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To Plot Your Energy Investments, Consult the Map: James West

Source: Peter Byrne of The Energy Report (7/2/13)

Understanding asset values is the name of the game for early-stage resource plays—that’s how investors in the Bakken made huge returns. But with the first round of shale plays largely maturing, where are the next big opportunities for junior explorers? In many cases, abroad, says James West, publisher of The Midas Letter. In this interview with The Energy Report, West rolls out the map and shows us where juniors are headed. He also names some companies who are thriving on North American soil. If boots-on-the-ground prospecting puts a glint in your eye, read on.

The Energy Report: What are the key considerations investors should make in evaluating geographical location and political risk in junior exploration and development plays?

James West: Outside of North America, there are a few obvious no-go zones—Russia, China and parts of war-torn Africa. Then again, we did see a great junior success in Kenya with Africa Oil Corp. (AOI:TSX.V), so certain regions in Africa are less risky. Presently in Kenya, I’m watching the progress of Africa Hydrocarbons Inc. (NFK:TSX.V) with interest as the company seeks to emulate Africa Oil’s success. Africa Hydrocarbons commenced drilling on its 47.5%-owned Bouhajla Block, located onshore in Tunisia within the productive Pelagian Basin.

Australia carries little or no political risk of expropriation. Terra Nova Energy Ltd. (TGC:TSX.V; TNVMF:OTCPK; GLTN:FSE) is drilling in the Cooper Basin in Australia. Initial production wells that BeacChevron Corp. (CVX:NYSE) drilled in that basin are pumping 2,000 barrels per day (Mbbl/d). And investors will do well to concentrate on Canada and the United States—there is just so much profitable activity going on in the shale space and in legacy wells and oil field redevelopment.

It’s actually Beach Energy Ltd. (BPT:ASX) that made the initial discoveries in the Cooper Basin, and is now flowing in excess of 10,000 barrels oil equivalent per day (boe/d). Chevron has farmed into two exploration permits owned by Beach Energy, but is a minority holder and non-operator.

TER: Are there any places where the political risk outweighs any potential payoffs?

JW: If a government is already inclined toward resource nationalization, then potential success does not really matter. A nationalized firm is going to lose it all, or see its assets tied up in international courts for years.

TER: Which countries in South America are safe?

JW: I am not too keen to invest in Argentina, even though there are Canada-listed TSX juniors producing oil there and at this point it is safe. I am nervous about the long-term political security of Argentina. But in Colombia, on the other hand, the trend is toward stability. Several companies doing business in Colombia are producing and exporting oil without incident. PetroAmerica Oil Corp. (PTA:TSX) is having great success. And Peru, Chile and, to a lesser extent, Brazil are very safe. Ecuador and Venezuela are at the opposite end of that spectrum. Those two countries are no-go zones.

TER: What type of challenge does a junior explorer need to overcome in a politically safe but geographically extreme region like the Yukon?

JW: Typically, the challenge for juniors in the far north is freezing temperatures, especially north of the Arctic Circle. But in the southwestern Yukon where, for example, companies like EFLO Energy Inc. (EFLO:OTCQB) operate, the weather is not so frigid. The challenge there is the snow pack. There are places where you cannot go with heavy equipment until the land is frozen over. That is the case in other Canadian regions, too. But those types of challenges to oil and gas exploration are not insurmountable. The oil sands in northwestern Alberta and northeastern British Columbia are a testament to that. Regardless of the challenges posed by extreme weather, the oils sands support one of the largest oil and gas production infrastructures to be found anywhere.

TER: Do drillers in difficult geographical locations tend to rely on service companies more heavily?

JW: Generally, the service companies are deployed at the same ratio. Local service companies have expertise relevant to the local weather patterns and the associated terrestrial challenges. So companies gravitate toward local firms for early-stage geophysics, but then when it comes to drilling deep, expensive wells, they gravitate toward the multinationals—companies like Baker Hughes Inc. (BHI:NYSE), Schlumberger Ltd. (SLB:NYSE), etc.

TER: You mentioned EFLO Energy. Could you give us a profile on that name?

JW: EFLO Energy has an interest in the Kotaneelee gas field in the Yukon, which is where Apache Corp. (APA:NYSE) recently announced a discovery hole with astounding flow rates. The potential size of the reservoir is over 30 billion cubic feet. It is proximal to where Apache is working on a very large land position with gas processing infrastructure. EFLO is well situated to take advantage of working one of the largest, but as yet undeveloped, gas fields in the world: the Kotaneelee.

