Non-conventional oil and gas plays have been a game changer for the North American oil industry. A combination of advances in technology (fracking, horizontal drilling) and shale plays (including the Eagle Ford, Bakken and Permian basin) has led to an explosion in U.S. oil production.
Whereas the U.S. non-conventional shale oil industry is advanced, Canada’s is still in its infancy — but signs are emerging that Canada’s shale oil formations could rival those in the U.S., if not have greater potential. A number of industry analysts expect unconventional shale oil and gas to play an increasing role in Canada’s overall oil and gas production mix.
What is the Duvernay?
One of the most promising shale formations is the Duvernay in west-central Alberta. The formation is believed to hold considerable resources; Alberta’s Geological Survey estimates that it holds around 443 trillion cubic feet of natural gas, 11 billion barrels of natural gas liquids, and 62 billion barrels of oil.
The high potential of the Duvernay has attracted a number of energy majors: Chevron, ConocoPhillips, Shell, ExxonMobil, Encana (TSX:ECA, NYSE:ECA), Husky Energy, Canadian Natural Resources, and Talisman (TSX:TLM, NYSE:TLM) have all entered the fray.
A key attraction for these energy companies is that the Duvernay’s super light oil and condensate are important diluents used to make bitumen produced from oil sands flow. Hence the attraction for ExxonMobil and its Canadian subsidiary Imperial Oil, Husky Energy, and Canadian Natural Resources, all of which have significant oil sands assets.
Canadian oil production is expected to explode over the next 20 years. The Canadian National Energy Board recently estimated that Canadian oil production will grow 75% between now and 2035 to 5.8 million barrels of oil a day, with the majority of this growth coming from oil sands.
As a result, demand should increase for super light oil and condensates. The National Energy Board estimated that demand for these products will more than double over the same time frame. Also important to note: selling at a 10% premium to Canadian crude, condensate generates higher margins for producers.
How can investors expect to benefit?
The Duvernay is an expensive proposition for companies to develop. It’s deep and expensive to drill. Producers operating in the Duvernay estimate that all-in well development costs are in the $10-$15 million range. This is significantly higher than the U.S. Bakken formation, where well development costs are estimated to be around $8.5 million.
Because deep pockets are needed, the larger, cashed-up players — Shell, Chevron and ConocoPhillips — have been active thus far. Another sign of the high development costs: troubled diversified energy company Talisman and oil junior Athabasca have signaled that they are seeking partners to help develop their Duvernay assets. Already, Talisman has made a $1.5 billion deal Canadian subsidiary of Malaysia’s Petronas, in which it sold a 75% interest in its Montney.
The larger companies’ exposure to Duvernay assets is minor compared to the scale of their operations. While that mitigates risk for investors, it also means that any drilling success is unlikely to be reflected by a significant bump in their share prices. (This despite both Chevron and Encana reporting impressive drilling results.)
In my view, the best opportunities exist with smaller players that are particularly active and having some success.
Two of the most promising companies are micro cap Yoho Resources (TSX:YO) and small cap Trilogy Energy (TSX:TET). Already Yoho receives 30% of its overall production from its Duvernay properties and Trilogy has drilled 11 horizontal wells. If either company experiences any significant success — a big if, to be sure — investors will be rewarded.
Foolish final thoughts
The Duvernay is shaping up to be an important asset for Canada’s rapidly growing oil industry — it has the potential to provide both higher-margin light sweet crude and valuable bitumen diluents. But it will take some time develop — and the jury is still out as to whether it will provide any direct benefit to investors at this time.