Horizontal Drilling Is Heading Out to Sea

Horizontal drilling is having an incredible impact on America's energy industry. When combined with hydraulic fracturing it was found to be the key to unlocking America's vast oil and gas saturated shale formations. But the drilling technology's next move is offshore where it's being used by Energy XXI (NASDAQ: EXXI  ) to breathe new life in left for dead oil fields in the shallow waters of the Gulf of Mexico.

Drilling down into Energy XXI's plans
Energy XXI has successfully applied horizontal drilling techniques to its oil fields in the shallow waters of the Gulf of Mexico. For example, the West Delta 73 field has enjoyed a strong boost in production from new horizontal wells as the graph in the bottom right-hand corner of the following slide notes.

Source: Energy XII Investor Presentation (link opens a PDF

In addition to the improved production, Energy XXI was also able to substantially boost its proved reserves from that field. As the above slide also noted, the proved reserves of West Delta grew by 30 million barrels of oil equivalent, which was about double the previous amount.

Looking ahead Energy XXI sees another 100 potential horizontal locations across its current asset base as noted on the map in the following slide.

Source: Energy XII 

Energy XXI sees these locations fueling strong growth over the next few years. Like onshore horizontal wells, these are low-risk projects that are highly scalable and repeatable while offering high rates of return. 

Better than shale?
What Energy XXI is finding is that horizontal wells in the Gulf of Mexico are turning out to be even better than similar wells drilled onshore. For example, the West Delta 73 field's first well came online at 3,000 barrels per day. That's an exceptionally large amount of oil as a 1,000 barrel per day well onshore is considered a very good well. Further, the other impressive number out of Energy XXI's horizontal wells are the decline rates. Whereas a horizontal onshore well's production can decline by as much as 60% per year, Energy XXI's wells are declining at a much more manageable 10% per year. Further, because of the makeup of the reservoir, these wells don't require any fracking.

Source: Apache  

Still, the energy industry is seeing a mass exodus from Gulf of Mexico shelf assets as producers focus is on two areas: deepwater plays and shale plays onshore. Apache, for example, sold its Gulf of Mexico shelf operations to privately held Fieldwood Energy for $3.75 billion. That move was part of Apache's portfolio rebalance as it focuses on its North American shale assets. Apache sees its North American onshore assets fueling stronger returns and more predictable growth, which is the direction it wants the company heading.

But Fieldwood Energy, like Energy XXI, has been busy buying Gulf of Mexico Shelf assets over the past year as it sees a lot of potential in these assets. In addition to buying Apache's shelf assets, Fieldwood Energy also purchased SandRidge Energy's (NYSE: SD  ) Gulf of Mexico business in a $705 million deal. What's interesting about the SandRidge Energy deal is it represented a bit of a homecoming for Fieldwood. That's because prior to forming Fieldwood Energy the company's CEO Matt McCarroll had founded Dynamic Offshore Resources before selling it to SandRidge Energy. Two years later he acquired those same assets from SandRidge in order to build his new company. Like Apache, SandRidge Energy wanted to put all of its focus on its shale assets to fuel future growth. 

In giving up on the Gulf Apache and SandRidge Energy basically gave away these assets to Fieldwood Energy. Because of that the company should be able to will leverage its large position in the Gulf of Mexico and pursue a similar strategy as Energy XXI to boost production by using horizontal drilling. With it being a repeatable and scalable process, the company can apply it across its portfolio to drive near-term production growth as well as add substantially to its reserves and extract a lot more value out of the assets than it paid to acquire them.

Investor takeaway
The Gulf of Mexico shelf has been basically left for dead by most oil producers. However, horizontal drilling has the potential to revive it much like the technology is doing onshore. That puts first movers like Energy XXI in the prime position to profit as the technology begins heading out to sea.

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