Back of the envelope energy calculations

I don't know the energy sector very well, but I come across interesting cost numbers every now and again.

I saw an article today that talked about the avg. Eagle Ford/Bakken shale/oil well producing about 400 barrels a day with decline rates of 50% per year. The article estimated the all-in cost of extraction/production was as high as $75/bbl.

I have heard the cost to drill a well varies between $5m-$10m (up from $1m to $3m less than 5 years ago).

Assuming the price of oil is $100/bbl and those estimates are about right, the economics are approximately:

Year 1: $100-$75 = $25/bbl margin x 400 x 365 = $3.65m profit
Year 2: $25/bbl x 200 x 365 = $1.825m profit
Year 3: $25/bbl x 100 x 365 = $912k
Year 4: $25/bbl x 50 x 365 = $456k
Year 5: $25/bbl x 25 x 365 = $228k
Total Profit Over 5 Years = $7.07m
Discounted at 12%
PV = $4.01m

Interesting.

P.S. From a USA Today article 11/4/13 "Tight oil development is still at an early stage, and the outlook is highly uncertain," says the Department of Energy's EIA in its Annual Energy Outlook 2013, adding its future will depend on how individual wells perform as well as their costs and the revenue they generate.

The reason: "sweet spots" — small areas with the highest yields. Hughes says these spots simply don't last long. Unless more wells are drilled, the Bakken shale of North Dakota and Montana loses 44% of its production after a year and the Eagle Ford shale of Texas, 34%. Most of the nation's major shale regions produce both oil and gas.

A Problem, an Issue, or a Conundrum

Actually it is probably more an issue and/or a problem, rather than a conundrum.

I am referring to the fact that financial markets like gold and oil are relatively small compared to traditional markets like equities and bonds.

The changing face of market players (the rise of hedge funds, SWFs, and ETFs), along with changing perspectives on asset allocation and investment strategy, has led to the prospect of significant demand/supply imbalances.

In other words, the flow of funds can unhinge a market from its fundamentals, aka bubble.

Energy Cycles...What Of Them!

From what I can gather, the US is sitting on a mountain of natural gas (access to shale has been a game changer). As a result, we will continue to see significant boom-bust cycles in the natural gas space (we're currently near the bottom of the cycle).

The same cannot be said for oil. From what I can gather, global oil supply is much more constrained. The oil supply and demand curves are highly inelastic in the short to medium term. As such, any uptick in demand, will put significant upward pressure on oil prices.

Note: OPEC has taken a little supply off the market in response to the decline in global demand, but we would very quickly come up against the supply constraint should any normalcy return.