Renewed Faith in Oil and Gas

Source: Brian Sylvester of The Energy Report  (12/27/11)

According to Jim Letourneau, author of the Big Picture Speculator, oil and gas aren't going away any time soon. Indeed, new technologies offer the industry and investors profitable opportunities. Read more about why Letourneau considers shale gas, shale oil and enhanced oil recovery "game changers" in this exclusive Energy Report interview.

Companies Mentioned: Daylight Energy Ltd. - GasFrac Energy Services Inc. - Shoal Point Energy Ltd. - Wavefront Technology Solutions Inc.

The Energy Report: Jim, in a nutshell what is the big picture in the oil and gas space right now?

Jim Letourneau: Despite a big renewable trend, oil and gas are still critical to world energy markets. We will need both for the foreseeable future, at least the next decade.

TER: You recently wrote about fear paralyzing the market. What effect is fear having on you as a newsletter writer?

JL: When people are scared, they want dividends, U.S. dollars and precious metals. No matter how interesting or exciting the company is, in a really strong bear market it will not matter unless the assets are productive today. People will look at a mine that is in production and has cash flow. A project that involves lots of drilling to build out a deposit is a tougher sell.

Most newsletter writers, myself included, do not like talking about companies whose stocks do not appreciate. Fewer people want to be invested in the stock market because they don't see why they should be. However, even that can be an opportunity. When people are fearful, sometimes the market can turn and have a really nice run. If we do not have new lows over the next couple of months and the trend changes, we would hypothetically be able to enjoy that for quite some time.

TER: Some oil and gas companies are boosting dividends in an effort to get attention in the market. Do you expect that to continue?

JL: That is a way of showing off, of saying "Look, we are so comfortable with our business model that we can afford to pay out dividends." If there is a bull market in dividend-paying stocks, there also could be a time when that popularity will end. It could be just a passing phase.

TER: But it does provide a bit of flexibility: A company can increase or decrease its dividend. It is one of the cards a company can play if it has a lot of free cash flow.

JL: Exactly. Some of the major gold producers are increasing their dividends. Everything else being equal, I would rather have a dividend from a gold producer than from a financial institution. Banks will tell you everything is great until the day before they collapse. If people are looking for dividend-paying stocks, at least gold mines or oil and gas companies have productive assets; they produce something of value. That's where I would concentrate.

TER: That seems to be where the Chinese are concentrating. Sinopec just bought Daylight Energy Ltd. (DAY:TSX) for a little more than $10 a share, more than double the closing price the day before the bid. Do you think China will continue to turn its dollars into hard assets while dollars still have value?

JL: The short answer to your question is yes. China is making acquisitions all over the world every day of anything that is productive.

It tells you something about the state of the market that Canadian investors thought Daylight was worth less than $5/share and China waltzed in and paid $10 without any haggling at all. This was an opportunistic move by Sinopec.

Chinese companies have taken the clever strategy of going for lesser-tier companies. If they go for a bigger one, they will take a minority interest so it is not seen as a takeover.

TER: What did Daylight have that the Chinese wanted?

JL: Daylight has oil, natural gas and high-content natural gas liquids in a few different plays in western Canada. The Chinese are buying companies with the potential for productive assets.

I think China also has a very long-term horizon concerning its energy policies. The country is willing to invest in the long term over a broad portfolio of energy sources. The Chinese know that all the investments may not all work out, but they can afford to do it.

We are still building out the capacity to export natural gas from North America. If that happens, our low-price North American natural gas will be very attractive to China.

TER: At a recent investment conference in Montreal, you told the audience about three "game changers" in the oil and gas space: shale oil, shale gas and enhanced oil recovery (EOR). Can you please give our readers the nuts and bolts of your presentation?

JL: All three of those things involve new technologies that are squeezing more oil out of the ground than we ever thought possible.

In terms of shale oil, the best example is the Bakken in North Dakota and Saskatchewan, and possibly Montana and Southern Alberta. The Bakken really changed the oil and gas landscape in North America to the point of using trains to transport gas from North Dakota to Texas. And there are a lot of other source rocks that have the same characteristics and will be developed over time.

Shale gas was actually the first big game changer. Five years ago we were building natural gas import terminals because we thought we would run out of domestic natural gas. Today, North America has the cheapest natural gas in the world and we are building export terminals. It started in Texas, in the Barnett Shale. For every argument that says shale gas will not work, there are arguments that say it will. A lot of the technical problems that exist today will be solved in the not-too-distant future. That is one of the reasons I am not a huge believer in peak oil; yes, you can extrapolate present-day trends, but you cannot predict what human innovation will come up with to increase supply.

That leads to the third category, which is enhanced oil recovery. Big picture, roughly a third of the oil that has been discovered has been produced. Getting the next third out will take some innovation. There are a lot of interesting technologies in EOR that make it quite likely that the next third will be produced. Recovery factors can move up from 33% to 50% or 60%.

TER: I see your point on shale oil and EOR. But gas prices on the NYMEX are at record lows. Very few companies can make money at that level. The only shale-gas companies seeing an uptick in their share price deal with natural gas storage, and they are running out of places to put it. How can an investor make money in shale gas?

