When Drilling Is Expensive, Piggyback: Interview with AOS
Africa is becoming the top choice for North American oil companies looking to diversify, and the East African Rift is the hottest of the hot, with Kenya waiting on commercial viability, Angola and Ghana already on the road to rival Nigeria and two newcomers—Namibia and Zambia—where the doors have been thrown open for exploration. Getting in on Namibia and Zambia is an extremely expensive endeavour, but here’s a way to de-risk this adventure, keep your shareholders calm and strategically position yourself to take advantage of the next big find without footing the massive drilling bill: Buy up a ton of acreage and sit back and let others do the expensive exploration and drilling on territory adjacent to yours. Then strike and watch offers come in.
In an interview with Oilprice.com, Alberta Oil Sands (AOS) CEO, Binh Vu … discusses:
• How to get in elephant-sized plays in the East African Rift
• How to save cash by piggy-backing on others’ expensive exploration
• Why Namibia could be a major oil monster
• What makes Zambia such an attractive oil venue
• Other African plays that are worth looking into
• Why it’s hard for juniors to compete in Africa
• Why someone will always need Canadian oil sands
• What heavy oil economics will look like over the coming years
• Why Canada’s Algar Lake is a major sleeper play
• What qualities investors should look for when betting on juniors
Interview by James Stafford of Oilprice.com
James Stafford: With the oil discoveries in Kenya and a lot of optimism over other rifts and lake systems including those present in Uganda, Zambia, Tanzania, etc. the East African Rift System has become an emerging oil hot spot. What we want to know is how to make money here without spending a ton of cash in exploration and drilling? What’s the smart way to stake a claim on the East African Rift Basin?
AOS: That is a great question. The truth is that this area has become quite expensive as it has been found to be increasingly prolific. Major signing bonuses, deposits, and commitments are required in spots like Kenya, Tanzania, and Uganda. There is very little opportunity for the junior explorers to compete.
We believe that Zambia is a fabulous jurisdiction because it shares the geology and rock age in certain large areas that have hosted the Lake Albert Discovery and the Block 10BB Kenya discovery. However, it is totally underexplored for hydrocarbons and thus provides much cheaper access to very prospective areas. Our company has successfully tied up ~18 million acres or what we believe covers about 33% of the attractive rift areas in Zambia – which equates to oil and gas rights over about 8% of the country.
James Stafford: How does an exploration company on a budget go about covering and “high-grading” targets over such a large area?
AOS: Without a doubt that is a highly important question for any company engaged in the pursuit of elephant-sized targets in new frontiers. One of the things that we do is first is aim for concession agreements that don’t tie us to expensive immediate seismic commitments. Second we eschew large and expensive 2-D seismic programs in favor of a process of high grading using satellites, other remote sensing techniques, and ‘ground truthing’.
We estimate that by using satellite data analysis over a number of criteria–gravity gradiometry, thermal emissivity analysis, geobotany analysis including vegetation anomalies and geo-microbial review over specific high-graded areas on our acreage–we can save millions of dollars and years of time. We then get to specific areas that are ready for smaller, focused electroseismic surveys / 3-D surveys, and that can then be attacked as drillable targets either to take on ourselves, or to farm down to majors who are looking for the next major rift discovery.
James Stafford: What does the playing field look like right now in Zambia? Who’s there, what are they doing, and how are you positioned to take advantage of all the money being spent there on exploration and drilling?
AOS: There are a number of companies there and we have focused on two lakes as well as two dry rifts that show very promising gravity responses from the most up to date databases. Our number one focus is on Lake Tanganyika. This lake spans through Burundi, Tanzania, DRC, and Zambia.
There are currently to our knowledge at least three major active seismic programs on Lake Tanganyika including one recently completed by Beach Energy, an Australian company with a $1.75 billion valuation. Beach is directly adjacent to AOS, on the Tanzania side of the Lake. It is likely that Lake Tanganyika will see at least 1 drill hole in 2014.
