The Alberta Bakken: Stealth Oil Play of the Year?

By
Keith Schaefer
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0

One of the Largest North American Oil Discoveries in Decades

What has the oil and gas industry so excited about the Alberta Bakken – the stealth play of the year?

Some big companies on both sides of the 49th parallel have spent millions buying thousands of acres of land – with almost no well data.  This flurry of activity says the industry is convinced the Alberta Bakken could be North America’s next big play.

“I think what has the industry excited is the potential and similarities between the Alberta Bakken and the Williston Basin (in North Dakota),” says Mike Marrandino, President of Primary Petroleum, which has 235 net sections in the Alberta Bakken in Montana.

“The (Alberta Bakken) reservoir size is over such a large land area, the potential is huge – if it does prove up.”

The original Bakken covers parts of North Dakota, eastern Montana and southern Saskatchewan, and estimates of how much oil it could hold (OOIP-Original Oil in Place) range from 5 billion to 167 billion barrels of oil, making it one of the largest discoveries in North America in decades.   And the industry is always figuring out ways to increase recoveries; i.e get a greater percentage of that oil out of the ground.

It is the largest onshore discovery in North America in decades, and is really the only shale oil play on earth with a production history.  In many of the new shale plays emerging around the globe, the management teams are saying – “This is a Bakken look alike!”

But are they?  How does the Alberta Bakken stand up?

Analysts agree the source rocks from the two plays were built up at the same geological time, but that eastern Bakken, in North Dakota/Saskatchewan, was the inside of a giant crater.  The western one was a big west facing beach.

Canadian brokerage firm BMO Nesbitt Burns wrote a report on the two Bakkens in October, and it said the Alberta Bakken meets the criteria for a big Bakken like discovery (my translation in brackets after each point):

i) pervasive petroleum saturation;  (lots of oil all over the place)

ii) abnormal pressure (high);  (high pressure=big wells)

iii) a lack of downdip water;  (no water below the oil)

iv) updip water saturation;  (lots of water above the oil)

v) low-permeability and low-matrix porosity reservoirs ;  (it’s typical tight rock)

vi) deliverability is enhanced by fracturing; and  (natural cracks in the rock make it easier for oil to get to the well)

vii) plays that are self-sourcing within a mature source rock fairway.  (there is lots of oil in an area surrounded by a bigger area where we have already found a lot of oil)

BMO concluded that the Alberta Bakken met its criteria on all counts.

Macquarie Capital, a large, world-wide resource investment bank and brokerage firm, compared them this way:

“Geological properties….To the west in southern Alberta and BC, the lower Bakken members actually correlate with the Exshaw formation, while the upper Bakken member is similar to the basal black shale unit of the Banff formation….”

TRANSLATION – the lower Bakken formation in North Dakota and Saskatchewan is called the Exshaw in western Montana and southern Alberta, but it’s basically the same thing.  And the upper Bakken is called the Banff formation in Montana/Alberta.

“….The Exshaw/Bakken is an organic-rich, marine, source rock that occurs in the lower part of the Mississippian-Devonian system.”

TRANSLATION – there is oil in the rock at the bottom

“….The formation as a whole represents a petroleum system that can be tracked from source to trap.”

TRANSLATION – you can see where the oil was formed, and you can also see how the oil has moved up until it hits the top of a cone in an impermeable rock and stops—trapped there.

“….The Exshaw, Bakken (lower and upper members), and Lodgepole formations consist of organic-rich, black, basinal  laminites with average TOC’s up to 12% in the lower Bakken, 40% in the upper Bakken, 5% in the Lodgepole, and over 20% in the Exshaw. Each formation consists of Type II organic matter (characteristic of most marine oil source rocks)…

TRANSLATION – the Total Organic Content (TOC) of the rock (this means enough little bugs died in one place millions of years ago) is big enough that it’s likely a lot of oil is present.

“…Unfortunately, the Lodgepole formation is typically less mature than the Exshaw/Bakken shales and as such over time has demonstrated the most oil expulsion of the three layers; in fact, it serves as the source rock for most Mississippian oil pools.”

TRANSLATION – most of the oil is gone and moved up into oil pools closer to surface

“…Conversely, the Exshaw/Bakken is considered the most conducive (and prospective) for horizontal multi-stage fracturing given that it has experienced limited migration, and most of the oil remains contained within the member.”

TRANSLATION – most of the oil is still there, and it looks like the best one.

“We have identified over 18 wells that have drilled through the Bakken near or on our property,” says Primary’s Marrandino.  His team has been evaluating old data  to better understand the similarities between their  Bakken package to that of the Bakken Williston Basin.  They have had to travel to Denver Colorado and Billings Montana to locate the physical data – old core, or “thin sections” and analyze them under a microscope to better understand the characteristics of the Alberta Bakken formation and potential oil in place

“It further de-risks the play,” he says.

So it looks like the two plays have very similar geological characteristics.  What about economics.?

BMO, Macquarie and Haywood Securities have all acknowledged that the Alberta Bakken is a deep, overpressured formation.  This leads them to believe that the deliverability (economics) may be superior to the main Canadian Bakken play in Viewfield, south-central Saskatchewan, but lower than the North Dakota Bakken in the US.

