Is Canadian Shale Gas Worth $35 Billion?

Shale gas in western Canada is at the epicenter of the energy world this week.

Excitement from energy investors over northern shale comes after Malaysian petro-major Petronas last week announced a massive investment here--$35 billion to build a liquefied natural gas (LNG) facility in the province of British Columbia. The deal is so big, it represents the largest foreign direct investment in Canada's history.

But the promise of natural gas riches here appears to justify the spend. Gas wells drilled into shale plays like the Notikewin, Montney and Horn River in northeastern British Columbia have yielded massive discoveries-some testing at towering rates up to 24.5 million cubic feet per day, along with valuable natural gas liquids.

Tests like that are as good as any results coming out of even the hottest U.S. shale plays, such as the Marcellus.

It's these rosy results that enticed Petronas to pay $6 billion for British Columbia-focused gas producer Progress Energy Resources in late 2012. Petronas is now making these gas fields the backbone for supply to its massive LNG development-which will ship gas across the Pacific to high-value markets in Asia and possibly beyond.

These are huge investments. But will Canada's shales live up to their promise? After all, these plays are in their infancy. What do we really know about the economics of shale production here?

To find out, let's take a look at some of the leading gas producers in British Columbia. And see what their financial performance tells us about just how good Canadian shale really is.

Big Profits On Tap?

A mere glance at some of the metrics around Canadian shale production suggests high-return potential.

As mentioned above, test rates from wells in these new plays have been spectacular. Shale gas producers like Bellatrix Exploration (TSX: BXE) report that horizontal wells in the company's Notikewin/Fahler play area enjoy average initial production rates of 9.5 million cubic feet per day. That's competitive with any of North America's shales.

The other point of note is that drilling costs appear very manageable. Bellatrix reports that the company's costs for a horizontal well run about $4.6 million. Considering the large initial production figures, that should mean rapid paybacks and significant profits.

But the real proof is in the financial performance of Canadian producers. Numbers that show Canadian shales do indeed appear to be significant money-makers.

Bellatrix has been one of the best performers in the burgeoning northern shale sector. In 2012 the company spent just under $180 million in the field (including drilling new wells and making acquisitions), and generated just under $250 million in new proved reserves. That means for every dollar spent, the company added just under $1.40 in reserves value. A solid performance.

Bellatrix has the advantage of not being a pure shale producer. Some of the company's drilling results were achieved in its Cardium light oil play in Alberta. But numbers from other pure gas producers tell a similar story of profitability.

Tourmaline Oil (TSX: TOU), for example. In 2012, gas-weighted Tourmaline spent $740 million developing its plays, including the Montney shale--and added over $1.1 billion in proved reserves value. Each dollar spent generated over $1.50 in returns.

Adding one more data point showing that drillers in Canada's shales are turning a significant profit.

Pick Your Producers Carefully

The numbers from Bellatrix and Tourmaline suggest that Canada's shales can indeed be a good investment.

But not every producer here is hitting home runs.

Painted Pony Petroleum (TSXV: PPY) is also focused on shale development in northeast British Columbia. But this company's results have been less stirring than other firms in the area.

In 2012, Painted Pony spent over $230 million in the field, but only came up with $83 million in added proved reserves value. Revealing that for each dollar spent, the company ended up with only $0.35 in value-equating to a significant loss on invested capital.

It's important to note those metrics cover only proved reserves. Painted Pony also holds a very large base of contingent reserves-in-ground petroleum has not yet been proven to be economically extractable.

The company's contingent reserves are nearly three times the amount of its proved and probable reserves. If this massive in-ground bank is eventually proven economic by drilling, reserves value could increase very quickly.

Until that time however, investors looking to tap the profit potential of Canada's shales should stick with companies showing a proven track record in creating value through the drill bit.