The Duvernay Shale Gas Play

Old oil fields never die. They just get better with age. It's a timeworn cliché but, in the case of Alberta's Duvernay shale, it may be the best example yet.

By now everybody has heard about the "shale revolution" and how it's set to dramatically change the energy landscape. And beyond a doubt, that much is true. Large volumes of natural gas are being found in the least likely of places: Quebec, Michigan—even countries like Poland and Latvia. That's all well and good—the world is finally cueing into the fact that cheap abundant natural gas will drive the global economy for decades to come.

Alberta has been a latecomer to the shale gas game, but that's about to change in a big way—thanks to the emergence of the liquids-rich Duvernay play. For weeks, speculation has been building that unknown buyers have been staking out a new shale play in Wild Rose Country, driving land prices at Crown mineral auctions to new heights. In fact the Alberta government took in $2.6 billion in the fiscal year ended March 31, which was an all-time high (but still far short of liquor, tobacco and video lottery).

Since last summer, unknown bidders have paid as much as $35,000 a hectare for land (2.5 acres=1 hectare) in an area called Kaybob that normally sells for only a tenth as much. At an Alberta land sale in March unknown buyers put up the ridiculous sum of $107 million for a single parcel near Fox Creek, 260 km northwest of Edmonton, a sure sign that something is afoot in the hinterland.

This is Montney country, to be sure. But the sheer scale of the bids was enough to turn heads and set tongues wagging in the high skyscrapers of downtown Calgary. All that money for deeper rights down to the Devonian—it could only be the Duvernay.

For the geologically inclined, the Duvernay is noteworthy because it's the source rock for the original Leduc oil discovery in 1947. In fact, it's a high quality source rock for most of the crown jewel oil discoveries in Alberta over the decades, from the Swan Hills to the Keg River reefs.

This is the same rock that built an industry. . .a gift that keeps giving to this day.

The Duvernay is, in fact, a perfect example of a well-known play that could never be developed without the technologies we have today: the dynamic duo of hydraulic fracturing and horizontal drilling.

On April 19, Trilogy Energy Corp. (TSX-TET), along with partners Celtic Exploration Ltd. (TSX-CLT) and Yoho Resources Inc. (TSX-YO) announced test results from their second Duvernay joint venture well.

The results were quite strong—7.5 million cubic feet per day of gas. More important, the well yielded 75 barrels of liquid condensates and 56-degree API oil for every million cubic feet of gas, for some 1,250 barrels of oil equivalent per day.

Although the crew at Canadian brokerage firm Peters & Co. were disappointed with the cost of the well—$17.5 million including the fracs—it was clearly impressed with the production numbers, especially the liquids content which amounts to more than 500 barrels a day alone (multiplied by $100 a barrel and you can do the math). Peters thinks there are cost savings to be realized with full scale development, which is usually the case with these early stage plays.

In some ways, it could be the most important well drilled in Western Canada since the first Leduc discovery well in 1947. That's because the liquids, which are priced on an oil equivalent basis, are more than enough to make up for the relatively weak gas price.

According to Wellington West Capital Markets, the addition of those liquids effectively pushes the realized gas price up to $8/Mcfe, which is not bad at all—especially in the current market.

These are the kinds of numbers that draw attention of major players and perhaps it was no surprise that Encana Corp. (TSX-ECA) came out the very next day and revealed itself as the mystery buyer of all those Duvernay rights, spending $300 million on land acquisition in the first quarter alone.

For a company like Encana—North America's second-largest gas producer, the shift into liquids is a no-brainer after the haircut they took in the first quarter. As one of the most gas-levered companies on the planet, they have to do SOMETHING.

And one look at the company's first quarter results tells the story: it barely broke even in the first three months of the year (thanks to effective hedging) compared to a $1.5 billion profit in the same period a year ago. They're basically giving the gas away for free.

Encana CEO Randy Eresman admitted as much at the company's annual meeting in Calgary last week when he suggested the company could give away the gas and still make money on the liquids.

In that sense, Duvernay is manna from heaven, and some serious good fortune for a trouble gas sector.

Plus, Alberta has a ready-made market for those liquids, which are used to dilute bitumen and heavy oil and make it flow through pipelines like the Keystone XL to the U.S. Those liquids have been in short supply in recent years, and there was even talk of importing them from offshore for use in the oil sands.

Coming soon: Which stocks, companies—junior, intermediate and senior—will benefit the most from this new play?

Keith Schaefer
Oil & Gas Investments Bulletin

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Keith Schaefer, editor and publisher of Oil & Gas Investments Bulletin, writes on oil and natural gas markets and stocks in a simple, easy-to-read manner. He uses research reports and trade magazines, interviews industry experts and executives to identify trends in the oil and gas industry and writes about them in a public blog. He then finds investments that make money based on that information. Company information is shared only with Oil & Gas Investments subscribers in the Bulletin—they see what he's buying, when he buys it and why.

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The Duvernay Shale Gas Play