Like most horizontal, multi fracked wells in the Bakken it is assumed that the initial flow rates of the Alberta Bakken will be high, with high decline rates, and a relatively large total amount of oil recovered.

For the Alberta Bakken play BMO Capital Markets estimates that oil companies will recover a total of roughly 250,000 barrels of oil per well (this is called the “Estimated Ultimate Recovery” or EUR) and a three-month average IP of 348 bopd. They say this yields a Before Tax Net Present Value @ 10% of ~$4.5 million for a Horizontal Oil Case, an Internal Rate of Return (IRR) of 75.9–108.8% and a Breakeven Supply Cost (BESC) of $41.25–42.20/ bbl.

These economics are just below that of the Saskatchewan Bakken, BMO adds.  It’s as big an “NPV 10” (the present value of how much money the producer might get after the well pays back its cost) as the Saskatchewan Bakken – which has the highest valuation per barrel of any basin/play in the country.

Keep in mind that there is only one well on which to base these figures, and that was a vertical well which hit a natural fracture—not exactly a typical well that investors expect to see over the life of the play.

Concludes BMO Nesbitt Burns: “Ultimately, when comparing the Alberta Bakken type well to the Saskatchewan Bakken type wells, the Alberta Bakken—due to the overall thickness of the reservoir, and the overpressured, Deep Basin setting—has the potential for a highly economic well.”

There are a basket of juniors in Canada that now have some very intriguing capital gains potential, if they get lucky with their geology.

I’ll tell you who they are and a rough outline of their plans in my third and final story on the biggest oil play most investors have never heard of, the Alberta Bakken.

Keith Schaefer
www.oilandgas-investments.com

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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The Bakken Play the Oil Majors Are Watching Closely

By
Keith Schaefer
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0

The best new shale oil play you’ve never heard of is getting ready to explode onto investors’ radar early in 2011 – the Alberta Bakken.

Located on either side of the Alberta/Montana border, the key land packages in this play have been assembled with very little news or fanfare – but by some very smart and successful companies, like Crescent Point (CPG-TSX) in Canada, and Rosetta Resources (ROSE-NASD) , Newfield Exploration (NFX-NYSE) and Murphy Oil (MUR-NYSE).

But these larger companies have been very tightlipped about their plans, and aside from Crescent Point’s one press release this fall, it’s not easy to get information – because everybody is still trying to buy more land. To date, there are only a handful of juniors involved in the Alberta Bakken, but juniors and the bigger intermediate producers are all putting a lot of money into this play hoping it will be just like the Saskatchewan and North Dakota Bakken play to the east – which created tens of billions of dollars in shareholder wealth and many buyouts – corporate takeovers – over the last 5 years. Recent reports by Canadian brokerage firms agree.

So the play is gaining momentum but hasn’t become mainstream yet. That will change in the coming months. The historical geological evidence is intriguing, even compelling.  But there is still only one well that has been publicly reported in the whole play – though several have been drilled.  And despite the fact that the Alberta and North Dakota/Saskatchewan Bakken plays have completely different geological settings, huge land prices have been paid for big parcels of Alberta Bakken land in areas where truly, very little is known about the oil formations (yes this will likely be a multi-zone play if it works).

This play was discovered on the US side of the border, in Montana.   And while there has actually been a lot more activity on the US side, but you have to look hard to find mention of it. Rosetta, Newfield and Quicksilver (KWK-NYSE) have each acquired roughly 300,000 acres in northern Montana in this play – a material land position even for companies this size – but you won’t find that information anywhere except in a couple lines buried deep in their quarterly statements.  Rosetta said in its quarterly released just last week they had acquired more ground.  Rarely do any of them include even one slide on this play on their corporate powerpoint. Rosetta and Newfield have each publicly said they are drilling 8 wells, though most of them now are vertical test wells, which the industry calls “strat” wells, which is short for stratigraphy.

___________________________________________________________________

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The next 12 months could be the most important of your investing career.

A scenario is unfolding in the oil & gas sector that will present dozens of triple-digit profit opportunities in the next 12 months.

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Basically they’re trying to gather geological information and determine the best place to drill a more expensive horizontal well.  No results have been released to date. But I can tell by reading the research reports on these companies that the analysts down in the US are watching this play. So are the majors, which did not participate much in the shale gas or shale oil boom in North America.

On the Canadian side, land prices around the Montana border edged up consistently this year – going from a low of $83 per hectare ($33.20/acre; 2.5 acres in a hectare) to $1535/ha, or $614 per acre – taking a lot of industry people by surprise at the time.  The highest price paid for one small block was over $4500/ha, or $1800/acre. Crescent Point came clean in September when they announced they had acquired over 1,000,000 acres in the play, mostly via an acquisition of a private company, Darian, which had a substantial land position, but also through some freehold staking on their own. Most of the land in the area was bought up by land brokers, a whole sub-industry in the oilpatch that acts as front-men for the oil producers. That is not unusual.

