THE GULF OF MEXICO SHELF

Some trillions of cubic feet of gas have been produced from the shallow waters of the Gulf of Mexico since 1947, when Kerr-McGee Corp. drilled its Kermac #16 in 20 feet of water in what is now Ship Shoal Block 32. In the intervening five decades, the province has shouldered much of the responsibility for supplying the nation's natural gas. Even today, the Shelf produces about 13 billion cubic feet (Bcf) of gas per day, more than one-fourth of the domestic total. The region also contributes some 800,000 barrels of oil per day. Inevitably, the romance of Shelf development has faded. Many companies now seek instead the massive reserves lying in waters far deeper, turning their backs on the small reservoirs and high-decline wells that remain the mainstay of the Shelf. Others have migrated overseas, where they delve for hefty reserves that lie yet undiscovered. Unquestionably, producers in the present-day Gulf face an untoward task. They scour a sea of steadily shrinking prospects. Gone are chances of finding the likes of Eugene Island 330, West Delta 30 or Grand Isle 43. These behemoths, swelling with reserves of more than half a billion barrels of oil equivalent (BOE), were found decades ago. A good-size prospect these days holds only a couple percent as much oil and gas. Today's production is also flash-in-the-pan. Operators battle precipitous declines-on average, production on the Shelf falls about 33% annually, and first-year rates of decline on new wells are around 47%. Couple the pint-size discoveries possible today with completion technologies that allow very rapid, very high-rate production, and producers race on a ruthless treadmill. A company must work very hard just to hold its production flat, not to mention grow it significantly. Yet, for all its well-known drawbacks, the Shelf is still a hospitable place for a feisty group of independents. For these firms, the aging area offers several pluses: a tremendous capacity to generate cash flow, a strong success rate, and blossoming opportunities for acquisitions, exploitation and even exploration. "Many people think that the future of the Shelf will be a short book," says Richard Nehring, president of NRG Associates. The Colorado Springs-based firm markets a database of the significant oil and gas fields of the U.S. "If they really looked at what's happening there, they'd see that the Shelf is a much more interesting story." Indeed, while the sizes of new-field discoveries on the Shelf may not enthuse the industry, the overall reserve additions on the Shelf can be impressive. "Over a period of several years, we see quite a number of fields on the Shelf with reserve additions on the order of 10- to 50 million BOE, and there are even a number that have additions greater than 100 million BOE." Additionally, a number of operators have been redrilling small- to mid-sized abandoned fields on the Shelf, netting commercial discoveries, says Nehring. "People are also beginning to resolve the deeper section, and the 12,000- to 20,000-foot depth slice on the Shelf can legitimately be considered a frontier area," he says. "We're seeing more drilling to greater depths each year." One of the largest independent producers working on the Shelf is Houston-based Vastar Resources, which trails only Chevron and ExxonMobil in gas production there. The company, formed five years ago, produces 725 million cubic feet of gas equivalent per day from the Shelf, about 50% of Vastar's total production. An active deepwater explorer, Vastar will also record its first deepwater production a bit later this year. "The Shelf has been one of our primary vehicles for growth," says Dave Stover, manager of Shelf production. "We expect that to continue." Between 1993 and the close of 1998, Vastar grew its production on the Shelf by 42% and its reserves by 54%. In 1998, Vastar enhanced its Shelf portfolio-largely a legacy from its Arco days-when it acquired 23 producing fields from Mobil. All told, the firm holds interests in 352 lease blocks and operates in excess of 120 platforms on the Shelf, which it defines as extending to water depths up to 1,000 feet. Among its largest producing Shelf fields are South Pass 60, South Timbalier 37, South Pelto 10, Mississippi Canyon 148, Grand Isle 41/43/47, and Eugene Island 175. Vastar sees two vastly different opportunities on the Shelf-large, complex fields and new-field wildcats. The complex fields are the foundation on which Vastar builds its Shelf program. These accumulations, generally older fields with intricate geology and compartmentalized reservoirs, provide opportunities for recompletions and new-pool reserve additions. "We like large fields with multi-pay horizons where we can continue to exploit newly identified reserves. We also like to build large interest positions and serve as operator," says Stover. One of Vastar's biggest programs is on South Pass 60. The 30-year-old field, one of the Shelf's largest, hosts a multitude of fault blocks and has enough remaining potential that it has sustained a $40- to $50-million annual program for the last several years. "We continue to reuse wellbores, recomplete zones and drill deviated wells at South Pass 60," he notes. "We've been able to use the same infrastructure and the same well bores as many as four or five times over, while maintaining very high production." The complex fields also supply the infrastructure necessary to make the development of subsidiary accumulations economically attractive, he adds. Exploration drilling is the second thrust of Vastar's Shelf activity. There's little question that the average size of opportunities