Last week I looked at the phenomenal success of a new breed of offshore explorers who are using unconventional drilling (read: horizontal drilling and fracking) to unlock billions of barrels of bypassed oil in places like the shallow-water U.S. Gulf of Mexico.

Offshore producers are now getting returns as good as their onshore competitors—but offshore stocks are valued much more cheaply.

But before investors jump off the dock, we need to understand the opportunity. What’s happened with drilling technology to create such big returns? And why is this happening now in the offshore space? What techniques are delivering the biggest successes? And what companies are best-positioned to take advantage?

After all, horizontal drilling offshore isn’t a new idea. French firm Elf Aquitaine was drilling horizontal wells in the Adriatic Sea off Italy during the early 1980s.

In fact, major producers in the U.S. Gulf went through a horizontal “mini-boom” in the early 1990s. Over 20 wells were drilled by operators like Amoco. Results however, were mixed and the technique was largely abandoned for the next decade.

Better Technology Arrives Just In Time

So why is horizontal drilling suddenly back in the offshore game and having a big impact?

I see two reasons for today’s surge in activity. One is just moving the new exploration techniques that were perfected onshore—offshore. Offshore wells are 3-100x more expensive than onshore, so there is obviously less financial risk onshore if it fails.

But the energy sector is also using some funky technology from other industries—like Apple’s iPhone.

The iPhone uses something called a “small-scale accelerometer”—a device that measures changes in movement around them, telling it you’ve turned the screen sideways and should adjust the view accordingly.

Petroleum engineers simply took this technology and applied it to the drill bit—designing “smart” tools that can tell exactly where they are in space as they move down a well bore.

All this new technology does two things:

• it makes the well cheaper, and
• improves aim

One of the major challenges in drilling horizontally is making sure the horizontal leg of the well stays within the target formation. Steer too high or too low and the well can pass out of the oil-bearing rock formation. Or the driller could penetrate the oil-water contact—resulting in big inflows of value-killing water (water supersedes oil in the well bore).

But keeping a horizontal well level through the target formation is difficult—especially in places like the Gulf of Mexico, where oil columns can be just tens of feet thick.

That’s where a recent advance called logging-while-drilling (LWD) comes in.

The latest revolution in LWD is a combination of improved technology (machines to collect and transmit data) and better technique (interpreting collected data and using it to make decisions).

All of these improvements cut their teeth initially in onshore U.S. shale plays.

When horizontal wells began developing shale basins like the Barnett in Texas, operators thought shales were one big blanket of rock. You could basically poke a drill hole into any part of the formation and get more or less the same result. (Stock Promoters still believe that!)

This turned out to be completely wrong. While shales are blanket formations that extend for hundreds of kilometers, they have lots of local variation—thickness, amount of sand, and natural fracturing of the rock.

Operators soon realized that placing a drill hole in the exact best part of a shale could make the difference between a three-month payback and a completely uneconomic well.

The problem was there was no way to tell from the surface where these sweet spots might be. Drillers needed a way to know what the drill bit was “seeing” as it moved through rock—and then react by steering the well into the most favorable location.

Luckily, this need for better downhole tools came just as technology was making some critical leaps. The result is that drillers today can collect very accurate, real-time information on the exact path of a well. That’s critical if you’re trying to steer a drill hole through an eight-foot think layer of shale.

More Information Means Better, Cheaper Wells

Shale drilling also pushed drillers to develop a bunch of other tools for collecting downhole geological information. Today, geophysical tools like gamma ray and resistivity meters are all “looking” into the rock around a wellbore as it’s drilled—and transmitting real-time information back to the drilling engineer.

Drilling technology is in fact getting so good that it may make some parts of the exploration process—like seismic—redundant.

That’s incredible—revolutionary even—as almost all E&Ps collect seismic before drilling begins. But the American Association of Petroleum Geologists recently forecast the industry is not far from being able to run “seismic while drilling”, where downhole tools collect seismic data while the well bore is being driven through the formation.

Using this information, drillers can spot—for example—sandy sections within a shale. And steer toward them, or away from them, depending on the best completion techniques known for that particular formation—that’s known as “geosteering”.

Engineers today thus have a lot more data to look at while drilling a well. In fact, initially there was more information than most professionals could interpret on the fly.

That’s led to the development of sophisticated computer modeling techniques. Software packages that combine all of the data coming from the downhole tools into a comprehensive model of the target reservoir. Updating every few minutes to show drillers exactly where the well is—and what rocks and other geologic features lie ahead.

Drillers have made a quantum leap in using such technology over the past few years. Where they used to fumble, they’re now capable of threading a well bore through thin, complex rock layers to pinpoint oil and gas pools.

The accuracy of this technology and technique also means quicker drilling. Which is key when expensive drilling equipment is sitting on a lease. Less time drilling means much lower well costs. And it’s this productivity from the services sector that’s ultimately made North America the only spot on Earth where shale drilling is economic.

What This Means for Offshore Development

Which brings us back to the offshore environment—and the revolutionary changes going on there.

Smart offshore operators looked at the developments happening in shale and realized that applications like geosteering and logging-while-drilling are perfectly suited to a place like the shallow-water Gulf of Mexico.

That’s because much of the oil here is hosted in an array of thin sand layers, stacked on top of each other. In the past, only the thickest of these reservoirs were targeted for production.

But all of the new drilling technology—and the skill of drillers in interpreting information from it—has opened up new options for skinny pay zones. It’s now possible to run a horizontal well through a sand that’s only a few feet thick, keeping the well within the formation, and allowing for an effective completion.

For the moment, only a select few operators are taking this game to the offshore. After all, the well costs here—even in shallow Gulf Shelf—are several times higher than in the onshore. Today, only the most skilled engineers are willing to take that risk.

But the moves are paying off—unlocking millions of new barrels in proved reserves for pioneering E&Ps. This is oil we always knew was in the ground—but no one thought would ever be produced economically.

Thus drillers here are essentially turning nothing into something. And from the look of returns on recent wells, that something might be the biggest play to come along globally for decades.

As mentioned, this revolution is beginning in the Gulf of Mexico. But where else might it soon spread?

Signs are already emerging that places like Asia and the African coast could be the next step for the offshore revolution.

In the third and final part of this series, I’ll look at where in the world investors can expect big profits next from offshore unconventional drilling.

From Dave Forest, Contributing Editor