TER: What is the situation with the share price of EFLO Energy?

JW: EFLO has held up well—between $1.40 and $2.60 during the last year. It’s at $1.50 right now, but that is a reflection of the fact that it has not been drilling much of late. The company is currently focused on building its executive team. Once it starts to drill and develop the oil and gas field, its share price will most likely improve. If it makes a decent-size discovery, it will be a very attractive takeout candidate for a foreign national oil company. China’s national oil companies are showing great interest in Canadian companies with large gas reserves.

TER: What about the Peace River Arch region? How does that differ from the Yukon in terms of geographical challenges?

JW: The Peace River Arch is a very mature, sedimentary basin. The geographical challenge is to find any available land left to prospect. The Alberta government has done such a good job of maintaining a database of all of the different pay zones that anybody can go online and effectively prospect for property. Where there is some success, the prices are driven up very quickly because the market instantly reflects demand. So it’s very tough to get positions in the Peace River Arch region. There are great barriers to entry for new companies that want to get in, but there are a handful of juniors that are developing production nicely.

TER: Such as?

JW: Aroway Energy Inc. (ARW:TSX.V; ARWJF:OTCQX) is a very successful company that I have followed since 2011. Unfortunately, it is currently suffering from the deflationary effect, which afflicts the entire TSX Venture Exchange (TSX.V). Due to the generally poor performance of mining stocks, its share price halved during the last year. That trend does not look as if it is going to change soon. On the other hand, the TSX.V has been beaten up so badly that there are fantastic bargains available. Aroway is an excellent case in point. The company is producing over 1 Mbbl/d, and it has a great land position. Its share price does not reflect the actual value of the company, and Aroway has substantial cash flow and is growing production on an almost daily basis.

TER: What services companies operate in that region?

JW: There is Enterprise Group Inc. (E:TSX.V), which I started following in 2006. The company recently announced several acquisitions. It has acquired a specialized engineering firm, an underground infrastructure construction company that is generating $12 million ($12M) per year in revenue. The acquisition will give Enterprise 40% of its earnings before income tax, depreciation and amortization (EBITDA) in 2013. Enterprise’s business model is to consolidate the oil field services industry in Western Canada. The plan is starting to pay off.

TER: From the investor point of view, what is the best type of corporate structure for a service firm—vertical or horizontal?

JW: Enterprise is integrating horizontally. It is in a position to capitalize on new trends in geophysics. It is able to offer everything to everyone. Companies that are more specialized tend to be boom-and-bust. When things are particularly good in their particular sector, then let the good times roll. But when the public appetite goes in a different direction, then those companies can flounder for years. Enterprise Group is acquiring companies across various subsectors in the oil field services and, thereby, insulating itself against future soft spots in the market.

TER: How is the Enterprise stock price doing?

JW: It is in the $0.70 range. The company has touched a 52-week high about 10 times this year. It has delivered a multiple of 7x. In July a year ago, it was trading at less than $0.20. Now, it’s trading up near $0.70, and it is poised to go higher.

TER: You mentioned that Alberta has an online prospecting database. Do other jurisdictions in North America maintain similar databases?

JW: Alberta has always led the oil and gas jurisdictions in preserving data and allowing access to it. That is really smart because it creates maximum demand for a potential hydrocarbon asset. The province’s tax base benefits every single Albertan. In contrast, look at Texas, which was ground zero for the development of the oil industry. The rights to oil and gas assets in Texas are controlled by a politicized railroad commission, which is more focused on real estate issues than developing energy assets. In Texas, it is almost impossible to figure out who owns what! If you are looking to acquire legacy data from previous hydrocarbon explorations on certain properties, it is like detective work. You have to chase information backward through courts and property deeds. That makes it almost impossible for a newcomer in Texas to buy properties without acquiring very specialized local expertise. At the end of the day, Texas is just not efficiently maximizing its hydrocarbon wealth on behalf of its tax base. That is not by design, it’s just the way the system evolved there.

TER: What about other high-profile drilling jurisdictions, like North Dakota, Wyoming and Nevada?

JW: Each of those jurisdictions is regulated by the by the Bureau of Land Management (BLM). But the Bakken in North Dakota is now rather mature. With the declining price of natural gas and the increasing costs of exploration, there are fewer and fewer entrants knocking on the door. Geographically, there are few incumbents, and they are able to operate and finance continued exploration from production cash flows. The grassroots junior boom in land purchases that was characteristic of 2007-2008 is largely over now because the basins are better defined.

TER: So what is a junior company without land to do? Go abroad?

