Kentucky’s oil and gas industry has had a rough several years. Activity has been trending downward for over a quarter of a century, although promising new drilling targets were discovered just a few short years ago and hopes were high. That all came crashing down in late 2014, when the prices of oil and gas plummeted.
Experience shows the market shifts, but for now, with oil prices sitting at about $45 a barrel and projected to drop even lower, and natural gas prices at about $3 per million BTU, Kentucky permits for oil and gas drilling are at a record low and are likely to stay that way for some time.
Kentucky ranks 20th in the nation for crude oil production, and 18th for natural gas, according to 2012 U.S. Energy Information Administration data, the latest available. But the oil and gas industry is overshadowed by its behemoth cousin, coal, for which – along with horse racing and bourbon – Kentucky is synonymous. (The commonwealth is the nation’s fifth largest producer of coal.)
The fact that Kentucky has an oil and gas industry at all comes as a surprise to many people, said Brandon Nuttall, a geologist in the energy and minerals section at the Kentucky Geological Survey (KGS) at the University of Kentucky. It is much smaller than the coal industry, and doesn’t get nearly as much press.
“Kentucky has been so focused on coal,” he said. “A lot of people have no idea that we have commercial (oil) wells that date all the way back to the 1800s.”
The footprint of oil and gas activity in Kentucky is small compared to coal, agreed David Harris, head of the energy and minerals section at KGS, but more than half of Kentucky’s 120 counties produced either oil or gas, or both, in 2016. The activity, occurring mostly in eastern and western Kentucky, can be easy to overlook, though.
“After the rig is gone, there is a very little evidence of an oil and gas well,” Harris said. “There may be a small pipe sticking out of the ground, a few tanks sitting on the location to collect the oil, but other than that, there’s not big evidence of the wells there. It is a bit hard to tell sometimes.”
The industry may be small, but it is still important to Kentucky’s economy, said Bill Barr, managing partner at BlackRidge Resource Partners and member of the Kentucky Oil and Gas Association (KOGA) board of directors. It pays millions in state taxes, employs thousands of workers, and for every dollar produced, it pays 12.5 cents of that to royalty landowners, he said. In 2015, that amounted to about $40 million.
In 2014, the industry directly employed more than 3,000 workers and paid them an average annual salary of $75,000, according to KOGA. That number is likely to be lower now, though, because drilling activity has all but stalled.
Although it is resilient, and things could turn around quickly if oil and gas prices increase or the geopolitical climate changes, the Kentucky oil and gas industry is “very stressed at the moment,” Nuttall said.
Just how bad is it?
“The oil and gas situation is not good,” Harris said.
Drilling permits issued by the Kentucky Division of Oil and Gas have been steadily declining since 2008 when oil peaked at over $130 a barrel, but the past few years have been particularly low.
So far this year, only 59 permits for oil and gas drilling have been issued. KGS predicts the total number of permits for 2017 will be 50 percent less than the number issued in 2016, making it the third year in a row permitting will have declined by 50 percent or more.
“The production numbers will typically lag behind the permitting numbers,” Harris said. “As soon as permitting goes down, you’re almost always guaranteed to see a decline in production. It’s been a pretty devastating change for the oil and gas industry.”
There are 250 to 300 small producers in Kentucky. In 2016, 2.59 million barrels of oil were produced statewide, a 9 percent drop from 2015, Nuttall said. The total value of oil produced in 2016 was $96.8 million, a 28 percent drop from 2015’s $136.3 million. There was, however, a slight increase in the number of wells in 2016, up to 12,425 from 12,019 in 2015.
Last year, there were 16,074 natural gas wells, a 6 percent increase over 2015, but the amount of gas retrieved from those wells was down 15 percent. The total value of the gas produced in 2016 – $107.3 million – was down a whopping 53 percent.
In 2015, the industry paid $16.3 million in taxes. That amount dropped to $9.1 million in 2016.
“Drilling activity is down, and here’s why,” Barr said. “We’re no different from any other business. We are market-commodity-price driven. If oil is at $100 a barrel, you’re going to spend more capital because you are going to have a better, quicker return on your investment. If oil is at $30 or $40, you’re going to have a slower return, you’re going to be more cautious, and your bank is going to require you to spend less money.”
