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RIL increases its bets on shale gas

RIL increases its bets on shale gas
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First Published: Sun, Aug 08 2010. 09 30 PM IST

Updated: Sun, Aug 08 2010. 09 30 PM IST
Reliance Industries Ltd (RIL) has acquired three shale gas assets in the last five months. Last week, RIL entered into an agreement with Carrizo Oil and Gas Inc. for a Marcellus shale joint venture. The consideration for the deal works out to about $6,260 per acre, much lower than $14,167 per acre Reliance paid for its first shale gas asset in April. What explains the disparity between the two assets in the same basin? Analysts say the recently acquired asset is in a comparatively early stage of development than the first one and hence carries higher risk.
Shale gas assets not just in the US but also in Europe have been attracting huge investments. Some believe that it could be a game changer in the energy business while others feel that the rush into shale has generated a lot of hype. In the US, shale gas came into vogue in a major way about five years ago when average gas prices were higher. Average Henry Hub natural gas spot price for 2005 stood at $8.89 per mmBtu (million metric British thermal units). Henry Hub prices are a common indicator for gas prices in US.
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Higher prices made shale gas an attractive space for some US companies to explore the opportunities. Unfortunately for them, gas prices have dropped considerably since then. So far, average Henry Hub natural gas spot price for 2010 stand at $4.70 per mmBtu. Debt-laden independent US companies have therefore been inking deals with cash-rich foreign ones, most of which involve payment of cash upfront with the foreign company paying for a large share of future drilling costs. No wonder Atlas Energy Inc., the firm with which RIL signed its first venture, saw its stock rise over 20% when the deal was announced. What will determine the fate of these shale gas investments is how gas prices and demand pan out eventually. While demand will no doubt recover, the risk is the rush into shale gas may become a victim of its own success, with rapidly rising supply if the fields are as rich as they are claimed to be.
But technology, a key obstacle for shale gas, has improved. “Back in 2007, major companies in the US exploring shale gas used a price of $6-8 per mmBtu for gas wells to breakeven. But, costs have dipped significantly with the advent of the new technology,” mentioned analysts from Edelweiss Securities Ltd in a note to clients in June. The report states that current break-even prices range from $3.25-6.35 per mmBtu, depending on shale formations. Reliance will also get technical exposure in this area, which could help the company to make shale gas investments in India. And then, of course, there’s Reliance’s need to put its cash hoard to good use.
The shale gas deals will take a while to add to the company’s profitability, with cash flows expected to become positive only after four-five years. Analysts’ estimates of the value of shale gas investments range from between Rs20 and Rs66 per share, depending on their guesses about the price of gas. That is not a lot for a stock currently valued at Rs1,000. For investors, much more pressing concerns are the company’s disclosure that production from the KG-D6 block is unlikely to increase in the next 6-12 months, contrary to earlier estimates. That has led to a correction in the stock. The shale gas investments are too modest and payback too far in the future at the moment. But their importance will certainly expand over time.
Graphic by Naveen Kumar Saini/Mint
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First Published: Sun, Aug 08 2010. 09 30 PM IST