Shell Creating Value In International Shale Plays - Is Colombia The Answer?

Aug.10.12 | About: Royal Dutch (RDS.B)

Shell (NYSE:RDS.B) has, as most other super majors have been, late to the shale oil and tight gas game. To my knowledge, I do not think any one of the North American shale oil or tight gas plays was discovered by a major. Over the last few years, the majors have recognized that they need to be involved in the shale business.

The majors have acquired and farmed into a large number of shale assets in North America. Shell, together with other majors, paid rich prices to get a part of the shale play. These shale plays were initially created by entrepreneurial oil and gas companies. Since the success of the shale development in North America, the oil companies have started to look for shale plays outside North America. The development of these shale plays are still at an early stage. The majors may have been late to the North American shale party.

The majors may be the companies who will be unlocking the international shale plays. Oil major is a better chance of being in the forefront when it comes to the international shale plays for several reasons. First, very few of the US and Canadian E&P who unlocked the North American shale plays have any overseas operation. They seem to think it is complicated to build up such an operation. Secondly, the majors have a significant advantage in terms of geology databases overseas compared to smaller companies, and this makes a substantial difference. This is because, in the US, most of the geological and well data is public information, while in most other oil and gas countries, such information is private. The integrated oil companies have a significant advantage by using their large geological databases which independent E&P cannot access.

Shell's shale oil and tight gas portfolio consisting of 12 million acres can be divided into two baskets, namely the mature North American portfolio and the non-North American portfolio, consisting of an asset where the commerciality is yet to be proven. The North American portfolio consists of assets in the Eagle Ford, Wolfcamp, Haynesville, Monterey, Niobrara, Bakken, Montney, Canol, Goundbirch, Deep Basin, Foothills, Pinedale, Utica, Marcellus, and Mississippi Lime. The International portfolio consists of shale plays in Argentina, China, Colombia, Egypt, Germany, Oman, Turkey, and Ukraine.

The next leg of value creation for Shell in its unconventional portfolio will, most likely, be to covert one of the international shale plays to a commercial producing asset. If Shell is successful, it could create significant value for Shell shareholders. It is still difficult to conclude which of the international shale plays will work.

The success of a shale play is dependent on several factors; the main factors are the following. 1. Geology supporting a shale development. 2. Established oil service industry which can provide drilling, completion, and fracturing services at a competitive rate. 3. Energy infrastructure can be used to process and transport the oil and gas. 4. Government support for shale development. 5. Incentives for the land owner to let the oil companies explore and produce oil and gas. 6. Support from the local population.

All these factors are present in the United States, where shale development has been successful. Few of the countries which have promising geology for shale development can support all the preconditions on the list. In the table below, I have summarized which precondition the different countries, Shell has shale assets in can support. Based on this, Colombia seems to be one of the countries where Shell's shale project may be more likely to become commercial.

Colombia's Unconventional and the Middle Magdalena shale plays

Colombia has over the last year come up as one of the countries which may be suitable for shale oil and tight gas development. The reasons why the country may be particularly suitable for shale development include the following:

  • The La Luna/Simiti formation in the Middle Magdalena basin shares remarkably similar geological characteristics to the Eagle Ford shale, and historical drilling in the La Luna/Simiti shale has produced a significant amount of oil and gas.
  • Colombia has a well-established oil industry with pipeline and process infrastructure in place.
  • Many of the oil service companies supporting the US shale industry (Weatherford, Halliburton (NYSE:HAL), and Schlumberger (NYSE:SLB), etc.) have a significant presence already in the country.
  • The Colombian Government is tremendously supportive to a potential shale development and has reduced the royalty rate. With up to 80% for unconventional development and the already attractive fiscal terms, Colombia will have some of the most attractive fiscal terms for shale development.

The Middle Magdalena basin spans south to north from the foothills of the Andes along the Magdalena River valley. The basin covers approximately 32000 km2 of land. The first oil in the Middle Magdalena Basin was found in 1918 on the Valle Magdalena Cira-Infantas block. The Cira-Infantas block has been the block in Colombia which has the highest accumulated oil production until today, approximately 1bn barrels. Most of the oil in the basin originates from the La Luna and Simiti source rock.