JW: For a junior company on the TSX.V, that’s a good question. I know of a couple of companies that are electing to go abroad. One of them that we hold in The Midas Letter Opportunity Fund is Rift Basin Resources Corp. (RIF:TSX.V). Its projects in Tunisia are advancing in partnership with another British oil and gas company. It is exploring further in Tunisia and also planning exploration in Gabon. It is assessing an opportunity in Indonesia that could be huge. And, remember, I do not categorically dismiss Argentina—Americas Petrogas Inc. (BOE:TSX.V) is successfully drilling unconventional shale oil and gas wells there. The stock is down to $0.85 from a high in the last year of almost $3. But, again, that’s largely a reflection of the ailing TSX.V.

TER: Are there junior opportunities in Brazil?

JW: It is very hard for explorers to compete with the national oil company, Petrobras (PBR:NYSE; PETR3:BOVESPA), which is majority owned by the government of Brazil. The country is really biased toward its own. Brazil is famous for that. Only rarely do outside companies acquire major Brazilian corporations. It is a type of covert resource nationalism, practiced not as a matter of public policy, but as a tacit demonstration of nationalistic attitude.

That said, my biggest winner of 2012 operates in Brazil. Abakan Inc. (ABKI:OTCQB) is building a four-line pipe cladding facility there. It will sell pipe to Petrobras. In fact, it has a joint development agreement with Petrobras, which holds a large percentage of its offshore wells at extremely high pressures. Petrobras pumps high-end hydrogen sulfide, which is extremely corrosive. Therefore, to produce the hydrocarbons economically, Petrobras needs to keep improving its gathering and transmission infrastructure. Abakan is really integral to Petrobras’ future going forward, and that is why Petrobras and the government of Brazil are assisting Abakan in acquiring the land and financing to build the pipe manufacturing plant. Abakan’s stock price has tripled in the last two years. It is waiting for a full NASDAQ listing. After Brazil, it plans to build an eight-line plant in Indonesia. Currently, its one plant throws off $60M annually in gross revenue, of which 40% is gross margin. It is a great cash maker, and there are a lot of projects in Indonesia and Brazil that will not move forward until the Abakan technologies can be deployed in the field.

TER: Are there any other geographical regions or undervalued exploration or service-oriented companies flying under the radar?

JW: Given the state of equity markets in general in the resource sector, a lot of investors are looking for yield. Our fund is no different. We are planning to invest in Argent Energy Trust (AET.UN:TSX), which is a Toronto-listed company that acquires producing oil and gas assets and distributes their revenue, minus the cost of administration, to the yield holders. Basically, it is averaging 10% annually in yield, and the unit holders are also exposed to a rising share price as the value of the portfolio increases and the company deploys capital to acquire more producers. For an energy-focused yield play, I cannot think of a better one than Argent Energy Trust.

TER: How does Argent manage to do that? Does it pick companies that are doing particularly well, or is it distributing risk over a bell curve?

JW: The key to Argent Energy Trust’s strategy is that it exploits foreign asset regulations. It is classified as a foreign asset investment trust. It distributes the income from foreign-producing hydrocarbon assets on a tax-optimized basis to unit holders. Brian Prokop, who is the co-CEO and president, was formerly with Daylight Energy Ltd. He has experience in building and producing oil and gas assets. He’s the perfect man in the perfect job! In terms of the tax benefits, approximately 60% return on capital is realized. The U.S. corporate tax on it is under 2%. It is a great way to play for yield in the energy sector.

TER: Any other comers?

JW: Surge Energy Inc. (SGY:TSX) bears watching. It was recently the subject of a bought-deal financing for $300M. It is moving more toward becoming a dividend-paying oil and gas company. That suggests great potential for the share price, as well as for the yield that the company will pay out. If it uses its treasury to acquire producing assets and distributes the proceeds to shareholders, that is far more attractive to me in the near term than a company that is raising capital to look for oil and gas assets when the return on that capital will be much lower.

TER: Thank for your time today, James.

JW: My pleasure, Peter.

James West is publisher and editor of The Midas Letter, an independent capital markets entrepreneur and investor. He has spent more than 20 years working as a corporate finance advisor, corporate development officer, investor relations officer, media relations and business development officer for companies involved in mining, oil and gas, alternative fuels, healthcare, Internet technology, transportation, manufacturing and housing construction.

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1) Peter Byrne conducted this interview for The Energy Report and provides services to The Energy Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: none.

