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Unconventional Opportunities in the Oil Service Sector: Part I


In 2006, unconventional natural gas will make up over 40% of domestic natural gas production and will continue to increase over the next 20+ years...


Conventional natural gas production peaked in 1995. Most of the current domestic natural gas production comes from existing wells as new discoveries have been few and far between. As conventional sources of supply have diminished, E&P companies have had to find new ways of extracting natural gas from "Unconventional" sources.

Unconventional natural gas production comes from "non-traditional" sources that require new technology to produce in commercial quantities. These sources include coal bed methane gas, tight gas sands, and shale gas. Some of the best performing stocks over the past few years have been unconventional natural gas companies such as Ultra Petroleum (UPL), a tight gas sands play with assets in the Pinedale Anticline, and Southwestern Energy (SWN), with assets in the Fayetteville Shale.

In 2006, unconventional natural gas will make up over 40% of domestic natural gas production and will continue to increase over the next 20+ years according to the Energy Information Administration (see chart below). Of the major sources of natural gas, unconventional production is the only one that has been increasing each year. Alaska could provide a boost in production in 10 years or so, but will require a way to transport the natural gas to the continental United States.

Tight gas sands are the most common unconventional resource and are defined as having permeability to gas flow of less than 0.1 millidarcies (mD). I like to think of tight gas as similar to a thick chocolate shake where you poke a straw in and suck as hard as you can, but little shake comes out. You can see the shake is there, you know its good stuff, but you just can't produce enough with conventional technologies (in this case, conventional technologies being a straw and the approximate 3 kilopascals of vacuum pressure a human can generate when sucking through a straw).

Gas producers have known for over 30 years that large quantities of gas exist in tight gas sand stones. The only problem is extraction. Some estimates put the gas in place (GIP) at over 15,000 Trillion Cubic Feet (Tcf) of gas, but only 2% of that gas in place (about 300Tcf) may be recoverable with current technologies. To put these gas in place estimates in perspective, the United States produces just over 18Tcf each year and consumes about 21Tcf of gas (the difference is made up by net imports). Ideally, you like to see tight gas resources with natural fracturing in place that allows gas traps to form, but that is not always the case. Most of the tight gas and shale gas resources require advanced technologies to unlock these assets. Some examples of these technologies include:

  • Horizontal drilling: A well whose lower part of the wellbore (the physical hole in the ground that makes up the well) parallels the payzone (does not necessarily need to be at a 90º angle) in an effort to increase exposure to more of the formation. Horizontal wells can cost 2 times as much as conventional wells, but can yield 3-4 times as much gas. It is estimated that as many as 10-15% of current natural gas rigs are drilling horizontal wells.

  • Hydraulic fracturing / multi-stage fracturing: Tight gas and shale plays are often hydraulically fractured to stimulate low-permeability reservoirs.

  • Underbalanced drilling: The reservoir is drilled by creating a negative differential pressure between the wellbore and the formation in an effort to reduce damage to the reservoir caused by drilling.

Often, it can take years (and millions of dollars) to unlock the value of an unconventional reservoir as E&P companies experiment with new technologies. Rarely does an E&P company figure out the optimal mix of technology to produce unconventional gas resources on the first try. Drilling for unconventional natural gas requires a mixture of art and science. But, once the technology is unlocked, an acreage position's value can increase by many multiples as the likelihood of commercial production increases.

There are several ways for investors to take advantage of the current secular bull market in unconventional natural gas production. The most obvious would be to identify E&P companies with large unconventional acreage positions and good prospects for commercial production. Another way to play the secular bull market in unconventional natural gas is to focus on the companies providing drilling and associate services. In Part II of my series on unconventional natural gas, I will focus on some of the opportunities in the oil (or should I say gas) service sector.

Don't miss "Unconventional Opportunities in the Oil Service Sector: Part II"

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