It is unusual to see a well licensed in the name of a land broker, which is what has happened with the one well in the Alberta Bakken that everyone is watching – here is a quick quote from BMO Nesbitt on this well: “In Alberta, one horizontal well has been drilled and completed targeting the Alberta Bakken (drilled under broker: Antelope Land Services 14-7-1-21W4: TD – Wabamum; results confidential). A second horizontal well is presently drilling (Antelope Land Services 16-24-2-25W4, licensed to the Exshaw, spudded August 17, 2010), and a third horizontal well licensed by Antelope Land Services located at 3-8-1-18W4 has also been drilled and rig released on October 3, 2010, to the Exshaw. It is believed that Crescent Point Energy is the operator of these three wells.”

Murphy Oil (MUR-NYSE) has also got involved, acquiring about 150,000 acres via a deal with the Blood Tribe in Southern Alberta.

The few juniors in the Alberta Bakken play stand to be richly rewarded if it works out as well as the early movers hope. This will also be good news for their shareholders – here is how Macquarie Capital sees the Alberta Bakken playing out for them: “Junior companies with meaningful, strategically situated lands will be purchased outright by mid/large cap producers who seek to bolt on additional acreage to already established positions. The potential exists that players who were late to the game may try to establish a position in the play via a small corporate acquisition, once some of the associated risks have been mitigated by the early-comers.” In my next two stories on this fast emerging play, I will compare what is known about it to the Saskatchewan/North Dakota Bakken, and list the junior companies involved on both sides of the border.

Keith Schaefer
www.oilandgas-investments.com

Follow this link for Part 2 of the Alberta Bakken series.

An Unconventional Nat Gas Play Goes “The Full Montney”

By
Keith Schaefer
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0

The Junior Players in this “Unconventional” Natural Gas Formation

Large land prices for natural gas parcels in Alberta are continuing to drive higher – despite some of the lowest gas prices in the last seven years in western Canada.

Alberta has made over $2 billion on land sales so far in 2010, at an average price of $629.57/hectare, vs. a total of $280 million at the same time last year, at an average price of $189.91/ha. And at the most recent sale, where $151 million was raised, much of that was for natural gas.

While that may not make sense, the answer can be found in one word – Montney.

This formation is turning into exactly what producers in western Canada need to stay competitive in a time of low gas prices in North America – big, thick and rich in higher value add natural gas liquids, or NGLs.

“The Montney is becoming increasingly attractive because it is recognized as a thick, highly pressurized formation with a lot of recoverable reserves of natural gas and with a high “NGL” content,” says Malcolm Todd, President of Donnybrook Energy (DEI-TSXv), which has 34 gross sections in the Montney.

The Montney is a NW-SE trending, football shaped formation that straddles the border between British Columbia and Alberta. Much of the merger and acquisition activity in the upstream Canadian gas industry has been here – and at high valuations.

Buyouts this year included ARC Energy buying Storm Exploration for $69,000 per flowing barrel – which at the time was roughly the average valuation price for junior/intermediate oil producers.    When Monterey Exploration was bought out by Pengrowth in July, they paid $200,000 per flowing barrel (but some other production behind pipe).

“Those were really strong sales, and it shows the long term money knows this is a good place to be,” says Ben Jones, CEO of Canada Energy (CE-TSXv), which has 42 sections in the Montney.

He added “our observation has been that critical mass and pipeline access drive the acquisition costs; i.e. large tracts bring higher prices than small, isolated tracts.  That’s somewhat counterintuitive – whatever happened to ‘volume discounts’?”

Jones listed off a number of geological factors that are making the Montney an industry focus:

1.      broad expanse-companies can assemble or buy a BIG land package

2.      intermediate depth

3.      sweet gas (vs Haynesville shale in Louisiana which has carbon dioxide)

4.      very fracable rock (“brittleness”),

5.      high amounts of natural gas liquids through much of the trend

6.      flat declines relative to other shale plays (VERY important for valuations…)

7.      The Barnett Shale appears to be the closest analogue in the US, although he says the Estimated Ultimate Recoveries (EUR) are higher in the Montney.

Donneybrook’s Todd adds that though the Montney is an “unconventional” play, it’s not a true shale play – it’s better.  It’s more like a sandstone, which means it’s more porous than a shale, and so the fracks should move farther into the formation – making Point #7 – higher recoveries – come true.

Jones could have added “multiple zones” – there is the upper, middle and lower Montney, and two zones called the Doig Phosphate and Doig Siltstone.  There is also the Duvernay zone at the very bottom of all the formations which has garnered a lot of attention recently – the Deep Basin it’s called.

Natural gas producers in the Montney have been getting 25-40 barrels of natural gas liquids per million cubic feet of dry gas produced, though sometimes higher.  The basket of NGLs trade roughly at 80% of oil prices, which greatly increase the economics for these wells.

Several other factors are also in play – the Alberta government reduced royalty rates in April, and that sparked a renewed interest in gas in the province.  Plus, there is a sense in the industry that gas prices will not stay low forever.

“Companies with the ability to fund land will continue to do so if they think it is quality,” says Doug Bartole, President of Vero Energy (VRO-TSX), a gas-weighted producer in Calgary.  “They don’t think in short term gas prices – and new crown land has long tenure. They will run their economics accordingly.  Current and near term price forecasts are not sustainable.”

