Next Shale ‘Boom’ - Our Money’s on Russia

When the US Energy Information Administration (EIA) released its first-ever report that looked at shale oil and gas potential from a global perspective, the first question that came to nearly everyone's mind was: Where will the next shale boom be?

It's a tricky question that has more to do with technology and political will than it does with reserve volumes. It's also a question that requires an understanding of the significant difference between technically and economically recoverable reserves.

Perhaps the bigger question is: Will there even be another shale revolution?

Before we answer that, let's do a quick review of the global numbers put forth by the EIA and Advanced Resources International (ARI)…

For shale oil (technically recoverable):
•    Russia (75 billion barrels)
•    US (48 billion barrels)
•    China (32 billion barrels)
•    Argentina (27 billion barrels)
•    Libya (26 billion barrels)

For shale gas:
•    US (1,161 trillion cubic feet-ARI est.)
•    China (1,115 Tcf)
•    Argentina (802 Tcf)
•    Algeria (707 Tcf)
•    Canada (573 Tcf)
•    Mexico (545 Tcf)
•    Australia (437 Tcf)
•    South Africa (390 Tcf)
•    Russia (285 Tcf)
•    Brazil (245 Tcf)

So the US nominally tops the list for technically recoverable shale gas reserves, but comes in a far second for shale oil reserves, but remains the only country undergoing a shale revolution. And while the global potential is indeed staggering-345 billion barrels of oil and 7.2 quadrillion cubic feet of natural gas--it's not all about numbers. And these nice numbers represent technically recoverable resources, not economically recoverable resources, which would be those actually worth exploiting for the certainty that they would generate economic return.

And no one comes close to the US in cornering the market on shale drilling technology. There are also geological differences that come into play. While US shale formations are "friendlier", so to speak, and easily tapped into with horizontal wells.

Taking everything into account, our money is on Russia first and China second. Russia because it's got proven ambition to develop its shale, while China has been developing its shale slowly, and Europe's development is piecemeal at best-certainly too spotty for it to ever be considered a "revolution".

Russia

Russia will be the next major shale theater because the political will is there-and the ambition outstrips anyone else's. Russia has major shale resources and has everything it needs to turn this into a revolution-technology, infrastructure, water and political will. Perhaps just as importantly, they have drilling traditions, much like the US, and a lot of sparsely populated shale space in which to do it. Russia's shale oil estimate comes from the oil-bearing deposits of the Bazhenov play in Western Siberia. There are no divisions here, and all signs are that Russia is preparing to fast-track shale development, though experts say Russia's shale isn't as easy to reach as US shale.

China

China is the only real rival to Russia here. It has bigger overall reserves, but is struggling with infrastructure problems and water supply, which is necessary for fracking. For now, these are unanswered questions and China is lagging behind Russia significantly. 

China's put a lot of thought into a shale boom, and on paper it's a major goal, with a Cabinet-level White Paper late last year calling for production of 6.5 billion cubic meters of natural gas from shale formations by 2015, and 100 billion cubic meters by 2020. We're not sure the goal is attainable at this point because it will require 1,380 wells to be drilled and China doesn't have the water to do it. (It will need 13.8 cubic meters of water). China also lacks the drilling experience, and depends largely on the US giants for this. So right now, it's slow going for Beijing. To date, China has drilled about 100 wells. Then we have geological differences that render a lot of China's shale more concentrated, deeper and difficult to frack. The environmental impact of large-scale shale drilling in a densely populated country is also a major hurdle. Finally, the infrastructure is not in place, and the pipeline network that does exist is controlled and monopolized by the state-owned companies who are under no obligation to let those private companies who have just won shale blocks in on it.

China's held two auctions for shale gas leases, and Chinese news agencies have intimated a third auction is planned for this year. This auction will reportedly see China try to lure in smaller, mostly state-owned companies to develop shale gas assets. The second sale of 19 blocks. The first sale of two blocks in 2011 went to the state-owned majors, while two private companies were among the 16 companies that won 19 shale blocks up for grabs in January this year. None of these companies has any experience in shale.

