Shale Investing 101: Matt Badiali Reveals the Science Behind Oil Investments that Pay Off Big Time
Source: JT Long of The Energy
Report (11/24/15)
As Matt Badiali, geologist and editor of the Stansberry
Resource Report, explains, it has only been in the last few decades have we
learned to release the potential of the massive oil and gas reservoirs in the
U.S. Now we are learning how to tell if a shale project will be profitable. In
this Energy Report
article, he shares three names he is watching closely.
Geologist Matt Badiali compares a
conventional oil field to a glass of iced tea. The ice cubes are the rocks, the
tea is the oil and the cup is the reservoir (just imagine the whole thing
upside down, so the cup is on top). The cup is a trap where oil and gas
accumulate after migrating out of the source rocks.
A shale resource is not like that.
It's the source of the oil. It is rock formed when much of Canada and the
central U.S. was an oxygen-starved ocean bottom. These rocks are filled with
carbon and if they are squeezed and heated in just the right way, the carbon
becomes oil and gas.
However, the rocks don't produce oil
and gas in the traditional way. You can't just drill into them and expect the
well to gush, like a conventional field. In the late 1990s, George Mitchell,
founder of Mitchell Energy & Development Corp., noticed something funny.
When he drilled through the Barnett Shale, near Dallas, Texas, the hydrocarbon
meter (oil detector) would light up as he cut through the shale layers. He
envisioned shooting a water gun with grains of sand sideways into these thin
layers to prop the sheets of rock open and allow the oil to escape.
He did it a few times and it worked.
This was revolutionary. Everyone was talking about peak oil and predicting a
shortage. George Mitchell ignored the conventional wisdom and unlocked a
treasure trove of oil. Even after the geologists proved that it worked,
however, the traditionalists pointed to all sorts of problems and said it would
never last. They were wrong.
"The fact is that the amount of
oil trapped in the source rock is enormous. In the history of the oil industry,
we have only tapped a fraction of what is there," Badiali says.
The potential of fracking has left
today's geologists searching for the most economic shale sources. He explains
his research process this way: "When I'm evaluating a project, I look for
rocks that are both 'porous' and 'permeable.' Porous means it has lots of
space, lots of holes that can fill with oil. Permeable means those spaces are
connected to one another. Shale is neither. That is why we have to artificially
induce those things.
Ideally, we want the shale to be a
combination of calcium carbonate (limestone) and silt, without a lot of clay.
It has to be the right kind of rocks and it has to have lots of oil. We measure
that as total organic carbon (TOC) by weight. A good shale holds between 1% or
2% TOC. The best shales hold over 5% TOC. Once we find that kind of rock, we
drill sideways through it. Then we blow it up and make rubble to free the
trapped oil and give it space to move around."
Since those early days, scientists
have continued to refine the technique to increase the output and life of each
well. "We have learned that using a lot more sand got a disproportionately
large result. Now drillers are experimenting with larger bore holes. Remember,
engineers have less than 10 years of experience getting oil out of shale. We
have over 100 years of experience with conventional oil fields. This science is
so new and the economics are improving rapidly," Badiali gushes.
There are limits to the new
technology, however. "Almost no shale wells can profit at $45 a barrel
($45/bbl)," Badiali warns.
Offtake capacity is also important,
according to Badiali. “You have to have a way to get it to market. Continental
Resources Group Inc. went to North Dakota and started producing massive
amounts of oil. But there were no pipes there and it is a long way from any
refinery or market. Because the price of building a pipeline would be so high
and the odds of getting it approved even worse, they turned to trains. The
problem with trains is they are twice as expensive as pipelines. That means if
you're producing oil for $60/bbl and you put it on a train for $20/bbl and sell
it for $120/bbl, it's still a business. When you can only sell it for $50/bbl,
it's a liability. That is a problem.
"The great thing about the oil
industry in the United States is it is incredibly nimble," Badiali says.
"When one area or commodity isn't economic anymore, they change. The
problem is that the price of land in the established plays near infrastructure
has skyrocketed. An acre that leased for less than $1,000 in the Eagle Ford in
2005 was $20,000 in 2011. The same thing happened in the Permian Basin and then
the Tuscaloosa Marine Shale. It was a land grab and the well economics weren't
a priority. Now those companies that overpaid for land are being hammered.”
Badiali uses Chesapeake Energy Corp. (CHK:NYSE) as an example of a
company that took on debt and had land in every shale in the U.S. "Today,
they are in big trouble, just trying to pay the interest on their debt."
He points to Exxon Mobil
Corp. (XOM:NYSE) as a major that took a different route. "Instead of
overpaying for dirt and then learning the business through trial and error,
they bought XTO Energy Inc. XTO, at that time, was the most profitable shale
driller in the country. In one easy deal, Exxon acquired both excellent land
positions and the best scientists in the industry."
Badiali warns that it may get worse
before it gets better for producers. "I think that we're now on the cusp
of bankruptcies galore because the marginal producers are struggling to make
ends meet. That will benefit the ones who survive in the sweet spots because
the cost of everything from the frack sand to the drillers and the pumpers has
plummeted."
One of the great misunderstandings
from outsiders looking into the oil industry is the role of debt, according to
Badiali. "Oil isn't like mining. Drilling a well is a binary question.
Either it produces oil or it doesn't. Traditionally, banks lent money based on
production. The company locked in prices for oil production (called a hedge)
and the bank used that future oil revenue as collateral. The problem was that
everybody assumed an oil price of $100/bbl. And they were wrong. When the model
is wrong by 50%, that can be a problem. When the hedges come off at the end of
this year, the real trouble is going to start."
The drill count is already down
dramatically. The rigs running today are running for one of two reasons,
Badiali says. "They are either drilling oil wells that can make money at
the current price or they have a work commitment. When companies acquire land,
the deal says that if they don't do work on it, it will go back out for bid in
a few years. Many of these companies spent a lot of money on that land. They
can't afford to lose that acreage. In the oil industry, you either drill it or
you lose it. So a lot of those wells are drilled, but not completed. Fracking
is expensive. So we are in a situation where some 1,400 wells are simply
waiting to be tapped as soon as the oil price gets a little higher."
When it comes to finding the
survivors, Badiali looks at geography first. "The Eagle Ford is still my
favorite basin because the rock quality is really high, but more importantly we
have decades of drilling data so we know what is down there. Devon Energy
Corp. (DVN:NYSE), EOG Resources Inc. (EOG:NYSE) and Pioneer
Natural Resources Co. (PXD:NYSE) are doing a great job on the science right
now. But I'm not buying them. Even the big players could feel some pain in the
coming year and they are very bought up," he says. That is why, for now,
he is watching and waiting.
Matt Badiali
is the editor of the S&A Resource Report, a
monthly investment advisory that focuses on natural resources, including
silver, uranium, copper, natural gas, oil, water and gold. He is a regular
contributor to Growth Stock Wire, a free pre-market briefing on the
day's most profitable trading opportunities. Badiali has experience as a
hydrologist, geologist and consultant to the oil industry. He holds a master's
degree in geology from Florida Atlantic University.
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DISCLOSURE:
1) JT Long conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report and The Life Sciences Report. She owns, or her family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: None. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
3) Matt Badiali: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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1) JT Long conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report and The Life Sciences Report. She owns, or her family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: None. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
3) Matt Badiali: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.
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