Geologists,
Geophysicists and Engineers
Energy
and Mineral Advisors Since 1982
181
MARIOMI ROAD NEW CANAAN, CONNECTICUT USA 06840
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www.ammoniteresources.com
SPRING 2011 NEWSLETTER AND GLOBAL ENERGY
OBSERVATIONS
To: Clients, Those we would like to include as
Clients, Ammonite Consultants, and Friends
From: Skip Hobbs,
Managing Partner
Re: Events of the
Past Year and Industry Observations
Dear Friends and Associates;
The global energy
industry over the past couple years has been a whirlwind of change and
volatility. Through our work as Ammonite Resources, petroleum consultants to
capital providers for the energy industry, oil and gas companies, and
government agencies; the experience I have had as the current President of the
American Geological Institute; a member, and now board member of the Council of
Scientific Society Presidents in Washington, D.C.; and through the experience I
have had as a principal in Ammonite Nova Scotia Corporation, the holder of two
large exploration licenses offshore Eastern Canada; I can ever so modestly say
that I have had a very “good seat” from which to observe the “pulse” of the
industry. I would like to share some of
my observations with you, so please don’t press the “delete” button now, but
print this out for a quiet read when your phone is not ringing.
Future of the Global
Oil Industry
Over the
past four years I have been presenting a speech at domestic and international professional
meetings titled “The Future of the Global
Oil Industry: The Resources and the Challenges”. The talk covers global oil
and natural gas supply and demand; where the future resources will be
developed; and the geopolitical, economic and national policy challenges the
impact supply and demand. A related talk
I have presented is titled “A Failed
Energy Policy: Implications for the USA and Planet Earth”. As an officer of a
major geoscience professional society, I have been able to obtain data and
supporting slides from major oil and gas companies, service companies, research
firms such as IHS Herold, from various government agencies, and from the
American Association of Petroleum Geologists, and the American Geological
Institute. The talk is continually
updated.
So what is
the principal observation/conclusion resulting from this four-year process?
When oil and gas prices peaked in early 2008, global demand was around 86 MMBO. The OECD economies have not fully recovered
from the financial devastation of 2008-2010, yet demand once again exceeds 86
MMBO/day, and global oil prices have now spiked over $120/barrel. Turmoil in
the Middle East, and the failure of the USA
to legislate a rational energy policy, and the decline in the US$,
adds to the uncertainty over future supply, demand and commodity prices. The
earth is still richly endowed with hydrocarbon resources. We are not running out of oil, nor are we at
“peak oil” in terms of proved and unproven hydrocarbon resources. The “problem”
is one of inadequate infrastructure to produce, process and deliver petroleum
to the end-user in the face of rising demand from the new global “consumer
class”; failed energy policy; monetary policy, and geopolitical conflict. I do not see international (Brent) oil prices
dropping much below $100/barrel anytime soon. The USA, which consumes 25% of
the world’s crude oil and refined products, could have a very significant
impact on future demand, and upward pricing pressure if the nation were to
implement an energy policy that called for strict miles/gallon standards for
all vehicles (35+ miles/gallon) by 2016; discouraged gasoline consumption by
imposing a new federal excise tax of $0.50 in 2011, rising to $1.50 in three
years; mandating strict energy conservation measures for all buildings and
electric appliances; promoting a transition to a natural gas economy; and
promoting the “green economy” through continued tax credits and regulatory
certainty.
Cheap and
abundant energy has made America
great, but the business model is no longer sustainable in the face of rising
global demand and the environmental impact of an unfettered fossil fuel
economy. Every drop of oil and natural gas will be produced, and sold at a good
price; therefore, petroleum companies
should not feel threatened by a “greener” energy policy.
Shale Gas and Oil
Plays
Shale
plays, and now shale oil plays, have been the main focus of late. Ammonite has reviewed dozens of new ventures
in the United States,
Canada, and
internationally. Houston based Senior Exploration Advisor Dr. Robert Merrill
has developed a good proprietary screening matrix and a Monte Carlo
model for projecting resource estimates. Our Chief Petroleum Engineer Lynn Pittinger
has prepared many normalized production profiles from published well data, and
is concerned that many EUR reserve projections represented by certain public
companies are much too high. Attractive IRR projections for shale plays are
regularly touted at energy investment conferences; but in our experience, many
of these are made for a “typical” development well, and do not include all
lease, infrastructure, and reclamation costs.
Often the “model” production profile is based on the initial “sweet
spot” wells, and does not reflect development of the entire leasehold, where
production will be log normally distributed.
As the
unconventional plays mature, we are seeing many submittals on the peripheries
of the plays. Some developers are making representations that are simply not
geologically supportable. For example, we recently reviewed a proposal to
finance a gathering system in the Marcellus Play in Pennsylvania. The area to be served by the gathering system
was not in the heart of the play; yet the production profiles and reserves
represented to the private equity financier were from the “sweet spot”. Ammonite pointed out that the Marcellus in
the subject area was half the thickness and about 1500 feet shallower than the
wells for the alleged “analog”. We also
recently reviewed a resource report (note – I wrote “resource”, not “reserve”)
by a well-known engineering firm, that purported to represent the potential
resource from an emerging shale play. The numbers looked fabulous, but we had
to point out that the purported resources were completely hypothetical as there
are only limited, albeit encouraging, well tests, and no established production
from which production profiles can be established. These instances demonstrate
the importance of good investment due diligence.
