By John Kemp
LONDON Dec 11 Shale oil and gas production will
become a lot cheaper as the industry absorbs and shares lessons
of advanced fracturing techniques, accelerating along a learning
curve that started in the 1940s.
The concept of a learning curve is most often used with
clean energy technologies such as wind power and solar.
But it applies equally to petroleum technologies such as
hydraulic fracturing, where it may be having an even greater
impact on costs and energy prices.
The idea that costs fall as industries get more experience
with producing goods and services dates back to at least the
1930s ("Factors affecting the cost of airplanes" 1936).
Subsequent studies have found evidence of "learning by doing" in
industries as diverse as shipbuilding, semiconductors and solar
Now it may be having the same effect on oil and gas, as
exploration and production companies accumulate more experience
with advanced techniques like horizontal drilling, fracking and
Many analysts have made the mistake of assuming that because
shale started as a comparatively high-cost form of oil and gas
production it will remain expensive, helping underpin oil and
gas prices at a high level in the medium and long-term.
Most believe real oil prices will not decline below $80 or
$90 per barrel in the long-run because of the fairly high
production costs of marginal supplies like shale.
That largely ignores learning effects. Efficiency
improvements have already begun to cut the cost of horizontal
drilling and hydraulic fracturing for cutting-edge producers in
mature shale plays like the Barnett and Bakken.
As the technology is refined further, and efficiency gains
diffuse across the industry, the potential for further cost
reductions is significant and could lower the projected floor
for future oil and gas prices.
INVENTION, INNOVATION, DIFFUSION
Learning curves, sometimes called progress functions, relate
unit costs to the total quantity of the good or service produced
to date. The learning effect is normally expressed in terms of
the percentage cost reduction for each doubling of cumulative
A wide range of learning rates has been found in different
industries, but the most common progress ratio is around 81-82
percent: ie for every doubling of cumulative output unit costs
fall by 20 percent.
"Technical change is a gradual process that evolves through
different stages," Cambridge University researchers Tooraj
Jamasb and Jonathan Kohler wrote in a study of learning curves
in the energy sector ("Learning curves for energy technology"
Jamasb and Kohler explained that in Joseph Schumpeter's
classic invention-innovation-diffusion paradigm, the first stage
"invention refers to the generation of new knowledge and ideas.
In the innovation stage, inventions are further developed and
transformed into new products while diffusion is the widespread
adoption of the new products."
The whole process takes time. New technologies may take
years to become widespread and for efficiencies to be apparent
FRACKING SINCE 1947
Fracking is not new. The first oil well was fracked
experimentally in Grant County, Kansas, in 1947. The first
commercial application came at wells near Duncan (Oklahoma) and
Holliday (Texas) in 1949.
In the first year, 332 wells were fracked, with an average
production increase of 75 percent. Since then fracturing
treatments have been employed more than 2 million times on oil
and gas wells, according to a history written in 2011 for the
National Petroleum Council (NPC), an industry body which advises
the U.S. Department of Energy.
Fracturing is now used on 95 percent of all new wells, and
the technology is being continuously refined and modified to
optimise fracturing networking and maximise resource production,
according to the NPC ("Hydraulic fracturing: technology and
practices" working paper #2-29).
But while the technology has been available for over 60
years, its full potential has only been realised in the last two
decades, when it was coupled with horizontal drilling to unlock
oil and gas in rock formations such as shale.
It first revolutionised gas production, starting with the
Barnett shale in Texas in the late 1990s and early 2000s, and
more recently oil output, starting with North Dakota's Bakken
shale from 2005.
MORE COST REDUCTIONS ARE POSSIBLE
Basic horizontal drilling and hydraulic fracturing
technologies have now moved all the way from invention
(1940s-1980s) and innovation (1990s and early 2000s) to
diffusion throughout the entire industry (2005-2012).
There have been corresponding cost reductions. Drilling
company Helmerich and Payne claims its latest generation
of rotary rigs can drill a horizontal well in just 15 days
compared with an industry average using older equipment of 30
Efficiency improvements are confirmed by the leading
exploration and production company Continental Resources
, one of the Bakken pioneers, which says the number of
wells that can be drilled by a single rig each year has risen
from eight in 2010 to 11 in 2012 and forecasts it will hit 12 in
Fracturing is also becoming cheaper. Services company
Schlumberger has criticised the wasteful brute force
approach employed in the past. It overused horsepower, fractured
too many stages of a well with too little prospective
production, and failed to target the formations with the most
In future, Schlumberger predicts that "smart fracking" will
be targeted at only those horizontal well sections which promise
the best oil and gas yields .
There is still plenty of scope to squeeze much more
efficiency out by spreading best practices from innovators like
Helmerich, Continental and Schlumberger to the rest of the
The goal for all companies in the exploration, production
and oilfield services sectors is to create highly standardised
"frac factories", which would bring the assembly-line
efficiencies of Henry Ford's motor manufacturing to oil and gas
production, raising output and squeezing costs.
SHORT-RUN INFLATION, LONG-RUN COSTS
The full extent of efficiency improvements has been masked
by the inflation in drilling and fracturing costs over the past
decade. The upsurge in oil and gas drilling activity has been so
sudden it has caused acute shortages and massive cost escalation
in everything from fracking sand and guar gum to experienced rig
crews and petroleum geologists.
But those shortages should start to abate as the supply
chain responds. The bull market in oil and other commodities is
now well into its tenth year. The availability of everything
from fracking sand to experienced staff has begun to increase as
companies and workers respond to incentives to enter the oil and
gas industry. Costs are already coming down in some areas.
Oil industry inflation is essentially a short-term cyclical
phenomenon (albeit the short run can extend 3-5 years or more in
complex capital-intensive businesses like petroleum). In the
next few years, some of the run up in costs and wages should
reverse. Hiring rates for onshore rigs and especially
pressure-pumping equipment have already begun to soften.
As inflation abates, the full impact of learning by doing
and efficiency improvements will become much clearer. It will
probably force analysts to revise their assumptions about the
industry's long-run marginal costs and oil prices.