The U.S. Shale Oil Boom

by Tony D'Altorio

The U.S. Shale Oil Boom

by Tony D'Altorio, Investment U Research

Wednesday, January 5, 2011

Thanks to new and ever-improving technology, the U.S. natural gas is booming. Thanks to horizontal drilling and hydraulic fracturing, estimates of U.S. natural gas reserves have tripled.

Now, that same technology is being applied to look for oil… in the same places.

The process involves drilling 10,000 feet down and across. Then, water is pumped in repeatedly at high pressures to fracture the rock and let the oil escape.

It has lifted hopes of the first significant rise in onshore U.S. oil production in decades. The method could add 1 million barrels of oil a day to U.S. supplies in five to eight years.

To put it into perspective, that roughly amounts to 10% of what we import on a daily basis. It would add to the approximate 3 million barrels already extracted daily from the Bakken Shale, which covers most of North Dakota and parts of Montana.

Back in 2005, the U.S. Geological Survey estimated the area contained 151 million barrels of oil. But by 2008, it upped that figure to 3-4.3 billion.

That alone makes the Bakken Shale the biggest U.S. oil field outside Alaska. And that was before 2010, when the North Dakota Geological Survey pegged the Three Forks-Sanish zone as containing nearly 2 billion barrels alone.

That brings the total resource potential to more than 6 billion of oil.

As the technology continues to improve, so will the estimates there and elsewhere. Harold Hamm, CEO of Continental Resources (NYSE: CLR), says only a third of U.S. onshore oil is termed recoverable due to technology limitations.

And that means there is plenty of room to run with this investment opportunity.

Shale Oil vs. Shale Gas

Along with technology, plunging U.S. natural gas prices factor into the shale oil boom.

Shale gas has pushed down U.S. natural gas prices to under $4 per million BTU from their record high of $13.69. That pushed smaller, independent oil companies long focused on natural gas to buy into shale oil.

They have good reason to, since a thousand cubic feet (mcf) of U.S. natural gas used to sell for a tenth of the price of a barrel of oil. But now that gap has widened tremendously: One mcf of gas sells for a twentieth – or less – the price of a barrel of oil these days.

The independents’ search for shale oil acreage made such land increasingly expensive. Back in 2009, $300 per acre was a typical price tag; now, it can run as high as $12,000.

Take the Niobrara Shale, which runs through Colorado, Kansas, Nebraska and Wyoming. Mineral leases hot spots there that fetched $10 an acre two years ago now go for $5,900 according to energy consultant, Wood Mackenzie.

The agency estimates shale oil extraction in many locations is profitable at $50 a barrel. In response, the number of rigs drilling in the U.S. rose from a low of 180 in May 2009 to 720 in November 2010.

Many industry insiders think it will double from there in the next two years.

Shale Oil Investments

Numerous smaller U.S. independent oil companies like what they see.

They even like it enough to finance the switch by selling off all or parts of their traditional natural gas businesses. Businesses like EOG Resources (NYSE: EOG), Petrohawk Energy (NYSE: HK) and Range Resources (NYSE: RRC) all think it worthwhile.

EOG was among the first gas-focused independents to see the potential of shale oil. In 2008, it began snapping up the liquids-rich portions of the Bakken and Eagle Ford Shales in Texas, ahead of the hordes.

It plans to sell about $1 billion in dry gas assets to fund its new focus. In doing so, it believes it can go from deriving 23% of its North American revenue from liquids in 2007 to 67% in 2011.

Devon Energy (NYSE: DVN) has similar aspirations. But with its financial strength, it doesn’t need to sell its dry gas assets.

Devon wants to spend about 90% of its capital expenditure (between $4.5 billion and $4.9 billion) on oil and liquids-rich drilling in 2011. And it’s repositioning its rigs to do that.

Thanks to the BP (NYSE: BP) oilrig accident, operational costs in the Gulf are up. And the government has restricted new offshore drilling activity greatly, which will only increase interest in onshore US oil prospects further.

That all leads to big benefits for companies like Devon and EOG that already hold vast tracts of shale oil acreage. They can extract oil profitably at $50 a barrel, or sell some or all of their shale oil acreage – at a huge profit – at a later date.

The events of recent years have created one big win-win situation for these businesses.

Good investing,

Tony D'Altorio

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