Oil and gas explorers discovered the least amount of oil in 2017 since at least the 1940s. This is the claim of industry consultant Rystad Energy and is perhaps a reason why exploration firms remain firmly out of favour with the market.
The risks associated with exploration are significant. Oil and natural gas test wells effectively offer a binary outcome for both the company and its investors. Either the well finds oil or gas in commercial quantities, or it doesn't. And share prices soar or slump accordingly.
The graphic below shows how the exploration process works from start to finish.
WHERE SMALLER EXPLORERS FIT IN
Small cap exploration companies typically focus their activities at the front end of this process and sell assets on in the event of success.
Principally, this is because they lack the funds required to bring discoveries on stream and believe more value can be created in the exploration phase than in developing crude deposits and selling production.
A company might have several leads across its acreage but in order to turn this into a list of 'drill-ready' prospects they will typically acquire seismic data. This is a means of mapping the structure of rock formations under the earth’s crust.
It is used by geologists to identify so-called ‘structural traps’ that could potentially contain hydrocarbons. There have been several developments in this area in the last two decades, notably the emergence of ‘3D seismic’ which provides visualisations of structures in three dimensions.
EXPLAINING THE GEOLOGICAL PROCESS
Despite these advances, the basic principles of acquiring the data have remained the same. They involve using an energy source, typically a controlled explosion, to send sound energy waves into the earth so the different layers within the earth’s crust cam reflect them back.
These reflected waves of energy are recorded over a set time period using special sensors and placed on a storage medium. Once recorded this information can be processed using specialist software which in turn produces a data set.
After a promising geological structure has been identified, the only way to confirm the presence of hydrocarbons (and whether they can be successfully brought to the surface) is to drill a well. A commercial discovery has three key requirements:
1) There must be a source rock somewhere in the sub-surface of the area being drilled which, at some point, generated the gas or oil.
2) There must be a separate, sub-surface ‘reservoir’ rock which can contain the hydrocarbons.
3) There must be a ‘trap,’ a high point in the reservoir rock in which this gas and oil are concentrated into commercial quantities.
FACTORS TO THINK ABOUT AHEAD OF DRILLING
Funding - Is the company capable of meeting the costs of drilling. According to industry data provider Rigzone the day rates on the most expensive offshore rigs currently stand at $502,000 and even relatively straightforward wells can cost upwards of $30 million a go.
Track record - Can the company or any of its management team point to previous exploration success. These offer no guarantee of future discoveries of course but at least suggest a degree of competence.
Geography - There is nothing wrong with drilling in frontier regions or countries where there is political instability but investors should at least be aware of these issues before getting involved. You should also expect to be compensated for these risks by dent of a discounted valuation.
For land-based operations a pad is constructed at the chosen site to accommodate drilling equipment and support services.
Operations over water can be conducted using a variety of self-contained mobile offshore drilling units, the choice of which depends on the depth of water, seabed conditions and prevailing weather conditions in the immediate area.
DRILLING DOWN
All wells involve drilling a hole in the ground which is known as the wellbore. Initially a larger drill bit is used to drill a surface hole - known as spudding. This is lined with casing and cement to protect groundwater.
After the surface hole is completed, the main drill bit is inserted and the well is drilled to the total targeted depth. Just like you use different bits to drill masonry and wood at home.
Drilling fluids or muds are used to cool and lubricate the drill-bit, flush cuttings of rock to the surface and to plaster the side of the wellbore to prevent it from caving in.
A relatively straightforward exploration well would usually take around 30 days to drill but more complex wells can take many months and companies can often face delays due to the technical challenges involved in sending complex equipment hundreds of metres below ground.
