Energy Exploration: Investing Essentials

Here's what you need to know about energy exploration before considering it as a industry worth investing in.

Aug 5, 2014 at 12:00AM

There are very few industries out there as critical to the global economy than the oil and gas industry. Just think about it for a second: If all clothing retailers were to all of the sudden disappear for a day, we would notice, but the world would probably continue on. Now imagine if oil and gas just stopped flowing for a day: no driving cars, no deliveries of goods, no airline flights. The global economy would come to a screeching halt.

To keep that global economic engine running smoothly, we constantly need to explore and identify new sources of oil and gas to replace older ones in decline. This makes the energy exploration business a pretty compelling place to invest. Let's take a quick look at what the industry is all about, how companies explore for new sources of oil and gas, and what investors should know about the industry if they are considering investing in this space. 

Images

A retouched photograph the first successful oil well. Source: Library of Congress via commons.wikimedia.org.

What is energy exploration?

For the entire existence of human civilization, we have been on the hunt for new energy sources. At one time, energy exploration involved the hunting of whales for their oil used in lamps, but what we now associate with energy exploration is the search for oil and gas. The exploration for oil and gas by drilling got its start in 1859, when Colonel Drake successfully drilled the first oil well in Titusville, Pennsylvania, that yielded 25 barrels per day. Since then, the industry has grown around the world and now produces close to a hundred million barrels of oil and gas per day.

Today, energy exploration takes places in all corners of the globe, and we are constantly pushing the limits of the industry by exploring sources of oil and gas that were once considered unattainable, such as those far offshore or trapped in complex geological formations. 

How big is energy exploration?

There are thousands of companies around the world engaged in energy exploration, ranging in size from companies working on one rig to the gigantic national oil company of Saudi Arabia -- Saudi Aramco -- that produces over 12.5 million barrels per day of oil and natural gas. All told, the entire industry generates several trillion dollars in revenue annually and employs millions of engineers, geologists, and the always essential roughnecks -- a nickname for men and women who do the manual labor on an oil and gas rig.  

How does energy exploration work?

Energy exploration is the process of discovering oil and gas and then drilling into the ground to extract it. The process normally follows this path.

  • Teams conduct what's known as a seismic survey. This involves creating a seismic pulse that travels underground and is reflected back to the surface based on certain structures underground, and these reflections are collected with an array of sensors. These surveys help to identify locations and approximate sizes of potential reservoirs.
  • A test well is drilled. If a hydrocarbon formation is located with a well, then several tests are conducted to measure how much oil and gas are present, and if they can be economically extracted. Further exploratory wells are also drilled to determine the full extent of the reservoir.
  • Development wells get drilled to actually start production in this new reservoir, and additional wells are drilled across the entire formation to maximize the output from that particular field. In the case of shale oil and gas, this is where companies use hydraulic fracturing and horizontal drilling to open up fissures in the formation to allow oil and gas to flow freely to the surface. 
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Today, energy exploration takes places miles offshore in over 15,000 feet of water. Source: Ralf Roletschek via commons.wikimedia.org.

It sounds pretty simple when described like that, but the entire process can take years to conduct and can cost several billion dollars depending on where those activities are taking place. To call it a crap shoot is probably going too far, but many test wells are unsuccessful. Companies in the space normally recover the costs of several unsuccessful attempts with just one well that hits paydirt.

What drives energy exploration?

The primary driver for energy exploration is the world's demand for oil and gas. We consume billions of dollars worth of it every day filling gas tanks in our cars, heating our homes, and using products that are manufactured from petrochemicals. Demand for oil is the doppelganger for the broader global economy; the only time demand for oil and gas wanes is when we are in a global recession. 

For companies in the energy exploration business, the price for these commodities is immensely important. Certain oil and gas reservoirs require a certain price of oil to make them economically accessible, so as oil and gas prices rise, companies can be a little more cavalier with exploration activities, because more expensive sources are justifiable. Integrated oil and gas companies, some of the biggest in the energy exploration space, can see profits swing up or down by hundreds of millions of dollars as the price of a barrel of oil changes just $1.

Investors in energy exploration companies can't really control or foresee what oil prices will do, though. So, it is important to watch the costs exploration companies incur when developing new sources. Metrics such as cash margin per barrel and return on invested capital are strong indicators of the costs a company is willing to take on for new sources. 

You can follow Tyler Crowe at Fool.com under the handle TMFDirtyBird, on Google+, or on Twitter @TylerCroweFool.

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