Offshore Oil Stocks: Where Should Investors Look in 2014?


We’ve seen in the first parts of this series there’s a revolution underway in offshore oil drilling.

Techniques like directional drilling and multi-stage fracking—perfected as part of the onshore shale revolution—are yielding some of the highest returns on capital anywhere in the world.

That’s because of new technologies like “logging-while-drilling” applications. That allow operators to pinpoint oil-bearing horizons and drill offshore wells at low costs that make these fields economic like never before.

To date, successes have come mainly in the U.S. Gulf of Mexico. The place where offshore drilling was initially perfected in the 1960s.

But as with that initial offshore boom, operators wielding unconventional offshore drilling tech are now bringing it to other basins globally.

Judging from the big gains such drillers have seen in the GOM, this expansion will be extremely profitable. So the question is—where should investors be looking with offshore oil stocks?

The most obvious answer is Southeast Asia—at least according to one major player in this space.

That’s John Schiller, CEO of successful unconventional driller Energy XXI (Nasdaq: EXXI). Schiller noted on the company’s most recent investor call that Southeast Asian geology is very similar to what his firm is drilling in the U.S. Gulf Coast.

He also said that Energy XXI is looking at opportunities here—in places like Malaysia.

Recent results from a nearby oil hotspot—the Gulf of Thailand—confirm the potential of this area.

Former OGIB portfolio stock Coastal Energy (TSX: CEN) has been using unconventional completions on its Thai offshore wells. And seeing excellent returns. In 2012, each dollar spent by the company yielded nearly $2.20 in proved reserves.

That’s an industry-leading operational performance—anywhere in the world. And likely a driver for a $2.3 billion takeover offer recently tendered for Coastal by the government of Abu Dhabi.

The opportunity here is largely driven by new logging-while-drilling technology—that’s allowing directional drillers to exploit thin and/or stacked reservoirs. Such technology enables operators to “geosteer” a well—making corrections to the drill angle in order to keep the well bore within the target reservoir, even if these rock layers are only a few metres thick.

Going For The Skinny Pay Zones

Such thin reservoirs are where the offshore horizontal drilling boom has the biggest potential to create big production and reserves adds.

In many parts of the world, thin reservoirs were traditionally not a target for drilling. There simply wasn’t enough reservoir rock in contact with a conventional, vertical well bore to pull in economic amounts of oil or gas flow.

In many cases, drillers even passed through such thin reservoirs—on the way to thicker horizons deeper down. The thin pay zones were often left behind pipe without being completed.

That can make such zones a low-hanging target for today’s beefed-up drilling technology. In many parts of the world, we know exactly where these thin reservoirs are located—and we have a lot of information about their geology and mechanical properties.

Using this data, drilling engineers can complete these zones with horizontal techniques—at very low risk of a dry hole.

A lot of the pioneering work in this regard has been done in deep-pocketed regimes in the Middle East. In late 2012, operators in the United Arab Emirates began reporting good results from using long (read, 15,000 feet) horizontals to produce thin carbonate units, where traditional completions had been struggling.

But offshore unconventional technology and techniques are now becoming so well-understood, they are being applied commercially in many parts of the world. Mature basins have particularly been a target—with operators in the North Sea being early adopters of horizontal drilling as well as fracking.

As with the U.S. Gulf of Mexico, unconventional development in the North Sea has begun mainly in the near-shore environment, within the southern parts of the Sea.

Last September, operators from Centrica reported that they had completed a frack delivering 1.4 million pounds of proppant (the grains that keep cracks in the rock propped open) in just a four-day period.

Centrica estimates this task would have required 12 to 25 days a few years ago. Probably making the well uneconomic—given the high day rates charged by services companies in the offshore. As a bonus, the frack was also engineering to use seawater—further reducing costs, and making the process more environmentally palatable.

Established locales like the North Sea could thus become the next big thing in unconventional drilling. Helped along by low prices for development acreage here.

That’s because several cornerstone developers have recently been divesting projects—in December stalwart player Wintershall announced it will sell 14 North Sea licenses to Hungarian energy major MOL for $375 million.

Those reserves are selling at a very attractive price. Analysts have pegged the deal as costing about $20 per barrel of in-ground reserves. That’s a price point similar to what unconventional developers have been paying for old acreage in the Gulf of Mexico.

At such prices, the economics start to look very good around recompleting such fields with unconventional technology. Thus we could be looking at the start of a renaissance, where a new breed of enterprising E&Ps takes the reins—then use new drilling to coax more oil out of old, thin reservoirs.

Offshore Unconventional Tech Goes Global

But it’s not just old, established offshore fields where big finds from new unconventional drilling are lurking. These techniques have recently been used to revitalize oil output from oil fields further afield. In the South China Sea, for example.

Chinese petro-major CNOOC reported last year that horizontal logging-while-drilling technology helped turn a Bohai Bay marginal oil field here into a moneymaker.

The advanced equipment helped place nine horizontals within a narrow target zone in the small field. By steering straight, the company estimates it improved its drilling efficiency by 60%. Equating to a cost savings of $32 million.

Production from the advanced horizontals also came in higher than expected—to the tune of a 30% improvement. Creating a very profitable field development—in tricky spot that easily could have turned into a money pit.

Advances in fracking technology are having a similar impact in places like Africa. In late 2012, Total completed its largest-ever offshore frack treatment—on an old oil field off the coast of the Republic of Congo.

The Tchendo field here had been in production since 1991. But the conventional oil was starting to dry up. Noting that a large amount of oil in place still remained, Total pushed to design an unconventional completion to up recoveries.

Results are still pending, but fracking looks to have the potential to unlock big new reserves here—and potentially at look-alike fields along the west African coast.

The re-development of old fields like Tchendo likely represents the most immediate opportunity for profits from new offshore drilling techniques. Risks are low and upside is big in places where billions of barrels of oil have been left in the ground over the decades.

Look for keen drillers to start picking up such projects on the cheap—and using new technology and know-how to improve production and profits from the world’s aged giant fields.

Catch up on part 1 of our series here, and part 2 here