on the Shelf is shrinking, says Debbie Knight, manager of Shelf exploration. "When I first started working offshore in the mid-1980s, we were looking for prospects in the 100-Bcf range and higher. These days, we are looking for opportunities in the 50-Bcf range." Yet, several factors offset the smaller prospect size. Knight says improving technologies have allowed Vastar to better analyze and assess prospect risks, and to consequently generate high drilling success rates. Vastar is particularly keen on 3-D AVO (amplitude versus offset) technology, which works by comparing the amplitudes of near, middle and far seismic traces. The relative strengths of the seismic amplitudes at various offsets can indicate the presence or absence of hydrocarbons. The company has built a world-class processing center, and unlike most of its competitors, internally reprocesses existing 3-D data for AVO purposes. Says Knight, "We have a definite edge because we reprocess the data in-house with proprietary techniques. Our costs are low, our results are high-quality, and we can turn the data around quickly." Another plus is the increasing willingness of companies to deal their acreage in the Gulf. "We used to have to wait for a lease sale to come around to put together a prospect. The market is still competitive, but these days if we find a prospect we like on another company's acreage, we are much more likely to get into it through a farmout or a trade," says Knight. Too, experience cannot be underestimated. "We have a very long history in the Shelf, dating back decades," she says. "We've always been here." Certainly, Vastar's success rates for exploratory drilling are enviable. In 1999, 71% of its 34 Shelf exploratory wells were productive. Half of the 14 new-field tests were successes, as were 84% of its 23 extension wells. Vastar also drilled more than 40 successful development wells. This year is shaping up to be one of Vastar's busiest yet on the Shelf. In 1999, the independent devoted $200 million to development work on its Shelf properties; it will spend more in 2000, although the final numbers were not available at press time. Its development schedule calls for more than 80 operated projects, including drilling wells, sidetracks, recompletions and rig-performed workovers. The company also anticipates participating in another 40 outside-operated projects. The 2000 exploratory budget includes another 40 wells, of which 33 will be extension tests. "We are switching our effort just a bit toward extension drilling in 2000, because the former Mobil properties have thrown off a considerable number of these opportunities," says Knight. "Our challenge is to continue offsetting the high decline rates that are normal for the shallow-water Gulf, and with our program we have the ability to do that," says Stover. Houston independent Apache Corp. made quite a splash in the Gulf when it spent $715 million in cash, plus a million shares of Apache stock, to acquire a package of Shelf properties from Shell Exploration & Production Co. last year. Apache already operated on the Shelf, posting gross operated production of about 200 million cubic feet equivalent per day at the beginning of 1999. The 22 fields in the Shell deal, containing proved reserves of 127 million BOE, were producing 24,900 barrels of oil and 125 million cubic feet of gas per day. All are in water depths of less than 700 feet. Shell also kicked in 16 undeveloped blocks and license to 3-D seismic data covering more than 1,000 blocks throughout the Gulf. "The Shell acquisition has been magic for us," says Roger Plank, vice president and chief financial officer. "Our timing was very fortunate. We earned more in the third quarter of 1999 than we earned in all but two quarters of our 45-year history, and that's largely because of the Shell acquisition." Apache was prescient: the company bought the package of past-their-prime Gulf fields from Shell at precisely the inflection point of the last down cycle. The independent has made a name for itself adding value to old properties. It had positioned itself for an acquisition and was talking to different majors throughout the oil-price freefall. "Shell decided to sell its Shelf properties at the time oil prices were sitting at $16 per barrel," notes Plank. Apache completed a 22-million-share offering-15 million shares of common and 7 million shares of conversion preferred-and took possession of the properties in July, and it's never looked back. In the first four months it owned the fields, Apache ramped up gross operated production on them to more than 220 million cubic feet of gas and 31,000 barrels of oil per day from 160 million cubic feet and 27,000 barrels of oil per day. "The combination of buying properties to which we could add value and seeing prices skyrocket beyond anyone's expectations has our cash register ringing daily," says Plank. Apache's battle plan was heavy investment in its new purchase. "Shell is an excellent operator," says Jon Jeppesen, region vice president. "But we have a higher sense of urgency. We get things done quickly, and the things that we do have more impact on us than on a corporation the size of Shell." Simple steps such as drilling new wells, recompleting and working over existing wells, enhancing compression, and adjusting choke sizes all contributed to the production growth. "We list our projects by impact, and we first tackle the projects that will have the most impact on production," says Jeppesen. "Shell had identified many of the same opportunities, but their timetable was much longer." Some of the ex-Shell fields boast a long list of projects. At