2) The following companies mentioned in the interview are sponsors of The Energy Report: Aroway Energy Inc and EFLO Energy Inc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.

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Byron King: Forget OPEC. North American Energy Plays Bring Profits Home

Source: JT Long of The Energy Report (6/11/13)

Looking for profits in the oil and natural gas space? Look no further than shale plays, energy service companies and offshore oil drilling opportunities in the U.S., says Byron King of Agora Financial LLC. In this interview with The Energy Report, King discusses how dwindling exports to the U.S. from Latin America, Africa and the Middle East are shifting the supply and demand equation across the world. King also names companies in the service space with solid prospects for investors.

The Energy Report: Byron, welcome. You recently attended the Platts Conference in London, which addressed shifting energy trade patterns in light of growing U.S. export prospects and dwindling exports from South America and Africa. Has OPEC’s role diminished?

Byron King: The short answer is yes. OPEC is struggling right now. The Middle East, the West African producers and Venezuela are struggling. The West African players and Venezuela have seen exports to the U.S. decline dramatically. In countries like Algeria, oil exports to the U.S. are essentially zero, while Nigeria’s exports to the U.S. are way down. The oil these countries export tends to be the lighter, sweeter crude, which happens to be the product that is increasing in production in the U.S. through fracking.

The east-to-west trade pattern for oil imports to the U.S. has essentially gone away. This does not mean that the oil goes away. It means these countries have to find new markets for their oil—which they are doing, in India and the Far East. But that disrupts trade patterns as well. Imports from the Middle East to the U.S. are falling as well. These barrels tend to be the heavier, sourer crude that U.S. refineries are geared to process.

As the U.S. imports less oil, our balance of trade gets better. The recent strengthening of the dollar has a lot to do with importing less oil. Strengthening the dollar decreases gold and silver prices, so there is some monetary blowback from the good news out of the oil patch. Strengthening the dollar increases the broad stock market for the non-resource, non-commodity and non-energy plays. There’s an astonishing dynamic at work.

TER: When it comes to countries like Venezuela, part of the reason for the decrease in exports is because it has not invested its profits in infrastructure.

BK: Good point. In Venezuela, the government has taken so much money out of the oil industry to use for social spending, military spending and government overhead that the sustaining capital is not there. Even with Hugo Chavez’s death and new leadership in Venezuela, it will require years of sustained and increased investment to get Venezuela’s output up. After 10 years of dramatically bad underinvestment, the infrastructure is worn out. It will take a lot of time, money and some seriously hard political decisions to redeploy capital inside a country like Venezuela.

TER: If OPEC can no longer control the price of oil through supply because it does not have as much control of supply, what is keeping it from flooding the market with oil to get more revenue?

BK: That would work both ways. If OPEC floods the market with more oil, it will drive the price of oil down. Then OPEC nations would get fewer dollars for each barrel. All of that extra output, if sold at a lower price, might still yield less money, which is not a good thing if you are an oil exporter and need the funds.

The big swing producer is still Saudi Arabia. Saudi has spare capacity, but I suspect not as much as it wants people to believe. It gets back to that idea of peak oil. We’ve discussed it before, and yes, I know—fracking is changing the game to some extent. But you still need to keep all the books about peak oil on your shelf. Fracking is what happens on the back side of the peak oil curve, when you need barrels, are willing to pay high prices and throw lots of capital and labor at the problem.

A country like Saudi Arabia could increase its output, but not for long and not in a heavily sustainable way. It would damage its oil fields. Beyond that, the trick for OPEC is going to be getting several countries to agree to cut output to make up for the extra output from North America, in the hope of keeping prices where they are right now.

Brent crude—which is what the posting is for much of the OPEC contracts—is about $103/barrel ($103/bbl). If OPEC wants to keep that number—or not let it fall too much further—it has to cut output, not increase output. That is a very difficult and politically charged issue within OPEC. The Middle Eastern countries can afford a minor amount of financial turmoil right now. The other OPEC countries absolutely cannot afford financial problems stemming from low oil prices.

TER: Is there informal price control going on in the shale oil fields? As the price of natural gas has dropped, the oil rig count has dropped—and once the price goes up, those oil rigs could start up again. Could there be an OPEC of North America?

BK: I do not see an organized North American OPEC because there are too many companies in the mix. Too many people have a bite at the apple for anybody to control things. It is more like a tangle of accidental circumstances driving production levels. We are seeing a slight drop in the oil rig count in the U.S. right now. Part of that has to do with the natural gas cutback, but part also has to do with the efficiency of the fracking model. Fracking can be energy inefficient, but also can be industrially efficient.