The productivity of the La Luna and Simiti shale were confirmed by a small E&P company, Global Energy Development, which drilled four wells on their Bolivar block in 1997-1999. These wells were not intended to test a potential shale play at the time, but the company still managed to achieve significant flow rates. The two most successful wells, Catalina-1 and Olivo-1, had initial flow rates of approximately 10,000 barrels of oil equivalent per day, respectively 5,000 barrels of oil per day. The decline rate was exceedingly steep as the wells were not fractured at the time. Both wells produced over 600k barrels without any fracture stimulation. These wells indicate that the La Luna and Simiti shale may be as productive as some of the most productive US shale plays.

Shell's Colombian Position

Shell entered the Middle Magdalena shale plays as one of the first companies in June 2010 when they were awarded the VMM-27 block. The block is located in the northwest part of the Middle Magdalena basin. In 2011, Shell announced that it had farmed into VMM-28 block from the private company PetroLatina. The block is located next to VMM-27 block in the same shale play. Finally, in 2011, Shell bought a 50% stake in the VMM-3 block, which is located immediately to the east of the VMM-28 and VMM-27 blocks. Shell net land position in these three blocks is 327k acres. Before Shell entered the shale play, they were able to view Global Energy Development data room, covering the previous successful wells on their Bolivar block. Shell three blocks is located only 5-10 km to the southeast from the Bolivar block, which should significantly improve Shell chances.

Since Shell announced its land position in the Middle Magdalena shale play, other majors and E&P have showed significant interest for the area. In April, Exxon (NYSE:XOM) announced that they had farmed into the VMM-2 block immediately to the south of the Bolivar block and to the north of Shell VMM-3 block. Exxon's interest in this part of the shale play is significant because Exxon was the previous operator of the Bolivar block. At the time, the block covered a much greater land area including the current Bolivar block and VMM-2, and part of other block, as well. Consequently, Exxon has knowledge about the block as they was the previous operator of it and drilled a number of wells on the block 20-40 years ago.

If Shell Middle Magdalena block turns out to be as prolific as the drilling result from the late 90s on the Bolivar block indicated, this area could become a new Eagle Ford. Shell's large land position of 327k net acres could quickly become a billion dollar business if the land price reaches $20-30k/acres. This would become an essential part of Shell's unconventional portfolio. Shell is planning to drill three wells in the play in the second half of 2012.

Shell may also increase their land position as they have prequalified to take part in the Colombian 2012 license round. A number of blocks in the in the Middle Magdalena shale play will be auctioned in this licensing round. The competition in this auction round may become much stiffer compared to when Shell secured its first shale blocks, as a number of oil majors and large E&P will take part. The following companies have prequalified: Chevron (NYSE:CVX), ConocoPhillips (NYSE:COP), Exxon , EOG Resources (NYSE:EOG), Noble Energy (NYSE:NBL), Anadarko (NYSE:APC), Southwestern Energy (NYSE:SWN), and Plains Exploration & Production (NYSE:PXP).

Exxon is planning to drill two wells on their VMM-2 block in the second half of 2012. If the result of these wells is positive, it should be highly supportive for Shell assets. The Government-controlled oil company Ecopetrol has already drilled one well testing the shale. The well was drilled in a block, to the south of Shell's block. Ecopetrol has not yet announced the result of this well. Ecopetrol is currently the largest land owner in the Middle Magdalena basin. Ecopetrol is targeting to be producing 25k barrels of oil per day from the shale by 2015.

Conclusion

Shale oil and tight gas has over the resent year generated significant amount of shareholder value to investors in E&P companies but less to the integrated oil companies including Shell. I think Shell will, over the next few years, create significant value to its shareholders through its early positioning in international shale plays. The Colombian Middle Magdalena shale play looks very promising for Shell, and the company seems to have grabbed some of the best part of it. I suggest you buy Shell because international shale development could add value to the stock price. Smaller E&P companies managing to get a strong position in the Middle Magdalena shale play may also be interesting.

Disclosure: I am long RDS.B, NBL.