barnett Formation. Their only similarities are that both both names begion with the letter “B”, both contain lots of shale rock and both have been subject to broker-inspired hype.

Since this  “good news” has coincided in  with the promotion of stock in oil or gas companies,  I though that I would try to inject a word of caution into the discussion of this geological phenomenon with  possibly large economic, environmental and political significance.

First an ethical declaration  —   I am not a geologist and so cannot express a professional opinion on the  USGS study. However, from my experience with and from my knowledge of the oil industry, economics and finance, I will venture the following comments :

[1]     The US Geological Survey has some very competent professionals and very long experience in evaluating oil and gas fields. But it also has a long history of being optimistic in its projections, not only of reserves but of the future rates of production of oil and gas from the fields which it studies.

One conjectures that like many government agencies, it may have been “captured” by the industry which it is supposed to evaluate independently [and/or regulate] and has become a coconspirator in the latter’s efforts to keep us hooked on gas and oil until the last possible moment !  [In making this comment, we honor Samuel Beer of Harvard, who just died and who pioneered in studies of the “capture” of regulatory agencies by the regulated.]

[2]     Whatever the case with regards to [1], there certainly is a lot of oil to be extracted from Bakken. People are making money from this formation now, and some will make more money in the future. But that doesn’t mean that you will make money by investing in a producing company X or that Bakken is the next Saudi Arabia. These events may take place at some time in the future but at this point, to bet on these possibilities would be  “a leap of faith” unjustified by the facts at our disposal.

[3]     Note that the USGS study estimated only the oil and gas that is feasible to extract with present technology. It left unanswered such questions as, How much of that oil can we extract at an acceptable economic and environmental cost ? and  How fast can we extract it ? Needless to say, these are important questions.

[3]     With regard to these questions, we have a number of caveats  :

[a]          The amount of oil or gas which it is technologically possible to extract from a given reservoir is always greater than the amount which can be extracted  at an acceptable economic and environmental cost. Canadian tar sands are a prime example of this, which the assiduous browser can check out with a little patience, as there is a great deal of data available in the public domain.

[b]          In the case of Bakken, USGS says that the oil-bearing portions of the formation are “thin”. This innocent-sounding word implies the need for horizontal and/or other kinds of directional drilling throughout the formation. Unfortunately directional drilling can be up to three times more expensive than traditional vertical drilling, where [hopefully] the drill bit  goes straight down, with no wandering or wiggling, especially if the well is close to someone else’s leasehold !

[c]     Much of the oil is located in shale rock which has a low porosity.

Low-porosity rock requires expensive extraction technologies, regardless of the angle at which the well is drilled. Typically large amounts of water must be injected into the formation at high pressure, in order to break up the rock enough to permit extracction of commerically significant quantities of oil.

Will there be enough water near the sites where company X or Y would like to drill ?  Can this water be extracted at an acceptable economic and environmental cost ?  And what will be done with that water which comes back up with the oil ?  From an environmental point of view, this water will be dirty enough to present a significant cleanup and disposal problem. And last but not least, does anyone have prior claims on this water, like a neighboring golf course or Native American community ?

These are also important questions, ones which must be answered before an economic appraisal of the Bakken formation can be made.

[d]      The amount of oil remaining to be extracted from a defined unit of production is not the most important measure of the unit’s significance. The most important measure is that rate of extraction which optimizes total production over the remaining economic life of the unit. Depending on geology and other factors, a production unit with big reserves could have a low rate of extraction and vice versa. Since near money is worth more than far money, the latter case may be preferable in some instances. The actual situation at a specific location can only be determined by drilling, extracting and “doing one’s homework”.

In this regard, there is a curious stylistic feature of the documents which summarize the USGS study. In the oil industry, the rate of extraction is typically expressed in barrels per calendar day. However, the linked documents carefully avoid mentioning any daily production figures, even for current production. They use monthly, annual or total figures.  Perhaps the daily figures are buried in the study somewhere !  Of course, from the point of view of publicity, the use of monthly or annual totals gives bigger [and therefore more impressive] numbers, at least for lay people like ourselves.

Nevertheless, I was able to calculate that total 2008 extraction from the Formation was less than 99,000 barrels of crude oil per day. From another source, I have an estimate  of less than 230,000 barrels for 2009.

This compares with total US consumption of petroleum products of about 20 million barrels per day and Saudi production of over 8 million barrels per day of crude oils of all types plus refinery liquids extracted from natural gas. [The latter are in practice, substitutes for crude oil] . So Bakken has a way to go if it wants to make a dent in US supply, let alone beat Saudi Arabia.

My conclusions are as follows :

[1]     If you are thinking of investing in this formation, do so through a mutual fund which knows what it is doing and owns stock in several different companies active in the formation. DO NOT under any circumstances try to “pick and chose” companies yourself. The USGS study covers a large area, whereas companies must drill at specific locations, which may or may not be typical of the area. This is especially true with regard to shale formations, which can be quite diverse in their characteristics.

[2]     My conjecture is that if this formation could be developed fast enough, at the outside, it just might delay the coming peak in world crude-oil production by a year or two. However, this is not a significant number for anyone like an electric-utility planner who has a 30 year horizon. Oil prices will start to climb again well before the peak, so a short postponement of the latter will be of little help to those who did not prepare in time but were “asleep at the switch” , as Puerto Rico has been for so many years. End.

  1. January 12, 2010 at 4:43 pm

    I guess from the heterodox view, if a golf course owns water rights, then that would be an issue, but one could use eminent domain for the common good. As for indigenous american rights—-give me a break. We already did Dances With Wolves, and the Lone Ranger, so how much reperations are enough? Its so 20th century, when we have change.

    I do wonder whether any grass or bushes grow on that land—I guess some eco-wackos could transplant it to keep that lobby satisfied. My own view has always been that the wasteland between the Missisippi and the Left Coast could be a combination golf court/(sustainable) parking lot, since ain’t sh-t there.

    I do love the new heterodox arguments for investing in mutual funds. An old book by Kropotkin discussed early concepts of these (mutual aid, mutualism) and since then, communitarian (or ‘feminazi’) style approaches for Managing the Commons (Ostrum) have even gone mainstream. Mutual funds are (following lange/lerner) the probable answer. “Free at last, no money down’.

  2. Lewis L. Smith
    January 13, 2010 at 8:35 pm

    I only mentioned golf courses and Native American claims as examples of the kind of causes for legal action which might interrupt the development of a Bakken play. In no way, did I intend to pass judgment on the merits or demerits of such causes. Given the heterogeneous nature of shale formations in general and aquifers in that part of the country, the causes, their merits and their demerits are liable to be very site specific and beyond our ability to speculate in this blog.

    In recent decades, US courts have become more willing to give diverse causes a hearing, although not necessarily to granting their claims. Needless to say, when one has spent a lot of money on geological surveys and computer analyses of these surveys, interrupting site work to spend time in court will tend to push the accrued interest on such sunk costs well over budget by the time the production has started, even though one wins the case.

    I recall another energy case which illustrates the problem of novel causes very nicely. “H. Hill” lived on the side of a hill above a valley and enjoyed a beautiful view of distant mountains for many years. Then “out of a blue sky”, V. Valley, who lived in the same valley just below Hill, erected a wind generator on a very tall pole. Hill sued Valley for interrupting Hill’s view, which as far as Hill was concerned, represented an “acquired” or an “inherent” right. [I forget which.] Valley had to lower the tower a bit. [Probably the judge was an admirer of Solomon !]

  1. October 18, 2010 at 11:26 am

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.

%d bloggers like this: