Every year the stock market gives me new lessons to learn, and I’ll share a few from 2010.

When it comes to the junior and intermediate North American oil and gas plays, I want to buy expensive stocks.  I rarely buy cheap stocks.  That sounds counter-intuitive, but it makes sense.

When a company trades at a high valuation it can raise money with less dilution, and can use its stock as currency to take over other companies.  They can grow more quickly and more efficiently than companies with low valuations.

It’s my experience these companies get more growth priced in faster.  It’s a circle of prosperity where these companies use their stock or stock price to raise money to buy the better properties.  And the brokerage firms that raise them that money (and get all the fees and commissions!) support them by issuing research with higher and higher target prices.

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This Technological Revolution Has Earned Me

Short-term Oil & Gas Profits On More Than 3 Dozen Trades

New technologies – at this very moment – are revolutionizing the oil and gas exploration industries.

But only a handful of people truly understand how the technology works.

This remarkable scenario creates an enormous, short-term profit opportunity each time a company employs these new technologies successfully.

I’d like to show you exactly how this scenario is unfolding…and how you can pounce on the next triple-digit oil & gas blockbuster.

Click here to read my full report that explains how to get started.

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It was difficult for me to buy BlackPearl Resources (PXX-TSX) at $2.96 this year – I looked at the production rate, the reserve base, the growth that IMHO was a little too far down the road…it was just too expensive.  I loved their heavy oil space, but at first I didn’t think that was the right stock.  But the market told me I was wrong; I was missing something and I had to put aside my own interpretation on the same facts everybody else knew, and buy it.  It hit $7 and I still own (most of) it. ;0)

Of course there are turnaround stories, but they are few.  And the ones that meet expectations, in my experience, are even fewer.   This last year Bellatrix (BXE-TSX) was one – a heavily gas weighted producer laden with debt that brought in new management, developed their Cardium oil play… and the stock turned around.

My experience is that once the analysts and funds have pegged a stock on its valuation, it takes a big success by management to change the street’s mind.

I learned how trade “recaps”.  A new trend on the Toronto Stock Exchange (in the last 2 years) is the “recap.”  This is where a debt-laden junior with few prospects getsrecapitalized with new money directly from the wallets of a new management team (and their friends and underwriters).  As such, any debt is reduced or wiped out – and the new team has a big, cheap share position.  Often a new suite of properties is vended in at the same time or shortly thereafter.

These stocks are often tightly controlled and can quickly get and keep a big valuation, based solely on management’s reputation (think Legacy (LEG-TSX) or Wild Stream (WSX-TSX).  The team gets such a quick premium into the stock that it takes months to “backfill” the value into a stock chart – see these recap charts:

Many, but not all oil-weighted recaps had charts like these.  So I learned that if you still own a recap 2-3 weeks after the press release announcing the new team, you will likely have a losing investment for awhile. One exception is Scott Ratushny’s Midway Energy (MEL-TSX) – one of the first juniors to get into the Cardium play in late 2009.  It was a great success, as was Brett Herman’s Result Energy, which was taken out by Petrobakken after only being listed for three months.  That symbol was RTE-TSXv.

The natural gas-weighted recaps, as you would expect, did much worse than the oil weighted ones.  Companies like Cequence Energy (CQE-TSX) never regained the share price they achieved in the enthusiasm of their initial days. (Though I am quite excited about their new Montney drilling…)

I also learned that when I know I have invested in a a market leader with lots of room to run – which usually means they have a large land package in productive oil and gas area – I need to have more patience.  (But I do like to sell stock…)

With Painted Pony (PPY.A-TSX) I knew that their properties – both the Bakken oil lands and the Montney gas plays – had great addresses.  There was no question the oil and gas was there.  It was a question of whether or not I could wait long enough with my investment for management to develop its lands – because I was sure tempted to sell the stock in the summer when it was correcting and volume in the stock was low.

I was smart with Painted Pony – I did hold on and am now enjoying a tripling of my money.  But I was dumb with Wild Stream, (WSX-TSX), another OGIB stock pick this year.   Again, I knew Neil Roszell and his team to be very capable, and their four resource plays to be a relative no-brainer.  But it was a small position for me, and I succumbed to impatience and sold the stock in the summer.  While that was a profitable trade, it has since gone MUCH higher, just as I knew it would.

There are very few trades that I KNOW are going to work, and when I find one, I should be betting the farm and buying much larger than normal positions and be willing to accept a smaller return. (I’m talking% 50%-75% + vs. 200% or 400% that I get with some of the penny stocks.)

When it comes to exploration stocks – especially the international ones – I want to invest early in plays that have a BIG prize – one that creates what analysts call an “unrisked NAV” that is a multiple of its current stock price.  This unrisked Net Asset Value is a bit of a pie-in-the-sky number they come up with by saying – IF this company hits on ALL of their drill holes they will create a resource worth THIS much.  It’s a fantasyland valuation.

After I bought TAG Oil at $2.35, an analyst came out a couple months later and suggested it could have an unrisked NAV of $225.00 per share – a hundred fold increase.  Because international exploration involves more political risk, you want a big prize to outweigh that risk.

I know 2010 was a good year when my learning didn’t cost me anything.  Despite all my lessons, the OGIB subscriber portfolio – which is my real money – managed to eke out a 74.5% gain for the year.

– Keith

Toreador Resource’s Investment in the Paris Basin… and How Its Estimated 96 Billion Barrels of Oil was Discovered

It all started with a note.

It was a handwritten note on the margins of a long-forgotten report, in French, from a well site geologist many years ago who was on a rig drilling into the Paris Basin for conventional oil.

“That was our first clue,”says Craig McKenzie, President & CEO of Toreador Resources (TRGL-NASD). “The geologists were writing about uncontrollable oil flows from the Liassic shale and eruptions due to over-pressurization.”

“Rock was erupting into the well bore because the over-pressured oil was pushing everything out of its way. When you see this being repeated over linear distances of 50 miles or more, you get excited that this is not a one-off, but this is basin wide.”

That was the Eureka! moment for McKenzie and his team that the Liassic shale in the Paris Basin had the potential to be something very special.

It’s big.  It’s simple.  It’s over-pressured, which generally means bigger flow rates.  It’s been known since the 1950s.

The Paris Basin is the perfect example of the biggest Mega-Trend I see happening in oil and gas for the next 20-30 years: the export of shale technology around the globe, which should create dozens of discoveries for the industry, and many 5-10 baggers for investors who are able to ride this wave.

And the good news for investors is – so far – that many of these plays are being discovered by junior E&Ps (exploration and producers).

That can also mean a rocky ride for investors; juniors are by definition more risky and volatile.  Toreador’s story is no exception.

Back in 2007-08, the company had a suite of European assets, including some production in France, but the company had nearly $110 million in debt with a $40 million market cap.  Then the Crash of ’08 hit, and some tough decisions needed to be made.

One of those decisions was management.  Shareholders asked McKenzie, who was previously President for British Gas Trinidad & Tobago and later CEO of Canadian Superior, to step in as CEO of Toreador in January 2009.

“We treated everything in the company with extreme urgency,” recalls McKenzie. “2009 was a no pain no gain year – we sold prized assets of the company in Hungary and Turkey, and were very aggressive in buying down the debt and disciplined in our spending.  We focused the company to one set of assets in France, and wanted to make the base business sustainable.”

“The one investment we did make was in the Paris Basin.”  The Paris Basin is an area of roughly 100 by 150km east, south-east of Paris where Toreador already produces 900 barrels per day of oil  (from conventional reservoirs).

It was a good choice.  But it took some original thinking.

“The big majors had been drilling here in the late 1980s, with as many as 18 rigs, and they all  had a common view of the source rock.  But the thinking was that oil had migrated (up from the source rock shale) to conventional traps.  These major oil companies exited because there were just small discoveries.

“We think the reason they didn’t find any large conventional plays is that the oil is still in the source rock. There are no obvious signs of long distance (oil) migration or seepage at the surface,.  And through historical analysis we know it’s still over-pressured,” says McKenzie. (Unlike water, oil migrates up.)

So the new board of directors reasoned they needed to focus on understanding the Paris Basin better, and management started to acquire as much data as they could.

“We went searching for old cores in core boxes all across France in warehouses, searching shelves, and plugging them.” This would be the same as splitting core in mining.  Some of the core they were able to secure was just the size of a thimble of thread.

“We started getting back silica and high limestone content from our analyses of the cores.  The silica meant brittle shale, which means a favourable response to fracking.  Also, the limestone is important for shale oil in contrast to shale gas.  We’re happy to have silica, but gas molecules are small and go through rock much easier. Oil molecules are bigger and polarized – limestone is good for that.”

I asked McKenzie if his peers or the locals thought they were crazy.