Large-scale shale production will happen in China, but it's still very early days--and there's no way it can compete with Russia on this timeframe.

Europe

While the European Union as a "whole" has virtually no chance of a shale revolution, due to divisions over fracking that take half the plays out of the game, two venues have promise (but it's not mind-blowing): Poland and the UK. But overall, there probably aren't enough shale resources in Europe to make it worth all the political upset this would cause.

Nonetheless, you have to be careful about the hype, but the UK is shaping up to be a nice little shale venue. This month, IGas estimated it has as much as 170 trillion cubic feet in its license area. To put this into perspective, the UK consumes about 3 trillion cubic feet of natural gas a year. The hype here is that IGas, and other companies who have released impressive estimates, don't really know for sure because they haven't started drilling wells. There's also a lot of hype because only a high end of 30% of this is extractable-the rest is too deep and therefore too expensive to be economically viable. Explorers in the UK (and British officials) are not to be dissuaded, however. They are certain they are seeing the beginning of a British shale boom and estimate they are about 5 years away from commercial production. 

Poland's shale scene exploded a little prematurely, and proved to be a bit disappointing, with a downsizing of initial estimates, the withdrawal of ExxonMobil and now Chevron because of regulations could further dull the prospects here.

Elsewhere ….

For Australia there is a general consensus at this point that shale resources will be significantly more expensive to develop than in the US and could not be considered economically recoverable under current circumstances.

Algeria has large reserves and greater potential because the government is keen on making it more attractive for foreign investors. Algeria's shale gas estimates tripled from the initial 231 Tcf of 2011 to 707 Tcf today, and Europe is eyeing this greedily because it's easy to get to Europe and could supply the European Union for a decade. Algeria is also being spotlighted because the government took measures earlier this year to attract more investors specifically to its shale plays, with profits-based taxes to replace gross income taxes and long-term licensing to reduce some of the exploration risk.

Libya we like to ignore because despite the unrealistic optimism of foreign interventionist forces and big oil, this is a powder-keg of a venue and will remain one of the worst security nightmares around (which will also continue to affect Algeria's potential). 

Argentina could be the next best shale play outside the US, but it doesn't have the cash to develop it and there aren't too many investors willing to wade through the country's unfriendly energy policies.

The Best Shale Growth Stocks in the US

The best shale growth stocks in the US are those who have managed to make a solid footprint in North American shale plays, but have shifted their focus more towards oil and liquids, such as:

EOG Resources (NYSE:EOG): This company has seen double-digit year-on-year revenue growth every quarter from the beginning of 2011 through the first quarter of 2012. Its first quarter 2012 net income more than doubled from $134 million to $324 million. Today's it's trading at $131.85; in January 2010 it was trading at $99.35. EOG's Eagle Ford crude oil assets continue to outperform, ending the first quarter of this year with average daily production (net) of 153,000 barrels of oil equivalent. It's also riding high on amazing rate-of-return results in Bakken. (EOG is also investing in Argentina's shale potential).

Devon Energy Corp. (NYSE:DVN): Devon has great growth prospects because of its strong position in the Permian Basin and the Cline shale, and it's got plenty of cash for development. Devon has more than 1.3 million acres in the Permian Basin, with 2,800 producing wells, and 500,000 acres in the Cline, where it's got an estimated 3.6 billion barrels of oil. Devon is undervalued and selling cheap right now, not because of mismanagement, but because of low natural gas prices. We think it's going to profit hugely on the Cline, so it's a good time to buy. What we really like about Devon is that it can fairly painlessly offset any losses due to suppressed natural gas prices with easy liquids production.

Anadarko Petroleum (NYSE:APC): The company is big into deepwater plays in the US Gulf of Mexico, but it's more recent growth has been spurred quite a lot by its onshore shale assets. Anadarko was trading at around $66-$68 in early 2010; today it's trading at about $86.43 (close 26 June).