Vastar uses technology, strategy to compete with majors in deep water

Dec. 7, 1998
Vastar Resources Inc. discovered oil with the first well it drilled in the Gulf of Mexico deep water. Vastar logged 290 ft of net oil pay with the King well, on Mississippi Canyon Block 764. Shown here is Diamond Offshore Drilling Inc.'s Ocean Victory semisubmersible rig drilling the well late last year. Photo courtesy of Vastar. Pamela S. Pierce, vice-president of business development: "The deep water is increasingly becoming an environment where an independent can be successful." [7,246
Anne Rhodes
Associate Managing Editor-News
Vastar Resources Inc. discovered oil with the first well it drilled in the Gulf of Mexico deep water. Vastar logged 290 ft of net oil pay with the King well, on Mississippi Canyon Block 764. Shown here is Diamond Offshore Drilling Inc.'s Ocean Victory semisubmersible rig drilling the well late last year. Photo courtesy of Vastar.
Vastar Resources Inc. is defying conventional wisdom for independents and looking to the deepwater Gulf of Mexico as a key contributor to its future growth.

Despite the high costs and elevated risks associated with exploration in this relatively new province, the Houston-based independent is already finding success there, logging 290 net ft of oil pay with its first deepwater well.

Although this play was long thought to be the domain of major oil firms, with their deep pockets, Vastar and other independents are proving that, with a sound strategy, they can compete in deep water as well.

Vastar has used careful asset selection, state-of-the-art seismic interpretation tools, and creative partnership arrangements to support its exploration efforts.

Although Vastar's deepwater program is still in its infancy, it has already begun to pay off for the company, as shown by its King discovery (OGJ, Mar. 2, 1998, p. 62, and Aug. 3, 1998, p. 31).

Vastar plans to accelerate its deepwater exploration program in the coming years. With a semisubmersible under contract with Diamond Offshore Drilling Inc., Houston, Vastar plans to drill or participate in four to six wells in the deep waters of the Gulf of Mexico in 1999.

Vastar's genesis

Vastar was incorporated in September 1993 as a subsidiary of ARCO. It was then spun off in 1994 through an initial public offering.

"We were able to hand-pick our assets from the best that ARCO had in the Lower 48," said Pamela S. Pierce, vice-president of business development, at an Independent Petroleum Association of America meeting in July. "And we did that very judiciously, taking only those properties that we thought we would be able to grow and enhance.

"We were able to hand-pick an organization from the best (personnel) that ARCO had to offerellipseWe chose peopleellipsethat we thought would be able to transition from the culture of a major to the culture required of an independent.

"We started out with a very solid balance sheet, and we were able to generate significant internal cash flow as a result of our program and to increase our capital spending associated with our exploration and development programs almost four-fold over the last 4 years. This year, we'll end up at about $700 million worth of capital spending in our base programs (see graph, p. 28)," said Pierce.

Since its inception, Vastar has taken an aggressive approach to growth.

"We knew that we were going to have to show that we were able to sustain the kind of growth that the independent producers have been able to demonstrate," said Pierce. "And that's what showed us that we needed to get into the deep water, because we identified it as a world-class growth province we would be able to enter."

A solid foundation

Vastar's production is roughly balanced between onshore and offshore.

Its onshore operations are concentrated in about 40 fields in the Gulf Coast, Arkansas-Louisiana-Texas, Midcontinent, and Rocky Mountain re- gions. Offshore production is from about 40 Gulf of Mexico shelf fields.

The firm's production breaks out as 75% natural gas and 25% crude oil.

President and CEO Charles D. Davidson characterized Vastar's fields as "large, complex, and multi-pay," which he says make it possible for Vastar to apply technology and integrated work teams to squeeze out more production and reserves.

In first half 1998, Vastar's net production averaged 921 MMcfd of natural gas and 35,500 b/d of oil. These values represent increases of, respectively, 44 MMcfd and 700 b/d over first-half 1997 production.

Vastar expects to achieve production growth of 8-10% this year, said Davidson, not including an acquisition from ARCO that boosted Vastar's production by about 11% (OGJ, Aug. 10, 1998, p. 23).