“We weren’t crazy, we were different – in the beginning people didn’t pay us much attention, and then by the end of lastyear, people started asking questions. Now people are really beginning to appreciate what we’ve been doing for the last 20 months.”

So the team set to work analyzing an ever increasing amount of raw, unconnected data.

“Over 200 wells have penetrated shales in the Paris Basin,” McKenzie says.  “Of the 200 plus, we focused on the 60 in the deepest part of the basin.  It’s also the most mature rock, the most cooked of the organic matter.  In industry terms, it’s in the oil window.”

He gives me a quick layman geology lesson:

“Think of all that organic matter, settling for millenia, and it all sagged under its own weight.  So in the centre it’s the deepest.  It looks like a series of stacked plates now.  There is a window of 440-470 degrees Celsius in which oil cooks perfectly, and that’s what’s happened here.  With all the well penetrations you can start mapping out the depths, and at some point it (the Liassic shale formation) comes out of the ground, 50-100 miles away, but it (the oil) hasn’t cooked.”

The Bakken play in North America also has stacked plates – which are layered geological formations – and three are producing formations.  At this early stage in the Paris Basin, it also looks like the Paris Basin would most likely have three producing formations.

The data that McKenzie’s team rounded up came from the late 1950s to the early 1990s.  Because everyone was drilling through the Liassic shales to reach deeper targets, Toreador was just after incidental information from the drillers and the mud loggers.  And it all started to make sense after reading a series of hand written notes in French from geologists made 20-60 years ago.

“Last year we were sure we had something. We started talking to people in the Williston Basin (the Bakken play in North Dakota).  We were sure that the rock in the Paris Basin was analogous to that in the Bakken/Williston Basin.”

Fracking’s Game Changer

The debate continues over fracking, or hydraulic fracturing…

Environmental concerns, disclosures, regulations… just for starters.

Well, once you’ve read my new report, you’ll understand this debate better than 99% of the journalists who cover the topic.

And you could make a fortune in the process.

You see, one company has developed a patented fracking process that eliminates all environmental concerns over oil & gas fracking. And it does this while it increases production of the oil or gas.

I’ve been tracking this company closely for over a year. In fact I’m hard at work finishing my newest report, which I’ll be sending over to you shortly — exclusive to OGIB readers.

“We retained RBC Capital Markets (its sister firm Dominion Securities is Canada’s largest securities firm) to undertake a review of strategic alternatives. We opened a formal bid round for partnering, and engaged 40 companies.  All of them did their own technical audits of the play, and not one of them walked away because of holes in our logic.  They all agreed with our conclusions.”

“We received a number of bids, and chose not to go with a Super Major, private equity, or North American independents (producer).  We chose Hess (HES-NYSE) as it had the right scale, the right Bakken know how, and they’re reportedly spending $5 billion in Williston Basin over next 5 years, so they’re aggressive.”

“And we liked the way our teams worked together.  They replicated all our work going down to the warehouses themselves and doing their own testing.  With their experience and value in the market, they know how to do business internationally.  They set up office around the corner here from us in Paris.”

Toreador’s deal with Hess can be as much as $265 million to earn 50% of Toreador’s acreage.  So they obviously think the play has great technical merit.  While many investors are looking at this play’s success as a given after so much due diligence – Toreador’s stock trades at 6-7x its Net Asset Value (NAV), vs. a multiple of one or less for most oil and gas producers – McKenzie isn’t counting his chickens just yet.

“There is still risk.  After all this analysis, I can tell you lots of different technical things about the play – but I can’t tell you that there is one single long term completion, because there isn’t.”

Scott Hanold, Managing Director of Energy Research for RBC Capital Markets, agrees:

“While there is still substantial opportunity, we still have to prove this play works economically, which is a big hurdle.  Based on the current stock price, investors are already valuing $11 for this shale play as the conventional producing assets are worth about  $4.  If the shale is not productive and Hess walks away where does this stock go? Probably close to that $4-$5 level.

“However, with success, we could see TRGL shares double or more. Recent land deals in the Bakken – a similar play – were done at around $10,000/acre compared to a few hundred an acre just a couple years ago. That clearly shows how quickly exploration success and technology can create value. The key here is to get the first wells down and find out exactly what they have”

McKenzie says their first well will is expected to spud in January, and it will be continuous drilling until a first phase – which commits Hess to spending at least $50 million – is finished.  He expects the first two wells to be vertical, but there is no decision on wells 3-6 yet.