Five years ago and earlier, the idea of drilling wells was to look for oil fields. You were drilling into specific regions enriched with hydrocarbons that could flow into a well under reservoir energy or with just modest amounts of pumping or pressurization.

Today, with fracking, you are not really looking at oil fields. You are drilling into an entire formation. You are drilling into a large-scale resource and introducing energy into a formation to break up the rock and get the oil or natural gas out. To do that successfully is much more a manufacturing model than the traditional oil drilling model. This is why you see drilling pads that have room for 10 or 12 wells. You drill the wells directionally outward.

In western Pennsylvania I have seen some of the drilling maps for companies like Range Resources Corp. (RRC:NYSE). These companies have very efficient ways of corkscrewing pipe into the sweet spots of the formations with multistage fracks. They are draining the formations very efficiently. You see fewer rigs because each rig is being used in a manufacturing-type of process, as opposed to the olden days when drilling was similar to craftwork.

Modern drilling and fracking, at least in North America, is much more of an assembly line process. Companies are using the same drill pits over and over again. They are using the same drilling mud and the same fracking water. Much of the same equipment gets used multiple times on several different wells. In the olden days, each well was its own special unique construction. Of course, every oil or gas well is different, and the results depend on how you drill it.

TER: Which companies are doing this the best and are they actually making money?

BK: Five years ago, people would talk about how this well made money or how that well does not make money anymore. That’s harder to do today. The economics of the current fracking world are still up in the air.

The jury is out on many of these fracking plays. Companies are drilling a lot of wells and they are expensive. They are fracking the wells and that is very expensive. At a recent conference, a gentleman from Halliburton Co. (HAL:NYSE) said up to 50% of the different fracking stages on wells do not work. They either fail at the beginning or soon after they go into production due to many reasons—geotechnical failure; equipment failure; blockages in the holes, in the pipe, in the perforations; things like that. Once a company has put the steel in the ground, done its fracking and inserted its equipment, it is very difficult to get down there and fix what is broken.

Right now natural gas prices are so low that if a company is drilling for dry gas, it is almost a given that it is not making any money. If the company is drilling for wet gas and is producing, the gas helps pay for the investment. When you get into some of the oil plays in the Bakken formation in North Dakota, or the Eagle Ford down in Texas, you are starting to get a midcontinent price—or even better—for the gas plus associated oil or liquids. When I say midcontinent, I mean West Texas Intermediate; the WTI price as opposed to the Brent price.

Regarding the pricing structure within North America, the oil sands coming out of Alberta are selling at the low end of the market scale. If West Texas Intermediate is about $90/bbl, the Canadian sand oil might be $60/bbl. That is a one-third differential. Is that because the quality is so different? Not necessarily. The oil sand product quality is slightly lower than the WTI, but it is not a one-third difference in terms of molecules or energy content or refinability. The difference is in stranded infrastructure. The cheaper oil is geographically stranded up in the frozen north of Canada, and you have to get it out through pipelines and railcars. You cannot get it over the Rocky Mountains to the Pacific Coast. There are only a few places for that oil to go, so it comes south. In its first stop across the U.S. border, in North Dakota, it competes with the Bakken plays.

The great mover of midcontinent oil today is the North American rail system—the tanker cars. Back in the days of John D. Rockefeller, he could control oil markets with access to rails, rail shipping and tankers cars. Now you have to look at the cost of moving oil from midcontinent to another destination. If you are in North Dakota, you can move oil west to Washington or California, where there are refineries. Or you could move it to Chicago or farther east, to the refineries there. Or you could move it south, where you compete with imported oil at the Houston refineries. It is a very complex arrangement. And you must deal with the usual suspects—BNSF Railway Company and Union Pacific—the two biggies of hauling oil.

We’re seeing some truly astonishing developments here. Look at Delta Air Lines Inc. (DAL:NYSE), which spent $300 million buying the old Trainer refinery in Philadelphia. Actually, less than that when you take in the subsidy from the state of Pennsylvania. So now, Delta is importing oil from the Bakken to Trainer on railroad cars. Delta feeds its East Coast operations with jet fuel coming out of the Trainer refinery, including planes flying out of John F. Kennedy International Airport, which gives it a price advantage in the North Atlantic market. The price differential of just a few pennies a gallon on jet fuel is the difference between making or losing money on the North Atlantic routes.

Then, Delta can go to other airports where it operates, and beat up on the fuel supplier by threatening to bring in its own fuel. So Delta is extracting price concessions from vendors. It’s sort of an old-fashioned “gas war,” like when service stations used to see who could sell fuel the cheapest.