A short-lived boom
Kentucky oil production has been declining steadily for the past 30 years, with a few small spikes here and there. Things seemed to be looking up in 2013, however, when new drilling techniques were used to access natural gas and oil stores in the Devonian Berea sandstone in Lawrence County.
The Berea had been vertically drilled extensively since the 1920s, primarily for gas, but it had “nuisance oil” associated with it. The oil was considered a nuisance because it didn’t produce enough to be commercially drilled. Horizontal drilling and hydraulic fracturing changed that, in a big way. Oil production numbers went up to 4.1 million barrels in 2014 from 2.9 million in 2013.
“This little ‘play’ in Lawrence County actually turned around our production numbers, and we saw a significant increase in oil production in 2013 and 2014, which got a lot of people really excited,” Harris said. “It was a small boom there in northeastern Kentucky and the industry was feeling pretty good about it.”
A play is group of hydrocarbon fields or prospects in the same region that are controlled by the same set of geological circumstances.
Almost as quickly as it started, the boom was over. In 2013 and part of 2014 oil prices were nearly $100 a barrel. Not long after the oil play in Lawrence County began, prices dropped to $48 a barrel.
“Unfortunately, (drilling) that play is not economic at those prices, and so we’ve seen essentially all drilling in that area come to a halt because of the low oil prices,” Harris said. “That little bump has now started to decline again. We’re back on our downward trend, unfortunately, because nobody can make money at current prices.”
No new horizontal wells at the Berea sandstone have been permitted in 2017, Barr said, but there has been some drilling this year for wells that received permits in 2016. His company plans to drill up to four wells there later this year.
Natural gas had a similar boost in production that began in 2008, which “was really the beginning of a big shale gas boom,” Harris said. It lasted until 2014, when growing U.S. natural gas supplies pushed prices below the profitability floor for Devonian drilling. Production has steadily declined ever since.
Gas production involves much more than drilling, and isn’t economical at such a low price. The gas produced at the well often is a mixture of methane, ethane, propane, butane and other gases, Nuttall said.
“These other gases will increase the heating value of the natural gas. What you have to do is remove that because it interferes with transportation. The gas is too ‘hot’ for use in a lot of equipment,” he said. “Because of processing fees to take the raw natural gas to a (refined) product that can actually be sold into the pipeline and used, and then the transportation costs, you can actually lose money producing a natural gas well in certain parts of Kentucky.”
Improved technology leads to controversy, new targets and regulations
Both booms were the result of drilling reservoirs using two controversial techniques: horizontal drilling and hydraulic fracturing, or “fracking” as it has come to be known.
“The combination of those, drilling a hole horizontally into a formation rather than vertically and then using hydraulic fracturing to release the oil and gas from the rock, have really been the game-changer in the U.S.,” Harris said.
Conventional drilling involves inserting a vertical pipe into the ground to extract hydrocarbon liquids flowing between rock formations underground. The natural underground pressure is all it takes to pump the oil from the well to the surface. These formations have high permeability, meaning the fluids move easily through the rock.
Hydraulic fracturing was developed by Halliburton in the mid-1900s to extract oil and gas from geological formations with low permeability. Fracking involves injecting a high volume of water, chemicals and fine sands to “fracture” a deep rock formation to enhance the flow of oil and natural gas produced from a horizontal well, according to KOGA literature. Tens of thousands of wells have been hydraulically fractured in the U.S. in the last decade, boosting domestic production and driving down gas prices.
“Hydraulic fracturing started off with low volumes of water,” KOGA’s Barr said. “We learned that you could add surfactant, which is nothing other than dish soap, or similar items, to slicken the water. It allows it go into the rock easier. Over the years, we’ve added more and more chemicals, although it is still less than a couple of percent chemical, and the rest is water. We’ve learned to add nitrogen to the water and foam it to allow it to carry sand.”
That “recipe” was developed over the years, primarily in Texas, and those techniques have moved across the country. In Kentucky, he said, most natural gas wells have been fracked with nitrogen, an inert gas that has zero impact on the environment.