There are several junior Montney gas players, including – in alphabetical order – Advantage Energy, Birchcliff Energy, Canada Energy, Celtic Exploration, Cequence Energy, Cinch Energy, Crew Energy, Crocotta Energy, Delphi Energy, Donnybrook Energy, Insignia Energy, Orleans Energy, Painted Pony Explorations, Progress Energy, Rock Energy, Seaview Energy and Terra Energy and Trilogy and Yoho Resources.

PS – A good map to the British Columbia Montney land sales in 2010 is here – http://www.empr.gov.bc.ca/OG/oilandgas/petroleumgeology/UnconventionalOilAndGas/Documents/2010_August_Montney.pdf

by +Keith Schaefer

Why Producers Aren’t Hedging Natural Gas

By
Keith Schaefer
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0

Taking Their Chances in the Spot Market… Later

Natural gas prices in Canada are so low that end users are now trying to seduce producers to hedge, so they can lock in longer term low prices.  But few producers are keen to lock in long term losses.

RBC, Canada’s largest brokerage firm, suggested in a weekly comment that producers still have many reasons to hedge at $3.27 a gigajoule (GJ) now, and $4.11/GJ in April 2011.  For context, the full-cycle cost for new gas in North America is $5.60/mmcf and in Canada is $6.85/mmcf, according to independent analysts Ziff Energy.  So producers would be selling at a significant loss.

But some quick calls to the energy desks of the major Canadian firms showed that few producers are biting, and even one of my contacts at RBC said these “hedging strategies are geared more towards the end-user market; the end users are trying to lock in really good prices. But nobody’s hedging.”

RBC lists several potential reasons for hedging, which often mirror the Ziff Energy white paper from June 2010 on the state of Canadian natural gas (a GREAT read – not too technical – www.ziffenergy.com/download/papers/cdn_gas_crossroads.pdf.)

1.     Strengthening Canadian Dollar

2.     US Production Growth

3.     Reduced Canadian Imports

4.     Heightened Pipeline Delivery Competition in the US

5.     Abundance of Canadian Storage

6.     Material Expansion of Canadian Shale Gas Production

7.     Growth in Marcellus Shale Gas Production – Production has increased by over 1 bcf/d since January 2010

That’s a big list! And it’s not good news for producers or their investors – especially the junior ones who either have high gas weightings or are close to their debt limit.

But despite producers losing money on every mmcf out of the ground, some may be inclined to hedge, says Ralph Glass of AJM Consultants.

“The bigger producers are still drilling and they can afford to (hedge); it’s part of their long term plan and their economics of scale allow it.  The only advantage I can see is that if you’re making positive cash flow at $3.50/mmcf, this gives you stability to hang in for one more year.  But it’s not an investment strategy.”

He added even small producers may consider it: “A small producer that has limited cash flow cannot afford to pay for capacity costs without actually producing the volumes.”  This means they may have “take or pay” like provisions, where the producer must pay the pipeline companies their transportation tolls even if they don’t produce the gas.

For producers, it comes down to the same issue it always does – are prices going lower or higher?  By not hedging, major producers are saying that despite all the gloomy market data, they see prices stable or higher.

Long term dated future gas prices are now below $5/mmcf for a full two years out now.  With such a low, and flat futures pricing curve, producers are saying they would rather take their chances in the spot market then, rather than lock in losses now.

P.S. One of the most-asked questions I get from my readers is, “When should I invest in natural gas?”  Follow the link to read my response.

The ‘Freak of Nature’ Gas Field You Haven’t Heard Of

By
Keith Schaefer
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0

Natural gas companies are now trying to market themselves as “liquid rich” or “wet gas” producers whenever possible.That’s because these “wet gases,” or NGLs (natural gas liquids), are worth a lot more money than straight-up dry gas – which is methane.

Angle Energy (NGL-TSX) has what I call a “freak of nature” gas field just northeast of Calgary. The field contains a whopping 193 barrels of NGLs for every thousand cubic metres of gas produced. The industry expresses this as “xx bbl/xx Mmcf.”For a gas to be considered “liquids-rich” it must yield greater than 10 bbls NGLs for every MMcf sales gas when processed through a plant.  Many producers who speak of “liquids-rich” gas will have average yields of 15-40 bbl/MMcf.

So, how does something like 193 bbls/MMcf happen?

The first reason is that Angle’s Mannville gas pool is located in the “oil window” in Alberta.  What this means is that the pool is buried at a depth where the temperature is not too hot and not too cold.(If it was too hot, it would have turned to just gas, and if it was too cold it would never even have turned into hydrocarbons).The other thing that had to happen was MULTIPLE geologic events, which created the full spectrum of petroleum fluids to remain in deposits – and still kept all the hydrocarbons under the same pressure and temperature.

Petroleum fluids (which are oil, gas and condensate) are made up of many different hydrocarbons.  There are  five general types:

1. black oil

2. volatile oi

3. retrograde gas-condensate

4. wet gas

5. dry gas

A “volatile oil” generally has a higher amount of natural gas in it than a “black oil” does.  A volatile oil produces both oil and gas, and the gas helps to lift the oil, making production easier.  Imagine a bottle of pop that’s flat, and one that has just been opened.  Which one will flow out more easily when shaken? – you get the idea.  Think of natural gas & NGL’s as the carbonation and oil as the Coca Cola.

