Investors continue to be enthralled by the boom in developing onshore shale and unconventional plays, attracted in part by a perception that this business model carries almost no geological risk. This perception is not entirely accurate, particularly in newer plays that have undergone limited development.

TUTORIAL: Economic Indicators To Know

Texas Panhandle
QEP Resources (NYSE:QEP) demonstrated the geological risk that is still present in this business model with the release of the company's operational update for second quarter 2011.

QEP Resources is developing the Atoka Wash in the Texas panhandle area and announced that two recent wells into this formation were uneconomic due to low production of natural gas. The company also reported that a well completed to the Cherokee zone was producing water instead of hydrocarbons.

A Shock to Investors and Management
These unsuccessful wells were a shock to investors as well as the management of QEP Resources. The two Atoka wells were offsets to a successful Atoka Wash well that produced at a peak daily rate of 11.3 million cubic feet of natural gas equivalents per day.

The unsuccessful Cherokee zone well was also a surprise as it was drilled only a mile from a previous Cherokee well that produced at a peak daily rate of 13.7 million cubic feet of natural gas equivalents per day.

Permian Basin
Energen (NYSE:EGN) has a leasehold in the Permian Basin and is developing various formations on its acreage here. The company has been working on the Avalon Shale and recently drilled a test well on the eastern portion of its position.

Energen reported that the well produced 100 to 110 barrels of oil per day (B/D) and 400,000 to 600,000 cubic feet of natural gas per day. This is not enough production to make a $5.5 million well economic. The company has not given up on the Avalon Shale on its leasehold here and will attempt to adjust its completion techniques to increase productivity. Energen plans further test wells into the Avalon Shale in 2011, and 13 wells in 2012 and 2013.

Midstream
Sometimes problems occur that are out of the operator's control. Rosetta Resources (Nasdaq:ROSE) recently disclosed an interruption in production from the company's properties in Texas, where it is working on the Eagle Ford Shale. The company attributed the interruption to an "operational upset" at a gathering and processing plant owned by a midstream company.

Rosetta Resources said that the curtailed volume is from the company's core Gates Ranch properties and totals approximately 75 million cubic feet per day. This is a significant volume for Rosetta Resources, as it reported total company production of 155 million cubic feet equivalent per day in Q1 2011.

Only a Short-term Issue
This is only a short-term issue for Rosetta Resources, as the capacity will come back on line eventually. The company has also been proactive in securing midstream capacity to accommodate the growth in production over the next few years, and it has secured capacity of 277 million cubic feet equivalent per day by April 2013.

Midstream companies are aggressively expanding capacity to handle the rapid production growth expected from the Eagle Ford Shale and other areas. NuStar Energy (NYSE:NS) recently signed a letter of intent with an operator to jointly work on a pipeline to transport condensate from the Eagle Ford Shale.

Crosstex Energy (Nasdaq:XTEX) is building a new pipeline to transport natural gas liquids from the Eagle Ford Shale and other areas. The pipeline will connect with the company's fractionation plant in Louisiana.

The Bottom Line
Onshore development of oil and gas plays carries more geological risk than many investors might think, and a more realistic appraisal of this risk would be a benefit to those that dabble in the energy sector. (For additional reading, see What Determines Oil Prices?)

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