Impact Of U.S. Oil And Gas Shale Revolutions Wide-Reaching

Includes: APA, BP, HAL, OXY
by: Jennifer Warren


The respective shale oil and gas revolutions are long-lived and in the beginning stages.

The midstream space is expected to be an area of increasing capital flows within the industry.

Innovation in the exploitation, transportation and efficient use of natural gas and oil are investment themes intersecting all players on the supply and demand side.

Firms involved in deep-water and unconventional exploration and production could be early movers as Mexico opens its oil and gas industry to outside firms.

The Texas Energy Council held its annual symposium on Thursday, March 6th, at the Bush Presidential Library. The panel topics, panelists and oil and gas expertise presented offered an array of perspectives that is hard to find in one room in one day. A number of the panelists had recently attended the well-known IHS Cera conference in Houston. Undoubtedly, expected themes emerged, such as keeping regulation right-sized and with the states, the move toward using natural gas rather than diesel (or in combination) in drilling and production, and the industry's need to communicate its value and contributions in a more compelling way. The following note, while not exhaustive, provides a modicum of developments on the minds of those invested in energy on this day.


The symposium was kicked off with the former energy minister of Mexico and former president of Pemex, the Honorable Jordy Herrera Flores. He noted that Mexico currently has conventional oil reserves with 100% replacement rates, and has been producing 2.5 million barrels per day for the fourth year in a row. Net natural gas imports in Mexico are about 1.4 bcf p/d, and will likely double. And Texas producers are a big part of its import story now and in the future. Mexico is also importing about 400,000 b/d of gasoline. The key for Mexico as it opens up to oil and gas firms is its vital need for capacity to transform itself into a country that is increasingly energy-independent. They desperately need the infrastructure and expertise to deliver on their goals. Mr. Flores said that this is Mexico's last chance for economic growth and that Texas oil and gas expertise was a key to its future.

The new legislation that reforms Mexico's energy industry is a work in progress, according to those with knowledge of developments. What caught my attention was that the biggest opportunities for private firms would initially be deep-water and unconventional exploration and production. The reforms of 2013 allowed for public-private partnerships in upstream, midstream, downstream and power generation. It was noted, however, that there are still a number of laws that must be passed yet this year to facilitate these developments. Another panelist later mentioned that security would be an issue in Mexico - in practice, it would be similar to operating in Iraq with a security team and insurance costs. This will be expensive.

Additionally, Mexico has considerable gas reserves, in the 200-400 tcf range according to Mr. Flores. And yet in spite of the supply, Mexico needs to build pipelines, refineries and petrochemicals plants. This is why the Mexican government wants and needs to open up. They cannot do it with their own capital, labor resources and infrastructure. (Note there will be local content rules applying to using local labor.) They are, in effect, trying to leverage their neighbor, which is a good strategy. Investors should weigh the risks inherent in the Mexico play carefully. Pay attention to first movers and their ability to navigate and mitigate risks. My takeaway about Mexico is that the government has a very well-conceived plan and ideals. Incidentally, they will set up a sovereign wealth fund, "Fondo Mexicano del Petroleo" to channel funds toward the infrastructure of the country and other social programs.

Policy and regulation

As expected, the oil and gas industry prefers state regulation. The intricate knowledge to regulate the various technical issues of oil and gas production has many moving parts, even more so with the advent of hydraulic fracturing and horizontal drilling that can cover one mile or more underground. The ability to transfer state-by-state knowledge to federal bureaucrats would be a challenge, and one size does not fit all states. In fact, increasingly, foreign investors see the U.S. policy, legal and regulatory bodies as a risk and barrier to entry. To avoid challenges to firms about water quality issues, a lawyer and State Representative mentioned that firms need to inspect the area first, acquiring baseline data, to make sure old wells are not the problem before any new activities are undertaken. Often, the culprit of contamination is old wells that lack the structural integrity of new wells.