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Angle’s freak of nature Mannville pool is a “retrograde gas-condensate”.  The retrograde gas-condensate has much higher total NGLs than a simple “wet gas.”   It produces readily (which means it doesn’t need to be stimulated by a process such as fracking), as a volatile oil would, because it has both natural gas and natural gas liquids.

Also, the natural gas liquids will start to separate from the gas and produce both condensate and dry gas at surface.

Now, these retrograde gas deposits occur from Calgary all along the foothills up to the Montney gas play 1000 km north-north-west.

So why don’t I see other companies with similar NGL counts?

That just appears to be luck of the draw.  (The 2nd largest NGL count I’ve seen is the 100 barrels of condensate per day in Second Wave’s new Gilwood discovery three hours northwest of Edmonton.)

But technology does play a small role. As production of this exceptionally rich gas continues, and the pressure in the pool becomes lower, the condensate (the most valuable NGL) “drops out” in the reservoir itself.

Recovery of all that condensate is difficult.  The problem gets tougher when the reservoir is being produced using only vertical wells.  With 14 vertical wells in the Mannville pool, Angle is only seeing an effective 15-20% recovery of all the hydrocarbons in place.

Horizontal wells help solve this issue and produce the natural gas liquids more efficiently along with the gas.  Possible recovery factors with a horizontal well development are 60-70% of the hydrocarbons in place.  This is obviously a huge difference.

The other technology issue is having the right gas plant.  The capabilities of the hundreds of gas plants around western Canada vary widely.  Some are able to get out all the various NGLs, and some aren’t.  Obviously, the ones that can cost a lot more money and it’s not always worth it, or the operator can’t afford it.

DISCLOSURE: Keith Schaefer owns Angle Energy.

Investing in Southern Pacific Resources, Pt. 2

By
Keith Schaefer
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0

By Scott McLeod
Contributing Editor

(Note: Click here for Part I of this article)

The Company That’s Shaping Up To Be the Next Big Player in the Oil Sands

STP’s Properties (before the North Peace acquisition)

Financials

–  $65M cash in the bank,

–  $55M undrawn credit line

–  Debt: ZERO (NOTE that STP had $50M in debt back in April and has now paid it off)

–  Cash flow: $4M/mo from Senlac

–  The cash flow is strategic as they hedge production. The risk of a commodity crash is removed with production being hedged at $70USD and $90USD on half of their production. The other half is exposed but is enjoying the current commodity upside.

–  Because of this extensive capital requirements ($383.8MM Gross for McKay alone), STP will be taking on further debt. I’m not a huge fan of bank debt but with the exploration risk removed, I am comfortable with STP’s looming debt conditions. See Figure 2 for an example of the McKay spend profile. Costs will rise substantially in early 2011.

Resource

STP has 2 major properties and exploration opportunities. Senlac and McKay are the heart of current and next stage production while the Exploration Upside (W.I acreage with proven bitumen, still being evaluated). These exploration opportunities include South McKay, Hangingstone, Lesimer, Kirby, McKenzie and Ells.

STP-Senlac Property

STP’s cash flow comes from the producing (4,440 bbls/d) property called STP-Senlac. The reserve life indicates over 25 years of potential production exceeding 4,000 bbls/d. That’s comfortable cash flow.

This was the first of STP’s SAGD properties and is currently on production. SAGD is working with production averaging 4,400 bbls/d until 2024. See figure 1 below.

senlac development plan

Senlac Development Plan, (STP Corporate Presentation, August 2010)

STP-McKay Property

STP acquired the remaining 20% interest on March 19th, 2010 of their McKay property. A week later, STP announces their reserve increase and the story starts to play out like Bankers Petroleum – Bankers’ stock took off when the market started to revalue the company based on long life reserve potential, instead of cash flow per barrel. Then we have their very recent (today) announcement of formal approval for McKay. Right now, shareholders are consistently getting good news.

Now that STP has formal approval for STP-McKay, watch for dramatically increased production over the next several years. First steam will commence this winter with production from McKay ramping up to 10,000 bbls/d by 2014 with total production around 14,500 bbls/d.

Mckay project spending

Forecasted McKay project spending, (STP Corporate Presentation, August 2010

Valuations

I am not as familiar with valuations for oil sands companies so I’ve assumed $100,000 / flowing barrel and discounted land positions. I cannot predict wells/section as the SAGD pairs are determined on a steam to oil ratio.

First, according to Raymond James (see Table 2), STP is trading at around $0.11 per barrel of recoverable resource (assuming today’s price of $86/bbl). This number is a lot lower than it should be. Canadian brokerage firm BMO Capital Markets has STP trading at $0.21/boe in an “Existing and Under Construction” valuation.

Compare this to Canadian Oil Sands Trust, MEG and OPTI; these three are much larger companies and are trading at $2.70, $1.31 and $1.35 per boe. STP’s $0.21/boe is a huge discount to those numbers.  How large a discount should there be as a pure play – even a junior one – in the sector?  And as oil approaches $100/bbl, the dollar per recoverable resource becomes negative for STP.  All their assets have been independently appraised.

recoverable resource for STP

Value ($USD) per barrel of recoverable resource (Source: Raymond James)

———————————————————————————————————–

Dozens of Explosive Profit Opportunities Ahead

The next 12 months could be the most important of your investing career.