There is a
lot of interest in international shale plays. The perception is that a company
can apply what it has learned in the USA
and Canada, in
for example, Germany,
Australia, Algeria,
or in Argentina. There are many international opportunities, but
the competition from the majors and large independents is also intense. Every
traditional “source” rock is now a candidate, but subtle and not so subtle
differences in stratigraphy, tectonics, petrography and geochemistry will
determine the winners and losers.
Internationally, one must also pay very close attention to license
terms, surface culture, markets, and geopolitics.
Colombia
Colombia
has been a “hot spot” for emerging independent oil and gas companies. Ammonite
has evaluated numerous new company submittals in Colombia. In December 2009, The Colombian National Hydocarbon
Agency (ANH) engaged Ammonite as its advisor for the 2010 area-wide leasing
round. During January 2010, Ammonite’s Dr. Robert Merrill, Dr. Steve Schamel,
and Skip Hobbs worked closely with ANH in Bogota,
reviewing geological, geophysical and other data from 13 different basins
across Colombia,
for the purpose of preparing the 2010 Colombian Round presentation to the
international petroleum industry. We
developed a three-hour PowerPoint presentation on the petroleum prospects of
Colombia’s mature, emerging and frontier basins for the ANH “road show”, and
introduced the presentation with a 30 minute overview in Houston, Calgary and
London. We like Colombia
very much in terms of its future geological potential and the regulatory
environment. Three-D seismic from the Llanos
Basin looks very similar to that
from the Canadian Western Sedimentary basin in Alberta,
and indicates the future potential for stratigraphic plays, as in Alberta.
Drilling density in the Llanos, Putamayo and Eastern Cordillera basins of Colombia
is 1 well per 200 km2 versus 1 well per 2.5 Km2 in the
Western Sedimentary Basin of Canada.
Private Equity Trends
The trend
in private equity energy investing over the past several years has been to back
proven management teams for their Newco #2, or #3 “re-loads”. This naturally
means less work for Ammonite, for as one manager put it, “we don’t need you to
tell us that “Mr. Big” knows what he is doing, nor review the assets under
consideration, because at this point, there aren’t any.” However, there are many attractive “asset”
opportunities in the hands of unproven management teams. The challenge is to find some good managers
who can be brought in to mature the business plan, and to provide a high level
of confidence in the ability of the company to execute its specific strategy.
Everyone
has been so focused on shale resource plays over the past five years that we
believe it is time to look again at conventional resource opportunities. Lease costs are down, there are many 3D
surveys available in the traditional plays which can be reprocessed with new algorithms
to find by-passed drilling objectives, and many of the “traditional” prospect
generators are very hungry for work.
Good deals can be made!
Geothermal Energy
Over the
past three years Ammonite has evaluated dozens of geothermal projects in the United
States, and some in Europe.
Earlier in his career, Lynn Pittinger, our Chief Engineer, worked on Unocal
geothermal projects in the USA,
Indonesia and
in the Philippines. We like the resource. Our work has generally
been to review the proposals submitted to Ammonite’s private equity
clients. Included in the submittals are
engineering reports on the geothermal resource prepared by “big name”
engineering firms. After reviewing many of these reports, we have concluded
that some projects are being recommended based on a limited understanding of
the geology of the deposit, and with projections of the resource magnitude, and
its production profile, based on limited and sometimes incomplete data. The geothermal industry is, in our opinion,
less sophisticated then the petroleum industry in understanding and modeling
the reservoir. In one instance we found that the engineering firm had assigned
“proved reserves” to undeveloped locations on the other side of a sealing
fault. We made recommendations to the operator regarding how “proved reserves”
should be defined for a geothermal resource, using the petroleum reserve class
definitions as a model.
Mineral Resources
The boom in
commodity prices has sparked a renewed interest in mineral exploration. Over
the past year Ammonite has looked at a number of gold prospects, an industrial
mineral prospect, and recently, a titanium deposit in Chile. Denver-based consultant David Abbott is
Ammonite’s principal mineral investigator. David was once the geologist for the
SEC’s former mining office in Denver.
We love
mineral ventures, but beware! Good due
diligence is absolutely necessary. Many
submittals are re-incarnations of old prospects which were uneconomic in a
lower commodity price environment. You must understand the statistical
significance of core hole assay data, and the stages of maturing a mineral
prospect to a commercial mine (David is an expert on this). Environmental
considerations are particularly important in old mining districts. We are being considered as potential experts
in an international mining investor lawsuit, where the public company represented
“average run of the mine” ore assays from samples taken from a high-graded ore
pile. It can now be disclosed, that I
was the “behind the scenes” expert consultant for law firms which represented
the class of investors in the United States
in the CDN$ 6 billion Indonesian Bre-X gold scandal in 1997. Yes Virginia,
fraud does occur in precious metal mining ventures!
