Fracking in the Land Down Under
But many investors naturally wonder where the revolution may be headed next, whether there are investment opportunities outside the US, and if so which companies may benefit.
Let’s look at where the world’s shale reserves are located, but first let’s review some terminology:
Oil resource – the total amount of oil in place, most of which typically can’t be recovered.
Oil reserve – the amount of oil that can be recovered economically with existing technology.
Tight oil – liquid hydrocarbons that are obtained by hydraulic fracturing of shale formations (e.g., Bakken Formation and Eagle Ford Formation).
Oil shale – sedimentary rock that contains solid hydrocarbons called kerogen (e.g., Green River Formation).
Shale oil – the oil that can be obtained by cooking kerogen, but also frequently used interchangeably with the term “tight oil.”
Hydraulic fracturing – the fracturing of a resource-bearing rock, typically with high-pressure liquid. Commonly known as “fracking.”
Horizontal drilling – the practice of drilling an oil well horizontal to a resource-bearing formation to access a greater fraction of the formation.
Fracking revolution — the result of the application of hydraulic fracturing to horizontally-drilled wells, which greatly boosted US oil and gas production. Also called the shale oil revolution or the shale oil boom.
The colloquial use of the phrase “shale oil” has led to occasional confusion as some pundits have incorrectly presumed that the 1.4 trillion or so barrels of oil shale resource in the Green River Formation would be accessible by the fracking techniques that turned North Dakota’s oil resources into oil reserves. But as we scour the world for future beneficiaries of the “shale oil revolution,” it’s important not to confuse a country’s oil shale resource with the country’s tight oil resource. The fracking revolution has rendered vast amounts of tight oil and gas economical, but profitable production of oil shale remains elusive.
The US government has attempted to assess the world’s shale oil and gas formations. There are a number of considerations for whether we can forecast a tight oil boom for a particular country, but the most obvious is that there has to be enough oil to make the effort worthwhile.
The following figures collected by the US Energy Information Administration (EIA) point to a likely list of candidates for a future tight oil boom:
Top 10 countries with technically recoverable shale oil resources. Source: EIA.
The US and China are in the top four for both shale oil and shale gas reserves, while Libya, Venezuela, and Pakistan made the top 10 for shale oil, but are replaced in the top 10 for shale gas reserves by Algeria, South Africa, and Brazil:
Top 10 countries with technically recoverable shale gas resources. Source: EIA
It may be surprising that there are no European countries on either list, especially given that some of them are aggressively attempting to develop their tight oil and gas reserves. But one of the factors that will drive future tight oil development is the diversity of economical energy options for a particular country. Countries that are highly dependent on Russian natural gas will have much more incentive to develop their tight oil and gas than countries that have ample conventional energy supplies.France has the largest estimate of technically recoverable tight oil in Europe at 4.5 billion barrels, although it’s banned hydraulic fracturing. Poland and the Netherlands are second and third in Europe, respectively, and both countries are working to develop their resources. Poland is also estimated to have Europe’s largest technically recoverable shale gas resource at 148 trillion cubic feet, and last year reported the successful recovery of shale gas from a test well.
Lux Research, a firm that provides strategic advice and ongoing intelligence for emerging technologies, recently published an assessment of shale gas and tight oil opportunities outside of North America. It put Australia at the forefront of the next wave of development as a result of “existing infrastructure, low population density in resource-rich regions, and a welcoming government position.” China and Argentina were also viewed as countries with enormous potential, but with somewhat greater challenges than Australia faces.
Australia’s 2012 natural gas production was 4.7 billion cubic feet (bcf) per day, an increase of 50 percent over the past 10 years. (For reference, 2012 US natural gas output was 66 bcf/d). Thus far Australia’s growing output of natural gas has been largely due to coal seam gas (CSG). CSG can be extracted like shale gas in the US, with hydraulic fracturing of a coal seam (as opposed to a shale formation). Unlike the US, Australia produces nearly twice as much natural gas as it consumes. This has driven a great deal of investment in infrastructure so Australia can export liquefied natural gas (LNG) to meet growing demand in Southeast Asia.
Australia has three operating LNG plants, and seven others are being built. The North West Shelf Venture is owned by an international consortium, and started exporting LNG in 1989. ConocoPhillips (NYSE: COP) is the majority owner and operator of the Darwin LNG facility, which began production in 2006. The Pluto LNG project started production in April 2012 and is primarily owned by Woodside Petroleum (ASX: WPL), the operator, with a 90 percent interest.
The bulk of Australia’s shale oil and gas is located in Western Australia, an area with a population density less than half of Wyoming’s. While Victoria in Southeastern Australia has banned fracking until at least mid-2015, and there is some vocal opposition in Western Australia, comments from Western Australian government officials have been viewed as a positive sign for developing the state’s shale resources.
Kip Ferguson, Executive VP of Exploration for Magnum Hunter Resources (NYSE: MHR) recently told Bloomberg that Australia would be the next big thing in the fracking revolution:
“We’ve looked at Colombia, we’ve looked at Mexico, we’ve looked at Argentina, we’ve looked at Poland, and we’ve looked at China of course. None of those areas are prepared to allow the unconventional technologies to develop these plays. They aren’t as far advanced as Australia.”
