Drilling for Unconventional Gains

"Investors like long-lived assets because production is more predictable and sustainable," he says. A conventional natural gas well in the Gulf of Mexico, for example, can consist of 20 billion cubic feet, most of which would be extracted within a couple of years, and thereafter production would decline in a steep curve. On average, the big natural gas drillers have allowed their production to decline by about 25% over the last five years after the initial exploration phase was over.

A longer reserves life means that the decline rate is slower, about a 10% decline over a very long period of time. And because natural gas represents 30% of total U.S. energy consumption, the demand for their production is voracious.

Anderson of Palo Alto Investors also likes Toreador Resources(TRGL) because it applies its exploration technologies to under-explored, yet gas-hungry markets such as Romania, France and Turkey. He also recommends ATP Oil & Gas(ATPG), which operates in the declining gas fields of the North Sea.

Other investors, however, are more skeptical about the unconventional players. "Don't get me wrong, I think there is a great future in unconventional gas," says Bernie Feshbach, who owns an investment firm specializing in the energy sector. "But most of these stocks are pushed out of shape, this whole sector is overpriced," he said.

Unconventional Biz, Exceptional Gains Smaller resource plays are a good alternative to the household energy names.

Indeed, these stocks may not have the name recognition as Exxon Mobil (XOM), but they have enjoyed some huge price appreciation in the past year. Southwest Energy(SWN), for example, is up some 200% in the past year.

Still, no drilling (or investment) is foolproof. Infinity(IFNY), for example, drilled four wells in the Barnett Shale area in Texas that had massive amounts of formation water that made them "uneconomic." The company's management said that it was part of the learning curve of understanding the area's geology, and that future drilling will be more efficient now that some of its problems were studied. That was a steep learning curve for Infinity shareholders, who saw their shares plunge 15% on June 23 in reaction to the news.

The bottom line in unconventional exploration, however, is the commodity price. As long as natural gas prices remain in excess of $6 per thousand cubic feet, some even say above $5, these companies will remain very profitable.

Accordingly, most investors believe that a decline below $5 will most certainly have a detrimental effect on the unconventional resource players.

"The big risk in this play is the price risk," says Feshbach.

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