Shale, he said, had a fast pay-back and the mid-point internal rates of return produced by conventional analysis indicated BHP should invest aggressively.
It was also, however, highly capital-intensive, all-in costs were high, cash margins were thin, there was little optionality in what were short-life assets and the value generated relative to the investment was weak.
“So you have one shot at making money. If the near-term cycle goes against your expectations (oil prices are extremely volatile) you can easily lose value,” he said.
BHP’s experience isn’t unique. A Reuters’ analysis of the sector published early this month said that in 2018, as had been the case for years, US shale producers spent billions more than they generated.
The economics of shale are challenging, not only because of the capital intensity, but also because of the nature of shale oil and gas resources.
The Permian basin is much-sought-after because it has the most productive acreage, with a higher number of “sweet spots” or shale containing good volumes of liquids. Unhappily, as Beaven indicated, the wells have a short resource life and therefore, because production tapers off quite quickly, companies have to drill ever-increasing numbers of wells to maintain production.
The producers have become more productive.
BHP is a good case in point. It more than halved both the time and the cost of drilling its wells while more than doubling the production from its acreage.
The rate of increased productivity across the sector has, however, been slowing after an initial burst due to the new techniques and disciplines developed in the still-youthful industry.
The big bet Chevron and Occidental want to make – along with the “super majors” like Exxon and Shell that are also very active in the Permian – is on scale.
Chevron and Occidental already have among the biggest portfolios of acreage in the Permian and the Anadarko holdings are contiguous to their own. Wirth described Chevron’s expanded footprint as “a 75 mile-wide corridor”.
Chevron plans to exploit that corridor by using what is called “pad” drilling, where multiple horizontal wells are drilled from a single location, or drilling pad. It says it can cover a square mile from a single pad.
BHP, like Chevron, thought it could turn shale production into a scalable and efficient manufacturing operation. It couldn’t, but maybe the super majors can. Chevron thinks it can extract $US2 billion of synergies from the Anadarko deal. Occidental thinks it can bring superior extraction technology to bear.
There is a “small” problem with bottle-necks – BHP, confronted by inadequate pipeline and store infrastructure resorted to trucking its oil from its fields – but, again, the Chevrons and Exxons of the world may be able to rationalise and prioritise the infrastructure as ownership of the acreage is consolidated.
One of the attractions to Chevron of Anadarko is its 55 per cent ownership of a listed entity that those “mid-stream” infrastructure and logistics-related assets and services. Beyond the shale-related acreage and assets, Anadarko also has producing fields in the Gulf of Mexico and a big LNG project it is leading based on a gas resource in offshore Mozambique.
Essentially Chevron, Exxon and Shell are betting that their size and the scale of the onshore operations they envisage will, with their expertise, low costs of capital, marketing expertise and access to end-customers, enable them to do what the earlier players in a fragmented sector couldn’t: make a respectable return on capital.
Some analysts are sceptical of the Occidental bid because it doesn’t have that same scale.
The majors and second tier playrs like Occidental are committed to the oil industry in a way that BHP, while exposed to it through its conventional oil and gas assets, isn’t. They need to keep finding or buying oil reserves and producing oil from them just to stand still, almost regardless of whether they are low-returning.
BHP walked away from the onshore oil and gas sector with $US10.8 billion. Half the net proceeds were deployed in an off-market buy-back last year and the other half via a $US5.2 billion special dividend in January.
The timing of the buy-back of 265.8 million shares – at a 14 per cent discount to the then market price of $27.64 — was fortuitous. With the shares now trading above $38 the use of the proceeds has effectively added a couple of billion more bangs to those bucks it salvaged from its shale debacle.
Stephen is one of Australia’s most respected business journalists. He was most recently co-founder and associate editor of the Business Spectator website and an associate editor and senior columnist at The Australian.