We like Lake Tanganyika as the right spot for the next Lake Albert (3.5 billion barrels reserves) discovery because of the almost identical geological setting and rock age as well as the size of the Lake and the major indications of an existing petroleum system. Lake Tanganyika has multiple oil slicks and natural oil seeps including one that is believed to be the largest natural oil seep in the world. You can see it from Google Earth.
James Stafford: You’ve also recently acquired acreage in Namibia, which just made its first-ever commercial oil discovery. What are the prospects here and what kind of timeframe are we looking at?
AOS: I’m glad that you asked that. Namibia to us is a potentially direct analogue to all of the major offshore discoveries in Brazil (plate tectonics theory) and Angola to the north. Offshore Namibia has the identical age and rock type as the discoveries in offshore Angola. Combined, those two countries have nearly 30 billion barrels in reserves.
Namibia itself, however, remains highly underexplored with only 16 wells drilled in 20 years–seven on Kudu Gas Field alone–and the majority of the rest were shallow shelf wells. People are starting to get the idea and now. BP, Petrobras, Repsol, Galp Energia, HRT, are all there.
HRT has had success there on their first well of this three-well campaign where they discovered light oil for the first time. Their second well was dry. The third well on which they will begin drilling in August in their PEL-24 block which borders directly on to AOS’ 2.5 million acre land package in the Orange Basin – blocks 2712A and 2812A. We are at ground zero.
HRT rates their play chance there at 25% and to my knowledge it is their biggest target–a 30 billion barrel monster. If that one works, I would think that there will be companies knocking down our door. We will know likely in late September, maybe the beginning of October.
Regardless, there should be at least five more wells drilled and $500 million to $1 billion being spent offshore Namibia over the next 12-18 months, so it really fits well with our strategy of being in highly active basins where majors and big independents are spending lots of money around us to prove up major discoveries.
James Stafford: AOS’ new Africa portfolio is an ambitious diversification of its original assets in Alberta oil sands. Why the need for diversification here?
AOS: It is indeed; however, I think that what shareholders need to understand (and many of ours do not) is that AOS has been traded for the last 24 months strictly on its balance sheet. It basically always trades at its cash per share. Why is that? Very simply there is or has been in recent times, very little capital market appetite or excitement for small companies developing SAGD oilsands plays.
Athabasca Oil was one bright spot, but that was a marvel of financial engineering that caught a window.
AOS has 500+ million barrels of oil sands resources which are getting no value. Combine a terrible junior market with complete apathy for this asset class, and the result is a share price that declines almost in lockstep with the treasury, and a total lack of response or enthusiasm to basically just about any kind of positive news.
We feel that while AOS is underpinned by its cash and by real assets on which the company has spent almost $65 million developing since 2007, it adds meaningfully to shareholder value by bringing into the fold, as cheaply as possible, blue sky scenarios with major lottery ticket potential and requiring little to no cost commitments over the next 12-18 months.
Ultimately, as we gain approval at our flagship Clearwater project in Alberta, part of our plan as we examine our options to unlock value in two distinct plays could be to dividend out our African assets to shareholders into a new company on a 1 for 1 basis, such that shareholders retain 1 pure play share of Oilsands in Alberta (Clearwater, Grand Rapids, Algar Lake), and one pure play share of our 21 million acre and growing high-impact African exploration portfolio (Zambia, Namibia, DRC).
James Stafford: Mainstream media reports generally put a price tag of $75 to produce a barrel of Canadian oil sands, but is this really reflective of the true price once you get past the start-up phase?
AOS: Some of the junior oilsands development companies that have made the transition to SAGD have stumbled without a doubt. Connacher and Southern Pacific being two recent examples. I believe, however, that the economics are actually superlative once all problems are solved, and of course you can go on producing for a very, very long time. The margins of an operation in full-swing and after start-up/growing pains, are much better than the mainstream media is reporting.
