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Stranded Assets, My Foot: The Next Oil Bonanza Could Be Deep Under Water

Investor's Business Daily

The biggest oil stocks may be about to hit the next oil bonanza after initially missing the shale boom.

Consider this: Crude prices can fall to $35 a barrel, less than half current levels, and Royal Dutch Shell (RDSA) could still profit off a deepwater oil project in the Gulf of Mexico.

Shell gave the final green light to the Vito project in April, after slashing development costs by 70%. A month later it announced a deepwater oil discovery, also in the Gulf. This isn’t a coincidence. The oil major plans to boost deepwater oil production by over 200,000 barrels of oil equivalent per day, to more than 900,000 by 2020. This comes even as Shell also ramps up shale activity in places like the Permian Basin.

Oil companies are again looking at deepwater projects, which are notoriously expensive and were ripe targets for cuts after crude collapsed in 2014. But deep-pocketed giants like Shell, Exxon Mobil and Chevron are now uniquely positioned to capitalize on what could be the next boom. The steep startup costs of a deepwater drilling platform and rig mean only the biggest oil majors can afford to invest. Meanwhile, years of squeezing out inefficiencies have made deepwater oil increasingly competitive with shale. And those onshore plays are more crowded, with many smaller companies vying for land, labor and equipment.

“A gap had emerged between offshore and onshore,” said John Kerr, chief technology officer for Baker Hughes‘ oilfield equipment business, in an interview with IBD. “The last three to four years we basically applied a strict diet into what was a historically expensive environment.”

Oil Companies Weigh Deepwater Oil Vs. Shale

Analysts caution against direct comparisons, saying they are like apples and oranges. But in general, shale drilling is more nimble. That means companies can respond more quickly to price fluctuations by adjusting activity without sinking their cash flow. A well in the Permian can cost about $10 million.

But deepwater oil projects, those that reach depths of 500 feet or more underwater, can require billions of dollars of total investment. And their complex, sprawling operations can’t throttle back so easily. The Vito development, for example, is beneath more than 4,000 feet of water and will consist of eight subsea wells.

However, once those upfront costs are sunk, so to speak, deepwater projects look different. Before oil crashed, they used to cost as much as $1 million a day in the Gulf of Mexico, according to Wood Mackenzie, an energy research company. Today that’s down to $400,000 or less.

The steep rate of decline for shale well production also requires companies to ramp up drilling just to keep a shale project’s output steady, driving up costs. A typical onshore shale well’s output drops off 60%-80% in 12 months, said James Williams, an economist at energy consultant WTRG. But a typical offshore well has a 10%-12% drop-off rate in 12 months.

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