ELH article-
A Promise Still to Come
by Keri Korteling
July 26, 2002
California’s infamous power blackouts and astronomical natural gas prices in 2001 sparked a drilling frenzy in the San Joaquin Valley that rivalled the dot-com bubble for hyper-activity in the stock market.
But nearly two years later, the promised gas bonanza of East Lost Hills and other San Joaquin plays are still just that – a promise. Natural gas prices are back to normal, and the economic slump has shredded the original rosy demand forecasts.
The many companies large and small that bet the farm on a quick payout are now struggling to keep the play alive, hoping that the next gas price and power demand bubble is just around the corner. No one really talks about the San Joaquin any more. It has returned to its status as a sleeping giant.
That first wave of wild catters included Pyr Energy (AMEX: PYR) and Berkley Petroleum. Denver-based Pyr, last year abandoned one of its prospects in the East Lost Hills area of the basin. Pyr has not reported any recent developments in California. Berkley was snapped up by one of the two majors now operating in the area. Anadarko (NYSE: APC) bought the Calgary-based firm in February of 2001 for $777 million and $250 million in assumed debt.
Tiny Elk Point Resources (TSX: V.ELK) continues to work alongside Anadarko, but not without having incurred some substantial capital costs. Other players have maintained their exploration programs in the area, but investors are suspicious about the play, preferring to remain on the sidelines.
Spectacular blowout
Drilling for petroleum products in the San Joaquin Valley is nothing new, with more than a century of production coming out of the dry lands of Kern and Solano counties. Interest in the area lit up literally with a massive blowout at Berkley Petroleum’s Bellevue #1 well in November of 1998.
According to the San Joaquin Geological Society, the well burned petroleum from the Temblor Formation at estimated rates of 40 to 100 million cubic feet of gas for two weeks, fueling a rush to stake land in the basin along with the corresponding stock frenzy.
The basin became crowded with exploration initiatives involving a tangle of partners with a myriad of joint venture and working interest initiatives as juniors and dreamers tried to grab a piece of the pie.
There is little doubt among the many players involved – the explorers, the bankers and the analysts – that substantial deep gas reserves exist in the San Joaquin basin. However, the trick, according to at least one analyst, is to get information that will lead to more precise prospecting of high deliverability wells.
"Our view has always been that even though it’s a very mature oil producing province, the deep zone really is wild cat exploration," says Andrew Boland, a Principal and Small-Cap E&P Analyst at Peters & Company in Calgary.
Drilling 20,000 feet or more than 3 miles into the earth to get at the reserves means that operations are slower: for example, pulling the drill stem to the surface takes two full days. At that depth the wells are highly pressured, complicating the completion process.
Complex geology
The geology is complex. "They are gas charged tight rocks in general with a fracture component," says Boland. "The difficulty has been trying to map the fracture sets so that you can find high deliverability wells."
The bigger picture for gas has not been positive. Prices are lower, and the ability to hedge has been curtailed by the scandals afflicting energy merchants like Enron and Dynegy (NYSE: DYN), according to Ed Fetzer, an investment banker with C.K. Cooper & Co.
"You are facing the full economic costs of commodity fluctuation. Even though people are bullish about the price, they can’t risk their company." As well, he says, increased environmental regulation has added to capital costs for gas producers.
At the same time, most commentators are positive about the prospects for future increases in the price of gas. While last winter was not severe, energy consumption is hardly languishing, and natural gas, with its green cachet, is the energy of choice. It’s cheaper, more efficient and cleaner than other energy sources.
Big companies hold the key
Larger players involved in the San Joaquin like Anadarko may well be the ones to solve the complexities of finding and completing high deliverability wells. In the meantime, the exploration requires substantial capital outlay, with as yet no real production. The Houston, TX-based firm has production from the infamous #1 well, but other properties remain at the exploratory stage.
Testing may have to continue for some time, possibly more than two years, according to Peters & Co’s Boland, before exploration firms and operators have a comprehensive knowledge of what kind of commercial viability exists in the basin.