Midcontinent oil, midcontinent economics and transport by rail have completely altered the economics of other industries, including the rail and airline industries. North American shale oil plays have had an extensive ripple effect through the U.S. economy.

TER: Could building more pipelines to export facilities in the U.S. shrink those differentials?

BK: More pipelines will shrink the differential, but pipelines take time. In the environmentalist political world we live in today, it takes years to do all the permitting, and pretty much nobody wants to have a pipeline running through the backyard. Existing pipelines are golden because they are already there. Maybe they can be expanded, the pumps improved; we can tweak them or put additives in the fluid to make the product move faster. There are all sorts of possibilities with existing pipelines.

For the pipelines that are not built yet, you have the whole NIMBY (Not In My Backyard) issue. The railroad lobby and the lobbies of companies that build railroad cars also do not want to see new pipelines because these companies are more than happy to ship oil on railcars, even though in terms of energy efficiency safety and spillage, rail is less efficient overall.

TER: Based on this reality, how are you investing in shale space—or are you?

BK: Right now, I am investing in the shale space at the very fundamentals. It is a pick-and-shovel approach to investing. I focus on what I call the big three of the services companies—Halliburton, Schlumberger Ltd. (SLB:NYSE) and Baker Hughes Inc. (BHI:NYSE)—because these companies have people are out there in the fields with the trucks and equipment, doing the work and getting paid for it. Another company that I really like is Tenaris (TS:NYSE), one of the best makers of steel drill pipe. You could buy U.S. Steel Corp. (X:NYSE), for example, which is doing very well in tubular goods, but it is a big, integrated steel company with iron mines and coal mines. It owns railroads, and sells steel to the auto industry, the appliance industry and the construction industry. Tubular and oilfield goods are just a part of U.S. Steel. With a company like Tenaris, it is more of a pure play on the oilfield development.

TER: Are you are a fan of oil services companies at this point in time?

BK: Yes. In terms of a company that is actually out there doing the work, I have great admiration for Range Resources. Its share price seems bid up pretty high. In terms of the large caps, I am looking at global integrated players: BP Plc (BP:NYSE; BP:LSE), Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE), Statoil ASA (STO:NYSE; STL:OSE) and Total S.A. (TOT:NYSE), the French company. They are big, global and pay nice dividends. Even BP, for all of its troubles, is still paying a respectable dividend.

TER: Those are companies that also have exposure to the offshore oil area. Is that a growth area?

BK: Offshore is booming. Some companies are very good at what they do, and when you look at the pick-and-shovel plays, that would be companies like Halliburton, Schlumberger and Baker Hughes, among others. Transocean Ltd. (RIG:NYSE; RIGN:SIX), the big offshore drilling company, is making a nice comeback, as is Cameron International Corp. (CAM:NYSE), which is in wellhead machinery, blowout preventers and things like that. FMC Technologies (FTI:NYSE) is a fabulous subsea equipment builder, and Oceaneering International (OII:NYSE), which makes remote operating vehicles (ROVs), has done great the last couple of years and is still growing.

A couple of points about offshore. In the U.S. offshore space, in March and April 2010, right after the BP blowout, the U.S. government basically shut it down. The offshore space was utter road kill. By the second half of 2010, it was dead. It went from being a $20 billion ($20B)/year industry to about a $3B/year industry. Here we are, three years later, and the offshore industry in the U.S. is recovering. There is still growth.

If you look at the rest of the world’s coastlines, you see an increasing amount of concessions, leasing and acreage—whether it is in the Russian Arctic or the North Sea or off the coast of Africa. There are booming areas offshore of West Africa and East African plays, with companies like Anadarko Petroleum Corp. (APC:NYSE) and its huge natural gas discovery off of Mozambique. In the Far East, off of Australia, there is a whole liquefied natural gas (LNG) boom. Much of the Australia hydrocarbon story is in offshore LNG. These are huge plays involving great big companies, a lot of money, steel in the ground and lots of equipment that either floats on the water or sits on the seafloor. It is all good for the offshore space.

TER: Are there any particular projects that a BP or Shell is doing right now that you are excited about?