Observations of the
President of the American Geological Institute
I have been
greatly honored by my professional peers to have been elected president of the
American Geological Institute (AGI).
This organization is a federation of 49 geoscience professional
societies with over 120,000 members. AGI
member societies cover the geological, and geophysical and planetary sciences,
including water, soils, atmosphere, earthquakes, volcanoes, fossils, oil and
gas, mining, and geoscience education. The AGI maintains a professional staff
of over 60 full-time employees in Arlington, VA,
runs a global internet geoscience database of over 3 million references,
develops K-12 earth science curriculum and textbooks, engages in geoscience
workforce studies, and runs a comprehensive government affairs program.
Congress regularly calls on AGI to identify leading experts to testify at House
and Senate hearings on such subjects as earthquake hazards, water resources, mineral
resources, energy policy, climate change, and most recently – rare earth
minerals.
As
president-elect, and now president, and next year, past-president of AGI, I was
invited to become a member of the Council of Scientific Society Presidents
(CSSP), a semi-“think tank” organization in Washington,
D.C. that represents nearly every science
except the medical sciences. CSSP has
about 1.3 million scientists in its 70 member professional societies. The CSSP
is regarded highly, like the National Academies of Science, by policy makers in
Washington. The group holds two
3-day conferences each year to discuss a range of topics of scientific and
public policy interest. Invited speakers – leading scientists, congressmen and
senators, and senior government officials, present prepared remarks followed by
a 30-40 minute discussion period, and then a coffee break, during which time we
can talk directly with the speakers. Access to the top officials has been
phenomenal. For example, I have been able to personally discuss climate change with
Dr. John Holdren, President Obama’s Chief Science Advisor – and then had lunch
with him, and Dr. Marcia McNutt, Director of the US Geological Survey;
discussed the viability of building renewable energy vs. fossil fuel electric
power plants in the developing world with Dr. Robert Zoellick, CEO of the World
Bank; and discussed our lack of a national energy policy with Rep. Bart Gordon,
former Chairman of the House Science & Technology Committee. In December, David Hayes, Deputy Secretary of
the Department of the Interior - #2 under Secretary Ken Salazar, addressed the
CSSP on the drilling moratorium in the Gulf of Mexico.
Hayes told me over coffee that as scientists we did a fabulous job in finding
and producing oil and gas in very challenging operating environments. However, he said, that the scientists and
industry had let the country down in not being able to readily kill a blow out
in deep water, and in failing to design and have available the equipment to
rapidly deploy and contain and capture spewing oil. Hayes said that until the
offshore industry can demonstrate to the government and public, that there will
not be another Macondo, and should a blowout occur in deep water, it can
rapidly contain it, there would be no new deep water drilling permits. Fortunately,
the industry was able to demonstrate this ability, and drilling permits are now
being issued – albeit very slowly.
As someone
who is a geologist within the oil industry, and a political conservative, I
have been a skeptic about the anthropogenic factor in climate change. Climate
has always changed over geological time. However, in my role now as President
of the American Geological Institute, through interactions with scientists of
all disciplines – and especially the ones doing climate studies; meetings with
government officials; plus, reading of National Science Foundation funded
climate studies, and various scientific society position papers, I have made a
180 degree shift in my attitude towards the impact of fossil fuels and humans
on climate. As a former “nay-sayer”, I now believe the preponderance of the
scientific evidence supports a significant anthropogenic contribution to global
warming and ocean acidification. The biosphere simply cannot adjust to the
accelerated rate of change resulting from the burning of fossil fuels and
massive deforestation. The website of the Geological Society of London has an
excellent position paper on climate change which explains “all” at http://www.geolsoc.org.uk/gsl/views/policy_statements/page7426.html.
We have a
serious earth-changing problem with CO2 and other greenhouse gases
in the atmosphere; and must deal with it - now.
The public and Congress simply do not understand the science, the
problem, and the need to make changes in our sources and consumption of primary
energy. Fossil fuels provide 84% of USA
energy, and even with all green energy initiatives included, the EIA projects
fossil fuels will still supply 78% of the nation’s primary energy by 2035. In absolute terms, the US
will consume more coal and petroleum in 2035 than it does now. It is essential
for the sustainability of “planet earth” and the well-being of its human
occupants that we and the rest of the world significantly reduce CO2
emissions. How we do so is indeed a major technical, political and economic
issue, as is getting China
and India to
participate. The longer we delay the
process, however, the more costly it will become to adapt to, and mitigate, the
changes that are already occurring.
We hope
that your investments in energy and mineral resources in 2011 will be a
success. It is going to be a very exciting year given the geopolitical uncertainties,
and the insatiable demand for commodities as the developing world enters the
modern “Consumer Age”. Please keep Ammonite in mind for your due diligence
requirements. We offer unparalleled
expertise and a thorough understanding of both the technology and business of
natural resources. We are not a big firm, and have no junior associates. This
means that you will get our undivided attention should you require an
independent, objective review, on a potential energy or mineral investment
opportunity. I shall look forward to your call.
Yours very sincerely,
Skip
G. Warfield Hobbs
Managing Partner