Davy Jones discovery may herald new wave of drilling on GoM shelf

Don Stowers,Editor – OGFJ

James R. Moffett, co-chairman of McMoRan Exploration Co., believes early indicators suggest that the company's first exploratory well in the Davy Jones prospect is so significant that it may "reshape thinking" about the whole subsurface geology of the Gulf of Mexico shelf. If Moffett is right, some industry observers believe this could spur a new wave of drilling on the shelf, provided natural gas prices make it economical to do so. This would be a boon to drilling contractors and oilfield service companies, as well as the operators, partners, and investors in the projects.

In January, New Orleans-based McMoRan announced what may be one of the largest discoveries in decades in the shallow waters of the shelf. The apparent Eocene-Paleocene discovery just off the central Louisiana coast could eventually produce 2.0 trillion cubic feet (tcf) or more natural gas, says McMoRan.

Estimates of the size of the discovery range from 2.0 tcf to 6.0 tcf, rivaling the largest gas finds ever made in the Gulf of Mexico, but the size of the resource potential is as yet unknown. Nevertheless, it suggests the same rock and sand layers that have yielded major oil and gas discoveries several hundred miles farther out in the Gulf may be equally rich in shallow water areas, where exploration and production is much less expensive.

McMoRan cautioned that flow tests and confirmation drilling are needed to identify the content of liquids, if any, in the hydrocarbons and the areal extent of the Wilcox sands, the geologic structure the company is drilling into, but it hailed the Davy Jones well as an important data point in overall Gulf Coast/Gulf of Mexico exploration, said Alan Petzet, chief editor – exploration for Oil & Gas Journal, in a Jan. 25 article.

The apparent pay in Wilcox below the salt weld is a "great signal" that operators might also encounter Cretaceous Tuscaloosa sands if they drill even deeper on the shelf, said Moffett. The Tuscaloosa is a prolific producing reservoir onshore. If present, the Tuscaloosa sands would be below the Davy Jones well's projected total depth of 29,000 feet. He noted that in the deepwater discoveries, sands are thicker in the Lower Wilcox than in the Upper Wilcox.

The quality of the Wilcox sands "assures us…that we're just a mirror image of what's going on out in the Shenandoah-Kaskida-Tiber Wilcox trend" in the deepwater gulf, Moffett added.

The ultra-deep well is located in 20 feet of water 10 miles south of Marsh Island, La. and has currently been drilled to about 28,530 feet. Initial wireline log results noted pay at Davy Jones at 135 net feet of hydrocarbon-bearing sands in four zones in Eocene-Paleocene Wilcox. Just days after the first announcement, McMoRan added an additional 65 feet of pay to bring the total to 200 feet and potentially adding 0.5 to 1.0 tcf to the find.

The newest log, which encountered the additional pay, was a 394-foot section of the Davy Jones well, drilled from 28,134 feet to 28,530 feet. The Rowan Mississippi jackup is drilling the well, and McMoRan has an option on its sister rig, Rowan Ralph Coffman.

Larger diameter holes will be needed at development wells to accommodate larger tubing to handle expected flow rates of 100 to 125 MMcfd and ultimate recovery of at least 100 bcf per well, says McMoRan. Formation tests of Wilcox at the discovery well are probably at least a year away.

A conventional platform will likely serve as a central production facility.

In a conference call held after the January announcement, Moffett said it would likely take drilling at least 10 more wells at a cost of $150 million to $175 million each to bring the field into production.

"We envision a very busy three years on the exploration side and the development side of Davy Jones, Blackbeard (a related project), and other discoveries we hope to make," said Moffett.

Speaking at a meeting of the Houston chapter of the Society of Independent Professional Earth Scientists (SIPES) on Feb. 18, Moffett noted that of the more than 48,000 wells drilled on the Gulf of Mexico shelf, only 6% were drilled below 15,000 feet and only seven wells have been drilled to 25,000 feet or below.

"Both the deep gas shelf plays and the ultra-deep shelf plays are vastly under-explored," said Moffett. "If development drilling confirms what we see on seismic, which is one big uniform structure that covers 20,000 acres…this is going to be a huge reserve and significant to the entire strike and dip sections in the shallow-water shelf."

McMoRan groups have 12 or 13 other drill-ready Wilcox prospects below the salt weld plus 15 to 20 prospects and several leads above the salt weld in what it calls the Flat Rock-JB Mountain-Blueberry Hill minibasin, which encompasses more than 200,000 acres roughly between the two wells.