Vastar's exploration success rate this year was 55% through the third quarter, said Davidson. This included its first deepwater discovery, on the King prospect on Mississippi Canyon Block 764.

The firm's first-half net income was $80.8 million vs. $121.2 million in 1997. In the third quarter, its earnings were $37.6 million vs. $52.4 million in third quarter 1997, and total production was 1.246 bcfed-a 5% increase over third-quarter 1997 production.

The fact that Vastar's reserves and production are more heavily weighted toward natural gas has helped it fare better than many independent producers in recent months.

Also improving the bottom line, says Davidson, is the fact that first-half unit costs were less than in 1997.

Davidson said his firm's success can be attributed to its three-pronged approach: keep costs down, concentrate assets in key areas, and create financial flexibility.

Vastar also looks for growth opportunities through tactical acquisitions in and around its core areas of operation. It announced its largest-ever such deal in August, in which it acquired from ARCO interests in 23 producing fields in the central and western gulf.

The deal was a creative one, in which ARCO subsidiary Western Midway Corp. swapped certain of its California assets for the interests in the 23 fields, owned by Mobil Exploration & Producing U.S. Inc. Vastar subsequently acquired all of Western Midway's shares for $170 million in cash and $300 million in debt.

The 23 producing fields acquired from ARCO included 45 lease blocks and 93 platforms with 295 active wells. As part of the transaction, Vastar also acquired interests in more than 40 undeveloped lease blocks.

The acquired fields have proved reserves of 360 bcfe, while total reserves-including risk-weighted probable and possible reserves-are estimated at 600 bcfe.

Vastar expects the acquired properties to yield net production of 180 MMcfed in 1999.

Davidson said, "It is rare to have the opportunity for such a large-scale acquisition that meshes so well with our existing core holdings and technical and operational strengths."

Vastar had an extensive exploration and production program on the Gulf of Mexico shelf before the acquisition. The firm believes it now owns more net shelf acreage than any of the other independents in its peer group, which includes large independents such as Anadarko Petroleum Corp., Enron Oil & Gas Co., and Union Pacific Resources Co.

"Our expanded shelf portfolio, together with the successful emergence of our deepwater program, should help ensure that the Gulf of Mexico remains a major source of production for Vastar well into the future," said Davidson.

Deepwater foray

In its early years, Vastar had a couple of covenants that it held very closely, said Pierce: "We wanted to be very tightly focused on the bottom line. We knew we were going to have to stay focused on what our costs were and what our spending patterns were. We were going to have to shorten cycle times-we were going to have to be able to get wells drilled, get them hooked up, and get production going down the pipeline much faster than our competition.

"The other thing was that we were going to be out there looking for reserves that the majors had overlooked. We were going to buy into propertiesellipse(and) prospects that were too small for the majors to take a look at.

"The deep water gave us a chance to growellipseA company the size of Vastar can actually double overnight with just a few significant discoveries."

Although deepwater exploration was something that Vastar evaluated very intensely, it wasn't new to the employees who were working on the project. As far back as the late 1970s, Pierce had been on various ARCO task forces that were examining deep water as an entry vehicle for ARCO.

Vastar inherited several deepwater gulf leases from ARCO. Since then, said Davidson, "Our strategy has been to acquire high-value, drillable pros- pects."

"When we went into deep water in 1995, we took a program approach and said we needed to build a staff, acquire drillable prospects, build a database, and obtain access to a rig," he said.

As an independent, Vastar knew that it would have to take a careful approach to acquiring deepwater acreage, because pre-investment expenditures can mount up quickly, given rapidly increasing lease costs.

Pierce summed up Vastar's strategy: "We knew that we would not be successful by just going out there and buying raw acreage. We knew that we had to have prospects on that acreage, and drillable prospects with a very short time-frame associated with them."

Vastar currently holds 124 deepwater blocks containing about 50 prospects (see map, p. 28).

"Today, it would be almost impossible to duplicate the buildup of deepwater assets that we have," said Davidson.