BK: Shell has a big play onshore in the U.S., part of the whole shale gale. Shell is a big global integrated explorer, but is backing away from the offshore East African plays because they are a little too expensive for the company’s taste. Shell has made investments in West Africa, off of Gabon, and also in South Africa, in the Orange Basin. I think Shell envisions itself as a future key player in South Africa, which is good because South Africa is a big, industrially developed country with a large population and big markets. South Africa has ongoing social problems, but it needs energy. So if Shell is successful in offshore South Africa, there’s a built-in market. Shell doesn’t have to tanker oil in or pipe it in or somehow move it halfway across the world.

TER: In light of what happened with BP, are these offshore oil plays riskier, since one accident can shut everything down. Or are large companies like Shell diversified enough that it doesn’t matter?

BK: I will never say that accidents do not matter. As we learned from the Gulf of Mexico, an offshore accident can be a company killer. BP literally went through a near-death experience. In the minds of some people, BP is still not out of the woods. The company has made settlement after settlement and it is still not done paying. It has divested itself of many attractive assets over the past couple of years to raise enough cash to pay settlements, fees and fines.

The good news about the aftermath of the accident is that, globally, there is a heightened sense of safety awareness in the oil industry. Companies have watched the BP issues very closely and learned every lesson they possibly can. All of the solid operators are hypersensitive and hypercautious toward offshore operations.

It all comes back to benefit some of the service players I mentioned earlier. The fact that many offshore drilling platforms had to upgrade blowout preventers to a much higher specification benefited the likes of Cameron and FMC Technologies. In the new environment, your subsea equipment must be built to a higher specification. So say thank you to FMC Technologies—which will gladly build it to that higher spec and charge you a higher price.

The numbers of inspections that companies must do when they work at the surface of the ocean are enormous. If a company has to inspect every 48 hours, it needs more ROVs. Who makes ROVs? That would be Oceaneering. There are other opportunities in other spaces, such as dealing with existing offshore platforms, existing offshore pipelines and existing offshore rig populations. One company that has done very well in our portfolio in the last couple of years is Helix Energy Solutions Group Inc. (HLX:NYSE). It deals with offshore repairs and servicing issues, and offers decommissioning services.

Individuals who go into these kinds of investments want to become educated about them. We are in these investments with a long-term, multiyear horizon because that is the investment cycle. From prospect to producing platform, these kinds of investments can take 10–15 years to play out. It’s like an oil company annuity for the well-run oil service guys.

The good news is that there is long-term reward, because large volumes of oil come from offshore. When looking at the shale gale, on the best day of the year in the Eagle Ford or the Bakken onshore, a really good well can produce 1,000 barrels per day (1 Mbbl/d). Six months from now that well could produce 400 (400 bbl/d), and a year from now it might produce 200 bbl/d. The decline rates are really steep. On some of the offshore wells, we are talking 15–20 Mbbl/d, which can be sustained for several years. The economics of a good well and a good play offshore are for the long term.

TER: It sounds like your advice is for people to do their homework and be in it for the long term.

BK: Yes. My newsletter, Outstanding Investments, talks about oil and oil investments all the time; subscribers receive my views over the long term. As an investor, you want to educate yourself about different companies in the space, what equipment is used in the space and what the processes are. You do not have to be a geologist or an engineer to invest, but you need to be willing to learn. There is an entire offshore vocabulary that you need to understand to appreciate the investment opportunities. You also need to be able to keep your sanity during times of tumult, when the rest of the market might be losing its grip. And you need to understand why you went into a certain investment in the first place and when it is time to get out.

TER: That is great advice. Thank you so much for taking the time to talk with me today.

BK: You are very welcome.

Byron King writes for Agora Financial’s Daily Resource Hunter and also edits two newsletters: Energy & Scarcity Investor and Outstanding Investments. He studied geology and graduated with honors from Harvard University, and holds advanced degrees from the University of Pittsburgh School of Law and the U.S. Naval War College. He has advised the U.S. Department of Defense on national energy policy.

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Oil Exploration in West Africa

By Dave Brown – Exclusive to Oil Investing News

The West African offshore oil and gas industry has a history of exploration of more than 50 years, with international majors and smaller firms having held, and relinquished, licences all along the coast since the British discovered oil in the Niger Delta in the late 1950s. Nigeria and Angola are the largest oil producers in West Africa; however, exploration and development throughout the region is widely dispersed across the countries of Mauritania, Ghana, Ivory Coast, Benin / Togo, Cameroon, Equatorial Guinea, Gabon and Congo.