JL: There are two sides to the story. First, abundant, cheap shale gas is good for consumers of natural gas. Second, all commodity bull markets end.

Natural gas is not the best place to invest, but, it does point to the opportunities. The service companies that unlock the shale gas are doing fairly well. I suggest that people look not so much at the producing side but more on natural gas being used as transportation fuel. Some petrochemical industries and the steel industry will benefit from cheap natural gas. So, you have to be a little bit nimble.

TER: Could you give our readers a name or two in the shale-oil space?

JL: I really like Shoal Point Energy Ltd. (SHP:CNSX) because not too many people pay attention to the company. It discovered Green Point, an oil-in-shale play in Port au Port Bay in western Newfoundland. The Green Point shale can be over 2,000m thick, compared to the Bakken, which is typically 30m thick. The extra thickness really changes the amount of oil per section. Shoal Point has an oil-in-place number of at least 100 billion barrels, calculated from volumetrics. Production will be the challenge, but that is just too big a resource to ignore.

TER: The company also has the Ptarmigan oil-in-shale play in Newfoundland and the South Stoney Creek gas play in New Brunswick. How is Green Point progressing?

JL: There was a delay for further testing and Shoal Point had to wait for permits. Investors got a little discouraged because everybody wants results right away, and the share price languished.

Now, the company has the permits and will deepen the well and test it soon.

TER: In other Newfoundland oil projects, the provincial government has wanted a piece of the action. Does the government have a piece of this?

JL: I'm not sure. But, I cannot imagine Newfoundland not having a royalty interest because that is typically how we do things.

TER: Are there other shale oil plays?

JL: There are a lot in the Alberta Bakken, in Montana and southern Alberta, where that play has yet to really ignite and catch on fire. Companies are also looking in the Duvernay in Alberta. That is a deeper, Devonian shale that sourced a lot of the Leduc oil.

TER: Do you have any names in the shale gas space?

JL: Given that the price of that commodity keeps dropping, one way to play shale gas is through service companies. GasFrac Energy Services Inc. (GFS:TSX) has gotten a lot of attention for using gelled propane as the carrier fluid instead of water.

There has been a lot of concern about the use of water in fracking. Very few people realize that most oil and gas production in North America involves about 10% oil and 90% water.

People like GasFrac because it does not use water. But more importantly, in certain types of formations having a liquid hydrocarbon that changes to the gas phase when the pressure drops helps avoid the formation damage and other problems that can happen when you use a massive water-based frack.

TER: In terms of enhanced oil recovery, what names are you following?

JL: There are very few specific companies; usually it is an oil company with a project. One that I have been following for a long time, and worked for, is Wavefront Technology Solutions Inc. (WEE:TSX.V).

All versions of EOR involve injecting a fluid. It could be water, CO2, chemicals or nutrients. The more uniform and evenly distributed those fluids are, the better the process will work. Wavefront has patented an injection process that provides that uniform fluid distribution.

The company is not quite profitable yet, but the growth will come quickly from its Powerwave application for EOR.

TER: Wavefront now has a market cap of around $68 million (M). It would not take long for a major producer to get older assets to market if this technology works as well as you suggest.

JL: The biggest upside for oil companies using the technology is that they can increase their reserves without infill drilling. The oil industry does not just jump and try new technology; it likes to see some proof. Wavefront now has proof. The longest Powerwave installation is over four years old. It has numerous case studies that document how the technology works and how it makes money for the client. It has made the transition from an unproven technology to a proven technology. It is now a commercial technology with a lot of upside.

Wavefront is essentially a technology company that licenses its technology to oil companies. Wavefront will not have a lot of additional expense to sell 100 tools or 150 or 200. The scalability is exciting.

TER: If a major can apply that technology in its old basins, it would not take long to reach perhaps, $70M worth of oil.

JL: Definitely. Of course it depends on the size of its fields, but increasing ultimate production by 5-10% provides some big numbers. More and more people are seeing exactly that. Wavefront could become a takeover target. The company has roughly $24M in cash. It has a lot of staying power.

TER: Jim, what should investors be keen on in the oil and gas space in 2012?

JL: I would still look to oil and gas service companies with the right technology. Shale gas fracking companies are interesting plays to look at.

I would not be too excited about natural gas producers. Those producers who are moving toward liquid rich natural gas are a little more interesting.

Overall in the oil space, the only thing that would move oil prices any higher would be severe geopolitical tension. And I wouldn't be shocked to see some unpleasant geopolitical tension in 2012. Economic news is creating tension all over the world. When that happens it's usually pretty bullish for energy prices.

TER: Jim, thank you for your time and insights.

Jim Letourneau is a public speaker, geologist, corporate evangelist, and investor in emerging technologies and discoveries.

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DISCLOSURE:
1) Brian Sylvester of The Energy Report conducted this interview. He personally and/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: None. Streetwise Reports does not accept stock in exchange for services.
3) Jim Letourneau: I personally and/or my family own shares of the following companies mentioned in this interview: Shoal Point Energy Ltd. and Wavefront Technology Solutions Inc. I personally and/or my family am paid by the following companies mentioned in this interview: Shoal Point Energy Ltd. and Wavefront Technology Solutions Inc. I was not paid by Streetwise for participating in this story.