Wood Mack analysts debate: tight oil vs deepwater

By Luke Geiver | January 27, 2020

Global consulting and research firm Wood Mackenzie shares its take on the question of which is more attractive to investors: tight oil or deepwater. 

“Investors remain perplexed by the US tight oil phenomenon. But the economics of tight oil actually share all the characteristics of conventional deepwater developments,” Graham Kellas, senior vice president for global fiscal research, at Wood Mackenzie said. 

Kellas and the global consulting firm’s Principal Petroleum Economist, Joshua Firestone, looked at the impact of bonus payments, royalty and tax terms on the full-cycle economics of US tight oil and deepwater. 

At first glance, it is difficult to compare these two divergent growth themes, the team said, “Yet we’ve shown that they are more similar than you think.” 

According to the researchers, both themes have transformed in the last few years. While fundamental differences exist, the expenditure and cash flow profiles of these very different plays are converging, they said.   

“We’ve also used those investment metrics to evaluate both propositions. That analysis was conducted on project fundamentals: revenue and costs only,” the team said. 

Kellas and Firestone have turned their attention to the impact of fiscal terms: how do we factor in the cost of acquiring land? What about royalty rates? How big is the resource owner’s share of value? And what’s the project risk? 

Kellas said: “A wide range of fiscal terms applies to both tight oil and deepwater. Tight oil investors that own land can have ‘royalty-free’ production. 

“Combined with relatively low state and federal taxes in the US, the resource owner share of project value for tight oil landowners is the lowest of any major producing country in the world. No deepwater terms can compete with this,” he also said. 

“Tight oil leases contain known resources; it’s the quality and future commerciality of these resources that carry the risk. In contrast, deepwater exploration may result in multiple large discoveries, spread over a large area—think Stabroek in Guyana. Or it may result in no commercial discoveries at all. Discovery risk has a significant impact on the price investors are willing to pay for deepwater acreage,” he added. 

Most tight oil production is subject to royalty, and the rates can be high. As royalty is based on revenue, not profit, this has a significant impact on margins and breakeven prices. Seemingly good projects can quickly turn bad if the royalty rate is too high. And the same is true for deepwater projects, where terms have stiffened following exploration success. 

According to Kellas, “Deepwater licence areas tend to be several orders of magnitude larger than tight oil and bonuses payable are much lower on a US dollar per acre basis. But the actual sums payable can also be huge—hundreds of millions of dollars – with no guarantee that commercial production will result.” 

Most US tight oil and global deepwater acreage can be acquired for small signature bonus payments—but highly prospective acreage is expensive. 

“At first glance, this comparison suggests that discovered deepwater resources are less expensive than tight oil. But this only tells part of the story,” he said.

In the period from June 2016 to June 2019, there were far fewer deepwater transactions than in the Permian. And the popularity of the Permian at that time meant investors were keen to acquire acreage in one of the world’s few oil hotspots. 

Kellas added: “There is no such thing as a typical tight oil or deepwater asset. Instead, there is a wide spectrum of assets generating a huge range of values. Tight oil can be more valuable than deepwater, and vice versa. It all depends on the specific assumptions associated with the opportunities on offer. 

“In short, it comes down to what matters most to the investor.”