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Investing in Oil Wells Like a Venture Capitalist: Conventional vs. Unconventional Wells

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One of the big myths of investing in oil wells is that you need scale to compete. While that’s true for the large projects that require significant development capital, you can also find pockets of opportunity in small-scale drilling projects. In many cases, the big money can’t or won’t pursue these projects because it won’t move the needle for their organization. That opens up a window of opportunity where the small investors enjoys a structural advantage over their larger peers.

To understand why, let’s first review the brief history of conventional (i.e. vertical) versus unconventional (i.e. horizontal) drilling in the U.S.

INVESTING IN OIL WELLS: CONVENTIONAL VS. UNCONVENTIONAL

Horizontal drilling and fracking techniques have been around for decades, but they were mostly uneconomical until the last 15 years. So for roughly a century, the only game in town for big and small drillers alike was conventional, vertical wells. But by the 1970s, many conventional fields began suffering widespread depletion, pushing U.S. oil and gas production into secular decline.

Then, everything changed with the improvement of shale drilling technology in the mid-to-late 2000’s. Advanced technology applied towards new shale deposits opened up vast new opportunities for allocating large scale capital into low-risk projects (at least from an operational perspective). The flood of investment dollars into the shale patch accelerated the ongoing secular shift away from conventional field development.

However, conventional deposits never disappeared completely. Instead, they became concentrated in smaller sweet spots, amidst the broader trend of depletion in most large fields. As such, large-scale capital deployers couldn’t afford to spend time and resources chasing one-off projects in conventional formations. This left behind pockets of rich opportunity for small-scale, independent drillers.

SHALE BOOM PULLS CAPITAL AWAY FROM CONVENTIONAL DEVELOPMENT

Jason Mertz, an independent driller and owner of Mertz Energy LLC, is one of the independent drillers stepping in to capitalize on the remaining conventional opportunities. In a 2019 interview with Oil and Gas investor, Mertz described the industry dynamics at work driving the capital allocation decisions in shale versus conventional fields:

“In the (shale) resource plays, it’s easier to deploy large amounts of capital in a short time. That is why the big private-equity houses are attracted to the shale plays. Those have a risk profile more like bonds. The risk profile in conventional development is more like equity, and the bond market is many times larger than the equity market.”

As Mertz points out, the big money favors shale development because you can put a lot of money to work into relatively predictable, lower-risk projects. But the downside of shale is the added well expense and faster depletion rates, which often means lower returns.

WHY CONVENTIONAL WELLS?

Conventional development, on the other hand, comes with higher risk given widespread depletion issues. Even with the best geological data, you never quite know what’s under the ground until you start drilling. The upside is that conventional drilling comes with much lower costs and produces long life wells with slower decline rates. So when you hit the right sweet spot, the upside from conventional wells can exceed the cost by many multiples.

In other words, conventional development is a lot like venture capital. You take on a higher risk of a total loss (i.e. dry hole) with any single project… but across multiple wells, a few good opportunities can generate stellar returns even with some misses along the way.

Just like with VC investing, picking the right partners is critical for a successful drilling program – particularly with conventional wells. At EnergyFunders, we work with some of the best operators in the oil and gas business. Proven operators and industry veterans, who bring decades of drilling experience to the table.

The EnergyFunders platform was built to connect individual investors with independent drillers and tap into the potentially lucrative opportunities that the big guys leave behind.

Through the history of EnergyFunders conventional drilling programs, we’ve seen both the ups and downs of how the business works. We’ve participated in our share of dry holes, but we’ve also had big discoveries, like the Theall project, a 13,500’ exploration well brought to us by Houston Energy. When you build a diverse portfolio, we think the wins make the potential risk worth it … just like a venture capitalist does.

Many of EnergyFunders’ projects to date have been conventional drilling projects, where we explore for new oil and gas. If this is the type of investment you are looking for, come and take a look at our Wildcat Funds.

WHICH ONE IS RIGHT FOR YOU?

When investing in oil wells, you have options for two types of projects: conventional or unconventional. (Conventional wells are vertical and unconventional wells are horizontal or some other form.) Unconventional wells tend to have less dry-hole risk – and more predictable (and often smaller) payouts. You know there’s oil in the ground before you drill with unconventional, whereas with conventional wells you never truly know until the drill bit meets the ground.

EnergyFunders has both kinds of oil and gas investment opportunities – so with a diverse portfolio you can invest in both. Learn more about our strategy for investing in oil.

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