A previous post about comparative gasoline prices inspired me to write a post on where oil comes from and how difficult it really is to get oil out of the ground and to the consumer. It’s quite an involved process that I don’t believe a lot of people really appreciate. After I better understood the entire process, I had a new appreciation for the thesis of energy prices being too low just because of the sheer difficulty to get this stuff out of the ground. Now, this is just a broad overview of the process; please understand that there are a lot of specifics that I am leaving out.
I also want all readers to note that I am writing about countries where all of the country’s oil is not nationalized (for example Saudi Arabia, Iran, Venezuela, Mexico). For an independent oil company to exploit oil in these countries, very special agreements between the independent company and the national oil company must be reached.
Exploration & Seismic
First you have to find the oil. We know the locations of where a lot of big oil fields lie in the world: places like Saudi Arabia, Western Canada, Gulf of Mexico, and the North Sea. We also know, in these locations, where the big oil fields are, and a lot of them are already drilled up pretty good. This kind of approximate location guides oil companies to where they need to look for oil. Once they find a plot of land where they think there is oil, maybe from other oil well logs or seismic data from close sections of land, they will run some tests on the plot of land. The most common is called a seismic survey. Essentially a seismic survey sends vibrations into the ground and records how these vibrations make it back up to the earth’s surface. In the past these logs were in 2D format, but as of recently 3D seismic data is now available. From the 2D or 3D logs from this type of survey, well trained geologists can determine (or guess) what kind of material is under the ground. Generally these vibrations are made by large trucks pounding the ground (for onshore wells) or ships with special equipment that set off little explosions (for offshore wells). There are images below showing how a seismic survey works as well as some 2D and 3D seismic data:
Once the seismic data is collected, geologists look at the data and look for patterns similar to ones they have seen where oil has been found before. Many people in the industry will tell you that this part of the process is a little more of an art than a science, and therefore when they think they’ve found an oil pool, there is still uncertainty if it is actually oil or something else like water. Following this, some other research may be included, such as well logs from wells close to the location or from a similar formation. A geologist will then recommend to the management team that the well should be drilled.
Land & Mineral Rights
Once the management is reasonably convinced there is oil there, they will start the process to obtain the mineral rights as well as the land access rights to that location. In some cases (but not always), these rights are held by the same entity. Either way a mutually acceptable payment or royalty must be determined to be paid to the land and mineral owners. If the land is held by an individual, typical contractual negotiations occur between the operating company and the land owner. Some countries (one fine example is Canada) where many of the mineral rights are owned by government (oil is not nationalized, the rights are just owned by the government) have very well established mineral rights auctions that occur at specific times of the month.
Assuming that the geological data indicates the presence of oil and the proper rights are obtained, a company is ready to drill. A hole is drilled into the ground using a drilling rig. This is effectively a large machine with a long spinning rod and a bit at the end. Images of an onshore and an offshore rig are shown below.
Different bits are required to drill through different types of underground matter. For example, a different bit is required for drilling through sand than for drilling through hard rock. If you turn your attention to the image below, the middle-left bit and the far right bit would be used for drilling through softer material and the far left bit and middle-right bit are used for hard material. These are only a small sample of the bits that are used; hit up Google images to see some other types.
As the well is being drilled, a drilling fluid or, as it is known in industry, mud is circulated through into the well for a couple of purposes. The main purposes are cooling the bit as well as providing a medium to remove the material that is being drilled though. The right type, consistency, and makeup of the mud is particularly important to the drilling process, so important that I could write an entire post just on drilling mud.
A well will be drilled to the target formation. According to the EIA, in the U.S. this depth averaged around 5,700 ft. in 2006. Geologists can determine where the target formation is from well logs that are recorded based on the material that the drilling rig pulls out of the ground, as well as core samples from the well. The target formation has an area of what is called “net pay,” which is effectively the part of the formation that is economically producible. Net pay regions can range from as large as a couple hundred feet to only a few feet (all depending on the location and the formation). The wells with only a few feet of net pay really astonish me. Think about it: you drill 6,000 ft. into the ground to find a formation to produce that is only 10 ft. tall. That’s pretty impressive by any standard. And we get to enjoy all that technical expertise for only about $70 per barrel of oil (or 42 U.S. gallons, 159 liters).
After the well is drilled, metal casing is placed in the well to hold the hole open so oil can be produced. In cases where high pressure is expected, concrete can also be placed around the metal casing for additional structural integrity.
Completion & Tie-In
Following drilling, a well must be completed. “Completing” a well allows the well to produce oil. The main part of competition is perforating (or “perfing”) the well. This is done through busting little holes into the well casing so oil can flow up the tubing of the well and to the surface to be produced. Additionally, the top of the producing region (the region of net pay) is closed off and a smaller piece of tubing is put down the well for the oil to flow up to the surface. In most cases, some chemicals are put down the well to clean out the tubing and casing as well as to stimulate the well for production.
In some cases, the pressure of the oil in the target formation is large enough to push the oil up the tubing and to the surface, but in many other cases a pump jack and/or some other type of removal assistance will be used. A picture of how a pump jack works is below.
As of recently, fracturing (“fracing”) a well has become quite common. Effectively fracing forces high pressure fluid with small rocks or sand into a formation creating small cracks in the formation so the liquid oil can then flow through more easily. I speak more on the effects of natural gas well fracing in a previous post.
Typically after these steps the well is set to produce. It just needs to be tied into a pipeline or other type of liquid transportation system, and production can begin.
The bottom line is, how much does this all cost? Well a lot more than you’d probably guess. As a result, somewhere in the entire process, many companies will look for a partner to assist in providing capital for the project in return for a portion of the profits from the well. To get a sense of the magnitude of the cost, the EIA reported that in 2007 a typical onshore U.S. oil well cost around US$4 million to drill and complete. Offshore wells cost substantially more, typically in the US$35-100 million+ range (depending on the location and the depth). These values vary substantially and are just averages, but the point is, it’s really expensive to drill. And since one can never be sure if there will actually be oil in the well (i.e. they might drill a “dry hole”), it’s best to share the risky capital with other partners in case there is no pay at the end of the day.
This short summary only touches the surface on what drilling and producing an oil well entails, but it helps to know that there’s a lot of science, risk management, and knowledge that goes into each drop of gasoline in your car’s tank.