Here's Why the Tuscaloosa Commotion May Be Unwarranted

Last month, I took a look at why many companies and investors are so keen on the Tuscaloosa Marine Shale as the next big shale oil play in the United States. As I noted then, however, a small group of dissenters disagree. The points they raise suggest that the Tuscaloosa commotion may be unwarranted.

Unfavorable geological conditions
The first thing that separates the Tuscaloosa Marine Shale from other shale formations, such as the Bakken and Eagle Ford, is its depth. The Bakken and Eagle Ford have maximum depths of 7,500 feet and 10,000 feet, respectively. The Tuscaloosa is up to 15,000 feet deep. Further, the Tuscaloosa has a thickness ranging from 500 to 800 feet, compared to the Bakken and Eagle Ford formations, which have respective thicknesses of 140 feet and 475 feet.

A second characteristic that sets the Tuscaloosa apart is the physical properties of its shale rock. The rock is mushier and less brittle than the rock in other plays. This translates into greater difficulty in cracking the rock using hydraulic fracturing. Instead of cracking cleanly as more brittle rock does, the Tuscaloosa's rock will often absorb fracking fluids and expand, closing any cracks that are made.

This play poses some unique technical challenges for E&P firms operating in the area.

Questionable economic viability
The unfavorable geological conditions described above contribute to the questionable economic viability of the Tuscaloosa play. Drilling and per-well costs are much higher for Tuscaloosa than for other plays. For the Bakken shale, drilling costs are about $10 million, and costs have decreased to about $5 million-6 million for other shale plays. Drilling costs in the Tuscaloosa have ranged from $11 million to $20 million.

Unclear methodology and inconsistent production
Another issue is the "repeatability" of operations. The term refers to the horizontal drilling and fracking method or methods that will work across the widest range of well sites. Wells drilled to date have shown wide variation in their 24-hour initial production and 30-day initial production numbers. There have been duds that produced 35 BOE/d and averaged 85 BOE/d over a month. On the other hand, there have also been superstars boasting 1,540 BOE/d with a 30-day average of 1,137 BOE/d. It seems that the results for the next 20-40 wells will have a defining impact on whether the Tuscaloosa will stay in the conversation as a major play or be relegated to the sidelines. Firms must conduct more drilling to accurately assess operational repeatability and production potential.

Major players exit or question the Tuscaloosa
Devon Energy (NYSE: DVN  ) , one of the first E&P firms to begin operations in the area, exited the Tuscaloosa last year. The company sold its interest in 277,000 acres to Goodrich Petroleum (NYSE: GDP  ) for $26.7 million. Devon Energy spent a total of about $119 million in the Tuscaloosa, including the costs of lease acquisitions and drilling seven wells. Although Devon took a shocking loss on this play, the firm refocused on the more proven Permian Basin, Mississippi Lime, and Barnett Shale plays. According to Amelia Resources LLC President, Kirk Barrell, the horizontal drilling method that Devon used was lacking and yielded underwhelming results. Goodrich Petroleum's purchase made it the largest holder in the play.

Encana (NYSE: ECA  ) has not exited the formation, but has slowed the advance of its presence and operations. Encana is one of the largest leaseholders in the Tuscaloosa and targeted the play as one of its five core areas this year, but is not aggressively drilling or acquiring more holdings at this time. Instead, the company is conducting appraisal drilling to fully assess the shale. Encana will spend up to $150 million on appraisal drilling in hopes of establishing repeatability for its operations. If results are disappointing, it is possible that Encana will follow in Devon Energy's footsteps and exit the Tuscaloosa.

Foolish conclusion
In my first look at the Tuscaloosa Marine Shale last month, I considered the merits of the play and why so many investors and companies were excited about it. This article presented several reasons to temper that excitement. The Tuscaloosa is different from other shale plays due to the technical challenges it presents. While those other plays are still booming and companies can operate in those areas less expensively than they can in the Tuscaloosa, it makes sense for companies to focus elsewhere and perhaps wait and see as firms like Goodrich and Encana figure things out. For me, the Foolish conclusion is that the Tuscaloosa will be one of the next big things, but its time is most likely not now.

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  • Report this Comment On July 07, 2014, at 4:55 PM, divedogg wrote:

    Helpful article. I bought low (at 13) and am still sitting on a nice profit. I hate to sell because it would be a short term capital gain, although in retrospect I should have taken a quick 130% gain when it was at 30. Now that its down to 23 I'm hoping the bad news is priced in for the time being. Of course the next well will be a big data point that hopefully will propel the stock higher again. My thesis is that GDP will overcome the technical issues and wind up with a fantastic asset in the TMS. Even if the cost of drilling is higher than other shale formations, the profit margins are still huge with WTI oil holding above $100 and natgas above $4. Of course if oil prices collapse then that will be another story, but I'm okay with that risk for now. This stock is nothing if not volatile, so I think it is worth buying on the dips and maybe if you have it in an IRA or other tax free account you can trade it around the vol. I recently bought END on a huge dip and am hoping for a similar result!

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