Low Risk Shale Oil Investments - Public Stock vs. Buying and Selling Leases
by Jack Overstreet
Dear Readers,
In 1986, the U.S. domestic oil and gas industry was on life support. Oil dropped below $10 a barrel, natural gas was cheap, and the investment community was unimpressed with the overall results of the 1973-1982 “boom” in exploration. Driven by high marginal income tax rates in the late seventies and the boundless promises of promoters, through the public markets and private placements, investors dumped billions into oil and gas companies and drilling ventures. In fact, the value of all oil and gas reserves discovered in that period was less than the total cumulative exploration and development investment!
This was conventional oil and gas exploration the “old” way – vertical wells based on seismic and subsurface (and sometimes fanciful) geologic mapping – when the average wildcat success rate was one well in 9. However, at the end of that period, a few independent oilmen were already experimenting with how to extract natural gas from the rocks that sourced hydrocarbons (coals, for methane, and shales, for both oil and natural gas). By the late nineties, coal bed methane and shale gas projects in several basins were proving highly economic and repeatable, i.e. “no dry holes”, and the oil and gas business started fundamentally changing. George Mitchell was quietly proving horizontal drilling and hydraulic fracturing to access gas locked in the Barnett Shale, and others were about to prove a multibillion barrel resource in the Bakken Shale of Montana and North Dakota. As to identifying more candidate source rock “resource plays,” the rush was on.
Today, the economic stars are oil operations in the Bakken and Eagle Ford shales, with “honorable mention” to the oil window of the Barnett in Texas, and the Niobrara Shale in Colorado and Wyoming. Over just the past eighteen months, horizontal drilling has been applied to some oil-charged limestone formations in the central U.S., also resulting in wells initially producing hundreds or thousands of barrels of oil per day (“Mississippi Lime Play”), led by companies like Sand Ridge, Chesapeake, and Range Resources. While low natural gas prices have put previously successful plays like the Woodford Shale in Oklahoma on hold, some are still modestly profitable due to low exploration costs and high volume wells, such as the Marcellus Shale in Pennsylvania. The life cycle of some of these oil and gas plays will literally be thirty to 50 years and beyond, especially as technology keeps improving the recovery factors. Meanwhile, the national land grab continues in other prospective basins across North America and around the world - now including the Illinois Basin, where Next Energy is currently focused.
So, how does the individual investor add to his portfolio participation in such giant, low-risk, legacy oil plays? For most, the answer is going to be through ownership in public companies. By researching the companies which are technology leaders in horizontal drilling (EOG, as one example), heavy in oil rather than gas projects (Continental), and undervalued (do your research), the average investor can gain representative oil ownership in turbulent times. Since most individual horizontal wells cost from $2 million to more than $10 million apiece, even substantial individual investors are unlikely to see the old private placement opportunity – the drilling is being financed mainly by industry and its Wall Street private equity backers.
Other than public stock ownership or starting you own oil company with land in a proven play, the lowest risk, highest potential return model may be what Next Energy and its team have developed over the past fifteen years. We avoid the drilling risk – and the highest potential returns associated with paying those costs – and instead focus on the very early scientific identification of projects and “real estate” acquisition. Essentially, we are one of the companies buying the oil and gas leases, packaging them into massive controlling blocks overlying technically proven or indicated oil reserves, and then selling the land to the large independent oil companies for development.
We attempt to recover for our participants more than what they put in, over a short investment lifespan, and retain a “free” or carried interest in future oil production that might put us in a strong multiple ROI over a period of years. By not taking the drilling risk, and getting in and out early, we have generally avoided being caught in commodity price swings or sustaining any principal losses. In fact, since our first coal methane resource play in 1999, Next Energy and its team have not lost investor money, and have sold seven straight gas or oil projects for an average net investor cash-on-cash return of 2.38:1 (best performer was more than 8:1 – just cash – and the worst was 1.26:1). The quickest return from investment was in about six months, and the longest was about 19 months (average 12.43 months). These projects took in $28MM from investors and paid them back $68MM. More importantly, in excess of one thousand producing gas or oil wells have been drilled on our leases in thirteen years, and our investors will ultimately receive an additional 5:1 to over 20:1 on three of the most successful projects. Enough of the walk down memory lane…
Today, our eighth project, covering 21,000 net acres in the Niobrara oil shale of Colorado, is being partly sold to a major oil company for a 2:1 net ROI, and further sales should complete divestiture this year. Our ninth project is still taking investment – approximately 175,000 net acres of oil and gas leases have been taken in a new shale oil and Mississippi lime combination play – the southern Illinois Basin. We are and have been competing against industry leaders and feisty independents which must visualize the same geology – Range Resources, Shell, St. Mary (SM), El Paso, Woolsey, Roxanna, Plains Exploration, and reportedly ConocoPhillips. When we sell out, probably over the course of the third and fourth quarters, our geochemists estimate the retained overriding royalties may expose our group to participation in well over a million barrels of oil per square mile in the best areas.
So, when the non-oil investor receives a drilling prospectus on a conventional, vertical well, unless that well is offsetting production, the odds of success are still poor – drilling is a game best played by those who do it for a living. The safest way to participate in a strong oil market is through careful research of and investment in public oil companies, but the returns will also be in the typical range. We’ve found that by treating oil investment without sentimentality – we think of ourselves as investing in real estate after a lot of research (“location, location, location”) – we can tie up barrels for pennies, get out quickly, and then ride along with the big boys on development without the indigestion of paying the drilling costs!
The oil market continues to be fascinating, and perhaps natural gas will stage a comeback in five years or so. As we wrap up Illinois, we continue to look for where else we can be early and right again – to figure out where is “Next!” To contact us, write jack@next-energyllc.com, or phone 303-220-1154.
Sincerely,
NEXT ENERGY, LLC
Jack Overstreet, Manager