Is Hydraulic Fracturing The Next ‘Massive’ Investment Opportunity?

May 27 2011 | 10:32am ET

By Mary Campbell, Senior Reporter

What you think of when you hear the term “hydraulic fracturing” or “fracking” probably depends on whether or not you’ve seen the Oscar-nominated documentary Gaslands, with those who’ve seen the film picturing tap water being set on fire with a Bic lighter and those who haven’t seen the film thinking, “What’s hydraulic fracking?”

But if you’re Marin Katusa, chief energy investment strategist for Casey Research, you’re thinking, “massive opportunity.”

“Massive” is a word Katusa resorts to frequently when discussing the process of recovering oil and natural gas from the shale which holds it—and whether you’re talking about the amount of water required for the process, the cost of drilling a single well, the potential environmental hazards or the profits to be realized, it seems to be an appropriate one.

“In 2010 there was nothing hotter than the European shale game,” Katusa told FINalternatives during a recent interview. It’s a game his company has been following for some time:

“We have a lot of experience in the shale game,” he said. “We were the largest shareholders of a massively successful shale deal in Europe, the first one. Casey Research wrote the first research and technical report focused on the potential for shale gas in Europe.”

Shale can hold both natural gas and oil deposits, but it’s the natural gas deposits that have Katusa excited—specifically, the shale gas deposits of Europe. Shale gas, considered an “unconventional” source of natural gas, has been produced for hundreds of years in North America (generating marginal profits until recently). Shale gas deposits now provide 25% of America’s natural gas and are expected to provide 45% by 2035, according to Casey Research data, but it’s a new industry in Europe, where only three wells have been drilled to date (by way of comparison, 364 shale wells have been drilled in the Marcellus shale formation in Pennsylvania in the first four months of this year alone).

A number of factors have conspired in the past decade to make shale gas production more lucrative: the rising price of natural gas as “conventional” sources dry up, the desire of countries like the U.S. for energy self-sufficiency and advances in drilling techniques, specifically, advancements in hydraulic fracturing.

A Word About Hydraulic Fracturing

Fracking, a technique used since the 1950s, involves drilling a well, then pumping in water, sand and chemicals at high pressure to fracture the rock and free the oil or gas. The cracks are held open by the grains of sand or other “proppants,” as they’re called, allowing the gas to flow out. In the past decade, the practice has been taken “to a new level” according to Casey Research literature on the subject, with the development of horizontal drilling techniques.

“You have to understand,” says Katusa, “that a shale well is drilled thousands of meters below the water table…You’ve got your water table, then you drill much below that, then you go horizontal…And you can do multiple fracks on the same wellset—you can do bilateral or trilateral horizontals.”

But the technique is controversial. First, there’s the sheer volume of water used in fracking—it can take up to 8 million gallons to frack a well and a single well may be fracked up to 18 times.

Then there’s the question of wastewater—the 50% to 65% of the fracking water recovered after completion of a well. Thanks to the Bush administration’s 2005 Energy Policy Act (legislation largely written by then-vice president Dick Cheney whose former firm, Halliburton, pioneered hydraulic fracturing), fracking is exempt from the requirements of the Safe Drinking Water Act, the Clean Air Act and the Clean Water Act. According to Casey Research:

“The Halliburton Loophole, as it has become known, enables gas companies to pump millions of gallons of fracking fluid into old wells or to leave the fluid evaporating in open pools, without having to identify the chemicals in the fluid. Those chemicals include benzene, toluene, boric acid, xylene, diesel-range organics, methanol, formaldehyde, and ammonium bisulfite.”

Wastewater stored above ground adds “significant risks to the fracking process,” according to the research.

And while, as Katusa noted, shale wells are dug well below the water table, which to some extent ensures the safety of the water supply, chemicals have been known to leak from improperly cased wells. The results, as described in Casey Research’s own literature, are the same as those documented in Gaslands:

“In Pennsylvania, the Department of Environmental Protection acknowledged a contamination of the aquifer that fills household wells in a rural area of Dimrock after more than 60 wells were drilled in a 9-square-mile area. The fracking operations turned the water brown and imbued it with dangerously high levels of methane, iron and aluminum. Fracking fluids leaked into streams, turning them garish colors and killing fish. One woman’s water well blew up. A family was evacuated from their house because of dangerous methane levels.”

Earlier this year, there was a natural gas blowout in a Bradford County, Pennsylvania well owned by Chesapeake Energy. In its wake, the company released a list of the chemicals in its fracking fluid (the “secret sauce,” according to Katusa, that energy companies are loath to reveal).

After examining the list, a local professor of biology and environmental sciences told Pennsylvania’s WNEP news, “We don't know enough about these chemicals and their effect on us or bugs and streams or fish and lakes. It takes time and money to do research on how toxic or how nontoxic these chemicals are, and you look at some of these safety sheets and there’s not a lot of information there.”