James Stafford: For how long will the US continue to need crude from Canada’s oil sands given current levels of production from US shale plays? What is the production price comparison here? Will it cost more to sustain production from wells in the Bakken and Permian Basins?
AOS: This is an interesting question. My personal view is that whether it be the US or someone else, there will be no shortage of demand for what the Canadian oil sands can produce. Further, there is a lot more certainty in terms of consistency and longevity of the oil sands assets and their production profile, once they get going.
James Stafford: What are your predictions for North American heavy oil economics over the next 2-3 years? Plenty of investors think this is the place to be with a lot of refineries coming out of turnaround and getting heavier and heavier despite all the light shale oil. Will demand for heavy oil rise?
AOS: I read analyst prognostications on this stuff every day. They can certainly have different complexions depending on who you are listening to. To me it’s pretty simple: I don’t believe that prices are going to go outside of a range (below, or above) where extremely healthy margins can be made by good operators, for their shareholders. We will be range-bound here at healthy levels is my overriding feeling on this.
James Stafford: What can we expect from AOS in terms of Canadian oil sands development in the next 6-9 months; in the next 2-3 years? What drilling will occur across AOS’ oilsands acreage?
AOS: Alberta Oilsands has four main projects domestically, and two of them are sleepers. For our flagship Clearwater asset with 373 million barrels of resources we hope to receive ERCB permits for production in Q4 of this year at an initial rate of up to 5,000 bopd, with a phase II of up to 40,000 bopd. This will be a game changer for us, and is the one thing that probably will move our market much higher immediately.
Our Grand Rapids project has resources of 119 million barrels and we have just completed an EUR study that demonstrates its ability to produce as much as 30,000 barrels a day, for 40 years. This is highly encouraging and is totally overlooked by the market.
Our third asset is a sleeper asset, in my opinion. AOS has taken on a partner to drill its Algar Lake project. We chose this partner because of its history of great exploration success. The team has, from scratch, made two separate billion+ barrel discoveries in Alberta and Saskatchewan and sold each to the majors. They want to turn their focus to Algar Lake now because it has the potential for cold flow production. Cold flow CAPEX is ~25% of SAGD CAPEX. On the OPEX side and on the operational complications side, it is basically the same story as well. Those are fundamental and major benefits.
If I can find a couple hundred million barrels of cold flow today, I think that the world is at my door. The 5 well program this winter will be enough to tell us if we have the next Pelican Lake – CNRL’s most profitable operating division per barrel, full stop.
James Stafford: It is no doubt a very difficult time right now for most junior oil and gas explorers and developers–whether with a domestic focus, or an international focus. What do you tell investors?
AOS: I would say that I don’t see that risk capital coming back for some time. It will be very opportunity specific and success driven. You want to look for companies that have the ability to survive for a while with the cash in the bank, are underpinned by real assets with a real value, and also can provide the excitement and possibility of a geometric return on investment.
James Stafford: And does AOS qualify for those criteria?
AOS: Not to toot our own horn here James, but my view of the world is: AOS is trading at just above cash value. Our combined PV10 between Clearwater and Grand Rapids is $823 million–or about 225X our market cap net of cash. We have a very small burn rate. We have multiple catalysts that can take us much higher in the next few months, including: Success in Namibia by HRT in September; approval at Clearwater for production in Q4; partners on our vast African acreage, or other discoveries near our rift acreage; demonstration of cold-flowing reservoirs at Algar Lake; and a strategic partner for Clearwater or Grand Rapids.
If any of these things come to fruition I think that the market and our own shareholders will sit up and take notice again and realize that right now they get all of those potential outcomes for free while we sit trading at cash value, with 500 million barrels of oil booked, and 21 million acres of prime exploration ground with 100s of millions of dollars being spent right around it.
James Stafford: Thanks very much for sharing your views with us on both the African landscape for exploration and discovery, as well as the outlook for heavy oil prices and oil sands development in Canada.