A scenario is unfolding in the oil & gas sector that will present dozens of triple-digit profit opportunities in the next 12 months.

The early stages of this game-changing event have produced winners of 78.7%…181.4%…even 301.7% — but that’s just the tip of the iceberg.

I’ve prepared a full report that explains this astounding scenario in clear detail…including how you can take full advantage.

Click here to read this report – right now – free of charge.

————————————————————————————————————

Here are some potential valuations I have come up with. See the below chart. I’ve broken out stages of production from 3,500 bbls/d to 12,000 bbls/d to 24,000 bbls/d. I have assumed shares outstanding will be constant and that the value per flowing barrel does not change. These are simple assumptions. We all know the price of oil can swing dramatically. I think by assuming $80 and a fair valuation per flowing barrel, one could add these phases of production and get to an Enterprise Value (remember, nothing discounted).

Southern Pacific Resources (April 2010) STP is based on $70/bbl oil
Production is based on current oil – nothing else.
2010E Production is est ~ 3547 bbls oil/d
NOTE: This is oil sands production
Proved Base production value             = Production (boe/d) x avg $ per flowing barrel $/sh
= 3550 100000 $1.44
+ = $355,000,000
Probable (end 2012) Upside value per flowing well = Production (boe/d) x avg $ per flowing barrel $/sh
= 10,000 100000 $4.07
+ = $1,000,000,000
Best Case Scenario (2015) Upside value per flowing well = Production (boe/d) x avg $ per flowing barrel $/sh
= 24,000 100000 $9.76
= $2,400,000,000
P+P Reserves Total Value (NPV) = $3,755,000,000
EV/share                                    = Total Value / shares outstanding
= $3,755,000,000 246,000,000
= $15.26

Valuations based on production and avg$/flowing barrel.

Summary

The uptrend in the stock price recently says that relatively inexperienced management team at STP continues to impress the street. Acquiring the Senlac property when oil was in the low $30’s, completing their 100% interest in McKay and getting formal approval for McKay while increasing proved reserves have played out well for the Southern Pacific Team.

With such an attractive low valuation (trading at less than 20c per boe in the ground) I will continue to be long STP with a modest 5000 shares (average purchase price, $1.06/sh). I will also continue adding to this winning position as share price breaks through the coming resistance levels.

Production could be well over 20,000 bbls/d by 2015.

Good investing,

Scott McLeod
Contributing Editor

Scott McLeod is a Geologist with 4 years of experience. His experience includes conventional prospecting of offshore plays in the North Sea and Mackenzie Beaufort to gas and oil resource plays of the Central Alberta Cretaceous and Jurassic to the conventional reef and tight gas plays of the Devonian and Triassic of NE BC. (Email: Scott.A.McLeod@gmail.com)

Investing in Southern Pacific Resources Stock

By
Keith Schaefer
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0

The Company That’s Shaping Up To Be the Next Big Player in the Oil Sands

By Scott McLeod
Contributing Editor

Scott McLeod is a Geologist with 4 years of experience. His experience includes conventional prospecting of offshore plays in the North Sea and Mackenzie Beaufort to gas and oil resource plays of the Central Alberta Cretaceous and Jurassic to the conventional reef and tight gas plays of the Devonian and Triassic of NE BC. (Email: Scott.A.McLeod@gmail.com)

With a green light from government this week — along with new property acquisitions — Southern Pacific Resources (STP – TSX) is primed to make a big move in the Canadian Oil Sands.

Before I dive in, here’s a quick snapshot:

Company Profile

Shares Outstanding: 322.8 MM (Fully diluted)

Recent Price: $1.38 (Oct 18th Close)

Market Capitalization: $445.5MM

Land: 155,775 (net) Acres of Oil Sands Leases

Current production: 4440 bbls/d (STP does produce gas but mostly for fuel ~ 1mmcf/d)

Hedging: 1500 bbl/d @ $70USD and $90USD for calendar 2010

Southern Pacific is a Canadian listed Heavy Oil (pure play) Company exploiting oil from two major properties in the Canadian heavy oil and oil Sands: Senlac and McKay. These properties have the potential to increase production to greater than 25,000 bbls/d. That’s a 500% increase. STP purchased the Senlac property from EnCana in early 2009 when oil was trading at $30/bbl and the world looked quite bleak. With the continuous rise of the price of oil and a modest rebound in the equity markets, shareholders in STP have done quite well.

The big news driving the stock this week was government approval for STP to begin developing their main asset, the STP-McKay SAGD project (Steam Assisted Gravity Drainage – see Wikipedia explanation here:  http://en.wikipedia.org/wiki/SAGD), which the company plans to grow into a 12,000 bbl/d production asset.