The prospects aren't necessarily contiguous because geologic frameworks are different above and below the salt, says OGJ's Petzet.

The large ultradeep structures were interpreted on regional 2D seismic data, on pre-stack time migrated 3D seismic data, and on proprietary reprocessed pre-stack depth migrated 3D seismic data. Available deep well data were utilized to calibrate the geologic model for the section above the salt weld.

The ultradeep prospects are similar to deep, large sub-salt structural traps in the deepwater Gulf of Mexico with reservoirs of Middle Miocene and Lower Paleocene age at depths below 20,000 feet subsea. The Middle Miocene to Lower Paleocene sandstone reservoirs in both the deepwater and deep shelf were deposited in deepwater depositional environments, says McMoRan.

Preservation of porosity and permeability with depth of burial is a major risk factor for deep sandstone reservoirs in the shallow water areas of the Gulf of Mexico shelf.

In a recent issue of The Oil Drum, authors Arthur Berman and Joshua Rosenfeld said the news from the Davy Jones well "appears to open an important new gas play in the Gulf of Mexico. McMoRan's findings will undoubtedly encourage more deep drilling of Wilcox targets in this trend. Meanwhile, the next 1,000 feet in the Davy Jones well may yet reveal the highest quality reservoir sands that correlate with the basal Wilcox 'Whopper Sands' in the deepwater."

Tempering that enthusiasm, Berman and Rosenfeld also noted that the discovery is based on sketchy information from well logs and does not represent an actual flow test. The reason for the incomplete data, they point out, is the extreme depth and high pressure and temperature of the Wilcox reservoir in this well.

"Bottom-hole pressures may be as high as 25,000 pounds per square inch, by far the highest pressures known in Gulf of Mexico wells," they added. "Reservoir temperature is probably considerably more than 400 degrees Fahrenheit. Gas has never been produced at these temperatures and pressures, and may present engineering obstacles."

McMoRan operates the Davy Jones prospect and is funding 25.7% of the exploratory costs. It holds a 32.7% working interest and 25.9% net revenue interest in the project.

Other working interest owners include Plains Exploration & Production Co. (27.7% interest), Energy XXI Bermuda Ltd. (15.8%), Nippon Oil Exploration USA Ltd. (12%), W. A. "Tex" Moncrief Jr. (8.8%), and an unidentified private investor (3%).

Energy XXI is funding 14.1% of the exploratory costs to earn 12.6% net revenue interest in the prospect.

According to Madison Williams Equity Research, stock prices of McMoRan, Energy XXI, and Plains Exploration & Production have gone up 51%, 38%, and 1%, respectively, since the Davy Jones announcement on Jan. 11.

Based on the current 200 feet of net pay, Dahlman Rose estimates the Davy Jones discovery at 3.0 tcf (gross) and worth roughly $10.00/share to MMR (risked). Analysts with the firm say that after an expected production flow test in the second quarter, Davy Jones' value "could rise significantly with derisking."

The positive results could continue as McMoRan continues to drill to its target depth of 29,000 feet.

"New wireline log results, especially from the Tuscaloosa section, which have never been drilled into on the shelf, could provide additional upside catalyst to the equity," reported Dahlman Rose.

Until additional data needed to further de-risk the discovery is known (pressure data, production data, reserve data, additional wellbores), the value to each company at this point is largely an option value based on each company's net revenue interest and outstanding share count.

"From a structural standpoint, the 135 feet of net high-quality play, if homogeneous across the simple four-way closure, could suggest 7,000 acres of closure updip to lowest known hydrocarbons," said Madison Williams. "Volumetrics could suggest up to 1.6 tcf."

Fully developed, a 1.6 tcfe gross reserve should produce roughly 500 gross MMcfed, which could double [Energy XXI's] production and increase its net reserves by 50%, according to the research company.

Dahlman Rose pointed out that since Davy Jones is still undergoing exploration, there could be another 14,000 acres downdip if the reservoir were filled to spillpoint on the 20,000-acre plus structure. Such a scenario would bring the reserves up to 6.0 tcfe.

During an earnings call with analysts on Jan. 21, John D. Schiller, chairman and CEO of Energy XXI, commented on the Davy Jones discovery: "I can assure you we believe there is more good news to come associated with this project."