Vastar began amassing new deepwater acreage in 1995 and signed a 3-year contract with Diamond Offshore for the Ocean Victory semisubmersible drilling rig. Diamond Offshore refurbished the rig in 1997, adding stability enhancements, a new mooring system, and a third mud pump, at a cost of about $111 million (OGJ, Nov. 10, 1997, p. 40).

Vastar drilled its first deepwater well on the King prospect on Mississippi Canyon Block 764 late in 1997. The company intends to drill four or five wells during each year of the contract term.

At the same time Vastar was drilling King, a partner-operated rig was drilling Kilmarnock prospect on Garden Banks Block 258. The Kilmarnock well was plugged and abandoned after finding noncommercial quantities of hydrocarbons.

The King well yielded better results, however. In February of this year, Vastar announced that the King exploration well cut about 200 ft of net oil pay. Drilling was suspended at 17,580 ft because of an engine room fire on the Ocean Victory.

Wire line logs had detected 170 ft of net pay in two high-quality Miocene sands, plus two other zones with a total of 30 net ft. The well was temporarily abandoned while the rig was moved off location for repairs.

Vastar later returned to the well, reentered it, and drilled it to 20,796 ft MD. In July, the company announced the discovery of two deeper oil-bearing zones. Total net pay for the well is now 290 ft.

"Having our first Vastar-operated deepwater well achieve such a promising multiple-pay discovery is very encouraging," said Davidson. "We now look forward to establishing production from King and to testing the other prospects in our deepwater inventory."

Vastar's partners on the King prospect are Shell 33.33% and BP Exploration & Oil Inc. 16.67%. Operator Vastar holds the remaining 50% interest.

The firms are finalizing development plans for King, but the project is expected to include one or more subsea tiebacks to Shell Deepwater Development Inc.'s nearby Mars platform, if capacity permits.

Davidson says he expects the initial King well to have production capacity of 5,000-15,000 b/d, adding that a few more development wells are warranted there.

Deepwater province

It is easy to see the draw of deep water for Vastar. To date, there have been more than 35 discoveries in the deepwater Gulf of Mexico containing a total of 4-5 billion boe. And the average size of those fields is 150 million boe.

Even more promising is that estimates indicate that there are 10-20 billion boe left to be discovered in the deepwater gulf.

The success rate for exploratory wells in the deepwater gulf is at least 30%, says Pierce. "(That's) not too bad a chance factor-a one-in-three shot of finding at least 50 million (boe)."

"The deep water has become a world-class geologic province for oil and gas production," she added. "It's a fairly stable political environment, and we've got pretty good economics."

Despite spending $40 million per exploratory well and waiting as long as 5 years for production to come on stream, Pierce says there's also "a technology leveling that's occurring in the Gulf of Mexico, and in the deep water, that's enabling more and more competitors to (enter)."

"The other thing that's helping in the deep water," she said, "is that there is an increasing infrastructure of pipelines and production facilities (and) increasing opportunity to share those resources. Some of theellipseearly entrants into the deep water are willing to offer space on their platforms for production, they're willing to share in prospects, and they're willing to partner.

"The deep water is increasingly becoming an environment where an independent can be successful," Pierce concluded.

Technological edge

The combination of industry results and geology in the deepwater gulf are very compelling reasons for a firm to try its luck there, says Pierce. "But here's where the independent's view of operating in the deep water begins to take a shape that's a little different from a major's."

A typical exploratory well in deep water costs about $40 million vs. as little as $100,000 that an independent might spend for an onshore well, says Pierce.

"We need to maintain that culture of cost-consciousness, even when we're spending significant dollars in the deep water. So when we decided to enter the deepwater play in late 1995, we were very determined that we were not going to let costs get out of control, and that we were not going to lose the cultural progress that we had already made at Vastar."

Vastar identified several issues that would be critical to its success in deep water. Foremost among them was technology.

"Cutting-edge seismic processing technology is imperative to successful exploration in the deep water, and in the overall Gulf of Mexico," said Pierce. "And we've gone toellipseconsiderable effort to ensure that we have the best set of tools available."