A standout panelist was the British Columbia oil and gas commissioner, Paul Jeakins. The province of British Columbia has a proactive public and private mechanism in place to address public quality of life issues before they become a problem. Firms disclose their frac fluids at the Canadian Frac Focus, like the U.S. counterpart. He noted that in British Columbia, from the period of 2007 to 2013, exploration and production shifted from 90% conventional over to 90% unconventional activity. Canada is the third-largest gas producer in the world, with 2,900 tcf in four shale basins.

When the BC watchdog heard about the earthquakes in Texas, they began deciphering the issues. They are addressing public issues in real time to deal with challenges before they become overblown or distorted by various groups that would benefit the few at the expense of the many. They "report on everything" - water quality and supply, compliance reporting, best practices and even which are the most trusted sources of information. (Universities were first, followed by experts, then environmental groups.) These challenges surrounding regulation and public education are areas the industry needs to proactively address.

Another theme that emerged from the morning panels was that North America - the U.S., Canada, and Mexico trifecta - is an energy powerhouse. But currently, the low price of natural gas is problematic and that exports are essential. The supply side isn't the problem - it's the demand side. Interestingly, in spite of Canada's ample gas supply, U.S. Marcellus gas is making its way to Ontario. And we know that Texas natural gas flows to Mexico. These trade dynamics are also testaments to how U.S. shale energy has changed markets. Investors should pay attention to how firms are leveraging their strengths to be flexible when new opportunities arise. Independent E&P, Apache (NYSE:APA) is hedged among the shale oil-gas interplay and across the borders of the U.S. and Canada.

Unconventional becomes conventional

The topic of the shift to unconventional production from conventional methods has repercussions. One panelist that headed the engineering and technology group for a large, private producer noted that over time, firms are losing the skill base of conventional production as the shift towards unconventional practices occurs. He mentioned that the national oil companies (NOCs) understand they need to adapt. In an earlier article on Halliburton (NYSE:HAL), I alluded to this very phenomenon of the great shift taking place. The reason majors and NOCs want to partner with independent firms is to learn how to work the shales, which vary, and apply the learning elsewhere. The global shale resource base is high, and repeatability is key.

The work in the shale basins will be ongoing for a long time, noted a panelist speaking about Texas' impact on the world regarding shale plays. Importantly, three key factors need to be addressed by industry, noted Tom Topolinsky of Hunt Oil: labor and technical skills expertise; water resources issues; and public education. Another panelist from Deloitte's Oil and Gas Group cited that the "harvest phase" is now upon us. Hydrocarbons must be transferred to markets in an economic way, and that this is a development story - not the drilling and purchasing of acreage chapter that has occurred. He mentioned that now midstream capital deployment will be catching up.

• Between 2012 and 2025, IHS projects a cumulative investment of nearly $346 billion across the midstream and downstream energy and energy-related chemicals value chains. Close to $216 million of this will come in the midstream and downstream segments of the unconventional value chain, including 47,000 miles of new or modified pipeline infrastructure. Source: IHS Cera.

The second half of the symposium drilled deeper into operator-specific topics, global shales' prospects, pipelines and other new developments sparked from the unconventionals revolutions. One impression: There is plenty of opportunity for innovative approaches to using resources more efficiently and economically. This means that more disruptive approaches and technologies can change the way oil and gas is exploited, produced and consumed across the many processes. A number of the firms represented in the room were evolving their offerings as the unconventionals activity continues into new phases and entrepreneurs have flashes of insight.

Finally, were it not for the numerous independent firms that have paved the way for this energy event of the 21st century, oil prices would be much higher. This message of the costly absence of revolution, one I have been attempting to communicate in various formats, hits the pocketbooks of every American and citizens around the globe. Too bad it is under-appreciated.

Interestingly, natural gas received more discussion time than shale oil, though they shared many common themes. A primary message was that the industry needs to be proactive in educating the public in order to sustain the momentum of the energy transformation underway. The investment opportunities in the entire oil and gas value chain are countless. While a number of majors and independents, such as BP, Occidental Petroleum (NYSE:OXY) and Apache are divesting assets to streamline their operations, find focus in this new unconventional order, and rationalize capital, investors need to find the spaces where they are most comfortable and keep their risk tolerances in mind.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.