“We’ve effectively picked the locations, but not how to drill them yet,” he says.  “When do we go horizontal and frack?  Right now we think well number three, but if we hit what we want on first two we could do it there.”

“It depends on logging, coring, and how fast we do the analysis.  We don’t know the orientation of the natural fracking, and how much it’s naturally fracked, and that will determine how we have to set up the frack design.  Note also that the vertical wells will have the flexibility to be re-entered and continued horizontally.  We’ll have maximum optionality.”

McKenzie adds Toreador and Hess will be looking for variability spatially (how patchy or consistent is the formation), but doesn’t expect much so they could do horizontals very quickly.  He voiced his opinion that, if all goes according to plan, the market could see the first IP rates (Initial Production) in late Q1 2011.

Vermilion Energy (VET.UN-TSX) also has a land position in the Paris Basin.  According to its recent quarterly results, it continues to successfully produce oil from two old vertical wells that it re-entered and fracked in the shale – which contributes to Toreador’s sky-high valuation – but Vermilion has thus far not announced any oil flow rates.

Even if the play does work geologically, RBC’s Hanold says there could be other challenges in the Paris Basin, like the lack of energy services (drillers, frackers) and the fact that the landowners do not own the mineral rights.

“There is not as big of an incentive for landowners in France as the government owns the royalty rights,” he says, “Whereas in North America you can quickly become rich if a company drills a big successful well on your land.”

So what kind of well profile does McKenzie expect to see – what would be his best guess on IP rate and economics?

“We’re using 400 bopd (barrels of oil per day) for a 30 day IP with a 50% decline first year,” McKenzie says, adding that the Banc de Roc formation in the Paris Basin looks to be very similar to the middle Bakken at Elm Coulee in eastern Montana.

“That’s more pessimistic than what’s happening in Elm Coulee.  Continental (CLR-NYSE), Brigham (BEXP-NASD),with that type curve, are looking at EURs (Estimated Ultimate Recovery) of 500,000 barrels, on a well that costs $7 million, giving $14-$15 per barrel F&D (Finding and Development), and 12 million barrels of resource per section (one square mile = one section).”

“We think it (the amount of Original Oil in Place, or OOIP, in the Paris Basin) can go higher but we’re basing at 12 million per section.”

He anticipates that fracking will take a “typical Bakken approach”, and be done by a multi-stage frack over a 5,000 feet lateral distance.

“We don’t know exactly what kind of technique or how many fracks; we’re just starting to science that, but we are working on getting the data to figure it out.”

The Paris Basin has gone from obscurity to front page news in the global oil patch in just over a year. As a result, there has been a staking rush, and getting land now is very competitive.  Toreador has up to 1.6 million acres awarded and pending, and McKenzie says there is a lot of competition for smaller land blocks closer to the edges of the play.

(Toreador’s ground is the pale yellow colour)

“We’re still seeing small players chasing us, but a lot of the US independents have too much on their plates to worry about France.  The larger independents don’t see the acreage size to jump into the game now into a new country.  In this phase, the Paris Basin is still frontier, despite its enormous potential.

“A lot of the bigger players are sitting on the sidelines to see how this works out, but that will change with positive results.  Then we’ll see larger companies be happy with smaller land positions – but the shale gas plays of eastern Europe are there as well and they have larger parcels available.”

That change McKenzie is talking about could happen at the end of March 2011.  With estimates as high as 96 billion barrels of oil resource generated for the Paris Basin, it’s a big play the world will be watching.

And it all started with a little note.

Keith Schaefer owns Toreador Resources.

by +Keith Schaefer

The top growth sector for investors in 2011

Hydraulic fracturing, or “fracing” companies are overtaking drilling companies as the largest subset of the energy services sector – and research from two Canadian brokerage firms suggests that investors can expect fracking companies to continue growing strong into 2011 and beyond.

All the data points to fracing stocks being the #1 place for investors to be, in the energy patch, in 2011.  I think it’s the easiest (safest) money in the oilpatch for the next 12 months at least.

(Fracing is when you send water and sand down a well at ultra-high pressure, and it blows out into the surrounding rock formation, fracturing the rock into many small pieces and creating pathways for the oil and gas in the rock to get to the well.)

Trican Well Service (TCW-TSX; TOLWF-OTCBB) is the largest fracing company in Canada, and it had revenues for the first nine months greater than $1 billion – up from $541 million in 2009.*

Precision Drilling (PD-TSX; PDS-NYSE) is Canada’s largest drilling company, and it had nine month revenue of $994 million, but squeaked past Trican for highest Q3 profits – $61.8 million vs. $53.74 million*.

