Some oil fields never die. In fact, some just get better with age.
Alberta's Duvernay shale may just be the best example yet.
It all has to do with the "shale revolution,” and how it's dramatically altering the energy landscape.
To be sure, large volumes of natural gas are being found in the least likely of places: Quebec, Michigan, even countries like Poland and Latvia.
That’s all well and good -- the world is finally cueing into the fact that cheap abundant natural gas will drive the global economy for decades to come.
Alberta has been a latecomer to the shale gas game, but that's about to change in a big way -- thanks to the emergence of the liquids-rich Duvernay play.
For weeks, speculation has been building that unknown buyers have been staking out a new shale play in Wild Rose Country, driving land prices at Crown mineral auctions to new heights. In fact the Alberta government took in $2.6 billion in the fiscal year ended March 31, which was an all-time high (but still far short of liquor, tobacco and video lottery).
Since last summer unknown bidders have paid as much as $35,000 a hectare for land (2.5 acres=1 hectare) in an area called Kaybob that normally sells for only a tenth as much. At an Alberta land sale in March unknown buyers put up the ridiculous sum of $107 million for a single parcel near Fox Creek, 260 km northwest of Edmonton, a sure sign that something is afoot in the hinterland.
This is Montney country, yes. But the sheer scale of the bids was enough to turn heads and set tongues wagging in the high skyscrapers of downtown Calgary. All that money for deeper rights down to the Devonian -- it could only be the Duvernay.
The Duvernay is noteworthy because it's the source rock for the original Leduc oil discovery in 1947. It's also a high-quality source rock for most of the crown jewel oil discoveries in Alberta over the decades, from the Swan Hills to the Keg River reefs.
It's the same rock that built an industry... a gift that keeps giving to this day.
The Duvernay is a spot-on, perfect example of a well-known play that could never be developed without the technologies we have today: the dynamic duo of hydraulic fracturing and horizontal drilling.
On April 19, Trilogy Energy Corp. (TSX-TET), along with partners Celtic Exploration Ltd. (TSX-CLT) and Yoho Resources Inc. (TSX-YO) announced test results from their second Duvernay joint venture well.
The results were quite strong -- 7.5 million cubic feet per day of gas. More important, the well yielded 75 barrels of liquid condensates and 56-degree API oil for every million cubic feet of gas, for some 1,250 barrels of oil equivalent per day.
If the crew at Canadian brokerage firm Peters & Co. was disappointed with the cost of the well -- $17.5 million including the fracs -- it was clearly impressed with the production numbers, especially the liquids content which amounts to more than 500 barrels a day alone (Do the match by multiplying by $100 a barrel). Peters thinks there are cost savings to be realized with full scale development, which is usually the case with these early stage plays.
In some ways, it could be the most important well drilled in Western Canada since the first Leduc discovery well in 1947. That's because the liquids, which are priced on an oil equivalent basis, are more than enough to make up for the relatively weak gas price.
Wellington West Capital Markets reports that the addition of those liquids effectively pushes the realized gas price up to $8 per mcf equivalent (mcfe), which is not bad at all, especially in the current market.
These are the kinds of numbers that draw attention of major players.
So it was hardly a surprise that Encana Corp. (TSX-ECA) came out the very next day and revealed itself as the mystery buyer of all those Duvernay rights, spending $300 million on land acquisition in the first quarter alone.
For a company like Encana -- North America's second-largest gas producer, the shift into liquids is a no-brainer after the haircut they took in the first quarter. As one of the most gas-levered companies on the planet, they have to do something.
And one look at the company's first quarter results tells the story: it barely broke even in the first three months of the year (thanks to effective hedging) compared to a $1.5 billion profit in the same period a year ago.
They're basically giving the gas away for free.
Encana CEO Randy Eresman practically said so much at the company's annual meeting in Calgary last week when he suggested the company could give away the gas and still make money on the liquids.
In that sense Duvernay is manna from heaven, and some serious good fortune for a trouble gas sector.
Plus, Alberta has a ready-made market for those liquids, which are used to dilute bitumen and heavy oil and make it flow through pipelines like the Keystone XL to the U.S. Those liquids have been in short supply in recent years, and there was even talk of importing them from offshore for use in the oil sands.
As I said, Encana shelled out $300 million on land acquisition, just in the first quarter.
It’s a big number considering there are only two published drill holes into the Duvernay – and neither one belongs to Encana.