Interest in Nigerian oil originated in 1914 with an ordinance making any oil and mineral under Nigerian soil legal property of the Crown. By 1938 the colonial government had granted the state-sponsored company, Shell (NYSE:RDS.A) (then known as Shell D’Arcy) monopoly over exploration of all minerals and petroleum throughout the entire colony. Until the late 1950’s concessions on exploration and production were exclusively maintained by Shell, then known as Shell-British Petroleum. However, other firms became interested and by the early 1960’s ExxonMobil (NYSE:XOM), Texaco, and Gulf had purchased concessions.

The deepwater sector still has a large avenue to expand and develop both in Nigeria and throughout the region. The amount of oil extracted from Nigeria is expected to have expanded its operational scope from 15,000 billion barrels per day in 2003 to 1,270,000 billion barrels per day by the end of this year. Deepwater drilling for oil is especially attractive to oil companies because the Nigerian government has very little share in these activities and it is more difficult for the government to regulate the offshore activities of the companies. Deepwater extraction plants are less predisposed to local militant attacks, seizures due to civil conflicts, and sabotage. This permits more resources and alternatives available to efficiently extract the oil, with less potential for conflict than the operations on land.

Recent Developments

Kosmos Energy, a privately held exploration company backed by Warburg Pincus and Blackstone discovered the Jubilee oilfield in an unpromising deep-water area off western Ghana in June 2007. On December 15 2010, the company announced the first phase of production was initiated, expecting to total 55,000 barrels of oil per day this month and increasing to 120,000 barrels of oil per day during the first half of 2011 as additional wells are completed. It represents the beginning of Ghana’s first significant commercial oil production and will allow the country to join the ranks of sizable West African oil  exporters. The production of light sweet crude began only 42 months after field discovery with an accelerated timetable corresponding with one of the shortest cycles for any deepwater floating production and storage and offloading (FPSO) based oil project of scale in deep water.

Anadarko Petroleum (NYSE:APC) had worked closely with Kosmos on the Jubilee well and during the summer of 2009 discovered hydrocarbons with the first deep-water well drilled in the equally unpromising Sierra Leone. Linking the two finds, more than 1,000 kilometres apart, became a new interpretation of west Africa’s petroleum geology which raised the prospect of a new oil province in the West African transform margin, an area between two tectonic plates. The extent of this area extends nearly 1,500 km along the coast from eastern Ghana, across Ivory Coast and Liberia, and to the west of Sierra Leone. In view of the size of the area and the number of prospects already identified, forecasts for the new province’s potential are considerable.

Exploration Growth

Much of the transform margin area is held by small or medium-sized companies and private equity interests, with Anadarko and Tullow (LON:TLW) having the largest exposure to licensing positions over the four countries.  ExxonMobil, British Petroleum (NYSE:BP) and China National Offshore Oil Corporation (CNOOC), possibly in partnership with state-owned Ghana National Petroleum Corporation (GNPC) have also been competing for interests.

In September of 2009 ENI (NYSE:E) acquired majority interests in two licences to the east and southeast of Jubilee. Vitol held the Offshore Cape Three Points and Offshore Cape Three Points South licences in a joint venture with GNPC and made a discovery with its first well in that month. Sankofa-1A, drilled 38 km east of Jubilee, showed 33.1 metres of gas column and 3.2 metres of oil, in a Jubilee-type upper cretaceous structure.

Vanco holds the key CI-401 area off Ivory Coast, the eastern border of which is only 5 kilometres from Tweneboa and only about 25 km from the nearest part of Jubilee. Neighbouring Liberia has seen relatively little exploration in recent times and its deep water remains undrilled. The government held a licensing round in 2004 and awarded three blocks off the western part of the coast, now of great interest following a find in adjacent Sierra Leone waters by Venus.

In addition to companies mentioned, several small firms are understood to hold licences in the transform margin area – the list includes Afren and Young Energy in Ghana, and Edison, Afren, Oranto and Yams Petroleum in Ivory Coast. Yams, a local company, holds a large area immediately south of Vanco’s CI-401, and, therefore, close to Ghana’s discoveries. Many of these small companies are reported to hold 100 percent interests and are likely to require joint venture partners for financing prior to drilling, so a considerable amount of corporate activity exists.

Potential in Guinea

Anadarko’s Sierra Leone discovery also seems to have accelerated activity in Guinea, its westerly neighbour, where Hyperdynamics (NYSE:HDY), holds a licence covering the entire offshore – an 80,000 square km area extending out from the coast by 150-370 kilometres. The company, which apparently has no other operations, has been trying to find a venture partner and in October 2009 signed an outline agreement with the UK’s Dana Petroleum. Dana was subsequently delisted as of October 28, 2010 and the assets are currently owned by the Korea National Oil Corporation.