I recently caught up with Keith Schaefer, Publisher of the Oil & Gas Investments Bulletin to discuss this topic:
PG: Keith, you’ve been saying Water Is the Next Big Thing in Oil and Gas– what is it about water that’s got you so excited?
KS: The increase in water use in oil and gas, with all this new horizontal drilling and fracking, has been staggering in the last four years. Each horizontal well that uses fracking uses 2-6 million gallons of fresh water. This year in the US, the industry will use anywhere from 70-140 billion gallons of fresh water. That water has a price—a price to source, to use, to recycle, and dispose of. And the price for all of that is growing.
PG: That’s a remarkable amount of water. But, let’s back up a bit and explain to me how water gets used.
KS: OK, quick background–over the last four years, the Shale Revolution has completely changed the oil services sector. Now, in mining, you don’t really have a services sector—there’s Major Drilling and Energold Drilling and a couple others maybe, but in the oil and gas sector it’s a multi-billion dollar business—the drillers, the fluid companies, and now the hydraulic fracturing, or fracking, guys.
All these groups have had to adjust really fast to all the new shale plays—which means buying a lot more equipment for horizontal drilling and hydraulic fracturing—or fracking as we call it. And it’s everywhere now; it accounts for 80% of all new drilling.
Hydraulic means water, and the industry sends huge amounts of water and sand down these long horizontal wells at super high pressure, which goes out into these shale formations blowing them to bits for a few metres around the well bore. This frees-up the oil or gas in the shale to flow out the well and up to the surface.
So fracking has, rightly, come under a lot of new, mainstream scrutiny. People are concerned it might affect their drinking water. While I don’t think that’s true—and lots of science is now coming out to that effect—the amount of water being used is a very real issue.
PG: Can we re-use all that water?
KS: Theoretically we can re-use 60% of it, because that’s how much fracking water comes back up to surface—30% right away and 30% over the life of the well. But the reality is the industry doesn’t recycle it, in fact almost none of it—it gets sent down what’s called a disposal well. And it does have to get cleaned a bit before it gets sent down, but it’s not fresh water again.
PG: So what’s the business model here? Or more specifically, “Where’s the money?”
KS: This industry is so new, it is literally forming before our eyes, and the business model is just being made up as we go along. Just as an example, there are now water pipelines being built in Texas for the industry. This has never happened before.
In some places, like the Marcellus shale in New York and Pennsylvania, there are no underground caverns like out west to dispose of water, so there is a huge trucking industry now being built to get that brackish, used water to disposal wells in Ohio.
In the Marcellus, it costs over $3 per barrel to dispose of water, and another $7-$10 per barrel to haul it away. If a well uses 4.2 million gallons of water to frack (I like to use this number to make calculations more simple, since there are 42 gallons to a barrel), then that’s 100,000 barrels. That’s $300,000 an oil producer has to spend to dispose of water for one well. Hauling could add over half a million dollars more.
So that’s a great opportunity for the right water services company. And that’s just for one well. Now more than 80% of the thousands of wells drilled in North America every year are horizontal and most of those require fracking. The dollar value of managing that water multiplies out fast.
But I think one of the big points here is—the industry is just starting to formally cost out all these things after having it just be part of general expenses for a long time. And another thing is that each oil and gas basin in the US has very different water needs. So the business will be very different.
But overall, the political pressure and the regulatory pressure around water use is only going to get more stringent, and the producers are going to have to document and cost everything now.
PG: Yes I read in the media all the time about how fracking could contaminate drinking water.
KS: Honestly, I don’t see that as an issue—and the science is bearing that out time and again—but that kind of pressure is forcing the industry to change the way it does business. And this is a good thing—not just for the environment, but for investors.
North Dakota said in mid-March they were about to ban all water pits at well sites. These oil and gas producers were just storing their frackwater in lined pits they dug in the ground. They could and did seep into the ground, and water management was difficult because of evaporation in Texas or freezing in North Dakota.
And 50% of all wells in the US have these pits still. What’s happened is the industry has responded with a bunch of different new types of water storage tanks, which cost a lot less and store a lot more water than before. The companies that make these new tanks are selling or leasing them like mad, with fantastic margins.
PG: OK, we’ll get to that but…I want to get back to recycling—that just seems to me to be a lot of fresh water just gone…year after year. What’s happening with recycling these billions of gallons of fresh water?
KS: Great question. I think this is the Holy Grail of the water services sector. Right now there are several competing technologies, some start up, some with established customer bases, that are trying to get market share. Some are public, some are private. But there is no clear winner yet. And that’s because there’s no clear business model yet either. Producers hardly know what to pay. But the good news is they want to do this. They are desperate to be seen as “green”. So they’re willing to pay.
But right now, sell side analysts are modeling costs to producers—which is revenue to water services companies—of just under 2 cents a litre or just over seven and a half cents a gallon treatment charges. That recurring revenue model should be very lucrative for the industry—if that’s the way it goes. I think it’s too early to say but that’s what service co’s are aiming for.
PG: So what are some of the companies you’re looking at, and what do they bring to the table?
KS: A couple of companies that I follow are Heckman Corp. (NYSE: HEK) and Ridgeline Energy Services (TSX-V: RLE)(OTCQX: RGDEF). Each has a different approach to the space.
Heckman is trying to be a one stop shop for water for the oil and gas industry. But because most of its work is in natural gas, and natural gas prices have been really, really low lately, Heckmann’s stock has been hit hard. The market is thinking that a lot of natural gas drilling will have to stop and that could hurt their revenue. I own it at higher prices than the $4 it’s trading at now. It’s a small position and I’m not a buyer or a seller here—more of a watcher.
Ridgeline has just sold their first water purification and recycling system to an oil and gas producer—EOG. They’re getting paid on a per gallon charge, but didn’t say how much. To me, this getting-paid-by-the-gallon charge is the Holy Grail of the water services sector, and Ridgeline has a technology that’s getting an early adopter willing to pay.
EOG is a big company and could order lots of these units just on their own. I think EOG will roll out several this year and then we’ll see Ridgeline start selling to more clients in 2013.
PG: And you are willing to offer my readers a free report on a couple of companies?
KS: Yes—two companies actually. I think Ridgeline’s system—which can be used in other areas like municipal waste water treatments—has a bright future. I confess I’m not a buyer of the stock today, but later this year as I get a sense of 2013 revenue potential, I plan to revisit the stock.
PG: Ok then. Is there anything else about the oil and gas industry you want to tell us?
KS: Well, your audience knows about junior mining. So the key thing I would tell your readers is that they should think of these new shale oil and gas plays as potash plays. Like potash, these shale plays are very consistent geological formations that often go for tens of miles. Once you hit one good well, there’s a good chance you will hit on your next 50 wells. Most companies I invest in have a success ratio of 90-100%. 3D seismic makes almost every hole after the initial hit just like development drilling in a mine.
And, one of the companies that I think can have this kind of success is the second free report I want to offer your readers. It’s one of my favourite junior producers with a great land position in the heart of the Bakken shale oil play in North Dakota. They start drilling late April. I’ve told my paid subscribers to take advantage of this pullback.
To download my two free reports today, simply go to: http://oilandgas-investments.com/get-two-reports-from-the-oil-and-gas-investments-portfolio/
PG: Folks we had Keith Schaefer with us today, editor of The Oil and Gas Investments Bulletin and you can read his free blog at www.oilandgas-investments.com. He publishes two free stories a week on a wide variety of oil and gas topics, and sometimes he talks about specific stocks.
Keith, thanks for talking with me today.
KS: My pleasure. Thanks for having me.