Dar & Company
Independents Discover an Attractive
Natural Gas Investment Model
(First published on www.SeekingAlpha.com on July 22, 2010)
US E&P independents continue to innovate domestically, giving them a pioneering competitive advantage over the majors and mini majors, which they then leverage through international expansion.
The development and initial rapid growth of natural gas production from shale and tight sands by independents, often quite small or start up companies, is well known. However, as established shale basins get crowded and global companies bring great capital and scale to this industry and natural gas prices remain low in real terms, independents have created a new and for now quite lucrative investment model within established shale and tight sands business: this is the hybrid play. It involves the joint production of gas and gas liquids or gas and oil from carefully delineated "windows" within gas shales or tight gas sands basins that are rich in condensates or oil.
The model is very young but is being adopted with the alacrity and enthusiasm typical of North American E&P independents. At present this model is almost entirely a
The
US E&P independents continue to innovate domestically, giving them a pioneering competitive advantage over the majors and mini majors, which they then leverage through international expansion.
The development and initial rapid growth of natural gas production from shale and tight sands by independents, often quite small or start up companies, is well known. However, as established shale basins get crowded and global companies bring great capital and scale to this industry and natural gas prices remain low in real terms, independents have created a new and for now quite lucrative investment model within established shale and tight sands business: this is the hybrid play. It involves the joint production of gas and gas liquids or gas and oil from carefully delineated "windows" within gas shales or tight gas sands basins that are rich in condensates or oil.
The model is very young but is being adopted with the alacrity and enthusiasm typical of North American E&P independents. At present this model is almost entirely a
The
EOG Resources (EOG) is a prominent and insistent advocate of the hybrid model and, in the past four years, has focused on developing and executing this model. In the Cleveland Sands, EOG identified the oil window from old production from vertical wells. It then used horizontal drilling to verify the conclusion. The company liked the results and now has 60,000 net acres. The company has a reserve base of 8.5 million barrels of oil and 130 billion cubic feet of gas in this play and has achieved attractive economics, with an after tax return close to 40% at current strip prices and a finding cost of $15 per barrel of oil equivalent (BOE). This success has become the template for EOG's search for other hybrid opportunities.
In the
Another Granite Wash formation, the
In the Barnett, EOG claims to have pioneered the hybrid strategy. This strategy has attracted the close attention of many other companies, which include the most skilled in horizontal drilling and shale resource development and also the best capitalized E&P companies in the world. The Barnett hybrid play is so new that even EOG has been operating there for a little over 2 years. The company has told analysts that the Barnett oil potential makes it the 17th largest oil field ever discovered in the
Should the oil and liquids potential and drilling economics of the hybrid play continue to be validated there is likely to be a step increase in the deployment of technology, capital and management resources in the Barnett. Companies such as Chesapeake Energy (CHK), Marathon (MRO), Devon Energy (DVN), ExxonMobil (XOM), Forest Oil (FST), Quicksilver Resources (KWK) and Anadarko Petroleum (APC) already operate there and have the ability to identify and develop resources in the oil and condensate window of the Barnett, assuming that it is still feasible to buy or buy into significant net acres at acceptable cost.
The leading hybrid shale play, however, is one of the newest shale basins to be developed: so new that the first commercial well drilled in the basin was less than 2 years ago by Petrohawk Energy (HK) when there was no indication there was a significant oil and gas liquids window in this basin....the now internationally famous Eagle Ford basin. No shale basin has gone from complete obscurity to global recognition and enthusiasm as quickly as the Eagle Ford. The trend is big: it ranges over 330 miles from
The Eagle Ford oil and gas liquids resource base is so large that the industry believes it is second only to the Bakken in recoverable reserves. If this so, then the 5th and 6h largest oil fields ever discovered in the
The economics of the Eagle Ford liquids window is compelling. Petrohawk, which has equal amounts of net acreage in Haynesville and Eagle Ford (about two-thirds in the oil and condensate window) is reallocating capital spending away from the former to support greater drilling in the latter, going from 4 to 8 rigs (over 2,000 potential drill sites in the liquids window). The company estimates that its Eagle Ford position has 340 million barrels of risked resource potential. While Petrohawk is the pioneer, it hardly has the play to itself. Over 30 companies already operate in the Eagle Ford.
EOG has over 500,000 net acres (2,840 potential well locations) in the oil window with potential reserves of nearly 700 million barrels of oil. In the NGL window the company has additional acreage with an estimated 100 million barrels of potential reserves. The company calculates that its direct after tax rate of return for Eagle Ford ranges between 66% and 95%, depending on the well and product mix. A typical Eagle Ford well drilled by EOG is thought to be 77% oil, 12 % condensate and 11% gas, so that the current low price of natural gas is not an impediment to resource allocation.
Conoco-Phillips (COP) is reportedly allocating a majority of its North American exploration budget to Eagle Ford, where it has 300,000 acres. Royal Dutch Shell (RDS.A) has acquired 150,000 acres in the liquids window and started drilling. This asset is expected to become an important part of Shell's North American E&P portfolio. BP bought into a position held by Lewis Energy Group giving it half interest in 80,000 acres. France's Total (TOT), via its joint venture with Chesapeake Energy, may be entering the basin as well.
There are 2 strategic questions the industry is now asking:
1. Are the hybrid shale and tight sands plays of
2. Can these plays be scaled to attain the status of a new industry that may have, eventually, global reach?
It is likely to be another 2 to 3 years before these questions can be addressed for North America, another 5 before they can be addressed for Australia, another 10 years, at least, before they can be addressed for China, India, Poland and Hungary and perhaps another 15 years before they can be addressed for the other parts of the world.
In
Companies and investors alike are following this keenly. The shale resources of the