The Duvernay is the hot new stealth play in western Canada.
Yes, it’s early stage, but Encana’s big purchase shows they believe it will be a highly profitable play – so profitable in fact, the big dog of Canadian gas could become a take-over target itself. As I mentioned, the Duvernay is the “source rock” where much of the oil in the Western Canadian Sedimentary Basin was formed – and then migrated upwards into the pools and traps that have been the discovered since the first Leduc well in Alberta in 1947.
Ironically, Encana quoted Trilogy’s test numbers as a benchmark of success even though it hasn’t drilled a single horizontal well into the play. In fact, it only has one vertical penetration to date, which it described as “encouraging.” Assuming of course, a company like Encana has enough clout to create “the economies of scale” needed to drive down costs. Indeed, it has shown it has plenty of muscle, even in a weak gas price environment, to do just that.
On a conference call to discuss its disappointing first quarter results, company officials raved that the Duvernay has the potential to be a “top quartile” shale play in North America.
Confidence or cockiness? Given Encana’s reputation as a low cost producer that has become a victim of its own success by unlocking tens of trillions of cubic feet of reserves, we’re going to say both. Let’s face it, they ARE a big part of the reason there’s so much gas around these days.
But what happens next is an investor’s dream. This could be a HUGE new play, like the Horn River in remote northeast B.C., but on a larger scale.
Except Duvernay isn’t northeast B.C. In the Duvernay area, we’re talking about good roads capable of carrying good crews and equipment to work each day. You can even get a good cup of coffee on the way there, and drive back home at night – no camps with extended absences from family. It’s a virtuous circle.
So here's the full tally:
• The Duvernay has an abundant and highly profitable natural gas liquids, to the point where Encana says it can give the regular dry gas away for free and still make money.
• There is lots of infrastructure in the area – pipelines, gas processing centres, and so forth.
• Several junior and intermediate producers already own dozens of sections each of Duvernay rights that haven’t been priced into their stocks yet (this is exactly what happened in the Cardium play in late 2009 and Alberta Bakken plays in mid-late 2010).
So which companies/stocks will likely benefit the most from the emerging Duvernay play?
Companies like Trilogy have been playing Kaybob and another area called Simonette for almost two decades. Almost by accident, it’s now the largest Duvernay land holder after Encana.
Trilogy is either going to become a big fish in a small pond or its going to get swallowed fast. Ditto for Celtic and Yoho, which might as well hang out the for sale sign and get it over with.
Other junior companies that could be ripe for the picking include Donnybrook Energy (DEI-TSXv) and Cequence Energy (CQE-TSX). Both juniors own more than three dozen net sections near where Encana bought a large acreage position for the Duvernay – Donnybrook is on both sides of Encana’s new package – Simonette to the west and BigStone to the east.
Even Encana has been rumored to be a takeover target for a super major like Shell, and its shares must look pretty cheap right at $30 or so, especially if it’s sitting on another Marcellus or Eagleford. Unlike Exxon, Shell has been sitting on the shale gas sidelines and it could be looking to make a move. Taking out Encana would probably be a $40-billion bite and undoubtedly one of the biggest corporate deals in Canadian history (hypothetically speaking, of course).
But it’s not just producers that stand to gain from a big shale discovery in Alberta. Considering this first well cost nearly $18 million to drill and complete, it’s a trickle down economy with all the attendant drilling, completion and transportation stocks having nowhere to go but up.
Even if producers can get the all-in well cost down to $15 million or even $10 million, all your favorite drilling stocks, Precision Drilling Corp. (TSX-PD), Trinidad Drilling (TSX-TDG), and Ensign Energy Services (TSX-TSI), are going to reap the benefits of this next drilling boom.
Along with all your pressure pumpers and frack masters, the Calfracs (TSX-CFW) and Flints (TSX-FES) of the world, whose pumper trucks are the key to making unconventional gas a viable proposition.
And unlike Quebec or New York, even the politicos will get on board this train.
Given that the Alberta government had the scare of its life when its ill-conceived royalty changes just about scared every rig out of the province three years ago, it isn’t eager to make the same mistake twice. The bean counters in Edmonton are probably toasting their good luck about the Duvernay now, because this is the kind of tide that raises all boats, including theirs.
The Duvernay is the gift that keeps on giving. Only now, it’s going to be giving directly to investor’s wallets.
By. Keith Schaefer