North American Natural Gas Producers Move Forward in the Face of Skepticism
Monday’s $30 billion takeover of Burlington Resources (BR) by ConocoPhillips (COP) was questioned by analysts wondering if ConocoPhillips overpaid. After all why pony up for gas assets now when the natural gas price was expected to decline. Meanwhile RealMoney.com put out an article entitled EnCana Shares May Be Full of Hot Air. The article was critical of EnCana (ECA) having to spend more money to discover less gas when compared to Burlington. The perceived value of ECA and BR are lower outside of the gaspatch than within. What do the insiders know?
Burlington and Encana share some history, both companies got a head start in the oil and gas business through land grants and rights of way for railway construction. In 1864 Northern Pacific Railway Company (predecessor to Burlington Northern Railroad Company) received 40 million acres (an area the size of Washington State). The Canadian Pacific Railway (a predecessor to EnCana) received 25 million acres in 1864 (an area the size of England).
Natural gas prices in North America are the highest in the world. Explorers are currently running ragged on an “exploration treadmill”. The amount of gas discovered per well drilled is in steady decline, which means it takes far more effort just to maintain current production. What got us into this situation? The simple answer is found in the gas resource triangle. This triangle illustrates that vast gas resources exist in the presence of high prices and more technology once the low hanging fruit of conventional gas has been exploited. Unconventional gas is where the growth in North American gas supply is going to come from.
Unconventional gas is characterized by a need for specialized drilling and completion techniques (more technology). Conventional drilling methods used on an unconventional gas play will often yield a dry hole. Additionally, well spacing for unconventional gas plays is much denser. A conventional gas spacing unit is 1 well per section (a section is one square mile). Today wells are being drilled in Colorado with a spacing of over 60 wells per section. There is a chance that the drill rig and crew used to drill these wells are from China!
Burlington’s advantage over EnCana consists of their large landholdings in the Deep Basin in Western Canada (tight gas) and the San Juan Basin in Colorado and New Mexico (coalbed methane). Both basins were deemed unconventional in the late 1970’s and early 1980’s to the point that “bread and butter” exploration geologists were extremely skeptical of the potential of these basins. The big picture is that Burlington’s assets are slightly higher on the gas resource triangle.
Unconventional gas resources are significant but their lower grades require larger landholdings to justify their exploitation. It’s no coincidence that Burlington and Encana are major unconventional as producers as their extensive legacy land positions are a major competitive advantage when it comes to unconventional gas exploration.
Meaningful additional gas supplies for North America (LNG and arctic gas pipelines) are at least 5 years away from coming on stream. In the meantime North American gas explorers will continue to spend more money to drill more wells to find less gas.