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Oil&Gas Financial Journal

How shale tilts the scale

How shale tilts the scale

As shale gas changes the dynamics of the energy sector, it is changing the assumptions that underlie traditional investment strategies.

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How shale tilts the scale
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This article originally appeared in the October 2012 issue of Oil & Gas Journal.


Until recently, North America depended on imports of natural gas from other regions to meet its demands. But the discovery of vast reserves of gas locked in shale deposits and the relatively low cost of extracting it have created a glut of natural gas in North America and turned the United States and Canada into potential exporters.

The US is looking for ways to absorb this available gas supply into its domestic economy. If power utilities move to replace thermal coal generation of electricity with gas-fired generation—which they may begin to do if current emission constraints are strictly enforced—it could generate substantial demand for gas.

Other opportunities to increase domestic gas usage include promoting natural gas vehicles or gas-to-liquids conversion methods for producing diesel fuel. What's more, if the Department of Energy and the Federal Energy Regulatory Commission (FERC) decide to allow exports of natural gas, it could help raise the price to levels that would boost confidence of energy companies and encourage investment.

In anticipation of this future demand, exploration and production players at the upstream end of the gas value chain face unique challenges that lie directly within their control. They need to adapt their production processes in the short term to deliver shale gas cost-effectively in a saturated market while developing competitive advantage for the longer term. These upstream players can choose from a range of strategic options to improve their positions, including rebalancing their portfolios, expanding across the value chain, partnering with other oil and gas players, and improving their operational skills to reduce costs.

First, winning companies will rebalance their portfolios across several dimensions: geography, the type of gas drilled for (dry versus wet), and the maturity of the assets (producing versus unproven). For example, Shell and Statoil have both recently said they will begin to focus their shale investments on liquids-rich shale that contains higher-value liquids, as a hedge against depressed gas prices.

Energy companies can also expand their position across the value chain. As shale production evolves, regional opportunities are emerging for gas and liquids infrastructure in new supply basins and end-use markets. For example, Chesapeake Energy formed two midstream subsidiaries that acquire and develop midstream assets to support its upstream operations.

Independent oil companies (IOCs) and national oil companies (NOCs), which have traditionally focused on the upstream, midstream, distribution, and marketing portions of the liquid natural gas (LNG) value chain, are looking at opportunities in liquefaction, shipping, and re-gasification.

Storage is another opportunity. It offers the ability to arbitrage across indigenous pipeline and LNG sources and, in some cases, creates related trading opportunities. Some companies are also exploring downstream moves into gas distribution and marketing. In North Africa and Italy, Eni has integrated across the region, with operations throughout the entire chain.

Mergers, acquisitions, and joint ventures are on the rise, fueled by the opportunities in shale gas as well as the challenges that IOCs face accessing new supplies. Since the late 2000s, IOCs in the US have been aggressively acquiring assets and know-how from companies that developed the ability to extract unconventional deposits (that is, oil and gas locked in shale). One prominent example is ExxonMobil's $41 billion takeover in 2009 of XTO Energy, a large unconventional independent with operations in several major shale plays.

NOCs have also entered the shale gas market, looking to gain expertise that they can repatriate to their domestic markets. Thailand's state-owned PTT Exploration and Production purchased Statoil's Canadian oil sands stake for $2.3 billion. Shale gas operators are also partnering for cash and growth: Pioneer Natural Resources formed a joint venture with Reliance Industries of India, gaining 45% share in the JV in exchange for $1.3 billion in cash to finance development in the Eagle Ford basin in 2010.

Finally, E&P players in the US are looking to reduce their costs in the short term, while creating more efficient operations for long-term competitive advantage. We typically see costs decrease as producers drill more wells or, in the case of shale production, more frac stages per well. But we are seeing some scale disadvantages in shale gas extraction, where costs rise at much higher levels of drilling and other required activities.

Shale extraction requires more functional hand-offs and more complex drilling designs. Thus, shale production lends itself to approaches that consider the entire value chain, such as Lean Six Sigma, which optimizes end-to-end manufacturing costs, reduces inventory, improves equipment utilization, makes functional handoffs more efficient, and reduces overall costs. Talisman Energy and Encana have said they are applying these principles to shale production, and Chevron is bringing them to its oilfield operations.

As shale gas changes the dynamics of the energy sector, it is changing the assumptions that underlie traditional investment strategies. As in all turbulent markets, there will be winners and losers. Players that proactively consider the effects of different scenarios and adjust their assumptions and strategic plans accordingly will be better placed to win.

Sharad Apte is also a partner with Bain & Company's Oil & Gas practice. He is based in Bangkok.

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