Europeans might have been perplexed by the recent U.S. government shutdown, but they have deepening understanding—and curiosity—about the booming U.S. shale plays. In a mid-October report, David Tameron, Wells Fargo Securities senior analyst, and colleagues discussed questions posed by European institutional investors during a recent trip to the continent. Overall, sentiment was cautious regarding U.S. E&Ps, while “constructive long term.”

Gains posted by E&Ps this year have contributed to European investors' caution, as they weigh taking profits “and/or waiting for a pullback,” the report says. Still, they remain interested in opportunities offered by U.S. shale players and the potential inherent in the move into a manufacturing phase in the shales.

“We believe the shales provide a repeatability and manufacturing model not found elsewhere in the energy investment world,” the analysts say. “Less new entrants forget, the repeatability and 98% drilling success rates are terms that have only been used with E&P companies for the past five to seven years.” They note that European investors' understanding of the U.S. E&P space has deepened significantly over the past several years—and even since last year.

European energy stocks and the majors have underperformed relative to U.S. independents. “Compare that to our universe of E&Ps, where 20 out of 40 names are up 40% or more year to date compared to the SPX's roughly 25.5% return,” the analysts says—the downside is that the move has made European investors guarded.

As for the manufacturing phase theme, European investors are listening. “This [phase] should result in resource optimization, continued improvement in drilling efficiencies, improved capital efficiencies, etc. And perhaps even a few years down the road, an increased number of E&Ps which could grow at 15% to 20% and still generate free cash flow,” according to the report.

European investors were unsure of liquefied natural gas facility permit status in the U.S., but indicated they thought it would be four to five years before exports could “meaningfully impact the natural gas markets.”

Finally, the Wells Fargo analysts fielded questions about consolidation in the U.S. shale plays. European investors wondered why the majors had not yet consolidated bigger plays like the Bakken, the Eagle Ford, and the Marcellus.

The Wells Fargo analysts say the “return on capital employed” factor is the most credible argument for why the majors haven't yet swooped down on the shale plays. “…majors can perhaps look longer term at five-year projects that have a better return than most E&P plays, especially if they are using a $65 to $70 per barrel crude deck longer term.

“Wait and see, but most seemed biased that we will see small and mid-cap consolidation from the mid- and large independents before we would see the largest six to seven independents get taken over.”

—Susan Klann

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