South Timbalier 295, the jewel of the acquisition, Apache immediately began recompleting wells. Shortly, it will move Noble Drilling Co.'s Eddie Paul jackup rig to the field for new drilling. "These are high-impact projects," says Jeppesen. "Some of the wells in this field can produce 1,500 barrels of oil per day." Apache is also working on properties at South Pass 62, Ship Shoal 274 and 189, and High Island A-528. It's already drilled wells at Green Canyon and plans several at West Delta 105. Apache goes for maximum profit up front, says Jeppesen. "We have fixed operating costs offshore, and we want to get the oil and gas out of the ground as quickly as possible. We do everything we can to accelerate production." All together, Apache spent $104 million in drilling and operations on the Shelf last year. Naturally, the fields offer a mixed bag of opportunities. Dating from the 1960s and 1970s, the ex-Shell properties are generally in good condition. Still, fields of that vintage require constant maintenance and remedial work. Too, some fields conform to expectations and others don't. "On some we beat the plan, and on some we don't. But overall our production is ahead of our projections." In 2000, Jeppesen expects Apache to devote about $85 million to drilling on the Shelf. Over the past several months, Apache has been running nine rigs, and it plans to maintain that level of activity throughout the year. Operations capital, which includes recompletions and compressors, will add $50 million to the overall total. Newfield Exploration Co. is one more Houston independent that likes the Shelf very much. Since its debut eight years ago, the company has grown its reserve base to more than 500 Bcfe, most of that located on the Shelf. Today, Newfield owns 166 blocks in the Gulf-scattered from the shoreline to the 600-foot water depth. The company produces 90% of its daily production of 315 million cubic feet of gas equivalent from the Shelf. Newfield makes the Shelf work by acquiring and exploiting properties, leveraging its infrastructure, and exploring in and around its producing fields. Typically, the company buys something that a major is divesting. It prefers to purchase properties for a low capital cost, often buying old fields and assuming plugging and abandonment liabilities. Then, it invests in these assets, with the goal of achieving a 15% to 20% rate of return. In 1999, Newfield's capital budget was $225 million, including $83 million in acquisitions. Two of the three major deals it closed last year were for Shelf properties. The largest transaction was a $57-million purchase from Ocean Energy Inc. The core asset of that three-field deal was Vermilion Block 215. Another was a buy of interests in several waning fields from Phillips Petroleum. For $3 million in cash, $8 million in future production and the assumption of P&A responsibilities, Newfield gained production of 15 million cubic feet per day from 22 Shelf properties. "Exploiting our acquired properties is our ongoing business," says Elliot Pew, vice president of exploration. "The assumption we always make is that our properties are not fully exploited. We go back regularly and restudy our properties, and many times we find new opportunities." In patented Newfield style, the company was operating a field at Eugene Island Block 202. "By closely working the 3-D seismic with the existing well control, we found three additional prospects on Eugene Island 198/199," says Pew. "It's a multiple-pay area with numerous faults, and when we carefully tied all the data together we could determine the exact configuration of the fault blocks. It took a lot of elbow grease, but we came up with three simple, low-risk tests." Two of those are now discoveries, and the third was drilling at press time. Newfield also likes to play off existing infrastructure. "We made an acquisition in South Marsh 141/144, drilled a number of wells and set two platforms. From our C platform, we found that we could reach out into Block 140, where an old discovery had been drilled but never produced." Newfield redrilled the prospect, made a nice reserve addition, and hooked the well up to its existing platform. While far from a high-stakes wildcatter, Newfield does thoroughly explore the areas in and around its fields. Last year, the company drilled Eugene Island 352, an exploratory well that it identified off its regional seismic data. Newfield owns a 3-D seismic database that covers 2,200 blocks, and it uses 3-D for virtually everything it does-exploration, field studies and recompletions, says Pew. In 1999, the independent successfully completed nine out of 13 tests for a 69% success rate. Its prospects generally fall into the 15- to 40-Bcf range; like other players in the Shelf, Newfield looks for subtle plays or plays with difficult lease situations. "Fortunately, there are plenty of these opportunities to keep up an active drilling program," says Pew. "We have a two-year inventory of drilling prospects." The company still sees much to do on the Shelf. "The industry has some opinions that the Shelf is very mature and that it is difficult for a company to sustain growth here," he says. "We have as many opportunities now as we have ever had, and as companies continue to exit we expect to enjoy even more." Denver-based Basin Exploration has taken a different tack from many on the Shelf. The company has built an impressive portfolio of Gulf assets by focusing on exploration in the Miocene trend offshore Louisiana, in water depths between 20 and 150 feet. The firm staked its future in the Shelf in 1995, after evaluating many other regions. One