Unconventional Energy Still Attractive - UBS

The market in unconventional resource development has gone through a “euphoric” first half of 2008, according to UBS, but as share prices have corrected by 28% since then, the brokerage suggests now is a good time to invest in the market.

“[This makes] a very attractive entry point ... for investors looking for exposure to these long-life, low-risk assets,” UBS said in a report released Friday.

The first half of 2008 saw an “unprecedented boom” in unconventional resource development across North America, says the UBS note, with new plays being announced almost on a monthly basis.” However, now is a good time to invest in the North American market as it offers “some of the  best balance between risk and reward of any global oil opportunity set.

UBS estimates an average after-tax rate of return of 68% based on $9/Mcfe. Buying into North American companies also offers much less political risk and shorter cycle times than other regions.

In particular, companies with a stake in the Bakken light oil and Haynesville/Lower Bossier gas shales deserve investors' attention. Bakken offers an return rate of 105% at $90 per barrel of oil prices, while Haynesville has an rate of return of 89%. Both sides have good access to infrastructure and are ready to develop.

The unconventional drilling boom has put pressure on gas prices, yet UBS expects natural gas production to increase by almost 9 Bcf/d over the next five years. Natural gas prices should average between $8 and $12/Mcf for the foreseeable future.

Top large-cap Canadian companies  to invest in include EnCana Corp (ECA), Nexen Inc. (NXY)  and Talisman Energy (TLM).  Small- to mid-cap options include Petrobank Energy and Resources Ltd (PBEGF.PK), Crescent Point Energy Trust (CPGCF.PK) and Galleon Energy Inc.(GLNYF.PK). All have ties to Bakken and Haynesville.

All prices shown in US%.

Comments

[AEB]

UBS' opinion is typical of analysts who know very little about the reality of the oil and gas business. $9/Mcf is not valid since the average spot price was $7.30 (Henry Hub) this week and plunging. The average U.S. wellhead price fell $2.30 in August compared to July to $8.32/Mcf and it will be much lower for September.

At these prices, none of the great shale plays are commercial. That is why Chesapeake has been having a fire sale on its leases in the Haynesville, Woodford and Fayetteville shales. Barnett Shale production in Q2 2008 had fallen 20% from Q3 2007 before the fall in gas prices because of perceived higher unit prices in Haynesville and Marcellus.

If drilling and leasing in the shale plays declines as it should, gas prices may rise but it will take a few quarters before this is felt.

As an industry insider, I like natural gas plays but there are hard times ahead for the companies involved in the shale plays. They paid too much for new leases and deals when gas prices were high (Plains paid $30,000/acre in the Haynesville!), and are using borrowed money to drill. They all have huge quarterly debt service and hedging losses so far in 2008 (Chesapeake's long-term debt was more than $13 billion before they started selling, and the company is only worth about $3.5 billion).

So I hope UBS is right, but it's hard to see what they based their positive opinion on. Does anyone think there might be something in it for them if a lot of people buy gas company stocks through them based on their advice????

[Clearlead]

AEB makes excellent points, but even with gas trying to hold in the 7's on the Hub (or bottoming at in the 6's), alot of companies earnings projections are based on an average of 8, so I wouldn't take the $7.30 last week as dispositive, plus not all E&P companies will end up hedging ineffectively as may be the case with CHK. That said, I think AEB is dead on with respect to the overpayment for leases/deals. So kudos to AEB for a great post on a rather weak article.

[applesauce]

Is that why BP has been paying billions for a 25% stake in CHK's deals. Short sided folks invest using todays numbers not taking into account what will happen when Russia cuts off Europe from fuel this winter and the growing likleyhood of Isreal dropping the mother lode on Iran. Fossil fuels are here for a long time and not getting cheaper to find and produce.


On Sep 06 09:18 AM AEB wrote:

> UBS' opinion is typical of analysts who know very little about the
> reality of the oil and gas business. $9/Mcf is not valid since the
> average spot price was $7.30 (Henry Hub) this week and plunging.
> The average U.S. wellhead price fell $2.30 in August compared to
> July to $8.32/Mcf and it will be much lower for September.
>
> At these prices, none of the great shale plays are commercial. That
> is why Chesapeake has been having a fire sale on its leases in the
> Haynesville, Woodford and Fayetteville shales. Barnett Shale production
> in Q2 2008 had fallen 20% from Q3 2007 before the fall in gas prices
> because of perceived higher unit prices in Haynesville and Marcellus.
>
>
> If drilling and leasing in the shale plays declines as it should,
> gas prices may rise but it will take a few quarters before this is
> felt.
>
> As an industry insider, I like natural gas plays but there are hard
> times ahead for the companies involved in the shale plays. They paid
> too much for new leases and deals when gas prices were high (Plains
> paid $30,000/acre in the Haynesville!), and are using borrowed money
> to drill. They all have huge quarterly debt service and hedging losses
> so far in 2008 (Chesapeake's long-term debt was more than $13 billion
> before they started selling, and the company is only worth about
> $3.5 billion).
>
> So I hope UBS is right, but it's hard to see what they based their
> positive opinion on. Does anyone think there might be something in
> it for them if a lot of people buy gas company stocks through them
> based on their advice????

[Brian Pursley]

Define unconventional.

[[e-mail]]

I believe there's a big future in natural gas. What I've been waiting or, and I'm so far unaware of is a strong competitor in the methane capture market. We put enormous amounts of methane into the atmosphere and eventually a player will come to market with a series of cost-effective and readily scalable methane capture devices for municipal sewer and waste-disposal applications and when that happens that company is going to skyrocket almost as fast as Google.

[jegan ;-)]

AEB ... Very interesting comments ... I also checked your webpage. Nice clear and concise. I like your style of reporting. jegan

[andydee]

With LNG in Europe at $12 to $16 and prices in Asia even higher what makes anyone believe the approx. 2 to 1 imbalance btw world and US NG prices will continue indefinitely? Spot prices do not define the LT price... Nor do prices over the next two or three months. The fact that NG is at $7.30 now (HH) says nothing about prices in 2009, 10 and beyond.

While I'm no supporter of the "analysts" in the industry, Aubrey of CHK and Bob Simpson of XTO may not agree on Haynesville, but they do agree that U.S. NG prices will be in the range that UBS asserts, $9 to $12. I suggest that those two gentlemen know a good deal more about energy than the poster AEB...

$30K per acre sounds high now, but wasn't it only a few years ago that gasoline at $2/gal at the pump was unthinkable? The Haynesville wells, as most of the unconventional wells do, yield about 80% of the EUR in the first 18 months or so...so a driller will get his investment back quickly...thereafter these wells have lifetimes ranging from 10 years to 40 years.... Oil wells in Calif, abandoned, or sold it for chump change when oil sold at $10 barrel - just a few years ago, are now making good returns when oil is at $100 barrel, even when just dribbling oil. Who can predict what the price of NG will be in 2020? except that it will be much higher than it is now...

A good example for Mr B to contemplate...DNR and others, including ECA are returning to old Oil fields and making money using tertiary recovery...(Liquid CO2 pumped into old reservoirs). Garth, at DNR estimates 1Billion barrels of oil, net to DNR out of played-out fields along the Gulf Coast. All-in cost of a barrel of oil to DNR will be about $30 per barrel...definitely economic to the producer at current prices and even at $75/barrel. DNR does no hedging...

Why bring up DNR and tertiary recovery? Gas in place in Haynesville, Barnett, etc. is a lot higher than EURs...someone sometime will figure out how to make that rock give up more of the gas trapped in it...