Market Analysis

Oil’s Next Act

Oil production has never been an easy exercise. But the increasing importance of deep water and shale production has introduced new challenges—and opportunities.

More than ever, exploiting oil reservoirs requires the use of advanced equipment and engineering services. Since oil companies have long targeted oilfields requiring the least effort for extraction, many of the lowest-cost oilfields are already depleted or in decline. So while it’s true the 40% rise in Emerging Markets oil consumption over the past decade is partly behind oil’s nearly 20% annualized rise, the rising cost of new production have likely contributed.i But with these challenges come opportunities.

The most widely discussed recent trend in oil and gas is the emergence of shale reservoirs as a new supply source. While long known, technical limitations and lower oil prices made drilling in those regions uneconomical. However, higher oil prices coupled with lower production costs resulting from the combination of horizontal drilling and hydraulic fracturing have changed that.

One primary challenge brought by shale production is it’s more technically demanding than conventional activity. For example, older-model drilling rigs lack the necessary horsepower to drill long horizontal wells through shale formations—necessitating specialized equipment that’s up to the task. Further, shale reservoirs drain faster than conventional ones—meaning more drilling activity is required to maintain a desired level of production.

But beyond this, given the high number of wells being drilled, demand is also rising for well-completion services, where well casings are cemented to prevent leaking and appropriate pressure and flow-control equipment is installed. Upon completion, hydraulic fracturing services begin, where high-pressure pumps inject fluids deep into shale formations. But all this gear has a shelf-life—the high pressures quickly degrade the machinery. Thus, equipment supply is actually pinched from two sources: Initial equipment for new wells and replacement equipment for old wells.

Little of this machinery is cheap or easy to design, presenting high barriers to entry in the equipment supply field. And oil companies are increasingly willing to pay for equipment that saves them time. Illustrating this, a recent industry survey of expected exploration and production capital spending for 2012 forecasted a 10% increase over 2011.

While shale is an exciting development, offshore exploration also has high potential, particularly in deep water. As with shale, drilling rig capabilities matter: Many older-model rigs cannot drill to sufficient depths to reach today’s targets. So deepwater-capable rigs and newer-model shallow-water rigs with faster and deeper drilling capability are increasingly in demand. As drillers find more success in deepwater, companies providing production services will also see more business, from the engineering and construction of offshore facilities, to the supply of subsea equipment and the transportation of equipment and personnel from the mainland.

Beyond these technical challenges lies another problem: Many servicers are increasingly realizing high labor costs. While this problem seems odd when unemployment is high, attracting labor is challenging since the work is demanding and most drilling occurs in remote locations. Also, many labor shortages are for highly skilled positions, such as engineers, so the overall pool of unemployed workers doesn’t much influence industry wages.

The days of “easy oil” seem numbered—and new complex oil reservoirs bring a host of challenges. But with every challenge comes an opportunity. Extracting oil from shale and deepwater fields is likely to be an increasingly big part of the Energy industry’s future, and understanding the nature of changes and how related firms stand to benefit is vital to investors.

i US Energy Information Administration; Thomson-Reuters

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.