Can BP Crack the Code to Success in U.S. Shale?

BP (NYSE: BP  ) announced earlier this year that it will separate its onshore US oil and gas assets in the lower 48 states into a new business by next year – a move that reflects the British oil giant's acknowledgement of shale's unique challenges.

By forming this new business, which will have separate governance, processes, and systems, BP should become more competitive against smaller, nimbler energy producers that have dominated US shale drilling in recent years.

Photo credit: Carrizo Oil & Gas

BP separates US shale business
According to BP, the new business will operate independently and will disclose its financial statements separately starting in 2015. While BP will still own the new business, it will be run by a separate management team working from a new location in Houston, instead of BP's North American headquarters at 501 Westlake Park Boulevard in Houston.

BP's chief executive Bob Dudley said the new business will be a "critical part of BP's portfolio over the long-term." Its management team will be tasked with overseeing operations across the company's vast onshore US portfolio, which includes 7.6 billion barrels of reserves spread across 5.5 million acres in Texas and the Mid-Continent.

BP's main areas of focus will be the Eagle Ford, where it held roughly 450,000 gross acres and had nine rigs operating as of year-end 2013, and the Anadarko basin, where it had over 1,000,000 gross acres and 12 rigs operating at year-end 2013. Success in these locations will require an entirely new approach to decision-making and cost management.

Why shale is different
While BP has considerable expertise in offshore deepwater drilling, onshore shale drilling is a different game. Deepwater development focuses on a small number of wells that each contain enormous volumes of hydrocarbons. By contrast, shale development features hundreds and thousands of potential wells that are more evenly distributed.

As such, successful shale development requires the identification of the most productive zones and the most economical methods of developing them, which calls for quick decision-making and exceptional control over costs. By forming a separate business, BP should be able to make quicker decisions, improve its drilling speed, and manage costs better.

Not only would this allow the company to improve its returns and compete more successfully against smaller, nimbler firms, but it would also increase the value of its US shale business in case BP decides to sell it at some point down the line.

Other benefits
Beyond improving competitiveness, BP's decision to separate its US shale business could also pay off in other ways over the long run. As the company improves its shale drilling knowledge and capabilities in the US, it can use that experience to unlock hydrocarbons from shale and tight oil reservoirs in foreign locations such as Russia, Oman, and Algeria.

In an interview with FuelFix, BP's head of technology David Eyton explained how the company's shale ventures in the US could translate into future success abroad: "There's an extraordinary diversity of experiments going on, so the industry as a whole is learning very rapidly, and it's quite cheap to learn in the lower 48 ... It doesn't cost very much to try things out here without losing your shirt. It's like a massive laboratory."

Investor takeaway
BP's decision to separate its US shale segment into a separate business shows that the company is serious about improving its competitiveness in an operating region that has proved hugely challenging for most oil majors. Its emphasis on cost control should help improve returns and make the business more valuable to potential suitors, while also providing knowledge and experience that can be used to develop other shale reservoirs around the world.

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Arjun Sreekumar

Arjun is a value-oriented investor focusing primarily on the oil and gas sector, with an emphasis on E&Ps and integrated majors. He also occasionally writes about the US housing market and China’s economy.

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