of the lures was the ready access to speculative seismic data. "We liked the wide availability of 3-D spec data at a reasonable cost," says Michael Smith, president and chief executive officer. "The annual leases sales were also attractive." Basin zeroed in on the Miocene play because it was close to shore and had existing infrastructure, says Neil Stenbuck, vice president and chief financial officer. "Smaller prospects-in the 20- to 30-Bcf range-could still be highly economic there, especially if we could complete a high percentage of the opportunities we went after." That's an aspect on which Basin has been able to deliver. With two recent finds on West Delta 59 and South Timbalier 143, the company upped its 1999 discovery rate to 75%, successfully completing 15 of 20 wells. Its net production in third-quarter 1999 stood at 92 million cubic feet equivalent per day, and some 75% of Basin's year-end 1998 reserves of 179 Bcfe lie in the Gulf. "Our geoscientists are a huge reason for our success," says Smith. "Without the right people, we would not have entered the Shelf." Basin's Gulf team internally generates its prospects, acquiring the acreage via lease sales or farm-ins. If appropriate, the company will buy properties to enhance its prospect inventory. "We continually look for more opportunities, but we have a very deep inventory of exploratory prospects," says Smith. "So, we've been very selective on acquisitions." Basin spent about $85 million in the Gulf in 1999. It expects to maintain that investment pace this year, drilling between 15 and 20 exploratory wells. Although the book on the Gulf says the prospect sizes continue to shrink over time, Basin's own experience is just the opposite. "It's an undeniable attribute of the Gulf that the larger a production base, the more challenging it is to replace it. But for us, the prospects have been getting larger," says Smith. "As we've been able to build our prospect inventory, we've been able to increase the average size of the prospects. This year, we'll be drilling some of the largest prospects in our corporate history." Now is an excellent time to drill in the shallow-water Gulf, adds Smith. "We have seen an increase in costs from the lows of last summer, but we're still at prices that are about 50% lower for shallow-water rigs and boats than they were during the peak in the summer of 1998." Indeed, when Basin began acquiring its prospect inventory, it planned its drilling based on rig rates of $35,000 to $40,000 per day; costs for those rigs were still in the high teens at press time. "The play works very well at anywhere near these kinds of prices," he says. Smith says that abundant opportunities still populate the Shelf. "We understand the reasons many companies have chosen to leave, but that just creates more opportunities for those of us that have stayed." The Houston Exploration Co. agrees with that view. This independent has been a Gulf player since its inception in January 1986, says Tom Powers, treasurer and senior vice president, business development. About 45% of the company's reserves of 550 Bcfe are in the shallow-water Shelf. "We like the Shelf because we can significantly add to the reserve base of the company, through both drilling and acquisitions," he says. "It's also a lot less competitive than onshore, because not every company has the technical capability to work in the water." Houston Exploration also appreciates the Shelf because it's an area where it can concentrate assets within an existing infrastructure. "Most of the areas we work are very close to pipelines, and we like to spend every dollar that we can drilling wells," says Powers. "Successful prospects can be put on production very quickly, and the concentration of operations also yields low operating costs." The firm generally plays the Miocene on the Texas side, with its largest lease positions in the Mustang Island and Matagorda areas. Over the past five years, the company's offshore reserve additions have been almost evenly split between drilling and acquisitions. Houston Exploration's strategy relies heavily on drilling internally generated prospects. The company presently has a 50-prospect inventory on 77 undeveloped leases. Last year, it spent about $60 million and drilled 15 wells on the Shelf. That was a record for the company, and it expects to match that pace in 2000. "We're constantly participating in the lease sales, and we farm in to other properties," says Powers. "We replace more than 100% of our production through the drill bit." The firm also buys properties, preferring those it can operate. "We also like to have a high working interest, and we like to concentrate in areas we already work," he says. Its most recent deal was the November 1999 acquisition of West Cameron 587, which added 21 Bcfe to Houston's reserve base. "It's not a large property, but it has nice potential. That's a typical piece of business that we like to do on a regular basis," says Powers. Utility holding company KeySpan Energy owns 64% of Houston Exploration's stock and is exploring alternatives for that investment. Earlier in 1999, KeySpan entered into a joint venture with Houston Exploration to purchase 45% of its interests in 55 blocks in the Gulf and supply up to $100 million per year for its share of drilling capital. "If KeySpan monetizes its position, we will cancel the joint venture," says Powers. "Another company would either buy its interest or the whole company. We'd rather have the working interest than a financial partner, because the working interest would be more valuable to us in a corporate sale." In the meantime, the joint