Positives

–  Reserves continue to increase year over year

–  100% working interest in McKay property;

–  Predictable resource, predictable production = low risk

–  Cash flow consistent, if not rising every month

–  Long term (50 years +) growth

–  If you believe oil is going higher and/or staying above $80/bbl, STP’s share price is heavily discounted

Negatives

–  High capital costs

–  Looming debt with increased borrowing to fund these high capital costs (around $200MM of the forecasted $395MM in capital costs for McKay alone)

–  With further financing, we could see further share dilution

–  Although some productions is hedged, fluctuating commodities prices can negatively impact

–  SAGD Operations can be complex and issues with ramping up production can be encountered

–  Inexperienced management (relative to their peers), although with the recent acquisitions and hiring, the experience in operations and building of thermal projects have increased significantly

The Next “Bakken Buyout?”

This stock is now on the move – a fast-growing junior oil producer in the red-hot Bakken oil formation. They also have one of North America’s most valuable natural gas assets – which isn’t priced into the stock at all. After they added 95 million barrels to their reserves this week, analysts responded by upping their targets.

This little-known Bakken player could be scooped up by an oil major – or a natural gas major…any day now. Analysts say they would be getting the oil or the gas for FREE.

I’m sharing the name of this company – along with 12 pages of my own detailed coverage – in my new FREE report. CLICK HERE TO ACCESS YOUR FREE OIL & GAS INVESTMENTS BULLETIN STOCK REPORT!

Stock Chart

Looking at a recent stock chart, we see that a strong uptrend has occurred since break out with the MACD’s (Daily’s) both positive and the 50MA still riding above the 200MA. RSI is gaining strength, albeit entering overbought territory.

stock chart southern pacific resources

October 18th, 2010: STP’s stock is now in an uptrend.

In the last 6 months, STP has raise over $160 million in two equity financings. STP has also generated record funds from operations just over $35 million. The Company claims their contingent resource (P50) recoverable is around 489 mmbls with a reserve life of greater than 50 years. Digging deeper into the research we find that recent analysis done by BMO Capital Markets claim that recoverable resource is shy of 1 billion barrels at 807mmbbls. If STP were to ramp production up to 25,000 bbls/d, that’s a reserve life of 88 years! Either way, it’s starting to look like Southern Pacific is going to become a bigger player in the oil sands sector.

Another recent highlight (and helping to drive the stock price) is their recent announcement of the acquisition of North Peace Energy. The deal adds potentially another 1,000 bbls/d, 135 net sections of land, and another 105 mmbbls of reserves. STP plans to take this 1,000 bbl/d production to at least 10,000 bbl/d.

southern pacific resource properties

*Be on the lookout tomorrow for Part 2 of my report, where I’ll take a close look at STP’s properties… and offer my full valuation and investor summary.

Kind regards,

Scott McLeod
Contributing Editor, Oil and Gas Investments Bulletin

How To Find Inflation-Protected Yields

By
Keith Schaefer
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0

A Solid Income Stream with Inflation Protection Built In

James Keller is an analyst with Thermopolis Partners, LLC. Located in Jackson Hole Wyoming, Thermopolis Partners is an infrequent contributor to Oil and Gas Investments Bulletin.  MMcfe = million cubic feet equivalent.

Investors today are starved for yield.  Witness the 10-year treasury yield trading near 2.5%, and municipal bonds (iShares S&P Municipal Bond ETF) near 3.6%.  If you are an investor looking for yield but at the same time nervous or downright scared of the possibility of inflation, these are not the vehicles you want to own.  Inflation will eat away at the purchasing power of your principal, and many would argue that as inflation increases, so will interest rates, which will turn your fixed income capital gains into capital losses.

In order to find inflation-protected yields, you have to look harder and deeper at high-yielding equities.  I’m not talking about low single-digit yields like you’ll find in the large, blue-chip dividend payers.  We’re looking for much higher dividend payouts.

If you screen for high-yielding equity assets in the US, you find a majority of them are tobacco, financial or energy companies.  For the purposes of this article, we’ll focus on an oil & gas company.

The go-to income based equities for US retail investors are usually midstream Master Limited Partnerships (“MLPs”).  A note of explaination about MLPs: Typically US-listed entities that receive at least 90% of their income from the production, distribution or processing of natural resources such as oil, coal, iron ore or natural gas.  MLPs distribute a large portion of their cash flows to investors in the form of distributions.  These distributions are tax-advantaged because a large portion of the distribution is considered “return of capital” by the IRS.  Return of capital is not taxed on the day of distribution; rather, it reduces your cost basis and allows investors to defer their tax payments on the distribution until the units are sold.

These are fine vehicles for dividends, but we have a few issues with MLPs that may leave some investors disappointed.  MLPs, in general, have garnered so much attention recently that they have become relatively expensive in our view.  It seems like every month there is a new billion dollar MLP ETF or MLP fund created.  Hence, many of the mid-stream MLPs now trade at 5-6% dividend yields, where an 8-10% yield was usually the norm.

In addition, some of the largest MLPs have structures where the General Partners (management) can take, as a first cut, a huge amount of the cash flow that would have otherwise been paid to the owners of the common LP units.  For example, one of the largest midstream MLPs has a clause in its partnership agreement that allows them to pay the General Partner 50% of the cash flow the partnership generates in any period after reaching certain milestones.  Since the milestones have been met, cash available for distributions to the LP units is now just 50% of the cash flow that is generated by the entire business.