Drilling companies have been the biggest single subset of the energy services sector FOREVER.   But the onset of horizontal drilling and multi-stage fracing has changed that.  And even though the “new” fracing industry is now 5-6 years old (from the time when the size of frac jobs went sky high – from a few tonnes per well to more than a couple hundred tonnes) it is still struggling to keep up with soaring industry demand.

This is good news for investors in fracing stocks. The industry is being p-u-l-l-e-d into the limelight.

There are some obvious reasons for this trend, such as the huge increase in the number of horizontal wells over the last five years as the Global Shale Revolution intensifies – an increasing number of horizontal wells is using an increasing number of fracs per well.  See this chart from securities firm Raymond James Weekly Energy Bulletin:

This chart shows that almost ALL the growth in drilling over the last year has been for horizontal wells, as the Global Shale Revolution intensifies.  I expect the Global Shale Revolution to last 20 year – which bakes success into the cake right now for a lot of fracing companies.

Fracking’s “Holy Grail”

It’s a breakthrough technology that not only solves two of the oil & gas industry’s biggest problems…

…But also stands to make everyone involved a lot of money… including you!

It’s all in my new video. Click here to watch it.

But it gets better.  Fracing is taking up more and more of the budget for these wells.  First Energy, an oil and gas boutique brokerage firm out of Calgary, wrote in a December 13 report on energy services that “fracturing costs have come up the most among all services”, and that cost inflation in the oilpatch will benefit the fracing companies the most:

“Like in 2010, we believe the majority of economic rent will go toward the completions business. As a result, we see fracturing companies grabbing a higher percentage of the pie.” (Italics mine-KS)

Canada’s #2 brokerage firm, BMO Nesbitt Burns, outlined six reasons in a recent report why the fracking sector will remain strong for investors:

“1) Current Shortages: …a backlog of roughly 3,000 wells in the U.S. alone that have been drilled but not completed… more horsepower is required simply to meet current demand.

2) Continued Increases in Frac Intensity: …horizontal laterals getting longer and the number of frac stages in many plays continuing to increase

3) Longer Lead Times:…new equipment ordered over the next couple of months as part of 2011 programs will likely not be delivered as quickly as most people think…lead time is nine months to a year for new frac crews… most of the 2011 equipment capacity will not be deployed until around Q4/11

4)  Higher Attrition Rates:  With the proliferation of unconventional resource plays, fracs have increased not only in size but in pumping rates as well…some regions have gone to 24-hour operations…. that useful lives of many key components of a frac spread have been reduced by as much as 50%.

5)  More redundancies: In an effort to combat the higher repairs and maintenance costs many pumpers have added more horsepower on location than is actually needed to complete the job. Essentially, this allows the wear-and-tear to be spread over more equipment…it requires more equipment to be deployed, thereby helping to absorb more capacity.

6)  Equipment Aging:  a larger than normal chunk of the equipment in the pumping industry will be ready for replacement over the 2011–2013 time period, which should help delay the effects of the large amount of horsepower currently under construction.”

BMO Nesbitt Burns added that there was concern amongst their buy-side clients (the mutual/pension funds) that there would be too much capacity built in 2011, too much new horsepower (fracing companies are often ranked in size by their horsepower), but they did not consider that a concern in 2011.

Another final note for investors to understand is that the technology in this sector is still evolving, and it’s not just more/better technology. Some of it is out of the box innovative technology that is leapfrogging industry expectations in terms of production and cash flow fracking can produce.

I’ve made one of these innovative companies the #1 pick for 2011 in my portfolio.  It had a stellar 2010, up 80%, but I think this game-changing company will be one of my personal profit centres for years to come.

*sourced from The Daily Oil Bulletin

Publisher’s Note:  Many of my readers have emailed me to ask what my # 1 energy trade is.  That’s an easy one to answer at the moment.  It’s a little-known Canadian company with an extraordinary new technology… one that will shape the oil & gas hydraulic fracturing (fracking) market for decades to come. This company’s proprietary process is proven to increase production in wells by 40% or more — while it literally “pays for itself.”  I’ve put together a video that details this trade in full. Watch it by following this link.

Want to learn more about investing in junior oil and natural gas stocks? If you have a Facebook account, just “like” this article and a hidden link to Keith’s 10 page how-to on oil and gas investing will appear:

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by +Keith Schaefer