Going Further and Drilling Deeper in 2006

Barron's Online
By Dimitra Defotis

January 9, 2006

Editor's Note: This week Weekday Trader looks at the innovations and breakthroughs that might occur in 2006 in several key areas: energy, technology, medicine and finance.

EXTRACTING THE REMAINING OIL from the world's toughest terrain once seemed as likely as getting blood from a turnip.

But higher oil prices have filled energy companies' coffers. That has given them the means — and the will — to spend on more capital-intensive, high-tech fossil fuel exploration (such as extracting heavy oil from sand) and seriously develop energy alternatives, including solar power.

Global exploration spending should increase 20% in 2006, according to John S. Herold research, as demand surges, especially in Asia, and big oil companies need to go further afield to meet it.

So, with crude near $63 a barrel and natural gas prices nearly double what they were a year ago, the price is right for new projects and fuels.

“It is a combination of geographies and technologies — small improvements on existing technologies — that will bring growth in the industry,” says Stewart Johnston, a global oil and gas consultant with London-based CRA International.

Or, sums up William Gerlach, manager of the Gartmore Global Resources Fund: “You make hay while the sun is shining.”

Where in the World?

Global oil production tops 80 million barrels per day, as Russia and developing nations such as Equatorial Guinea and Kazakhstan contributed significantly in 2004, according to BP's 2005 statistical review.
But 2006 could be the Year of Kuwait. Its government is likely to open its oilfields to foreign investors this year, says Johnston.

Kuwait holds the third largest cache of proven oil reserves in the world. Only Saudi Arabia and war-torn Iraq have more.

Foreign investment, along with advanced technology, could more than double Kuwait's daily production to one million barrels from 450,000 now, Johnston estimates.

Big oil companies are chomping at the bit — no doubt because putting their stakes in the ground in Kuwait also could open the door for future work in next-door neighbor Iraq, where sabotage has limited production.

And those big oil companies are likely to work with oil and gas services companies, which get long-term contracts for exploratory work, regardless of its outcome, and could benefit even if oil prices fall.

Schlumberger and Weatherford International are two of the leading players among services companies (see Weekday Trader, “Two Oil Services Stocks that Look Slick,” May 12, 2005).

Crude Technology

The biggest exploration companies bring together equipment, sophisticated machinery and experienced people to do what is increasingly becoming energy's next frontier: using advanced technology to go deeper into the earth and under the sea to replace dwindling oil and gas reserves.

In Canada's oil sands, for example, Calgary exploration and production company EnCana is using a newer, lower-cost steam method to draw oil from oil sands, says John Kilduff, senior vice president of energy risk management at Fimat U.S.A., an energy trading brokerage.

EnCana says it is seeking partnerships to expand its oil sands production tenfold in the next decade to 500,000 barrels per day. It is projecting oil prices will average between $50 and $60 per barrel over the next five years, but believes that its projects will be profitable at prices near $40 per barrel.

Kilduff thinks that Chinese energy companies, hungry for oil and gas to fuel their country's nearly double-digit economic growth, may offer partnership financing for tar sands projects.

(Chinese-government-controlled oil company Cnooc on Monday said it will spend $2.3 billion for a 45% stake in a deep-water Nigerian oilfield. The deal would be its first big investment since its failed Unocal takeover bid.)

Chevron, which won the Unocal bid last August, also is diving into deep water for profits, along with three equal partners, including independent E&P Anadarko Petroleum.

In December, it struck oil in the deepest well ever drilled in the Gulf of Mexico — in 3,500 feet of water, drilled to a total depth of more than 34,000 feet.

Several technological refinements helped the project succeed, says Scott McCleod, manager of Chevron's Gulf of Mexico deep-water drilling projects.

They included lengthened drilling pipes, new blade designs on diamond drill bits and use of a new drilling ship — one of the largest in the world.

“The industry continues to push the learning curve,” says Robert Gillon, co-director of Research at John S. Herold, an energy research firm based in Norwalk, CT.

Is There an Alternative?

While new methods and materials help boost oil and natural gas supplies, they are still depleting resources as more people question whether the world's oil production has peaked.

Domestic U.S. oil production peaked decades ago, but some say worldwide production could peak over the next several years (see Weekday Trader, “Oil Output Could Peak, But When?,” Sept. 29, 2005, and Barron's, “Twilight For Oil?” January 2).

Solar energy may be one of the most promising alternatives in 2006 and beyond.

Some of the mostly small, private companies in that area could either go public or be gobbled up by the likes of BP, Shell and GE, all of which have invested in solar energy recently, says George S. Reichenbach, a partner with Braemar Energy Ventures, a venture capital firm focused on start-up energy technology companies.

But investors have to “avoid getting involved in research projects masquerading as businesses,” he adds.

Reichenbach is researching several private companies in the solar panel business. He estimates it generates roughly $3 billion in revenues and there are major manufacturing facilities of panels and related technology in the U.S., Germany and Japan.

Solar technology can be especially cost effective in providing power in locations that are distant from utilities. It can power isolated communities in developing countries or cellular telephone towers and highway signs in remote areas.

And new nanotechnology could double the amount of energy from sunlight produced by today's panels, Reichenbach says. Nanotechnology, which operates on the scale of single atoms, could result in smaller solar-energy panels and open new markets for these companies.

But, Guinness cautions, “many [alternative energy] companies are loss-making.”

And if oil prices fall?

Of course, corporate spending on alternative fuels or expensive extraction techniques requires oil prices to stay well above $40 per barrel.

An economic slowdown in the U.S., or especially China, would reduce oil demand and lower prices.

But threats to the oil supply, including civil unrest in Venezuela or the Middle East, seem more likely, keeping prices higher.

“Oil companies are now accepting that oil prices will stay over $40 per barrel, given demand especially from India and China, and they are now putting in place significant investment programs,” Johnston says.

It's about time. And who knows? If prices stay high and the technology keeps advancing, they may find ways to get oil out of a turnip, too.