The Shale Boom Won't Crash Anytime Soon, Described in 2 Charts

Will the sun set on America's Energy renaissance? Probably not for a while. Photo source: Chesapeake Energy

Someday, the oil and gas resources trapped in shale formations will no longer be economical, and the production boom we have seen will fade into oblivion; it's all just a matter of time. According to some analysts, that time is sooner rather than later. A recent report from the Oxford Institute of Energy Studies has brought into question the long-term viability of shale production in the United States and whether companies like EOG Resources (NYSE: EOG  ) and Continental Resources (NYSE: CLR  ) can continue to drill at their current breakneck speed and generate profits for shareholders. Let's take a look at the case they make as well as two charts from the industry that may counter that argument. 

The question of shale's sustainability
There have been several reports that have challenged the sustainability of shale oil and gas in the United States, and this recent one from the Oxford Institute is really no different. It challenges the long-term viability based on three main elements:

  • Well economics show a weak business model: Unlike conventional drilling where no hydraulic fracturing takes place, shale wells require additional resources to bring oil or gas to the surface, which in turn translates to higher costs than what we are accustomed to paying for a well. According to this recent study, this means that in the event that oil prices were to decline, several shale formations would be uneconomical, especially since the most productive parts of these shale formations have already been tapped and companies will only get marginal gains from wells outside the prime acreage in each play. 
  • Asset writedowns: In the study, several of the nation's largest shale players varying from Big Oil to smaller independents have all made major asset writedowns since the beginning of the shale boom -- $35 billion to be exact. One of the biggest culprits that the study highlights is Royal Dutch Shell (NYSE: RDS-B  ) . Since 2008, the company has made over $24 billion in shale oil and gas investments, and now it is contemplating exiting its entire shale portfolio because of weak performance
  • Financial performance cannot continue: The final aspect of the Oxford Institutes shakedown of the industry is that the financial performance of these companies will cause a rift between managers and shareholders because of the extremely high levels of capital expenditures required to just maintain current production, never mind continuing to grow it.
The rebuttal
There are some elements that do strike true and that investors in this space should certainly pay attention to when investing in companies in this space. But one of the most glaring issues with this report is that it deals with historical data. If we have learned anything about the shale boom in the U.S., it's that it is a space that is constantly changing. More importantly it is a sector that continues to improve on itself, which brings us to our first chart.

Source: Continental Resources and EOG Resources Investors Presentations

OK, so maybe I'm cheating because its two images at the same time, but what it goes to show is that operators are still driving down the cost of wells. In the past two years alone, Continental and EOG have reduced the cost to drill a well by 18.5% and 20.3%, respectively. As the cost for an average well becomes less, rates of return are increasing. Between 2012 and 2013, EOG saw its return on invested capital improve from 9.4% to 12.4%, and the company anticipates that number to climb yet again this year to 14.2%, putting it in line with many of the big oil companies like Shell.

Also, as costs decline, many of those marginal wells that are not in the prime real estate of a shale formation are more economical, which brings us to our next graphic:

Source: Enterprise Products Partners Investor Presentation

This map from Enterprise Products Partners shows the drilling inventory in just the shale formations where Enterprise has major pipelines. Based on its estimates, there are over 743,000 perspective well locations in these shale formations alone, and this does not even include some of the newer/emerging shale formations like the Monterey and Tuscaloosa Marine shales, as well as the Powder River and Uinta Basins. According to Baker Hughes' well count, about 6,000 wells were drilled in the fourth quarter in these regions. If this pace were to continue, that would leave over 30 years of drilling inventory. 

What a Fool believes
Developing shale oil and gas wasn't a perfect process when it started, and several issues still remain that we need to address for its continuing success, such as methane leaks and water consumption. Over the next few years, there are likely to be a few companies that don't succeed, or the price of oil could sink and the economics of certain shale regions would be unprofitable. At the same time, there have been great strides to make shale drilling a more profitable venture, but there are still many things the industry is looking to do to make it even more economical. Because of this, it is hard to see America's oil and gas boom falling flat on its face anytime soon.

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