U.S. Shale Bubble Inflates After Near-Record Prices for Untested Fields
Surging prices for oil and natural- gas shales, in at least one case rising 10-fold in five weeks, are raising concern of a bubble as valuations of drilling acreage approach the peak set before the collapse of Lehman Brothers Holdings Inc.
Chinese, French and Japanese energy explorers committed more than $8 billion in the past two weeks to shale-rock formations from Pennsylvania to Texas after 2011 set records for international average crude prices and U.S. gas demand. As competition among buyers intensifies, overseas investors are paying top dollar for fields where too few wells have been drilled to assess potential production, said Sven Del Pozzo, a senior equity analyst at IHS Inc. (IHS)
Marubeni Corp. (8002), the Japanese commodity trader, last week agreed to pay as much as $25,000 an acre for a stake in Hunt Oil Co.’s Eagle Ford shale property in Texas. The price, which includes future drilling costs, exceeds the $21,000 an acre Marathon Oil Corp. (MRO) paid last year for nearby prospects owned by KKR & Co. (KKR)’s Hilcorp Resources Holdings LP. In the Utica shale of Ohio and Pennsylvania, deal prices jumped 10-fold in five weeks to almost $15,000 an acre, according to IHS figures.
“I don’t feel confident that the prices being paid now are justified,” Del Pozzo said in a telephone interview from Norwalk, Connecticut. “I’m wary.”
Vast New Resources
The world’s largest energy producers, including Exxon Mobil Corp. (XOM) and Royal Dutch Shell Plc (RDSA), are revisiting onshore U.S. prospects passed over in recent decades in favor of deep-water finds in West Africa and the Gulf of Mexico. New drilling techniques developed in the Barnett shale of north Texas have enabled companies to crack previously-impervious formations.
Overseas explorers such as China Petrochemical Corp. and Total SA (FP) want to learn from U.S. partners so they can exploit vast shale resources in Europe and Asia, said Mark Hanson, an analyst at Morningstar LLC in Chicago.
The U.S. holds an estimated 2,543 trillion cubic feet of gas, enough to meet domestic demand for more than a century at current rates of consumption, according to the Energy Department in Washington. Shale accounts for 862 trillion of that total, or 34 percent. In China, shale formations hold an estimated 1,275 trillion cubic feet of gas, 12 times as much as the nation’s so- called conventional fields.
Buying to Continue
The buying spree is likely to continue because international oil producers are eager to amass reserves in the U.S., which surpassed Russia in 2010 as the world’s largest source of gas, said Christian O’Neill, an analyst at Bloomberg Industries in Princeton, New Jersey.
Oil production also has blossomed in the world’s largest economy, rising to a 9-year high of 5.78 million barrels a day in October, the most recent month for which the Energy Department in Washington has figures.
Hunt, the closely held Dallas company founded by Texas tycoon H.L. Hunt in 1934, has only drilled “a handful” of wells in its Eagle Ford shale acreage, which means it doesn’t yet know how extensive or rich those holdings are, Del Pozzo said. Similarly, because drilling in the Utica shale still is in its infancy, the geological characteristics and potential bounty of the region are hard to assess, said Manuj Nikhanj, head of energy research at ITG Investment Research Inc.
“The big risk is that people are jumping in with both feet too early,” Nikhanj said in a telephone interview from Calgary. “Of course, the other side of that is that if they wait, they risk missing out on what could turn out to be a big deal.”
Private-equity firms also are showing increasing interest in US shale assets, Sylvester “Chip” Johnson, chief executive officer of Carrizo Oil & Gas Inc. (CRZO), said in a Jan. 4 presentation at a Pritchard Capital conference in San Francisco.
Carizzo, based in Houston, has been selling fields in some of its first shale plays, such as the Barnett region, to raise money for drilling higher-profit Utica and Eagle Ford prospects that contain oil, he said.
Chesapeake sold $750 million preferred shares last month in a subsidiary created to finance development of its Utica shale holdings. The transaction entitles Magnetar Capital, Blackstone Group’s GSO Capital Partners LP and an investment group that includes EIG Global Energy Partners LP to 7 percent annual distributions and a 3 percent overriding royalty interest in the first 1,500 wells.
Buyers are studying fields more closely before committing, Nikhanj said. Total, Europe’s third-largest oil producer by market value, was selective about what sections of the Utica shale will be included in the 25 percent stake it acquired on Dec. 30 in 619,000 acres controlled by Chesapeake Energy Corp. (CHK) and EnerVest Ltd.
Total’s outlay, including drilling costs, will be $2.32 billion, or the equivalent to about $15,000 an acre, based on Bloomberg calculations. That’s more than four times the average per-acre price from seven Utica shale transactions tracked by IHS from March 2011 to September 2011.
“We are seeing prices move up quite dramatically in these exploratory shale plays,” Nikhanj said. “But the Total joint venture also shows us that these companies with deep pockets are doing more science” before signing deals.
The quirky nature of shale geology means the risks are high that an investment made in a sparsely drilled prospect will go bust, Nikhanj said. Rock density, porosity and pressure levels vary widely within each field, which means one parcel may hold enough fuel to justify prices of $30,000 or $50,000 an acre, while the adjacent land is almost worthless to drillers.
Brent oil futures, the London-traded benchmark for two- thirds of the world’s crude, jumped 26 percent to an average of $110.91 a barrel in 2011, the highest on record, spurred by supply disruptions in North Africa and escalating worldwide demand for fuels to run trains, airplanes and trucks.
As long as crude commands such lofty prices, explorers will continue to seek out geologic formations soaked in oil and gas components such as propane, Dan McSpirit, a Denver-based analyst for BMO Capital Markets, said in a telephone interview.
China Petrochemical, the Beijing-based crude producer known as Sinopec (600028) Group, and Total expect to glean expertise from their U.S. partners in the horizontal drilling and high-pressure water injection necessary to extract oil and gas from shale, said Hanson, the Morningstar analyst. Ultimately, the know-how will be transferred to virgin shale prospects in Europe, Asia and Latin America, he said.
‘Massive Land Grab’
U.S. gas explorers including Chesapeake and Devon Energy Corp. (DVN) are selling interests in shale fields to international energy companies such as Total and Sinopec to finance drilling on leases acquired during a “massive land grab” in 2007 and 2008 as oil and gas prices soared to record highs, O’Neill of Bloomberg Industries said.
The plunge in energy prices that followed Lehman’s bankruptcy and subsequent global financial crisis left operators like Chesapeake too poor to fulfill clauses that set deadlines for finishing wells on pain of forfeiting the leases, O’Neill said.
“These deals give the domestic exploration companies capital to drill so they won’t lose those assets, and gives the foreign companies the learning process they’re going to need to exploit shale resources on their own,” O’Neill said.
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