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Why the Rising Tide in Oil Hasn’t Been as Good for Offshore Drilling Ventures

This is a syndicated repost published with the permission of Money Morning. To view original, click here. Opinions herein are not those of the Wall Street Examiner or Lee Adler. Reposting does not imply endorsement. The information presented is for educational or entertainment purposes and is not individual investment advice.

The spread between West Texas Intermediate (WTI) and Brent continues to narrow.

Thanks to additional new U.S. pipeline capacity and the growing volume of oil product exports from American refineries, the glut of excess storage at Cushing, Okla., is shrinking.

This ongoing glut has been the single biggest reason why WTI trades at a discount to Brent. As I write this, WTI is approaching $104 a barrel and Brent $111.

With crude oil prices continuing to rise, you would think that would be good news for both onshore and offshore drilling ventures.

But it’s just not so, at least in the short term.

The distribution between onshore and offshore projects has changed in favor of land-based drilling, driven largely by unconventional oil.

This is merely the latest sign that, in oil at least, a rising tide does not equally raise all boats.

Here’s what this new development means for offshore investors…

The Unstoppable Rise of “Tight Oil”

Of course, the big difference in North America today is the substantial volume of unconventional oil reserves now available to be extracted.

This is usually referred to as shale oil (to parallel the rapid rise in shale gas). But actually, shale oil is only one type, and it is the broader category of “tight oil” that is spiking the volume.

This does not mean, of course, that conventional drilling has ceased. Far from it. But traditional vertical drilling into a standard oil reservoir is no longer the only game in town.

The combination of fracking (moving a large volume of water down-hole under high pressure) and horizontal drilling is driving the continent’s new unconventional oil supply.

And it’s not just a North American story either. Elsewhere, the rise of this new oil largess captured in shale or sandstone, in lateral plays or stacked lenses (the most common sandstone tight formations), is accelerating.

Some areas, such as the Silurian “hot” shale of North Africa, the Vaca Muerta (“Dead Cow”) basin of Argentina – also a huge source of shale gas, and the Bazhenov of Western Siberia in Russia, have been targets for some time now.

But the latest reserve figures are increasing the recoverable volume of these resources far more quickly than anticipated.

For instance, of the 148 areas worldwide, only 23 have the sufficient initial geology so far. Even then, those nearly two dozen plays contain more than twice the estimated North American recoverable reserves in unconventional oil (in excess of 300 billion barrels).

These figures do not include a number of other sites considered heavy with tight oil, in particular the Arckaringa basin in South Australia, which could hold some 233 billion barrels alone.

Of course, one of the major considerations in extracting unconventional oil elsewhere is the cost of the wells. According to an IHS report last September, the average tight oil well outside the United States would cost about $8 million, or 43% higher than what it would cost in North America.

However, when it comes to offshore wells, these costs can easily be much higher.

Offshore Drilling: Wait Until You See This Bill…

Deepwater projects (usually wells drilled in 550 feet or more of water) still remain the conventional oil ventures that have the best prospects for making huge discoveries.

In fact, the assumption these days in the oil community is that some 75% of all the largest yet-to-be-discovered fields worldwide are in found deepwater.

But these deepwater projects are becoming much more expensive to drill. Shallow areas can still use jack-up rigs (maxing out at 350 feet of water depth), but for the deeper moves there are only a finite number of rigs capable of doing the job. And their leasing rates exceed $300,000 a day on average.

The most expensive rig belongs to Transocean Ltd. (NYSE: RIG).

Called the Deepwater Pathfinder, this rig has a daily leasing rate that can easily exceed $650,000. That would put just the drilling costs of an average deepwater project at more than $80 million.

Add in the $200,000 a day for seismic studies, along with an equal amount for well completion, feeder pipelines, and other services, and a well project using this rig could approach $200 million.

What’s more, a genuinely huge offshore project would require an additional commitment for extensive production infrastructure that could run another $1 billion in design and installation.

Even so, the attraction of finding the last great “elephant” field continues to draw interest in deepwater drilling. In fact, IHS expects the size of the deepwater drilling market to expand from $43 billion during 2012 to $114 billion by 2022.

The reason is simple: Both the number of wells found in deepwater and the value of discoveries in deepwater have far exceeded the value of oil found in other areas around the world.

In other words, deepwater drilling is hardly going away. Nonetheless, in the near term we are going to see a slowdown in offshore drilling compared to projects onshore.

Where Offshore Drilling Goes from Here

The comparative cost is certainly one reason. Others are the intensified environmental requirements and leasing delays following the sinking of RIG’s Deepwater Horizon in the Macondo 1 disaster.

However, it won’t be North American offshore projects that carry most of the new work once deepwater drilling comes back. Instead, look for major projects off South America (Brazil), Asia (Vietnam), and especially West Africa (Nigeria) to lead the way in the next initial phase.

The primary element in this respect will be the availability of heavy drilling rigs. The cost of building and deploying these massive rigs worldwide is a major concern. While this will open up the market for new equipment, the multi-year planning/construction and budgetary requirements will preclude a quick fix.

First-stage offshore recovery will come rather soon in the shallow Gulf of Mexico, North Africa (assuming there is no further decline in political stability), and the Persian Gulf. In fact, we are already seeing signs of this movement offshore in Louisiana.

And over the past several trading sessions, signs have emerged that the shares of deeper-water producers and drillers are beginning to recover. There was even an announcement yesterday of a proposed offshore shale project.

But the prospect of onshore unconventional oil will still weaken the eventual rise of offshore drilling for some time to come.

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The post Why the Rising Tide in Oil Hasn’t Been as Good for Offshore Drilling Ventures appeared first on Money Morning – Only the News You Can Profit From.

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