"Oddball Oils"

10/14/2005 12:00 am EST

Focus:

Jim Jubak

Founder and Editor, JubakPicks.com

"The heady rise in energy shares may be tapped out, but there are ‘unconventional’ producers could have another great year," notes Jim Jubak. Here, the columnist for CNBC on MSN Money offers a look at a trio of "oddball" oil companies primed for profits."

"The shares of what are called ‘unconventional’ producersthose companies that mine oil sands or oil shale or drill in rock formations that other companies won't touch don't need rapidly rising oil prices to beat the market. Steady oil prices will do fine, thank you. The longer oil stays above $40 a barrel, the more credible the production and revenue projections of unconventional oil producers become and the higher their shares climb. That's not because these unconventional producers are sitting on so much cheap oil. Exactly the opposite, in fact. It's because their costs for producing a barrel of oil are so high.

"Here's how high production costs become an advantage. Consider one type of unconventional producer, one working in Canada's oil sands. The amount of oil locked up in these oil sands is huge. They are estimated to hold 174 billion barrels of recoverable oil, the second largest reserve in the world next to Saudi Arabia. But to get the oil out you have to mine the sands, ‘boil’ them to extract the oil that's mixed in, and then process it so that it can be refined by conventional refineries. All that costs lots of money. Many unconventional producers are looking at production costs of $25 a barrel.

"Now, look at the leverage. At $25-a-barrel oil, these unconventional producers are interesting ‘concept’ companies: At $30, they are handsomely in the black. Suddenly, their shares are supported by revenue and earnings. At $40 a barrel, unconventional producers can easily tap the capital markets to raise the money they need to expand production, and then reap the higher revenues that result. And at $40, major conventional oil companies and sovereign countries such as China that are hungry for new sources of oil begin to acquire unconventional oil production companies. This same leverage kicks in for oil companies producing oil from oil shale or by drilling deeper into more complex rock formations than most oil companies attempt.

"These unconventional plays aren't just another source for oil companies hungry for oil wherever they can find it. Unconventional sources of oil are remarkably predictable. A company doesn't have to sink a test well into a promising geological formation and hope for profitable amounts of oil and gas. With unconventional sources such as oil sands and oil shale, the oil company knows the oil is there and ready for the pumping if they sink enough money into the project. Here, I recommended the shares of three unconventional producers.

"Quicksilver Resources (KWK NYSE) offers a portfolio of unconventional oil and natural gas assets: fractured shales, coal beds, and tight sands. At the end of 2004, the company had estimated proved reserves of 968 billion cubic feet of natural gas equivalent. Oil shale in Michigan, Indiana, Kentucky, and Texas account for about 680 billion cubic feet of the company's natural gas reserves. The company's coal-bed methane wells in Canada, where Quicksilver Resources plans 280 new wells, have just started commercial production. Oil sand deposits in Montana with about 40 billion cubic feet of gas equivalent rounds out the company's portfolio. Our StockScouter rating system rates these shares a 9 out of a possible 10.

"The major unconventional asset at Carrizo Oil & Gas (CRZO NASDAQ) is its leases and lease options of 45,000 acres in the Barnett Shale formation in north Texas. This natural gas field stretches over 5,000 square miles and may be the largest onshore natural gas field in the United States. What makes this field unconventional? Natural gas companies have had to drill deeper than they initially expected and to employ expensive and initially experimental techniques for fracturing the shale to get at the gas. Using price comparisons from recent deals, Carrizo's Barnett gas reserves are worth $24 to $30 a share, KeyBanc Capital Markets calculates. The company also produces gas along the Gulf Coast, owns coal bed methane gas leases in the Rocky Mountains and has an exploration program in place in the North Sea. Our StockScouter rates the shares a 7 out of a possible 10.

"Ultra Petroleum (UPL ASE) controls 93,000 acres in the Jonah natural gas field and the Pinedale Anticline in Wyoming's Green River Basin. Gas was first discovered here in 1939, but the problem has been getting it out at a profit. The geologic formation consists of interbedded shale and sand. Thanks to the very low permeability of the sand, gas will flow out of the formation but only at very low rates. New technology applied in the 1990s increased the flow to commercially viable rates and high gas prices have done the rest. The big question for Ultra Petroleum, and for investors: How much gas does the Pinedale Anticline hold? It remains too early to say anything about the potential size of this reserve. More test results are expected later this fall or in early 2006. The company is also looking to get from Wyoming next year to increase the density of its wells on Pinedale to ten or 20 acres per well from the current 40-acres-per-well spacing. That will increase production from the Pinedale field. Our StockScouter rates these shares a 10 out of a possible 10."

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