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Insight: What's happening to Exploration?

Tuesday, April 22, 2014

Explorers should be deeply troubled by recent events, namely:

1. The general lack of success, especially in Frontier plays, and the evident lack of New Ideas and instead the re-cycling and re-hashing of old ones.

2. Exponentiating costs, especially for deep water drilling.

Exploration outcomes over the last 18-24 months

Over this period, the notable exploration successes have been:

  • US Shale Oil, notably the Eagleford, Bakken and Barnett plays.
  • Brazil Pre-Salt, with seven key oil discoveries – Lula, Sapinhoa, Iracema, Carioca, Carcara, Jupiter and Iara.
  • East Africa Gas offshore, in Tanzania and Mocambique
  • East Africa Oil onshore, in Kenya.

You will note that these are all continuations of earlier themes. Where are the “New Ideas”?

Other notable successes are hard to find and indeed it is much easier to point to some troubling failures. There has been disappointment all over NW Europe (North Sea, the Barents, onshore), for example, and Richmond Energy Partners have spotted 1 arguably commercial discovery in the last 27 Frontier wells drilled by the group of companies they cover!

Is exploration getting harder?

The poison of exponentiating costs

At the same time that exploration appears to be getting much, much harder, costs have been exponentiating.
Let’s consider a very simple model in which an enterprise aims to discover 100 million boe in a 4 well program:

  • Suppose the drilling cost per well is $25m and other associated costs for the whole 4 well program are $100m (drilling costs being 50% of total exploration spend are a normal working guideline), then the total program cost is $200m and the implied (success outcome) Finding (F) cost is $2/boe.
  • Now let’s suppose the drilling cost per well is $50m and, by a super human effort, other costs are kept at $100m, then the total program cost is $300m and the implied F cost is $3/boe.
  • Next, we take a big step and assume a drilling cost of $100m/well, with other costs powerfully constrained at $200m, giving a total cost of $600m and an F cost of $6/boe.
  • And finally, if we assume a drilling cost of $200m/well, with other costs still constrained to $200m, then total costs are $1000m and F cost is $10/boe.

So there could be then an “Explorers’ view” which says “so what? Oil price is over $100/barrel, F costs of $2 - 10 per boe are all OK!”

Why does F cost matter?

Let’s consider a simple metric for a “growing through exploring” company, namely:

  • X = Enterprise Value/2P reserves

It turns out that X ~ $8/boe for a “matured” E&P company.

Thus, for any company, the extra Enterprise Value (EV) potentially created by an extra 100 million boe is $100 x (8 – F). So…..

1. If F cost = $2.5/boe, then extra EV = $550m

2. If F cost = $5/boe, then extra EV = $300m

3. If F cost = $8/boe then extra EV = $0m.

For an Investor in:

  • A $100m Market Cap company, 1. and 2. are fantastic outcomes.
  • A $1bn Market Cap company, 1. is excellent, 2. is pretty good.
  • A $10bn Market Cap company, only 1. is of any interest.

So what?
Well, to generalise, drilling costs of $25 or $50m/well are nowadays characteristic of onshore exploration; $100/$200m per well costs are characteristic of deep water exploration.

Ergo, if you want to invest in a “growing through exploring” company find one that is exploring onshore……………….or invest in a drilling company running deep water rigs!

Conclusion – Back to the Future!

Exploration needs to become much more successful and at significantly lower F costs than have been the norm over the last couple of years.

Both “New Ideas” and dramatically reduced drilling costs are required.

These two will only be found together onshore.

Author: David Bamford
Company: Petromall

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