On Tuesday, I highlighted three dangerous myths about the U.S. natural gas industry and the truth behind America’s much-documented abundance of shale.
Indeed, while the masses are busy touting shale as a nailed-on winner, several massive energy companies have actually lost money on shale plays – and have simply walked away from their operations…
It’s like arriving at a hyped-up party and having an awful time.
Once these companies got their boots on the ground, they realized that their shale plays weren’t actually as good as they thought. There was less oil and gas in the ground – and it was economically impractical to extract.
But their losses will be someone else’s gain. And we can take full advantage.
You see, there are only three types of companies that will end up winning the shale revolution. And we’re going through each of them today…
Revolution Winner #1: Bargain Buyers
The biggest mistake that many shale-seekers made was that they simply paid too much for the land. Conversely, the winners in the shale revolution will be those companies that acquire land on the cheap.
It’s critical to amass the right property – at the right price – because it takes many wells to produce commercially viable quantities of shale oil, versus conventional oil. For example, it will take 2,500 new wells per year to sustain just one million barrels of oil per day in the Bakken region.
Well, these shale wells tend to deplete much faster than previously thought, with production of economically recoverable oil falling by 60% to 70% after the first year. And that comes at a cost between $60 and $80 per barrel. For the sake of comparison, Iraq could produce the same million barrels from 60 wells at a cost of less than $30 per barrel.
Revolution Winner #2: Balance Sheet Behemoths
It sounds obvious, but the second type of winner will be companies that not only have their costs in order, but are also growing revenue and profits.
Many drillers that lose money getting oil and gas out of the ground are simply absorbing these losses. That’s because costs for early startup, land acquisition, energy, labor and equipment are fiercely high at the early stages.
Some estimates peg startup costs at $1.50 for every $1 in revenue.
See the problem? That business model isn’t going to last long. And it’s playing out in the profits for some of the bigger players.
For example, Pioneer Natural Resources (PXD), one of the premier companies that got into the shale business early, has produced record amounts of oil and has shown massive revenue growth. In 2012, it notched $3.2 billion in revenue. In 2013, that number jumped to $3.7 billion. But operating income fell, largely due to the huge capital investments.
It will likely recoup those costs going forward, but it’s a stark reminder that the costs for finding unconventional, hard-to-get oil are very high. If they weren’t, Alaska would have shut its doors years ago.
Revolution Winner #3: Diversifiers
The third type of winning company is able to change its mix of oil, gas and natural gas liquids.
Chesapeake Energy (CHK), the second-largest natural gas producer in the United States, is one of them. For example, while the company is known for its gas holdings, the money it makes comes primarily from oil and natural gas liquids. And it’s fortunate to own some of the lowest-cost, highest-producing land in the Marcellus Shale.
EOG Resources (EOG) is another clear winner, and its shares are trading at close to 52-week highs – a much better performance than its rival producers.
The company is succeeding thanks to a vertically integrated model that uses its in-house fracking technology. This is producing superior returns from its wells, in addition to more efficient transportation methods. It’s also focusing on producing more oil and less natural gas products, which has resulted in higher margins.
Bottom line: Not all shale plays and shale-producing regions are built the same. Be sure to remember that as you build out your portfolio in the sector.
And “the chase” continues,