venture is proceeding business as usual. The Shelf remains an integral part of Houston Exploration's strategy, says Powers. "We created the company in the Shelf, and it's worked very well for us. It's a growth area for us, and it's where we spend most of our money." Small, privately held ATP Oil & Gas Corp. has also played the Shelf, since the company was formed in 1991. "We built the company in the toughest way possible," says T. Paul Bulmahn, president. "That was one project at a time." The company recently made Inc. magazine's list of fastest-growing private companies in America. The Houston independent specializes in marginal field development, typically working projects with reserve sizes between 5- and 15 Bcf. "We have very low overhead, so we can make something work where a bigger company might not. But, we also employ our own approach to marginal properties," says Bulmahn. ATP strives to bring marginal fields on line quickly, and sometimes it uses a more expensive technology to speed up development. "If we can get the reserves on stream faster, we can make the rate-of-return higher even though the return-on-investment might be lower," says Bulmahn. "We are certainly willing to employ cutting edge technologies, even though they might not be the cheapest way to develop a project." The company has used subsea technology on the Shelf; currently the firm has five such wells among its assets. In another case, ATP pushed existing technology to a higher level. A well in 500 feet of water lay 11 miles from the nearest platform, and the prevailing wisdom held that direct hydraulics couldn't be used for distances beyond five to seven miles. "We developed the well with subsea technology and laid an 11-mile pipeline and an umbilical controlled by direct hydraulics. The response times that we have experienced were faster than we had expected," he says. "We see control of operations as key to our strategy. We also take on projects 100% where we can," says Bulmahn. "We prefer to own the entire project and operate. By doing that we can push these projects into small windows. Any time we deal with a partner, that introduces elements that extend the amount of time required for the development stage." Minimal structures are another approach. "We use everything that technology has given to the industry, from tripods to caisson structures to four piles." Of the 18 platforms ATP operates, only one is manned. In 1999, ATP's proven reserves topped 100 Bcfe. Just at the tail end of 1998, the firm closed on the acquisition of Statoil's Gulf of Mexico properties. That deal brought 17 leases, 12 wells, and several undeveloped properties to the independent. "Now that we are larger, we are addressing packages of properties," he says. "We have a greater range of opportunities because of our growth, and we have more choices than ever in the market." TDC Energy Corp. is one more private entity busy in the Shelf. The New Orleans-based firm was founded by John Melton in 1986. Chairman and chief executive officer Melton was initially interested in marketing natural gas; developing gas supplies was a secondary concern. Eventually, the firm decided to focus on drilling wells for its own account. In the early 1990s it began working in the Gulf of Mexico, arranging financing through prepaid gas deals. The company's first Shelf property was a farmout in Eugene Island 294 in 260 feet of water. TDC used a subsea completion to put the property on line. "Then, we bought a property at West Cameron 601. That field had a lot of upside, and put us on the map," says Melton. Today, TDC's production ranges throughout the Shelf. The company operates 25 million cubic feet of gas and 1,000 barrels of oil production per day, and its reserves are now approaching a net present value of $100 million. The company operates 13 properties and holds interests in another five blocks. "We exploit and redevelop older properties," says Charles Richards Jr., president. The company acquires its properties both by purchase and farm-in, and has even bought a couple of blocks in lease sales. TDC is also compiling an exploratory inventory that it intends to drill in the future. "Our pockets haven't been deep enough for exploratory drilling. But now that we are getting larger and our inventory of exploratory projects has increased, we intend to increase our exploration efforts," says Melton. TDC is intrigued with minimal structures, and several years ago created a program with Atlantia Corp. to develop lighter-weight, less-costly fixed facilities for the 250- to 500-foot water depths. "Our intent was to take farmouts from the majors that were marginal and use this technology to drill those opportunities," says Melton. The project was shelved when service prices rocketed in 1997. "Now that service costs are lower, we intend to reinitiate that project." TDC presently has three of the minimal structures producing. "These minimal structures work because they have far fewer facilities on them," says Richards. "The discoveries are significantly less than the exploring company hoped to find. A company like ourselves can put one of these structures on a one- or two-well field. They are very economical and very practical for the development of smaller fields." In waters 200 to 400 feet, a field holding 15- to 25 Bcfe would be a candidate for this technology. In deeper water, the minimum reserve size might be 50- to 70 Bcfe, he notes. "We're dedicated to maintaining our efficiency and to reaping the less attractive barrels out of the ground," says Melton. "That's the story of the independent. And we think the Shelf is the place to do just that." M