MHR is joining Australia-based New Standard Energy (ASX: NSE) to develop the Cooper Basin in Australia. Santos (ASX: STO), Drillsearch Energy (ASX:DLS), Senex Energy (ASX: SXY), and Beach Energy (ASX: BPT) are other Australian companies active in developing the Cooper Basin’s shale resources. ConocoPhillips has also partnered with New Standard Energy on a shale exploration program in Western Australia.But there are skeptics that any country can come close to repeating the US shale revolution. Leonardo Maugeri, a former executive at Italian oil giant ENI (NYSE: E), is currently at the Harvard Kennedy School’s Belfer Center for Science and International Affairs. Last June Maugeri published The Shale Oil Boom: A U.S. Phenomenon, in which he forecast that US shale oil production could triple by 2017.
But in the paper he provided a warning, which also signals an opportunity:
The central role played by drilling intensity in this early stage of shale oil and gas development has a crucial but almost unnoticed implication for the possibility of replicating the success of the American experience in other parts of the world. The United States concentrates in its territory 60 percent of the global availability of drilling rigs; moreover, 95 percent of US drilling rigs can perform horizontal drilling that together with hydraulic fracturing or “fracking” is required to liberate shale resources.
Combined with a relatively low population density in several shale areas, this vast supply is a key factor that allows the United States to achieve a drilling intensity level that is impossible for other countries to achieve. No other country in the world has ever experienced even a fraction of the overall US drilling intensity, a common feature of the US oil and gas industry since its inception. In 2012, for example, the United States completed 45,468 oil and gas wells (and brought online 28,354 of them) as against 3,921 wells completed in the rest of the world, except Canada. The drilling-intense nature of the shale business is a factor that will make the expansion of the shale phenomenon in other parts of the world improbable — at least in this decade.
Maugeri’s point is that there aren’t enough available drilling rigs to make the shale revolution a global phenomenon. While parts of Australia do have the low population density that has helped enable the shale boom in places like Texas and North Dakota, drilling rigs are the key bottleneck that will need to be addressed. Infrastructure will also need to be built.
Staying with the theme of Australian oil and gas companies, Santos and Woodside both have multi-billion market caps, and pay dividends (2.1 percent and 4.1 percent respectively). Both companies have operations primarily in Australia, but are well-diversified outside of the tight oil and gas space.
Alternatively, one could consider Magnum Hunter, which has lots of stock-market momentum and perhaps decent upside based solely on the valuation of its US assets. Success in Australia would be enough to move the earnings needle, but the company is well-diversified in the Marcellus, Utica and Williston Basin shale plays in the US.
The least risky strategy would be to own shares in a large oil and gas company that is pursuing opportunities in Australia. Conservative Portfolio holding Chevron (NYSE: CVX) has multiple interests in Australia, including the massive Gorgon LNG project. Gorgon will benefit from expansion of natural gas production in the country (whether shale gas, coal seam gas, or conventional gas), while Chevron’s 2013 investment in Beach Energy Limited was a direct investment in Australia’s shale gas industry.
Another option besides Chevron — with a risk/reward profile somewhere between Chevron’s and Magnum Hunter’s — would be ConocoPhillips. Like Chevron, ConocoPhillips has substantial investments in LNG, but is also testing the shale opportunity in Australia. At about a third the size of Chevron, and less diversified after spinning off its refining assets into Phillips 66 (NYSE: PSX), COP’s Australian shale investments have the potential to make more of a difference than in the case of Chevron.We will also be keeping a close eye on the companies that will build the infrastructure required to handle a shale boom in Australia. As we have seen in the US, there will be many opportunities for midstream companies as shale oil and gas production expands. We will also continue to closely scrutinize oilfield services suppliers Growth Portfolio Best Buy Schlumberger (NYSE: SLB), which does most of its business outside of North America and is perhaps best-placed to export the advanced drilling techniques pioneered in the US around the globe.
It is too early to tell whether an international shale boom would entail a big increase in the number of drilling rigs, or whether the shale boom outside the US will have to wait until the domestic boom dies down and frees up drilling rigs. As drilling in Australia is much more expensive than in the US, it will really come down to the price of oil. If the price of Brent crude over the remainder of the decade is $90-$100 per barrel (bbl), shale development outside the US will likely continue at a slow pace. Brent crude at $150/bbl, on the other hand, would have companies building new drilling rigs as quickly as possible.
In any case, developments in Australia’s oil and gas industry will continue to be closely monitored here at The Energy Strategist. Australia looks like the next destination for the fracking revolution, and it appears to be the country that offers the greatest potential rewards for investors. The only question is one of timing, and we’ll be on the lookout for timely opportunities.
Stock Talk
James Hanshaw
There has been a lot of excitement about the Cooper Basin. I have heard little about its distance from the markets and coasts for exporting. The infrastructure required, as I understand it, is virtually non existent and would take years and cost billions to build. I am not an expert on this and would welcome information from someone who might have researched this before I invest.
Robert Rapier
The infrastructure situation in the Cooper Basin is supposed to be pretty good. In Western Australia I think it’s lacking, but the Cooper Basin is in decent shape. Certainly more infrastructure will be required, but the hydrocarbons are much closer to population centers than with the hydrocarbons in Western Australia.
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Don Wallace
Where can I find the MLP’s that are directly, and indirectly, associated with the Keystone XL Pipeline?
Robert Rapier
Don, you will probably have a hard time finding that. The companies most immediately impacted are Canadian companies like TransCanada (for obvious reasons) and Alberta’s heavy oil producers. If the pipeline is rejected, then Kinder Morgan Energy Partners’ Trans Mountain pipeline expansion project would likely benefit as an alternative route out, and then TransCanada is hedging their bets with their Energy East pipeline project that would move crude oil from Alberta to Quebec and New Brunswick.
There may be some benefit for Bakken oil producers that are able to utilize Keystone XL, but some of them have signaled lately that they are perfectly happy to continue using rail.
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