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.

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?)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Stock Analysis

    The Biggest Oil Producers in Asia

    Learn which Asian countries deliver the most crude oil to market, and discover what companies are the biggest producers in each country.
  2. Stock Analysis

    The 5 Biggest Russian Oil Companies

    Discover the top Russian oil companies by production volume and find out more about their domestic and international business operations.
  3. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  4. Investing News

    Ferrari’s IPO: Ready to Roll or Poor Timing?

    Will Ferrari's shares move fast off the line only to sputter later?
  5. Stock Analysis

    3 Solar Stocks to Add to Your Portfolio

    Understand the growth and challenges of the renewable energy market and its success in 2015. Learn about the top three energy stocks to add to a portfolio.
  6. Investing News

    Glencore Shares Surge in Hong Kong

    Shares of Glencore International, a leading multinational commodities and mining company, jumped by around 15% on London Stock Exchange, after the shares had gained about 71% earlier on the Hong ...
  7. Stock Analysis

    The 5 Best Buy-and-Hold Energy Stocks

    Understand why energy companies' stock are volatile when oil prices are volatile. Learn about the top five energy companies to buy and hold.
  8. Investing

    Have Commodities Bottomed?

    Commodity prices have been heading lower for more than four years, being the worst performing asset class of 2015 with more losses in cyclical commodities.
  9. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  10. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  1. Can working capital be too high?

    A company's working capital ratio can be too high in the sense that an excessively high ratio is generally considered an ... Read Full Answer >>
  2. How do I use discounted cash flow (DCF) to value stock?

    Discounted cash flow (DCF) analysis can be a very helpful tool for analysts and investors in equity valuation. It provides ... Read Full Answer >>
  3. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  4. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  5. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  6. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!