GE Florence panel session—innovating and investing in unconventionals

Huge efficiency gains are just a start as independents ‘shrink to grow’ in the unconventional space. Industry is evolving from inventory starved, cash positive, to an embarrassment of richesse and a shortage of funds. North American energy independence is not likely given today’s economics.

Being short on ideas and time this month I thought that I would bring you some more from the ‘industry at large’ folder—specifically my notes from the excellent ‘Fast track on the future’ panel session at GE Oil & Gas’ annual meeting in Florence this month which provided a snapshot of the US shale exploration scene.

Kim Hatfield (Crawley Petroleum) traced the history of US shale exploration with a tip of the hat to the late George Mitchell who opened up the Barnett shale play. While the entrepreneurship of Mitchell and others was a force behind shale development, the key driver was ‘private ownership and 3-5 year leases’ that enabled operators to achieve huge acreage positions and develop them quickly. The result is huge efficiency gains—of 30-50% in drilling. Shale development involves thousands of virtually identical wells and involves taking big risks early on to optimize. Completion efficiency is also a big issue—but here, results may not be so clear cut. Geology ‘may vary’ and tweaks in completion may not show up for months in production figures.

Unconventional production technology is immature. While legacy artificial lift work reasonably well in early life—where liquid production dominates, it is not be so good for multi phase flow in long offset wells. We may be abandoning wells too early. We also need to be able to monitor wells better to understand what zones are producing what. Today there is a chicken and egg situation—we can’t categorize pressure and flows and therefore cannot optimize intervention techniques. We need to come up with better systems, five years after a well has been drilled is too late. We need downhole data and better analytics. One operator reported that eliminating one stage per completion per well would save them $2 billion.

Craig Jarchow (of private equity firm Pine Brook Partners) observed that ‘all innovation comes from pain.’ His pain, as an investor, stems from the significant changes that the non conventionals have wrought on the industry which is ‘no longer focused on inventory but rather on cash flow.’ Prior to circa 2005, the industry was cash flow positive, then the non conventional switch was flipped and industry is now ‘consuming capital.’ The pundits would have it that North America will be self sufficient by 2020/2030, but ‘do the math, it will take $500 billion investment to get there.’ The industry just does not generate this kind of money.

The new short-on-capital, long-on-inventory paradigm is ‘a complete change for oil and gas financing.’ Before, ‘we used to get a couple of guys with a few projects they could flip and double your money.’ Now it takes a whole team to identify and prove-up a play. Whereas $50 million might have done back in the day, the new paradigm requires up to $1 billion equity to start up. The ‘dirty secret’ of unconventionals is that they are hard and expensive plays. It can easily cost $50million to find out if a play will work and there may be 2-3 trials per company. A lot of up-front cash is required. ‘This is the pain that I am feeling.’

But the pain represents opportunity—for innovators to improve efficiency in the supply chain, drilling and completion. Having said that, Jarchow opined that there is only so much that can be done. Unconventionals only work at certain maturity and pressure (i.e. depth), ‘so it will cost.’ There is a lot do in regard of capital exposure. ‘We are still assessing unconventional plays by trial and error which is unacceptable.’ There is a need for improvements to technology and execution that lets companies assess an area, limiting financial exposure to ‘$10-20 million.’ The search for efficiency has caused some large independents to ‘shrink to grow,’ selling off conventional assets to focus on unconventionals where they have expertise.

The moderator (GE’s Mike Ming) tried to steer the debate back to its ‘innovation’ theme asking if investors should factor-in technology development into their projects. GE Aviation’s Greg Morris was positive, citing the impact of additive technology (a.k.a. 3D printing) on accelerating innovation. GE now manufactures its own fuel nozzles using the technique and has taken a large market share away from the incumbent.

Jarchow was sceptical, citing the poor performance of venture capital in green energy. There is risk in innovation, from execution (the quality of the management team), technology (will it work?) and the market (does anybody want it?). Historically, investors in innovation have not been compensated for these risks and technology does often fail. Jarchow cited recent disappointments in water treatment and battery technology to conclude that a portfolio approach was necessary. Hatfield observed that shale economics are ‘so thin that we may be making short term decisions without a concern as to where we will be in ten years time.’ Engineers are under pressure to cut costs and this may impact future production.

Ming again steered the debate back on track asking what the panellists thought of collaboration in what can be a ‘pretty tight’ industry. Will the new resource paradigm transform industry from its ‘proprietary’ business model?

Jarchow agreed that the new ‘abundance mentality’ could make for more collaboration. ‘We have economic incentives in spades—watch this space.’ Hatfield was concerned about this risk/reward equation for frontier areas and thought that protecting intellectual property and expertise remains important. But the prize is there as shale gas is transformed into ‘just in time inventory’ which can be ramped up quickly when needed, ‘damping volatility in commodity prices.’ More from the GE Oil & Gas annual meeting in our full report on pages 6 and 7, and on the event minisite.

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