Sharpe: Why not more rigs in the San Juan Basin?

George Sharpe



George Sharpe, Merrion Oil and Gas investment manager

Recent headlines lauded BP’s “new discovery” in the Mancos gas zone in the San Juan Basin.  Indeed, BP announced that the NEBU 602-1H, a 2-mile-long horizontal Mancos gas well drilled just south of the Colorado border, came on at 12.9 MMCFD (million cubic feet per day).  No doubt, that is a lot of gas!  

This positive news created a frenzy of excitement down at the local diner, where good news has been hard to come by these last few years. I hate to be the turd in the punch bowl, but sadly, I must bring some reality to this conversation. They say that a realist is just a pessimist that smiles on occasion. Except for the smiling part, I’m guilty as charged.

Let’s take a look at the Mancos development to date.  The map below shows the entire San Juan Basin from Durango to just north of Cuba. Also shown on the map are all permitted (red stars) or drilled Mancos wells (green dots for oil wells and red for gas wells).  Most of the drilling and most of the permits are in a rather limited oil fairway running along Hwy 550 south of town.  That fairway may ultimately expand as new wells are drilled, but right now, the “drilling money” is pretty focused on a fairly small area. 

The Mancos Formation area.

Where there is substantial running room is in the dry gas portion of the play in the deeper parts of the basin. The Mancos in that area is over-pressured, which helps cram a whole bunch of gas molecules into those itty-bitty pore spaces. Further, the higher pressure provides the reservoir energy to push the gas out of the reservoir, which helps maximize the recovery.  

WPX has drilled a handful of successful wells over the past few years, ironically only a few miles from BP’s “new” discovery (new for them, I suppose). WPX has a couple of older one mile laterals that have been on for over five years that look like they will ultimately recover around 5 BCF (billion cubic feet) each.  I’m sure BP is hoping to double that to 10 BCF for their two mile lateral.

So, with all this potential, why are only 6 total rigs running in the San Juan Basin?  Granted, that is 6 more than a year ago, but it pales to the 76 rigs drilling gas wells in the Appalachian Basin and 382 rigs drilling oil wells in the Permian Basin. Primarily it is all about “finding costs,” which are the cost to drill divided by the ultimate reserves for the well. The San Juan Basin is compared to these other basins below.

Natural Gas Finding Cost Comparison

Looking at the Mancos Gas, the projected finding cost for a 2-mile horizontal well are approximately $0.75/MCF.  When we are making $2.50/MCF at the wellhead, you think that would make all kinds of money, no?  However, when you consider that you have to pay royalties, taxes, operating expenses, and account for the time value of money, the “margin” gets a lot skinnier. A rule of thumb is that finding costs need to be less than 1/3rd of current prices to generate a reasonable rate of return on an investment. 

With finding cost at 30 percent of the wellhead gas price, again you would think that would be a go. However, the Mancos has to compete for capital drilling dollars with other basins, and the reality is, finding costs are much lower in some other basins. Why drill a Mancos well when you can double the bang for your buck elsewhere?  

That is why, despite their early success, WPX is currently marketing their Mancos Gas assets with plans to redeploy the money in the Permian.  

The bottom line is that the reason we only have 6 rigs running is that the Mancos is skinny economics, particularly compared to other basins. In addition, the San Juan Basin has the additional hurdle of dealing with the regulatory burden of BLM lands, State lands, and Indian lands while the Permian and Appalachia are mostly fee owned.  

So, while the Mancos still holds lots of potential and will eventually be drilled up, unfortunately, it may not happen very fast.  

George Sharpe is an Investment Manager with Merrion Oil & Gas in Farmington.