Tuscaloosa Marine Shale Set For Exploration Ramp Up

BMI View: The Tuscaloosa Marine Shale looks set to see a substantial uptick in exploration in the coming quarters, with a number of independent firms pledging considerable increases in capital expenditure (capex) to develop the play. While a technically challenging below ground picture keeps us cautious for now, we note that significant above-ground incentives and recent technological improvements could hold the key to unlocking the potential of this highly promising formation.

In recent months we have seen a surge of interest in the Tuscaloosa Marine Shale (TMS) play, as independents ranging from Canadian firm Encana to Houston-based Sanchez Energy and Goodrich Petroleum Corp. re-evaluate its potential as an economically viable producer in light of new drilling methods. We caution that significant risks remain given the nascent stage of this play's development. However, with companies benefitting from slowly improving drilling technologies, and recently implemented fiscal and regulatory incentives, exploration is likely to remain elevated in the coming quarters, with potential for 2014 to be a breakout year for the TMS.

Technically Challenging, But Could Be Ready For A Boom

New Play Emerging
US - Tuscaloosa Marine Shale Map

Tuscaloosa Marine Shale Set For Exploration Ramp Up

BMI View: The Tuscaloosa Marine Shale looks set to see a substantial uptick in exploration in the coming quarters, with a number of independent firms pledging considerable increases in capital expenditure (capex) to develop the play. While a technically challenging below ground picture keeps us cautious for now, we note that significant above-ground incentives and recent technological improvements could hold the key to unlocking the potential of this highly promising formation.

In recent months we have seen a surge of interest in the Tuscaloosa Marine Shale (TMS) play, as independents ranging from Canadian firm Encana to Houston-based Sanchez Energy and Goodrich Petroleum Corp. re-evaluate its potential as an economically viable producer in light of new drilling methods. We caution that significant risks remain given the nascent stage of this play's development. However, with companies benefitting from slowly improving drilling technologies, and recently implemented fiscal and regulatory incentives, exploration is likely to remain elevated in the coming quarters, with potential for 2014 to be a breakout year for the TMS.

New Play Emerging
US - Tuscaloosa Marine Shale Map

Technically Challenging, But Could Be Ready For A Boom

We believe there are a number of reasons for the surge in exploration recently. Perhaps most importantly, advances in exploration are beginning to make the play more economically viable. The TMS, spanning central Louisiana and southwest Mississippi, is by no means a new play, with companies having sunk wells in the area since at least the 1960s. However, a technically challenging below ground environment has long stymied its development. Namely, the oil producing formation is deep underground - up to 15,000 feet - while the area's softer, faulted rock makes it difficult to keep debris from clogging wells. This has long kept the cost of exploration high, and made scalability difficult.

However, in recent quarters, we have seen new methods of drilling begin to yield more promising results. For example the use of longer laterals and improved completions - enhanced with sand and clay stabilisers to prevent the ground from self-sealing - have been relatively effective in tackling the formation's geologic challenges. As such, while earlier wells have cost US$20mn plus, Goodrich is now reporting that it has lowered per-well costs to US$13mn. Moreover, the company sees potential to drive costs lower still through further improvements to the completions process, greater competition among services companies due to the increased activity in the play, and multi-well pad drilling.

Meanwhile, aside from oil companies' greater knowledge of how to tackle the below-ground challenges, TMS benefits from a number of other attractive features, including:

  • Significant and highly liquid resource potential: Estimates put TMS's potential at an estimated 7bn bbl of recoverable oil resources, and this may yet turn out to be a conservative figure. Moreover, we note that output leans heavily towards light oil, and with the oil-to-natural gas price ratio current heavily favouring liquids production, this benefits the play.

On top of the formation's high resource potential, the above-ground picture is also highly attractive.

  • Tax Breaks and Other Regulation: We have recently seen a number of new fiscal measures to incentivise drilling. For example, the Mississippi legislature has dropped the severance tax on oil and gas extractions by 80%, cutting it from 6% to 1.3% for the first 30 months of production. Meanwhile, in Louisiana the state has no severance tax on sales of oil produced for the first two years, though it jumps to 12% in the third year. Encana estimates that the Mississippi state tax cut could save up to US$800,000 for each well it puts into operation. Aside from tax breaks, we also note that other aspects of the regulatory environment, most notably the 'forced pooling' regime - compelling hold-out landowners in designated areas to participate jointly in mineral development - are also favourable to the industry.

  • Low Lease Rates: While admittedly having jumped noticeably in recent years, anecdotal evidence suggest that lease rates still remain relatively low given the play's nascent status.

  • Location: Moreover, TMS benefits from its proximity to both takeaway infrastructure and refining capacity. We acknowledge that producers' margins are likely to be a little lower than they could have been in past years as Louisiana Light Sweet (the crude produced at TMS) is likely to see its premium to WTI narrow in the medium term as new infrastructure from Cushing comes online over the coming months. That said, the light crude (with an API of between 40 and 45 degrees) will still retain a high value, and benefit from the surfeit of midstream and downstream infrastructure in the Gulf.

These factors have seen a significant uptick in interest from a number of players, including Goodrich, Encana, Sanchez Energy and EOG among others, such that 2014 looks set to be the busiest year yet for drilling. Indeed, Goodrich has suggested that after only 15 wells were drilled in the formation in 2013, we could be set to see between 45 and 60 in the coming year. Specifically, Goodrich has plans to significantly up its capex spend on the play, from US$65 in 2013 to US$300mn in 2014 - representing 80% of its total investment budget. This will see the number of drilling rigs under contract rise from two as of end-2013 to five in Q314, with the company targeting 24 wells drilled by the end of the year. Meanwhile, Encana - as part of a new strategy to bolster its liquids production - has identified TMS as one of its five major areas of focus in North America, with its most recent company strategy indicating that it is targeting the completion of between nine and 12 wells over 2014 ( see 'Encana Turning To Liquids Production Highlights Trend', December 16, 2013). Finally, Sanchez plans to spend 10% of its US$650-US$700mn capex budget on its TMS exploration and completion, with the hopes of drilling its first well in the emerging play this year.

Ramping Up Spending On TMS
Goodrich Capital Expenditure 2013 vs 2014, US$mn

Ultimately, we caution that it is too early to crown TMS the next Eagle Ford or Bakken. While the above-ground environment offers some very big incentives, and companies have begun to more effectively drill the play, the below-ground picture still leaves a lot of questions unanswered, as to the long-term economic viability of the play. Importantly, more information is needed, especially on whether output levels will live up to companies' hoped-for estimated ultimate recovery (EUR) numbers, in order to ensure that the play remains economically viable. ( See the chart below for Goodrich's projections with a EUR base of 600,000 boe and high case of 800,000 boe.) That said, with surging investment and a massive ramp up in investment in 2014 set to provide a significantly increased number of data points, the next year looks set to be a key in determining the play's future.

Profitable, If It Produces
Goodrich - Economic Expectations From Single Well With Base (600mboe) and High Case (mboe)
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