SINGAPORE -- Asian energy companies look set to catch up to their peers with investments in U.S. unconventional oil production, the area which has dominated global energy merger and acquisition activity over the last 12 months.
Asian oil producers have been notably absent from the market, but the largest need to diversify and expand to counter rapidly falling output at home. Many are likely to be attracted by minority stakes in reasonably priced "tight oil" assets, said Gordon Kwan, head of oil and gas at Nomura in Hong Kong.
Tight oil refers to crude oil found in shale rock formations. It is typically harder to produce than oil from traditional fields and is extracted by unconventional methods.
Asia's top 20 oil companies, including China National Petroleum, CNOOC, China Petroleum & Chemical (Sinopec), Oil and Natural Gas Corp., Inpex, and Petronas, have invested heavily in conventional assets within the region. These fields however are maturing and overall output is set to fall 20% over the next decade.
Conversely, Asian oil producers' exposure to low-cost tight oil-driven U.S. unconventional assets represents under 1% of their total upstream portfolio value, according to Adrian Pooh, an Asian upstream specialist at energy research company Wood Mackenzie. These U.S. fields are expected to expand output by more than 80% over the next decade.
Nomura expects China's CNOOC to leverage an existing shale joint-venture with Oklahoma-based Chesapeake Energy, a major operator of unconventional oil assets, to expand its U.S. footprint. Kwan said the experience of Sinopec and China National Petroleum's PetroChina unit drilling in Chinese unconventional fields could also be valuable. "We estimate China has the scope to invest as much as $50 billion into U.S. tight oil plays, if they want to," said Kwan.
U.S. tight oil production remains resilient despite the fall in global crude prices, said Eesha Muneeb, a senior oil analyst at energy information provider S&P Global Platts. West Texas Intermediate, a benchmark for crude oil, was trading at about $44 a barrel on June 20, compared with a recent peak of more than $100 in mid-2014.
Drilling techniques for hydraulic fracturing, needed to extract oil and gas from low-permeability rocks, have advanced so much that breakeven prices for U.S. tight oil are now comfortably below $40 a barrel. In the Permian basin, which straddles Texas and New Mexico, breakeven prices are even lower, at close to $30 a barrel, data from S&P Global Platts shows.
Asian companies need new areas to invest in and cheaper oil to bolster their production portfolios, Pooh said. Few Asian projects seeking investment now can compete with the large volumes and low breakeven costs of tight oil, he said.
On the other hand, tight oil operators have ambitious goals to ramp up drilling. A Permian basin study by Wood Mackenzie concluded that many U.S. players would welcome long-term external financing rather than take on more debt. This opens attractive opportunities for Asian investors, who are typically financially stronger than international oil companies.
The Wood Mackenzie report showed that Asian involvement in the world's hottest tight oil assets has been negligible so far, particularly in the Permian basin. This was despite $20 billion poured by Asian investors into unconventional oil and gas in U.S. states other than Alaska between 2010 and 2013. Most of this investment was in shale gas, which is also produced from tight rocks.
Of the 20 biggest Asian companies, only CNOOC, Mitsui, KNOC and Sinochem have some exposure to unconventional projects in the U.S., excluding Alaska. But past deals, often with U.S. independent producers which needed growth capital to drill newly acquired sites, did not always match expectations.
"Previous joint venture deals saw many Asian buyers pay big dollars at the peak of the market for shale gas projects that became secondary for U.S. operators," Pooh said. Shale gas cost carry deals, where the buyer paid for the full cost of drilling, also meant buyers took on more risk, but ultimately produced less than anticipated, he added.
Nevertheless, Wood Mackenzie expects buying interest in U.S. tight oil from big Chinese, Japanese and South Korean companies. Historically, the main sellers have been large North American players, such as Devon, Chesapeake and Anadarko, and this looks set to continue, Pooh said.
In May, Tokyo Gas snapped up a 30% equity stake in Castleton Resources, which is developing unconventional oil and gas assets in the Haynesville shale field in northwest Louisiana and eastern Texas. The deal marks the Japanese company's third investment in U.S. unconventional assets in the past two years.
In April, Thai mining and power company Banpu agreed to pay $112 million for a 29.4% stake in a venture developing gas in the Marcellus shale field in Pennsylvania. This marked the third deal signed by Banpu in the U.S. unconventional sector this year.
China's Meidu Energy and Yantai Xinchao have also done deals in U.S. unconventional assets over the past two years. Apart from state oil companies, private Chinese investors are also expected to be on the hunt for deals.
Despite the appealing prospects, Asian investors will need to be careful. Many were hit by falling oil prices from 2014 because they tended not to hedge their exposures. For them, risk management will be crucial, said Alan Bannister, Asia director at S&P Global Platts.
"It might be a case of once bitten, twice shy," he said. "So many previous investments went bad that I'm not sure Asian investors will have the appetite."
Tony Regan, managing director of DataFusion Associates, an Asian oil and gas consultancy in Singapore, also said that Asian investors need careful project analyses. "The U.S. has shown it can produce more for less, but the problem is the global market does not need it. There could be tears again as production rises, but prices fall."
Interest from Chinese state oil companies in U.S. shale gas exports could perk up too. Until now, Chinese companies have not bought liquefied natural gas under long-term contracts from the U.S. directly. But provisions of a 100-day U.S.-China trade action plan on May 11 may have changed the picture by explicitly connecting the world's fastest-growing supplier with the largest LNG growth market.