Energy XXI has a stake in 12 prospects in the area, and the apparent success on the first one bodes well for the other 11.

Schiller told the analysts: "We've come a long way, but that's been off a very depressed base. In our minds, and this is strongly supported by our analyst coverage, the current stock price [about $19.37 in late February] hasn't even reached a net asset value of our proved reserves, let alone the upside of our expanded property portfolio. So Davy Jones, the Blackbeard discovery, and the rest of our ultra-deep exploration program was essentially free."

He added that Energy XXI saw no scenario in which they would need to sell equities to fund Davy Jones development or to sell down any of the company's interests in the ultra-deep play to be able to stay in the game.

"The only point we are trying to make is that the economics is superb even in a conservative case and that we would not expect to ever be out of pocket by a tremendous amount of capital," said Schiller. "We also [plan] to remain active exploring the ultra-deep. Altogether, we expect our share in the ultra-deep program to be in the $50 million to $75 million range annually – that is, for Davy Jones development plus one additional rig drill and exploration prospects, full time."

According to Eric J. Fox, founder of Brittain Capital Management LLC, which manages the Alesia Fund LP, one risk for investors in Energy XXI and the other partners in the project is the physical location of these assets, which exposes them to the risk of interruption of production during hurricane season, which runs April through November. For Energy XXI in particular, says Fox, "This risk is exacerbated by the concentration of the company's assets in certain fields in the Gulf of Mexico. After the Mitsui acquisition, 37% of the company's production will be from the Main Pass 61 and 62 fields."

Fox added that, if some of the company's production were curtailed, the company might have difficulty serving its debt, which he estimated at $858 million. Despite this risk, however, Fox considers Energy XXI (EXXI on both the NASDAQ and London Stock Exchanges) a "stock to watch."

Dahlman Rose launched coverage of Energy XXI following its recent success in the ultradeep trend. In its first rating of the company, the research company noted, "While the corporate strategy differs [from McMoRan], Energy XXI has similar large upside catalysts." However, Dahlman rose continued, Energy XXI's core Gulf of Mexico assets are "much oilier, have higher working interests, and it intends to use free cash flow to be a consolidator on the shelf. If it continues to find accretive acquisition, maintains its base decline, and spends 25% to 50% of its cash flow on ultradeep exploration and development, we think EXXI will grow production per share at a reasonable, sub-10% pace."

As for McMoRan, it is one of the largest acreage holders on the shelf and onshore in the Gulf Coast area with rights to about one million gross acres, including 150,000 gross acres associated with the ultra-deep gas play below the salt weld. Prospects on this acreage have "multi-tcfe gross unrisked potentials" and target objective sections on the shelf in the Miocene and older age sections that have been correlated to those productive sections seen in deepwater discoveries by other industry participants, according to the company.

"Success at Davy Jones could be a transformative event for [the companies]," said Jefferies Research, in a note to investors. Jefferies noted that the discovery could boost McMoRan's year-end proved reserve base by 150% and Energy XXI's by 60%.

Toby Shute of The Motley Fool, which analyzes a variety of stock investments in the energy industry, noted on Jan. 11 that "McMoRan has come up an apparent winner [with its ultra-deep prospects]."

"Here's the trade-off," said Shute. "McMoRan saves a lot of money on its drilling rig by using a jackup instead of a half-million-dollar-a-day drillship. On the other hand, the company has to drill through several thousand feet more rock than its deepwater counterparts, which invites mechanical issues. Attempts at resolving these matters can get very expensive, or even worse, fail entirely."

The Motley Fool said the Davy Jones discovery was also good news for Rowan Companies, whose jackup did the drilling. "You don't have to buy the explorers to bank on a revival in shelf exploration. Rowan is the 'picks and shovels' play."

To date, the Davy Jones well has cost nearly $200 million. Development drilling will add another $1.5 billion to $2.0 billion to the cost. Production facilities will add even more to the eventual cost.

Provided future results measure up to expectations, the Davy Jones prospect may be the most important Gulf of Mexico shelf discovery in decades. It comes at a time when few companies operating in North America are pursuing objectives in natural gas plays with the exception of shale. For the participants in this exciting new discovery, the risks are present, but so are the opportunities.

More Oil & Gas Financial Journal Current Issue Articles
More Oil & Gas Financial Journal Archives Issue Articles
View Oil and Gas Articles on PennEnergy.com