Vastar has dramatically increased the size of its offshore 3D seismic database over the last 4 years. The number of blocks on which it has data has grown from less than 600 in 1994 to more than 3,600 in 1997, almost 2,000 of which are in deep water.

That number has continued to increase rapidly. As of September, Vastar had accumulated more than 3,000 blocks of 3D seismic in the deep water.

"One of the keys to using 3D seismic is the ability to take spec 3D seismic data andellipseenhance that data with in-house processing," said Pierce.

"We're using 3D pre-stack time migration and a DHI (direct hydrocarbon indicator) toolkit to enhance the spec seismic by reprocessing. We have a tremendous amount of in-house capability to reprocess 3D seismic. We've been able toellipsetake that spec data and enhance its value using our own proprietary techniques."

Not only has Vastar's in-house processing grown substantially in the past 4 years, says Pierce, but the cost of performing that reprocessing has fallen dramatically. Processing costs were almost $75/block for Vastar in 1994, but have fallen to about $8/block this year.

Vastar's senior vice-president of exploration and land, Robert P. Strode, said that one technology key to Vastar's deepwater program is its proprietary post-stack wave shaping tool, called Enhanced Recursive Trace Integration. "It is very fast on our computing system," said Strode, "and we apply it to all offshore seismic data."

Pierce added, "We've also been able to put the geophysicist side by side with the data processor. By putting those people side by side at the workstation, what we're able to do is to secure subtle changes in the data. As the geophysicist looks at the data from an interpretation standpoint, the data processor can then tweak the processing algorithm as necessary to enhance the image.

"We think this is having a significant impact on our success."

High risks

Pierce stresses that, for an independent, the risk factors, or at least the exposure of capital, is fairly high in the deep water.

"What we saw very quickly was that we were going to have to partner up, to be able to mitigate some of that risk," she said.

Partnering has taken many forms for Vastar. One example involved the Mirage prospect, on Mississippi Canyon Block 941 in 3,862 ft of water.

Vastar paid $11 million for a 100% interest in the block in a 1994 lease sale.

"We thought this was a great opportunity," said Pierce. "Our original estimates said there were 200-600 million bbl of oil potential associated on this block. But we also knew that it was going to take at least two wells, to the tune of potentially $80 million, to get an appraisal of the block.

"We very quickly said that, for a company the size of Vastar, an $80 million exposure is not acceptable.

"We had the cash," she said. "What we were interested in was mitigating the risk."

Vastar did so by trading a 25% interest in this block, plus a shelf property, to Unocal Corp. unit Spirit Energy 76. In exchange, Vastar received several producing fields in the Oklahoma and Texas panhandle area.

"That partner had some production that they had decided was not strategic for them," said Pierce. "So we decided to do a trade, giving them an entry into the deepwater prospect (in exchange for some) production in the Midcontinent.

"We were able to lay off the risks associated with a 25% interest in the deep water, but we were also able to secure a near-term cash flow associated with the production in the Midcontinent. It was just a better vehicle for being able to monetize the assets that both of us had," said Pierce.

Pierce notes that deepwater exploration is not for the squeamish: "Risk-taking is an absolute requirement. This is a high-dollar, high-stakes type of opportunity."

She added, however, "We are continuing to look for partnering opportunities on the prospects that we have, and we'll continue to look for opportunities to lay off some of the risks."

Vastar's prospects

About 40 of Vastar's 50 deepwater prospects have gross potential of greater than 100 million boe, says Davidson. And about 20 have net potential in that range.

"As a 525 million boe company, you can see that this gives us exposure to big upside," he added.

Pierce explained why Vastar was drawn to the geology of the deepwater gulf.

"Of the four play types that we're seeing in the deep water (see figure, p. 28), the type that has produced most of the discoveries is the fan lobe trap against salt. Roughly 77% of the discoveries currently identified in the Gulf of Mexico are in that type of a geologic environment.

"The second type of geologic environment that appears to have the most potential is the subsalt," said Pierce. "We think that the subsalt in the deep water offers significantly more opportunities than on the shelf."