Michael Schrampf, an analyst with Wunderlich Securities says playing stocks based on the prospects in the San Joaquin basin is a hit or miss proposition.
"The companies that are out there haven’t had a lot of success since the first well that began producing. There’s been a lot of problems with getting the wells completed and getting them tested. For a while, some of the players in the East Lost Hills, there was a disagreement between Anadarko, the operator, and some of the junior players over payment for services."
In the end, looming lease expiration forced the parties to settle their differences, but Anadarko’s Q2 operations report, released July 26, contains only a short update about East Lost Hills. The report says the company is completing testing of the ELH #4 and #9 wells. In addition, the Pyramid Hills 1-9 is at a depth of 20,500 feet and is being evaluated.
The big players, Occidental Petroleum (NYSE: OXY) and Anadarko, say little about the prospects in the area, preferring instead to quietly carry on drilling, hopeful that a positive result will bubble to the surface. Rumors have it that Occidental has had some limited success in Elk Hills, but there is no official word.
The energy business, says C.K. Cooper’s Fetzer, is relatively simple; it’s all about economics and cost-effectiveness. So, while the potential remains in the ground, the San Joaquin continues to be a capital drain, especially for the junior players. He says that one can’t keep building infrastructure to use a commodity that one can’t produce at a fixed rate; ultimately there will be a squeeze on the production.
Medium sized companies like Paramount Resources (TSX: T.POU) also have the resources to continue putting cash into exploration efforts for a while.
Among the small cap players diligently, and more quietly working to make that Hail Mary into a Thank God are Ivanhoe Energy (NASDAQ: IVAN)(TSX: T.IE), Habanero Resources (TSX: V.HAO), and First Goldwater Resources (TSX: V.FGD).
Some players still bullish
Some of the remaining players are bullish about the future.
Ivanhoe partnered with Aera to drill a site in the North West Lost Hills. The company says it plans to drill through the Temblor Sand and into the shale section beneath.
"We’re hopeful that the Northwest Lost Hills wells, given the diameter of the well bore [which, is 8 1/2 inches] and the position on the structure where we are that it might be one of the most definitive wells since the blow-out of the Bellevue #1," says John MacDonald, vice-president of investor relations at Ivanhoe. He says the company has the intention to drill and test the entire Temblor.
Ivanhoe has also identified 25 prospect areas, with about 75% of that number potential deep gas sites. It explored about 300,000 acres when the land was the hottest place on the planet to drill.
MacDonald says that the area could use some news of success in order to attract banking and pipeline interests, and move the play into a much greater concern for the state. He says that he is hopeful the appraisal stage will re-focus attention on the potential of the lands.
Habanero is working in the southern San Joaquin basin, and has a 10% working interest in a producing oil well in Kern County. Company director Jason Gigliotti says, "And, obviously right now, there hasn’t been a ton of success in the real deep stuff in the area."
Lately, the company has concentrated its efforts on a Texas property, and appears keen to allocate resources to the more promising find. Its other California property, the Pale Rider well in Solano County is not flowing, and Gigliotti says that with the infrastructure in place, Habanero is at the whim of its full partner Questar (NYSE: STR).
"Right now it’s a little harder to get people to put up a little more money when the stocks aren’t really running like they were," says Gigliotti. "Either way, we would like to test the deeper stuff. We just need to get a couple more partners, and we’d also like to get a little more revenue out of some existing properties that we have."
The East Lost Hills prospects absorbed capital on a scale that many juniors could ill afford, and some juniors were ‘drilled out of the play.’ Richland Petroleum was acquired by the Provident Energy Trust (TSX: T.PVE.UN) in January 2002. Westminster Resources became Vaquero Energy (TSX: T.VAQ) in June of 2002, and officially concentrates on properties in Alberta.
Elk Point’s recent announcements about East Lost Hills mirrored Anadarko’s operations report. Andrew Boland says that the company’s efforts in the region have put a drain on its capital resources.
Wunderlich’s Schrampf says that he cannot find good reasons to buy in now, given that few of the expectations have been met. The giant is, as yet, unmoved. |
