Shale drillers squeeze costs as era of exploration ends

Shifting Gears

Independent U.S. explorers spent more than $53 billion during the past decade snapping up drilling leases as breakthroughs in horizontal drilling and hydraulic fracturing allowed explorers to access previously impenetrable formations.

Of the 17 companies in the Standard & Poor’s 500 Oil & Gas Exploration & Production Index, Chesapeake was the biggest spender on prospective U.S. oil and gas leases with $19.9 billion from 2003 through 2012, according to data compiled by Bloomberg. The company, whose shares lost 36% from 2010-2012, on May 20 said it hired former Anadarko Petroleum Corp. Senior Vice President Robert Douglas Lawler as its new chief executive.

Chesapeake, the world’s largest driller of horizontal shale wells, said as early as March 2012 that all of the major untapped petroleum deposits in the continental U.S. had been discovered.

Expanding Sights

EOG Resources Inc. Chairman and Chief Executive Officer Mark Papa told analysts on May 7 that the company’s exploration unit is now looking for overlapping, oil-bearing geological formations that can be simultaneously tapped to extract “substantially larger” quantities of crude. Houston-based EOG is the largest owner of drilling rights in Texas’s Eagle Ford shale.

The payoff for the deeper-farther-faster approach remains to be seen for Chesapeake and explorers such as Devon Energy Corp., QEP Resources Inc. and Southwestern Energy Co., which have the poorest records of turning untapped reserves into barrels of crude for sale.

Producers use a calculation called the recycle ratio as a measure of profitability, dividing profit per barrel of production by the cost of discovery and extraction. So a $40 profit divided by $20 in costs yields a recycle ratio of 2:1, or 2. A higher number represents more profitability.

Recycle Ratio

Denver-based QEP’s recycle ratio was 0.69 in 2012 and Chesapeake posted a 0.97, data compiled by Bloomberg show. In contrast, Exxon scored a 4.5 and Total SA had a ratio of 3.3. The ratios include three-year averages for reserves used in calculating costs for the companies.

The best performers in the exploration and production index were Denbury Resources Inc., which uses carbon dioxide to coax more oil from wells, and Range Resources Corp., the second- largest holder of drilling rights in the Marcellus Shale. Both logged recycle ratios that surpassed Chevron Corp.’s 2.5 and BP Plc’s 2.8.

Devon and QEP said several factors lowered their recycle ratio numbers in the past couple of years, including falling gas prices that cut revenue as they shifted more drilling to oil projects, which are costlier than gas.

During the shift, the company is recording higher costs without yet getting the full benefit of bigger profits, said Vince White, Devon’s senior vice president of communications.

Improving Results

QEP incurred costs from an acquisition before production materialized from the assets, said Greg Bensen, director of investor relations at the company. QEP looks at the ratio using a multi-year view, he said.

Though Southwestern has some of the lowest costs in the industry, gas prices that collapsed to a decade low in 2012 reduced cash flow and forced the company to erase some proved reserves from its books, elevating per-unit costs for finding and development, or F&D, CEO Steve Mueller said in an e-mail.

“As the gas price increases, the F&D will drop dramatically as reserves are returned to the books and the yearly recycle ratio will be one of the best in the sector,” Mueller said.

Jim Gipson, a Chesapeake spokesman, declined to comment.

Analysts expect rising profits and stock prices will come to producers who embrace a manufacturing model, according to data compiled by Bloomberg.

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