Vastar's depositional model indicates that, as delta sand deposits built up toward the continental shelf edge, they fell off the shelf and were deposited in deeper water. As the sand built up between salt bridges, it created additional weight and depressed the basin between the bridges, then ran out into even deeper water.

"This is what gives us a good indication that there's great sand in the deep water," said Pierce. "We haven't seen a level of success with the sands (on the shelf) that we've seen in the deeper water, and we think the reason is that the sands have actually run off of that shelf and into deeper water."

Strode agrees: "We think subsalt geology is better in deep water than on the shelf. More operators are drilling this play now, and we think discovery volumes will likely grow."

This theory is illustrated by Vastar's depositional model of the Mars basin, which contains its King discovery (see figure, p. 29).

"What we're hoping, in this evaluation of the depositional model, is that sand has accumulated down in our Mirage prospect," said Pierce. "Again, that is what gives us the confidence that we've got a high degree of sand quality in the Mirage prospect."

Mirage, the second well to be drilled with the Ocean Victory, is drilling ahead. Well results will likely be disclosed in first quarter 1999.

On Mirage, says Strode, there is "a possible structural closure against a massive salt body in several of the important sands."

"Well-developed traps and amplitudes exist," he said. "The salt is bulging out, creating the possibility of traps beneath the overhang, deep in the section.

"We plan to drill a directional well and a deeper sidetrack well to test the upper and lower sections. The well will drill to 25,000 ft and be a more expensive, longer well to drill (than King)."

A list of Vastar's key deepwater prospects is shown in the table on p. 30.

The majority of Vastar's deepwater prospects can be drilled with the Ocean Victory rig. In order to drill in waters deeper than 5,500 ft, Vastar is negotiating with R&B Falcon Corp. on a long-term contract for a newbuild semisubmersible drilling rig. Vastar expects the contract to take effect late in 2000.

Vastar's drilling program through 2000 is illustrated in the map on this page. "It's fairly extensive across most of the eastern Gulf of Mexico," said Pierce.


Vastar is a goal-oriented company that keeps its eye firmly trained on the future. Despite a high-risk exploration plan, its performance objectives include:
  • Doubling reserves every 5 years.
  • Achieving average annual production growth of 10% or more.
  • Being the low-cost producer wherever it operates.
In order to keep costs down, Vastar may sell a few properties early in 1999, says Davidson. These may include assets acquired in Vastar's recent transaction with Mobil. "The key is to recognize when assets are better off in someone else's hands," said Davidson.

Vastar considers the deepwater Gulf of Mexico paramount to achieving its financial and operating goals.

"We think the deep water is the place to be," Pierce said.

Vastar has added 36 deepwater blocks to its inventory so far this year. Most of these came in an August Gulf of Mexico lease sale, in which Vastar was high bidder, alone or with partners, on 32 lease blocks. Of these, 24 are in deep water. (The U.S. Minerals Management Service later rejected Vastar's bids on two of the deepwater blocks.)

Strode, said, "We are very pleased to win what we believe is a top-tier deepwater prospect. This is the Entrada prospect on Garden Banks Blocks 782, 826, and 826, in approximately 4,800 ft of water.

"We have a recent-vintage 3D seismic survey that shows excellent direct hydrocarbon indicators, and we consider Entrada a candidate for drilling as early as 1999."

In that sale, Vastar also won deepwater blocks in frontier portions of the Port Isabel and Keathley Canyon areas, for which 3D data are not yet available.

Budgets for 1999 have not been finalized yet, but a Vastar official said he expects base capital spending to remain about the same as for 1998. As in 1998, about 15% of that total will be spent in deep water.

Davidson doesn't expect low oil prices to change Vastar's capital spending plans radically. One reason is that the company's production is heavily weighted toward natural gas. Another is that a focus on deepwater exploration necessitates adopting a much longer-term outlook on oil and gas prices.

"This is a cyclical business," said Davidson. "We're going to keep our cost structure low enough that we can be competitive in these types of environments. Deep water offers the opportunity to discovery large volumes of oil at relatively low finding costs-certainly competitive on a world basis."

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