It seems like every couple of months there is a new shale play popping up, followed by a run on leases in the area, a surge in expectations, dozens of industry conferences, and a migration of oilfield service providers to the area. With so many producers flocking to unconventional resources, one might be tempted to believe that conventional oil and gas properties have seen better days and are at the end of their useful life. But these assumptions would be incorrect.
Unconventional plays attract attention for their promise of growth and repeatable inventory. They are today's North American elephant prospects. But along with their high initial production rates comes a host of burdens that do not fit the business model of all producers. New plays can present exploration risk if they have not been adequately delineated, the wells generally cost a multiple of conventional well expenses, and well completions often require expensive technology and services to produce the best results. In their early life, unconventional wells have steep declines of 80% or more, and producers find themselves on a treadmill to bring new wells online as quickly as possible to maintain production rates. To retain acreage recently leased, producers often must sustain an uneconomic drilling program, as is the case for many producers today with natural gas spot prices between US $2 and $3/Mcf.
The effect of the aggressive, expensive drilling schedules of many producers today is that they need to fund these programs. This is typically done by accessing the capital markets and also selling their conventional assets to meet their cash flow requirements. There are approximately $200 billion to $300 billion of conventional oil and natural gas assets in the US, and many of them are locked inside unconventional resource companies.
Conventional properties continue to be a very viable long-term investment in oil and natural gas for several key reasons. First, there is generally no exploration risk when working with a field that is more than 50% developed and has an established production history. The availability of data on previously drilled wells and evidence of production performance offer a foundation of knowledge on which to build a solid capital program. In legacy conventional fields with large original oil or gas in place, increasing the field's total reserve recovery by 2% to 5% can produce a meaningful value increase.
Second, conventional assets with the majority of the reserves at proved-developed-producing status generally have a shallower decline rate than unconventional resource plays. Shallow declines result in longer field lives and predictable cash flows. Finally, the capital required to sustain and grow production is far less for a conventional field. There are many low-risk ways to boost production from legacy assets, including recompletions, artificial lift additions, and facility upgrades. These methods, along with cost reductions, often enhance the value of the assets. In addition to these benefits, conventional assets offer more stable, reliable production and cash flow than unconventional resource plays. When operators use commodity derivatives to hedge a majority of their production, it allows them to lock in their project economics in the field and improve cash flow stability. A company's ability to secure future cash flows from its production can be a valuable tool for investment vehicles such as upstream master limited partnerships (MLPs). The goal of MLPs is to maintain stable cash flows and pay quarterly cash distributions. Conventional properties offer a predictable production profile that fits the MLP business model. Even though conventional oil and natural gas investments can be viewed as a contrarian strategy today, they continue to produce free cash flow that appeals to a wide variety of investors.