And Kentucky’s “fracks” are small compared to those used in larger oil and gas production areas. A huge slick water frack in Kentucky would be 1 to 1.2 million gallons. In the Utica and Marcellus shales in Pennsylvania, a 12 million-gallon frack is considered small, Barr said.
The use of fracking has prompted environmental concerns across the country. An organization based in Berea, Ky., called Frack Free Foothills, formed in 2014 to protest fracking in Madison and its surrounding counties.
“Fracking produces large amounts of wastewater polluted with brine, toxic chemicals, hydrocarbons (oil and gas byproducts), and even radioactivity that has been known to pollute drinking water wells, streams and land,” according to the organization’s website. “Our water treatment facilities cannot handle this type of waste.”
In addition, Frack Free Kentucky claims being near fracking wells can reduce the value of property and that the process itself is linked to earthquakes.
The group’s efforts to fight fracking in Madison County helped encourage the state legislature to review and update Kentucky’s oil and gas drilling laws, which had not been updated since the 1960s, Nuttall said.
“A lot of the issues related to hydraulic fracturing and horizontal drilling in Kentucky’s regulations have been updated,” he said. “We now require pre-treatment and post-treatment monitoring of water wells. We now require there to be reclamation plans in place, and we require public disclosure of all of the chemicals used in hydraulic fracturing.”
Where do we go from here?
There are some potential new, unconventional oil and gas drilling targets being explored now, including the Rogersville shale, a very deep formation in Eastern Kentucky. Those new targets “could turn into significant increases in production in the state,” Harris said. “But it’s too early to tell.”
The Rogersville shale, located in Lawrence and Johnson counties, is attracting much interest, but little is publicly known about the exploratory wells that have been drilled there, Nuttall said. Economic viability of the Rogersville shale will depend on the production rates established there, along with higher commodity prices.
“There have been a couple of hundred thousand acres leased, and the players that leased it were major companies like Continental, Cimarex, EQT and some other larger companies,” Barr said. “It is an expensive play. The wells are 12- to 14,000-feet deep, and the stakes are high.”
If it is successful, he said, it will be transformative for that part of northeastern Kentucky, in terms of royalties paid to landowners, severance taxes paid to county and state governments, job creation and wealth creation.
“If you do the math, for every 1,000 barrels, 125 go to the landowners. At $50 a barrel, that’s $6,000 a day. That’s $180,000 a month,” Barr said. “That has happened in the Marcellus and Utica (shales) in Pennsylvania, northern West Virginia and eastern Ohio.”
To survive, Kentucky’s oil and gas industry must be ever-evolving, he said.
“We’ve got to be flexible, look for evolving play and apply technology,” Barr said. “The Rogersville could be a major example of that.”
Other factors could help boost the U.S. oil and gas industry, said Scott R. Smith, senior consultant with Smith Management Group, which specializes in energy project development and environmental permitting. A number of power plants are coming online that will be fueled by natural gas instead of coal, he said, and that will impact demand.
“A lot of people don’t realize how much gas those facilities are going to consume,” he said. “They may have underestimated that demand.”
The Trump administration has made approval of natural gas exports a significant part of its energy strategy. New U.S. Secretary of Energy Rick Perry said he wants to make the U.S. a “dominant energy force” by exporting oil, gas and coal to markets around the world. In April, Perry approved the first permit to export liquefied natural gas overseas. The first shipment was delivered to Poland in June.
Natural gas is the backbone of the petrochemicals industry, Smith said. Because Kentucky’s natural gas is not pure methane, the other gases have to be processed out and transported to the petrochemicals industry in other parts of the country. The commonwealth could benefit greatly by working to establish its own petrochemicals industry here, he said. Kentucky already has at least one company, a PVC manufacturing facility in Calvert City called Westlake Chemical Corp.
Barr remains optimistic about Kentucky’s future oil and gas prospects, even as the industry waits for prices to climb and demand to grow.
“So how do we continue on?” he asked. “The industry has to be selective as we look at our new prospects, we have to embrace new technology, and we have to do things better and smarter.”
“I still think there is a room for robust oil and gas fossil fuel industry in the state,” Barr said. “There are thousands of wells that have produced and will produce for decades to come.”
Lorie Hailey is a correspondent for The Lane Report. She can be reached at [email protected].