The temporary shutting in of wells is the one thing that oil companies are trying to avoid at all costs. That’s because restarting production is expensive and wells are not guaranteed to return to their flow rate. The doubts are so great that some experts wonder whether the current round of shut downs, far from preserving the resource, won’t accelerate oil depletion instead. Some Russian engineers are even considering burning excess oil, rather than downsizing production.
The COVID-19 crisis resulted in a quick and dramatic drop in demand for oil, estimated to be in the 25 to 30 per cent range in April. Much of this decline is expected to be reversed by the end of the year, but faced with a massive drop in oil prices and a lack of storage tanks, oil companies face a difficult dilemma: should they ride out this unprofitable streak or should they decrease production to cut their losses?
To the lay person, the option to cut production seems obvious. But an oil well is not a tap with a flow that can be adjusted as needed. Either it operates at full capacity or not at all. Valves are installed, but they’re only used during brief maintenance periods or emergency stops. Oil companies know that the decision to shut down for an extended period has three serious consequences:
- reopened wells may never return to their previous production rate
- pumping equipment must be repaired and refitted at great cost
- other facilities, such as refineries and pipelines, cannot be kept in operation without some minimal level of production.
Impact on wells
An oil field is a complex structure, where different grades of oil have settled over time in a porous type of rock such as sandstone. Drilling and pumping releases this mixture of oil and gas. Any cessation of the extraction process may result in the clogging of this porous rock with sediment or paraffin, which means that production may permanently be reduced by half, or even stop completely, when pumping resumes. This loss of productivity does not always occur and it is sometimes possible to repair part of the damage by injecting chemicals into the well. But it’s easy to understand why oil companies would seek to avoid damage to their property and costly remediation work.
In addition to the geological constraints, the shut down process is risky in and of itself. To close a well, a special drilling rig is used to inject a thick mud at the well head to block the flow of oil and gas. This blocks the pores of the rock to a lesser degree, alters the pressure inside the well and inevitably complicates any attempt to resume production. The well itself is also plugged by pouring cement into it.
To restart production, it is necessary to bring a new rig, drill the cement plug, and pump the sludge blocking the well head. The hope is that oil will start to flow again. If this fails, you have to drill a new well, inject chemicals or even perform hydraulic fracturation (fracking). These steps are costly and labour intensive. If all oil companies try to resume operations at the same time, there aren’t enough work teams around to handle the workload. At the end of the last similar crisis, some restoration work had to wait up to two years.
The Alberta oil sands are fraught with comparable challenges. The bitumen is separated from the sand by injecting steam into the ground. The heat and pressure levels must remain constant, otherwise the bitumen may clog in the underground reservoir and in collection pipes. At best, resuming production may require months of work, at worst, shutdown can permanently diminish the throughput of the facility.
Offshore drilling platforms have their own challenges. When pumping ceases, the pressure builds up quickly, causing methane hydrates to form and to clog pipes. Underwater pipelines that transport oil to the coast are particularly at risk. Relaunching production at offshore facilities is so difficult that it is considered to be the very last option for oil companies.
An enormous price tag
Decommissioning a well is expensive. In the case of a high-flow well, simply removing the submersible electronic pump costs about $150,000. For a medium-flow well, the bill is around $75,000. The underground environment is corrosive and a chemical treatment costing $2,000-$5,000 must also be applied to protect equipment that cannot be removed from the well.
Resuming production is also tremendously expensive. Cleaning the well of accumulated water costs anywhere from $10,000 to $20,000. In a high-flow well, repairing the submersible pump costs about $150,000 and replacing it costs double, just for equipment. The bill can reach up to $400,000 or $500,000 when you include labour costs. Even in a low-throughput well, repairing the equipment costs at least $50,000.
The bill for the chemicals used to restore a conventional well that has lost some flow ranges from $50,000 to $100,000. If the hydraulic fracturing of a shale oil well has to be redone, you’ll have to dish out an additional $3-$5 million.
Bear in mind that the fate of thousands of wells is currently at stake. In North Dakota, 6,200 wells are already closed, most of them with moderate flow and dependent on hydraulic fracturing. Given the high restart costs, the bill could reach up to a billion dollars. In Louisiana, nearly 17,000 wells will probably be shut down because of the crisis. In Texas, the numbers are even higher.
The cost is difficult enough to justify for wells with an average throughput. It cannot be justified at all for old wells reaching the end of their life, which often produce less than 10 barrels per day. These wells must continue producing or simply cease operating forever. Since there are so many of them, amounting to almost 11 per cent of US oil production, the loss could be significant for the industry.
Most refineries cannot operate below 60 or 70 per cent of their baseline capacity. A few select ones can go as low as 50 per cent, but no less. If oil production keeps decreasing, some refineries will have to close, temporarily or permanently. Production at US refineries has already fallen by 30 per cent, which means that they’ve already almost reached the shutdown point. The risk is all the greater as the demand for oil in the U.S. has declined from 18 to 5 million barrels per day during the COVID crisis.
Here again, we are talking about equipment which must continue operating as it will fall into disrepair when not in use. For some old and marginally profitable refineries it may therefore be financially impossible to resume operations after a shut down. It is estimated that the United States could permanently lose one to two million barrels per day of refining capacity after the crisis.
Another worrying piece of infrastructure is the Trans-Alaska pipeline. If a throughput of at least 400,000 barrels per day cannot be maintained, the oil flows so slowly that the surrounding permafrost generates a cooling effect. Under these conditions, ice crystals and paraffin are likely to form, which can block the pipes and damage the pumps. Oil production has been declining for years in Alaska and the pipeline is already used at minimum capacity. A moderate drop in production would therefore lead to a pipeline shut down, making any further oil production impossible for lack of transportation. In short, all of Alaska’s oil production could dry up at once.
In this context, it is understandable that oil companies are so reluctant to decrease production, even when they are in debt or bankrupt and even when oil is so cheap that they have to sell below the break even price. Resuming production is expensive and there is a risk of a permanent drop in production on startup, making the investment less attractive. Some Russian producers even say they would prefer burning unsold oil to shutting down wells. In addition, certain land use contracts require oil companies to pump the oil, under penalty of seeing their drilling rights transferred to their competitors!
Some analysts believe that the oil industry will emerge from the crisis in such bad shape that it won’t be able to finance the restart of the closed wells. As no sufficient alternative to oil will be deployed by the time the crisis is over, some are starting to suggest that a partial nationalization of the US oil industry might be in order.
What about peak oil?
When the crisis began, some observers believed that COVID-19 would delay peak oil (or its effects, as some analysts suggest it was reached in October 2018) due to diminishing oil demand. It now seems the opposite could be true and that we could actually be moving closer to peak oil. Some wells will be permanently closed and others will never return to their former production level. In addition, financially unsound oil companies will find it difficult to launch new projects.
We can therefore expect the current glut of oil to give way gradually to an increasing shortage. Gas station pumps are not going to dry up overnight, but prices are likely to rise again and oil might become too scarce and too expensive to fuel significant economic growth. Activists will welcome this fall in fossil fuels production, but we must bear in mind that a low intensity energy crisis could also hamper our ability to carry out an efficient energy transition.