The Top Unconventional Gas Play

07/29/2011 12:30 pm EST


Eoin Treacy

Global Strategist,

We’re getting to a point where traditional valuations for natural-gas companies aren’t able to keep up with new extraction methods, notes Eoin Treacy of Fullermoney.

This report by Allen Brooks for PPHB covering the US energy sector has a section on the economics of unconventional gas drilling:

"In conventional gas projects, significant upfront investments are made to tap into the whole of the interconnected gas reservoir at once, applying a tailor-made and optimized field development strategy. The present value of conventional gas fields is continually maximized by applying a rigorous value assurance review (VAR) system, using pre-determined decision gate-stages as part of the company’s auditable records.

"As a result of the established VAR process, cash flows of traditional or conventional gas projects invariably perform adequately. In contrast, field development plans for unconventional gas operators are highly susceptible to economic pressures.

"The traditional VAR process does not provide a guarantee for profitable unconventional gas operations. A fundamental handicap for unconventional gas development projects is that optimized well development and maximization of net present value are marred by much higher subsurface uncertainty.

“There is no gas interconnectivity between wells in unconventional reservoirs and the lack of gas communication means appraisal well data give very limited information over the rest of the acreage under leasehold or licensed. High variations in reservoir quality cannot be excluded by initial appraisal wells.

“Sweet spots only emerge gradually and after considerable expenditure has been made while the drilling of new wells advances to cover the acreage acquired. The initial risk in new unconventional gas plays is therefore very large. Opting out also remains a hard decision throughout the field’s development as that would mean deferred losses are moved closer to recognition."

We have maintained that shale gas is a game changer for the energy sector for quite some time. The reasons for this include its availability, security, proximity to major markets, low carbon emission credentials, and price.

The development of shale gas reserves in the US is happening in tandem with a global boom in the development of liquefied natural gas terminals. However, identifying the best way to profit from this theme is complicated by the fact that the prolific initial supply associated with unconventional shale gas wells has helped to depress prices.

Leading shale gas drillers have generally lagged mid-tier oil companies, but this is beginning to change. At least part of the reason for this is that they are increasingly moving towards exploiting shale oil reserves. The strong bullish commonality in the sector reflects heightened investor interest.

Anadarko Petroleum (APC) remains a leader, found support in the region of the 200-day MA a month ago, and has returned to test the April peak. While somewhat overbought in the very short-term, a sustained move below $70 would be required to begin to question medium-term upside potential.

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