Is Arctic Drilling a Boom or Bust Proposition?

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Before shale drilling became a huge craze in the late 2000s the Arctic was supposed to be the next oil frontier. The U.S. Geological Survey found that the Arctic holds about 90 billion barrels of oil, enough to feed the world's thirst for oil for about three years. But drilling in the Arctic isn't like drilling in the warm waters in the Gulf of Mexico or even the cold and arid land of North Dakota. It's extremely difficult and dangerous and it's posing major challenges for even the biggest players in oil.

Shell (NYSE: RDS-A  ) found out the hardships of arctic drilling when its Killuk oil rig broke free of the tugboats that were hauling it to Seattle for maintenance on New Year's Eve and crashed into a deserted island. This isn't the first challenge Shell has faced and it may be a warning sign for others. Noble's (NYSE: NE  ) Discoverer nearly ran aground in July. Just transporting rigs to the Arctic is a difficult task.

Big $$$ on the line
The huge bets on the Arctic are a challenge for big oil. Shell paid $2 billion for leases just to drill in Alaska, not even including costs for drilling rigs. On the other side of the coast in Newfoundland, Exxon Mobil (NYSE: XOM  ) and partners Chevron, Suncor, Statoil plan on spending an incredible $14 billion in capital costs by 2017 to build out oil drilling infrastructure there. The platform it is building is said to be capable of producing 150,000 barrels per day.

The sheer size of the investment and the dangers involved in harsh environment drilling make this a big risk for big oil. Even at a company the size of Exxon, the 36% stake in a $14 billion investment the Hebron development is big money.  

For Shell, it's already been a tough road. The U.S. Coast Guard is investigating the Noble Discoverer for inadequate pollution and safety controls, and has begun an investigation of the Killuk incident as well. Every incident brings not only legal and regulatory attention, it also makes a return on investment harder to achieve.

Beyond big oil
The huge investment taking place in frigid northern waters isn't limited to money being poured in by big oil companies like Exxon, Shell, and Statoil. Oil drillers are spending a lot of money to expand harsh environment fleets as well.

Seadrill  (NYSE: SDRL  ) already has nine harsh environment rigs with another two under construction, Transocean  (NYSE: RIG  ) has seven such rigs, and Noble has the rig Discoverer mentioned above. Big oil's big plans for the Arctic have implications that are trickling down the supply chain to drillers as well.

Easy oil being found elsewhere
Billions are being spent in frigid waters at a time when easier oil can be found in much more moderate climates that don't pose the same risks. Shale drilling has become extremely popular in the U.S. with the Bakken, Barnett, Marcellus, and even untapped parts of California being exploited for oil.

Drilling off the coasts of Brazil, Angola, and the U.S. has driven the ultra-deepwater market that has been so lucrative for rig owners. With large swaths of land off the coast of Africa yet to be developed, and shale oil adding to the possibility of U.S. energy independence, big oil is taking risks in the Arctic that seem to be higher than what it needs to be taking right now. Even oil sands in Canada have yet to become a big provider of oil.

Risk vs. reward
Shell's challenges in Alaska show that even as arctic waters open for exploration it's not a slam dunk for oil drillers. There may be a lot of oil below the surface in the Arctic but there are also a lot of risks -- with billions of dollars at risk in each project, big oil needs to be careful. ConocoPhillips for one is playing it safe and waiting to see how the experience of others goes. Right now, that looks like the best place to be.

Betting big on oil drilling
If you're an energy investor looking for exciting opportunities, then you should look into one of the more exciting plays in the space: Seadrill. To learn more about the strengths and weaknesses of this company, as well as what to expect from Seadrill going forward, be sure to check out this brand-new premium report put together by one of our top Stock Advisor analysts. Click here to get started.

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