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Shell’s Little Talked About Permian Position

: 27 Sept 2017

Summary

  • Royal Dutch Shell bought into the Permian back in 2012.
  • An overview of its JV with Anadarko Petroleum Corporation.
  • Where its acreage is located.
  • Operatorship controversy and probable split from Anadarko.
  • What to expect going forward.

Back in 2012, Royal Dutch Shell plc (NYSE:RDS.A) (NYSE:RDS.B) teamed up with Anadarko Petroleum Corporation (NYSE:APC) to develop the Permian Basin. Royal Dutch Shell plc purchased all of Chesapeake Energy Corporation’s (NYSE:CHK) 50% stake in the joint venture for just under $2 billion, a steal compared to where prices are today. Centered in the prolific Delaware Basin, this part of the Permian is home to some of the most economical unconventional horizons in the world, including the Leonard/Avalon, Bone Spring, and Wolfcamp plays. Let’s dig in.

Overview of the 2012 deal

At the time, the joint venture had a 618,000 acre position pumping out 26,000 BOE/d on a gross basis. Since then it appears that the venture’s footprint has shrunk down to roughly 580,000 gross acres as uneconomical leaseholds were sold off or retired. Production growth continued and now it appears the venture is producing over 100,000 BOE/d gross.

Below is a map of the acreage Shell acquired. When it comes to the Delaware Basin, it is all about New Mexico’s Eddy and Lea counties and Texas’ Culberson, Loving, Ward, and Reeves counties.

The acreage down south in Brewster County is about as non-core as it gets and most likely represents a large portion of the JV’s position that was either sold off or retired. Shell and Anadarko’s large contiguous position in Reeves, Ward, and Loving counties in the heart of the Delaware play is very noteworthy. Particularly in Ward and Loving counties as that’s where the venture’s acreage is most dense, where their holdings in Reeves is much patchier.

Operatorship controversy

The 50/50 JV between Shell and Anadarko expired in early Q3, and negotiations have been going on for a while now as to what will happen next. In Anadarko’s Q2 operations report, the company noted:

“Prior to the conclusion of the participation agreement with Shell on July 12, Anadarko completed all of the well proposals required to advance toward securing operatorship on approximately 70% of its JV acreage. Additionally, joint-operating agreements have been established in all areas where operatorship has been defined.”

Keep in mind ownership and operatorship are two different beasts.

Below is a look at the planned operatorship as of July 24, with Anadarko taking charge on most of the joint venture’s acreage.

For now, Royal Dutch Shell and Anadarko Petroleum have an economic interest across all 580,000 net acres. However, there have been rumors that Shell and Anadarko want to split ways and develop different portions of the Delaware Basin at their own pace. What that will look like is still up in the air, but the original deal wasn’t renewed for a reason.

The conflict between the two firms comes down to the delays and problems joint operatorships create for unconventional oil & gas developments. When its comes to targeting shale, chalk, limestone, sandstone, and other geological formations through “unconventional” methods (hydraulic fracturing and horizontal drilling), flexibility is key.

Unlike large conventional projects, where there are long lead times and limited flexibility once sanctioned, unconventional projects are constantly changing. The pre-FEED (concept design) and FEED (Front End Engineering Design) work basically lays out the exact path conventional projects will take.

It’s a completely different story for unconventional endeavors. Lateral lengths, the horizontal reach of horizontal wells, are always changing and usually getting longer. The completion method being deployed is always being improved in an attempt to produce more hydrocarbons per well.

Upstream operators are constantly contemplating what the space between each well should be, with the goal of trying to fit as many wells on one drilling spacing unit as possible without having those wells communicate with each other (interfere with each other’s production).

How many rigs and completion crews should be deployed is updated based on energy price expectations. How many wells are drilled and left uncompleted versus those that are drilled and brought online is another big consideration.

What oilfield service suppliers should be used, something that is more or less defined by the time a conventional project gets a final investment decision, is always being changed for unconventional projects.

In summary, there are a lot of moving parts. So the “beef” between Anadarko and Shell is that there are too many cooks in the kitchen. Having Anadarko and Shell split up the JV so each party can go at their own pace is best.

Significance for Shell

During its Q4 2016 conference call, Shell noted:

We could add 140,000 barrels a day by 2020 from the liquids-rich plays in the Permian and the Fox Creek. The average breakeven price for those barrels, the additional Permian and Fox Creek, is around $40 a barrel. That overall will bring forward the date for the shales’ cash flow neutrality.

The Fox Creek region in Alberta is home to a portion of the liquids-rich Duvernay shale play.

It appears Shell produces around 20,000 BOE/d from Fox Creek and 54-57,000 BOE/d from the Delaware Basin on a net basis. Making a 140,000 BOE/d addition equal to about a tripling of Shell’s current output.

Shell’s management team commented that its average breakeven oil price in those two plays is about $40/barrel. The Duvernay shale is interesting but I question the breakeven guidance for a play that is still in the early stages of development, and doubt the reliability of that guidance.

Completely different story in the Delaware Basin, where top tier operators have repeatedly shown that new wells can be economical even in a $40s WTI world (on an incremental basis). This is why most of Shell’s unconventional capex will be going towards the Delaware, making it the source of most of its unconventional upside in the medium-to-long term.

Midstream deal

A key part to making unconventional plays viable in a weak oil price environment is ensuring that the natural gas side of the production stream is also being marketed. Shell needs to have the infrastructure in place to handle rising associated gas streams produced along rising oil volumes (instead of flaring gas off). Associated gas includes dry gas and wet gas, with wet gas referring to the natural gas liquids produced (such as ethane, propane, natural gasoline, and butane).

Royal Dutch Shell’s midstream spin-off Shell Midstream Partners LP (NYSE:SHLX) recently purchased half of Crestwood Equity Partners LP’s (NYSE:CEQP) Permian gas gathering system for $47 million. Completed in June 2017, the Nautilus gathering system is contracted out to Shell under a fixed-fee 20-year contract to support growing gas streams in the Delaware.

The system was designed to gather 250 MMcf/d of natural gas per day through a network of 230 miles of pipelines that cover 100,000 acres in Loving and Ward counties. Acreage that Shell is set to become the operator, and possibility the sole owner, of once a new deal with Anadarko is reached.

Associated gas production will be gathered and sent to cryogenic processing plants, which will separate out the dry and wet gas products. After that, the dry gas is marketable to end buyers. Natural gas liquids still needs to be sent to a fractionator to separate out the various liquid gas types. There is some fractionation capacity in the Permian, but most likely additional raw NGLs production go to Mont Belvieu, Texas, where there is an enormous amount of fractionation capacity.

Final thoughts

The final deal between Royal Dutch Shell and Anadarko Petroleum Corporation will be important to look out for, especially in regards to what party gets what acreage. Whatever the case, Royal Dutch Shell appears intent on directing increasing amounts of capex towards the Delaware Basin as long as WTI is around $50 a barrel, which it currently is. By the end of the decade, Royal Dutch Shell’s unconventional positions will be fast approaching a tenth of its upstream production base.

Investors looking to read more about Royal Dutch Shell plc should check out why the bounce in Brent is so important by clicking here.

Disclosure: I am/we are long CHK.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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