Opportunity Fracks

And yet, given the world’s seemingly incurable addiction to fossil fuels, and the significant deposits of gas and oil that can be unlocked through fracking, it’s not a technique that’s likely to disappear anytime soon, despite the environmental concerns. Says Katusa:

“[That] Gaslands movie has a lot of scientific errors in it…but that doesn’t matter for entertainment purposes, which is all that documentary is good for, it’s an exciting story where gas is coming through the pipes in your sink, you can light your sink on fire…But the reality is, Germany just shut down seven of their nuclear reactors. They get, right now, about two-thirds of their natural gas…from Russia, Italy is over two-thirds, Serbia is over 90%, Finland is 100%, even the UK—over one-third of their gas comes from Russia. Romania, Ukraine—all of Europe’s addicted to Russian natural gas.”

EU plans to reduce this addiction by constructing the Nabucco pipeline to bring in gas from the Middle East are on hold for various reasons, and Europe has no conventional natural gas deposits, but they do have shale deposits. “So the way for Germany and Poland and Romania and the UK and all these countries to become less dependent on Russian natural gas is to develop their domestic shale resources which are massive,” says Katusa.

All of which makes European shale a very interesting sector:

“You look at what’s going on with Poland—Conoco Phillips with Lane Energy on the 3 Legs project, they drilled a successful well; Cuadrilla in the UK drilled a massively successful well…The area that’s going to get the hottest moving forward is going to be Romania. They have existing production in the conventional field, they have the infrastructure there, they’re trying to get away from the Russian influence and you have big, big money coming into Romania right now, that’s the next hotbed of Europe.”

Investing in this sector, however, requires some serious due diligence, which Katusa breaks down into the following factors:

 - Permits

Concerns about the environmental impact of hydraulic fracking have resulted in bans on the activity in New York State and the Canadian province of Quebec, in North America, and the Paris basin in Europe. (Katusa blames the French government’s decision on Gazprom, the Russian natual gas giant, which raised the alarm about potential damage to Europe’s water reservoirs. He is, to say the least, skeptical about the Russian company’s motivation: “I can’t remember the last time the Russians actually cared about anybody else in Europe,” he says. “Gazprom, you have to understand, is the largest distributor of conventional gas, they own the pipelines, the gas,, and you pay whatever they want if you want their gas. But [that] was the catalyst…and then the French got all up in arms about the shale gas and the Paris basin, so there’s a moratorium there.”)

Whatever the motivation behind them, bans on drilling exist in certain areas and are under consideration in others and the smart investor will be aware of this.

 - Titles

The next consideration is land titles. Says Katusa:

“There are a lot of risks associated with investing in the shale gas sector. Exploring for unconventional gas in Europe isn’t like drilling in Alberta or the Haynesville in the U.S.. You’re going into places like Poland, Serbia, Romania and Albania—they’re not really up to par on the global standards of the process and the permitting so you have to make sure the company you’re investing in actually has the right land titles and permits to explore, hence [that’s] why it’s so important to invest in people who have been successful in the area and have experience.”

You also need to watch out for companies hoarding land positions, industry jargon for securing title to as much land as you can then “hoping that a big company is going to come in and farm it.” It’s a strategy Katusa considers misguided because, “in the gas world, if you have title, you have to drill or else you lose your land. That’s something very important to understand.”

 - Capabilities (Physical and Financial)

The investor must also ensure the company he/she’s investing in has the capabilities to drill out a shale well—that means both the funding and the necessary physical equipment.

The price tag for drilling a shale well can run anywhere between $8 million and $14 million, says Katusa. “There’s a lot of junk out there and people who are saying they’re going to drill a well—with what? They have $3 million or $6 million in their till. Make sure the company not only has the money to explore, but also the expertise to be able to successfully execute a drill program.”

On top of that, he says, there’s only “a handful of proper frack sets in Europe to even drill a well. “You need 50,000 horsepower frack sets to get through the European shale rock. There are, I think, less than three of those available in Europe right now. So all these hundreds and hundreds of companies trying to say, ‘We’re going to produce. We’re going to do that.’  Where are you going to get your frack set? From a 1962 Russian drill rig? It ain’t gonna happen,” says Katusa.

Success Breeds Success

There is one simple rule for investing in the shale sector, according to Katusa:

“There’s very few people that understand the shale game. What you want to follow are the proven winners and there’s literally a handful of shale guys that understand it…If you’re going to invest, the big upside is in companies where management are heavily invested in it themselves, they have a track record of success, and the current endeavor that you’re investing in is something that they’ve done before…If you’re investing in the shale sector, you want to stick with guys who’ve done shale before and there’s a few great companies out there but you have to be very selective and smart with your research.”

Down the Road

In Katusa’s opinion, shale gas has a bright future. Asked where he sees the industry in 10-15 years he said, “You’re going to have over 60% of your gas production coming from unconventional sources such as shale. In the U.S., they’re at already over one-third and in Europe, they’re just starting. They’ve only done three wells. These wells come out massive. We’re talking tens of millions of cubic feet per day of gas whereas with a conventional well, a good one will come out at a couple of million.

“I can’t emphasize how much money is to be made if you choose the right companies in the right area. This is massively lucrative and that’s why they’re doing it.”

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