A Few Words About Nalco

Over the coming decade, I strongly believe that most of the best investment opportunities will emerge from the four following natural resource categories: Water, Agriculture, Gold and Energy…or what I call the WAGE group. And some of those opportunities will feature a combination of these resource categories. One of the most intriguing combinations is what I call the energy-water nexus.

It takes water to produce energy and energy to produce clean water. That nexus creates a number of profit possibilities. Sometimes, they are not so obvious. But often, a company that possesses expertise in water treatment will possess a related expertise in the energy field. The connection between water and energy is at least as old as the process of pumping water into old oil fields to boost production.

But the connection between these two precious fluids is changing quite a bit.

Let’s take a look at one of the less-obvious connections…

You may not realize this, but two-thirds of oil discovered stays in the ground. The average recovery rate is only about 35%. What if we could recover more of the oil we’ve already discovered?

If the recovery rate improved to 50%, the world’s recoverable oil would increase by 1.2 trillion barrels. It would double today’s proven reserves, says the IEA. That much oil makes even a cynical old oilman catch a gleam in his eye and starts his heart aflutter. Indeed, lots of big brains churn away at this problem day and night.

“It’s the prize for the next half century,” says Howard Mayson, vice president for technology at British oil giant BP, quoted in this morning’s Wall Street Journal. BP relies heavily on enhanced-recovery methods. These methods aim to improve that oil recovery rate.

As The Wall Street Journal reports:

“Enhanced recovery is a lifeline for the biggest oil companies, such as Exxon Mobil Corp. and BP, which are under intense pressure from shareholders to keep ramping up production and gaining access to fresh reserves. But that’s hard to do when the companies are shut out of the oil-rich Middle East and places like Russia. So they rely more and more on existing fields, some of which have been producing oil already for decades.”

It is like squeezing a sponge ever tighter to extract the most of what you can get. The old method is to simply flood the reservoir with water. The idea is to create enough pressure to make it easier to pump the oil out. It is not very efficient, but it works for a time. It is also becoming a bigger problem to secure the water supply. That’s why we see oil companies buying water rights out West. Currently, the shale oil plays consume a lot of water.

Instead of using water, some companies will pump the reservoir with carbon dioxide. Companies used to store carbon dioxide in old unused reservoirs. Using this method of enhanced oil recovery, they put that carbon dioxide to work. BP uses this method out in its Prudhoe Bay reservoir, to great effect. Recovery rates there are 60%. Now Prudhoe Bay, which people in the 1980s once thought would cease pumping oil in 30 years, looks to be good for another 50 years.

The WSJ describes another method BP uses: “flooding reservoirs with polymers that expand like popcorn when they come into contact with hot rocks, thus flushing more oil out of difficult-to-reach nooks.”

The name of that polymer is BrightWater. One company has a patent on this material and makes it for a profit. That company is Nalco Holding (NLC:NYSE), a company I recommended several months ago to the subscribers of Capital & Crisis. BP uses BrightWater in Argentina and Pakistan. “BP says the additional oil the new technology will produce over the next 20 years is roughly equivalent to finding a major new field,” reports the WSJ.

“Nalco,” you say, “but isn’t Nalco is one of the world’s largest water purification companies for industrial companies?” This is what we mean by energy-water nexus. The two are related. And Nalco sits right in the middle of that nexus.

Last year, Nalco’s energy services segment was a bright spot. Sales grew 17% organically for the year. In the fourth quarter, sales were up 23% despite the steep oil price decline. In that segment is Nalco’s enhanced oil recovery (EOR) business.

CEO Erik Fyrwald commented on this business in a quarterly conference call. “We are in with a lot of oil companies explaining and talking to them about it,” he says. “We believe as oil prices come back up, [EOR will be a] really big growth opportunity, just delayed for a period of time.”

The delay stems from the fact that many oil companies slashed their exploration and production budgets last year, when oil and gas prices were falling. But it seems inevitable that as the big oil reservoirs dwindle, the EOR business will be big down the road. Of course, EOR is only one of the many valuable things Nalco does in the energy-water nexus. It is no wonder why Warren Buffett’s Berkshire Hathaway is the biggest shareholder.

Nalco is a long-term buy.

Regards,

Chris Mayer,
for The Daily Reckoning