While You Tan, Oil Companies Could Be Drilling Beneath Your Beach

Horizontal drilling hits the beach.

Feb 9, 2014 at 1:17PM

Beach Day

A new breed of energy companies are quietly buying up oil and gas properties along the shorelines of America's Gulf Coast. These oil and gas assets are being tossed aside as many of America's oil companies would rather search for energy in the deepwater of the Gulf of Mexico or by using horizontal drilling techniques to unlock oil and gas from tight shale formations onshore. However, these leftovers could prove to be a real steal as horizontal drilling near the shoreline could unlock billions of barrels of oil still hidden underneath the sand.

The quiet buildup
Last year privately held Fieldwood Exploration quietly picked up Apache Corporations (NYSE:APA) Gulf of Mexico Shelf operations for $3.75 billion. This ended Apache's 30 year run operating in the shallow waters of the Gulf of Mexico. Apache just didn't see much potential from these assets, which would eventually cost the company $1.5 billion to retire when the wells ran dry. Apache also saw more growth potential as it used horizontal drilling to unlock oil and gas in places like the Permian Basin of Texas.

In addition to picking up Apache's Gulf of Mexico Shelf assets, Fieldwood Exploration also snapped up similar assets from SandRidge Energy (NYSE:SD). In that $750 million deal SandRidge Energy basically waved the white flag on its oil production plans in the shallow waters of the Gulf of Mexico. SandRidge Energy's plan all along was to funnel cash flow from those properties so that it could drill more horizontal wells into the Mississippi Lime formation in Oklahoma and Kansas. Instead it took what cash it could get for those assets and let someone else handle the abandonment costs as the wells ran dry.

Neither SandRidge Energy nor Apache saw much growth potential from these assets. Fieldwood Exploration, on the other hand, could be setting itself up for quite a boost. That's because it now has the assets and capital backing to follow on the heels of a company like Energy XXI (NASDAQ:EXXI) and begin to drill horizontally into the Gulf to unlock some of the oil that's still trapped beneath the sand.

Is the reservoir half full or half empty?
Energy companies are never able to extract all of the oil that's discovered in a reservoir. The global average recovery factor from a typical oilfield is usually 40% or less. In the shallow waters of the Gulf of Mexico these fields historically have done better than average at a 45% recovery factor. That said, when these companies plug and abandon wells there's still a lot of oil left down there.

Using new techniques like horizontal drilling has the potential to unlock more oil in the shallow waters of the Gulf of Mexico in a similar way as it's unlocking more oil onshore. In fact, the management team at Energy XXI believes that its usage of horizontal drilling could increase the recovery factor by as much as 5%. That small increase could net companies like Energy XXI and Fieldwood millions of barrels of additional oil and add billions of dollars in value to the reserves these companies are purchasing at fire sale prices.

Investor takeaway
Using horizontal drilling in the Gulf of Mexico is no sure thing. That's why Apache and SandRidge Energy both decided to cash out now in order to invest that capital on more sure things like drilling horizontal wells onshore. However, it will be interesting to watch as that same technology is applied in the Gulf of Mexico Shelf area. It could have the same game changing potential to unlock oil in the Gulf as it has in onshore areas like the Bakken Shale.

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Matt DiLallo owns shares of SandRidge Energy. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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