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US: Failing in shale

November 20th 2013 | US | Oil and gas | Multiple companies

Supermajors are struggling to cash in on the US shale oil and gas boom.

When it comes to unconventional oil plays, bigger is not always better. Some small independent oil companies

that bought into the shale oil and gas "revolution" early have weathered low gas prices with aplomb. But the

world’s biggest private oilfirms, which piled in later, have fared less well, often lagging firms with a fraction of

their market value.

Many of the latecomers frantically snatched up shale leases during the buying spree of 2009-12. But lots of these

parcels of land have proved disappointing and now look to have been overpriced. The influx of the supermajors

has contributed to another problem, too: a gas glut, exacerbated by inadequate pipeline infrastructure, that has

kept US benchmark Henry Hub spot prices largely below US$4 per million British thermal units (mBtu) since

2011. Companies are being forced to redirect their efforts to areas rich in more profitable crude oil and natural

gas liquids (NGLs).

Late to the party

One notable struggler is the world’s largest listed oil company. ExxonMobil’s US$41bn purchase of XTO

Energy in 2010 made it the top US natural-gas producer. Amid persistently low gas prices, however, the firm

has shifted shale drilling to areas blessed with large quantities of liquids—a strategy that has offered little

redemption for fellow struggler, Royal Dutch Shell.

In the second quarter of 2013 Shellsuffered a US$2.1bn impairment charge relating chiefly to its "liquids-rich"

North American shale assets. The company cited "insights from exploration and appraisal drilling results" and in

September announced it would divest over 100,000 acres of land in the Eagle Ford formation in Texas and

600,000 acres in the Mississippi Lime formation in Kansas.

Other companies—Anglo-Australian miner BHP Billiton, the US’s

Chesapeake Energy and EnCana, a Canadian company, for instance

—have slashed billions of US dollars from the book value of their

natural-gas properties. But Shell’s write-down of tight-oil acreage is

unusual. Whether this is a signal, as some argue, that the US oil

boom is overhyped, it is too soon to tell. What is clearer is that Shell

paid dearly for unexplored land at the peak ofshale mania.

The pioneers began work in Texan shale in earnest in the early

2000s, years before Shell bought land in the Barnett Shale field near

Fort Worth in 2006. It did not move into the Eagle Ford formation

until 2010, when Exxon acquired XTO Energy—just before gas

prices plummeted. Producers that arrived before the frenzy of

activity inflated land prices, in contrast, are able to break even at

much lower gas prices. Illustrating this, Petrohawk Energy, one of
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the first to invest in Eagle Ford, paid as little as US$175/acre for land there. But when BHP Billiton acquired

Petrohawk in 2011, the company’s Eagle Ford assets were valued at US$11,400/acre.

Not only did the later wave of drillers pay higher prices; they often seem to have bought lower quality properties.

Shale formations have sweet spots that are rich in valuable crude oil and other condensates. In many areas, the

early entrants had already hoovered these up before the supermajors arrived. Smaller players have also

withstood low gas prices by hedging forward production.

Evidence suggests that these companies have an edge in another department: innovation. A recent report on

shale drilling productivity in the US, by the US Energy Information Administration (EIA), found companies

generally require ever fewer rigs to produce more oil and gas. But it is smaller players that are driving efficiency

improvements.

Supermajors excel at financing and executing megaprojects, often in hard-to-access locations. In conventional

oilfields, companies typically drill a handful of wells in a massive reservoir, after which, hopefully, oil gushes forth.

But operating in shale requires a very different approach. Companies must drill a plethora ofsmall wells to

unlock oil and gas from the dense rock. Moreover, successfulshale drillers adapt their well designs to the rock

they are trying to penetrate, thus cutting costs and optimising output. Large, centralised companies seem less

adept at this so far—though Shell and Exxon, in their defence, might argue they have had less practice than

smaller peers.

Not so super

France’s Total, another company considered a supermajor, has also encountered reversals in its US shale

drilling. But some big groups are faring better. Among these, Chevron and ConocoPhillips stand out.

True, in terms of production growth in oil, the more lucrative

hydrocarbon, they too lag smaller, agile operators such as the US’s

EOG Resources and Chesapeake Energy. ConocoPhillips managed

to boost US oil production by 12m barrels in 2012, but

Chesapeake’s and EOG’s output surged by 17m and 22m barrels

respectively. Chevron posted one of the largest production declines;

Exxon and BP also did badly. Judged on production replacement

rates, meanwhile, independents are outperforming their bigger

cousins, with Chesapeake raising its by nearly 800% and EOG

improving by more than 500% last year, according to a study by

Ernst & Young, an accounting firm. (A value higher than 100%

means a company has more gas to extract at the end of a given year

of production than it had at the beginning.)

Still, Chevron and ConocoPhillips lead the pack when it comes to

total US oil production. BP had the third-highest output in 2012, but was the only supermajor that failed to

replace its reserves. Lagging behind were Exxon and Shell: the latter did not manage to pass the 100m-barrel

mark. These two also trailed Chevron, BP and ConocoPhillips when ranked by post-tax profits in the US.

Cutting losses
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US shale-oilresources offer one of the world’s biggest potentialsources of growth in hydrocarbons production.

So far as gas is concerned, the current glut will ease as pipeline infrastructure catches up, while The Economist

Intelligence Unit forecasts Henry Hub prices will climb somewhat, ahead of the launch of US gas shipments in

2015. Nonetheless, they willremain low by historicalstandards.

To capitalise on its vast shale assets, Exxon is concentrating its efforts on those bearing crude oil and other

condensates. Yet the success of the strategy will depend on the richness of Exxon’s land in heavier and more

valuable liquids—hard to judge without further exploration. For its part, Shell is not abandoning its US shale

ambitions entirely, but does plan to halve the number of North American regions where it has onshore

operations. The company may well be wise to pare back its US assets and focus on what Big Oil does best:

drilling big oil and gas fields.

Source: Industry Briefing