Which leads us to an interesting oil & gas producing MLP that has an attractive dividend yield (7.5%) and does not have a cash-draining GP/LP structure.  This company is also poised to grow cash flow significantly in the near future.  The Company is Linn Energy (NASDAQ:LINE), based in Houston.  All LINE units represent direct ownership of the General Partner:  Linn Energy, LLC.

Linn Energy has a boring business model.  They acquire mature US-based oil and gas assets and they hedge out nearly 100% of their production for 5 years.  In the interim, they pay out a tax-advantaged dividend, currently in the 7-8% range.  Their tax advantage is driven by a combination of the cost of drilling wells and production/depletion credits.

Linn’s dividend is made possible by the nature of the investments they make, and the prices at which they are able to hedge.  For instance, in the last 12 months, they have made Permian Basin acquisitions for a cost of $10-$12 per barrel of reserves in the ground.  After the acquisitions, they hedge out roughly 100% of that production at $85-$90 per barrel, essentially locking in a $48-$60 profit per barrel for the next 5 years (after operating costs in the $20-$25 per barrel range).  And because they use a combination of puts, collars and swaps,* they are providing 100% downside protection while also being able to participate on the upside should oil prices rise over the long term.

So how is a Company with such a boring business model going to increase production and cash flow in the near term without making a rash of acquisitions?  The answer is technology.  We’ve all heard about the recent developments in horizontal drilling and fracturing technologies that are unlocking massive amounts of shale oil and gas.  Linn Energy is poised to utilize this new technology on one of their large, horizontally undeveloped properties, which will grow both production and cash flow significantly in the years to come.

As part of its strategy to accumulate and hedge out mature assets, Linn purchased the largest land package in the Granite Wash basin on the border of Northern Texas and Western Oklahoma for $2.1 billion a few years ago.  The Granite Wash is a mature gas play that has turned into a winning lottery ticket for Linn Energy.  By applying horizontal drilling and completion technology, the Company has unlocked a giant resource of liquids-rich gas under the substantial acreage they purchased.  We estimate that the value of Linn Energy’s Granite Wash acreage is worth up to $5 billion today.

The Granite Wash basin includes up to 7 producing zones (most of which are wet gas, condensate-rich zones).  They have drilled about 400 vertical wells on the property to date, which provides the company with a detailed picture of the reservoir.  While Linn continued to drill vertical wells on their property, there were many companies applying horizontal techniques to the Granite Wash basin acreage surrounding them.  Linn took note, waiting for the optimal time to apply horizontal technology to their acreage.

In June of 2010, Linn drilled a horizontal well in one zone of the Granite Wash section, and it initially produced at 19 MMcfe per day.  The well cost $7.5 million, but it will pay off within 9 months due to the high liquids content of the Granite Wash wells.  Their second horizontal well was even better, achieving initial production of 60 MMcfe per day, paying off their original well cost in only 3 weeks.  This well has maintained 40 MMcfe of production after 45 days, and all of these wells are expected to decline to a rate of 2.5 MMcfe per day after 5 to 6 years.  Not all of the future wells will come online at 60 MMcfe per day, but even at 8 to 15MMcfe per day (which the company believes is the base-line for all of the Granite Wash initial wells), cash-flow break-even is always within the first year assuming $70 oil and $4 natural gas.

At current drilling plan levels, they expect to drill this prospect out for the next 3 to 5 years.  However, since there are up to 7 potential producing zones within the Granite Wash basin, this drilling inventory could be multiples higher.

Linn Energy is poised to grow production and cash flow by 20-30% per year for the next 3 to 5 years.  The company will not pay out all of that cash to investors however; they plan to raise the dividend much more modestly, in the 3-5% range.

Linn Energy’s future is looking brighter than ever.  The cash that they will be able to generate from this winning lottery ticket will give them a much greater cost of capital advantage over their competitors.  The excess cash flow will be plowed back into their bread & butter business model of acquiring, maintaining, and hedging out mature oil and gas fields.  The Granite Wash will provide the company with years of above average growth, increased dividend payments and a solid long-term production platform.

Editor’s Note:  Oddly enough, the founder and namesake of the company has recently sold a significant portion of his holdings in the company.  The stated reason was to diversify his holdings, which is understandable.  Unfortunately, it is hard to find assets with this much upside paying out 7.5% dividend yields, so from our standpoint, it would appear to be a case of “de-worsification”.

Disclosure:  Thermopolis Partners owns Linn Energy common shares.

*Puts are financial contracts between two parties, the writer (seller) and the buyer of the option. The buyer acquires a short position by purchasing the right to sell the underlying instrument to the seller of the option for a specified price (the strike price) during a specified period of time. If the option buyer exercises their right, the seller is obligated to buy the underlying instrument from them at the agreed upon strike price, regardless of the current market price. In exchange for having this option, the buyer pays the seller or option writer a fee (the option premium).  A Collar is an option strategy that limits the range of possible positive or negative returns on an underlying to a specific range.  A commodity swap is an agreement whereby a floating (or market or spot) price is exchanged for a fixed price over a specified period.

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