Big Growth Opportunities in Wellhead Equipment

Oil and gas resources once thought completely out of reach have now arrived in the fuel tanks and furnaces of consumers around the world.

Opinions differ about the future capabilities of oil field technology. Some argue that technology will allow us to unlock trillions of barrels worth of oil out of unconventional and not-yet-discovered resources. Others argue that every technology in use today was developed 20 or 30 years ago; not only that, but growing service industry bottlenecks could halt several desperately needed development projects in their tracks.

While both sides of this debate have valid points, I think it’s important to remain focused on the progress under way at major projects and depletion of large existing fields, and not argue about potential resources 30 years into the future. We want to profit from the decline of Peak Oil and its subsequent political instability now.

Since the advent of the oil business, scientists and engineers have developed a series of very remarkable technologies. Oil field technology tends to compound at a steady rate, extending the boundary of what was long considered the absolute limit of exploration and production.

Resource owners usually want to produce a hydrocarbon reservoir as fast as safety and engineering limits allow, so it makes sense that most oil field technology was developed to accelerate the process. The concept of “time value of money” doesn’t end on Wall Street; it extends to the oil patch. Producers are under pressure to satisfy the demands of employees, bankers, tax collectors, and shareholders, so the sooner oil and gas arrive, the better.

This picture of working to beat the clock not only applies for newer discoveries, but it also applies for projects that strive to extend the lives of older fields. Oil field equipment and services have become very expensive and are likely to become even more expensive in the coming years. The free market is the driving force behind oil field technologies.

If there’s thought to be a few million more barrels of oil left in an old well, an operator will go ahead with an enhanced oil field recovery project if the return on investment is high enough. But if oil and gas prices fall and service prices remain high over the course of this project, this operator can lose a lot of money. So timing is of the essence.

Oil service stocks that can grow regardless of operator budgets are difficult to find. But I recently discovered one for Strategic Investment readers that’s fairly unique. It’s fairly insulated from the booms and busts of the oil field investment cycle, yet has incredible growth potential. Its technology has proven to be very valuable for operators extending the lives of older wells, but it also plays a key role in unlocking the value of low-quality oil and gas. Its equipment and expertise will remain in very high demand by oil field operators around the globe for years to come.

How Sour Crude Can Lead to Sweet Profits

Low-viscosity, or “sticky,” heavy crude and sour crude with high levels of impurities like sulfur require extra steps in both wellhead processing and refining. The initial step in crude oil refining really occurs at the wellhead, the site where it’s first pulled from the ground.

The trend toward heavier, sourer crude oil will directly benefit manufacturers of specialized wellhead equipment. These lower grades of crude make up a steadily rising share of global oil production because, just as you’d expect, the sweetest, lowest-hanging fruit in the oil patch tends to be picked and consumed first.

More barrels of crude will require upgrading, particularly the abundant, yet barely accessible heavy crude from sources like the Orinoco Belt in Venezuela. Technology is what the Venezuelans, the Russians and the Saudis need, and they will pay up for it.

Some of the biggest wealth-creating companies of the next generation will be those that can unlock the value of these politically unstable resources – without committing billions in capital to projects that can be seized overnight.

I’ve already told my Strategic Investment readers all about a company that specializes in manufacturing oil and gas production equipment. It sells this equipment into most major oil and gas basins around the world, and it’s a great way to play on the growing natural gas market.

With that said, the odds are the next few years will look like the last few – a period of growing resource nationalization not unlike hoarding. Leaders of countries sitting on vast reserves are taking actions in the best interest of their people (or their personal Swiss bank account) and telling major oil companies to get out.

Vladimir Putin and Hugo Chavez wouldn’t have kicked the big oil companies out if they hadn’t planned on granting major development projects to big service companies like Schlumberger, Baker Hughes and Halliburton, just because of the fact that most of their countries’ remaining reserves are difficult to produce.

“Megaprojects” Hampered by Bottlenecks

Yet despite having access to the best oil field technology in the world, most big projects still suffer from bottlenecks, delays, and cost overruns. This phenomenon is widespread enough that it supports the core ideas behind the Peak Oil theory – most notably that the “easy oil” has already been consumed.

Chris Skrebowski, editor of Petroleum Review, became a leading Peak Oil theory proponent after initially setting out to prove that it was nothing more than worrywarts seeking to make headlines. With decades of international oil field consulting and research experience, he ran the numbers and concluded that data on both historical production and future projects were not precise enough to assume ample oil supply as far as the eye can see.

So Skrebowski started a “megaprojects” database to track the projects widely expected to satisfy growing demand. He’s noticed an undeniable trend of delayed startups and shortages of everything from drilling rigs to qualified personnel. Assuming that the current backlog of projects proceeds without a hitch, he expects that “24.8 [million barrels per day] of new capacity [is] due to come onstream between January 2007 and December 2012.”

An extra 24.8 million barrels per day of new capacity may sound like plenty for the world’s 2012 production needs. After all, it represents a little over 4% annual growth over the next six years. But this ignores depletion of the existing base, the elephant in the room that most Peak Oil critics either overlook or avoid.

Skrebowski warns that the data behind the existing base, especially from national oil companies like Saudi Aramco, are not transparent enough for us to make happy assumptions about long-term supply. If average global depletion is running a little over 4% per year – a fair estimate – the world is likely to have the same oil production capacity in 2012 as it has today. With relentless demand growth, flattening worldwide production would send oil prices well into the triple digits for good.

Skrebowski draws two conclusions from his latest megaprojects analysis. “First, data on production, project performance, and depletion rates are wholly unsatisfactory, particularly for the OPEC producers. Second, the large volumes of new capacity being added between 2007-2012 may not translate into the sort of increased production flows the world economy needs to underpin economic growth.”

Companies that play critical supporting roles in extending oil and gas production will be great investments over this 2007-2012 timeframe.

Good investing,
Dan Amoss, CFA

June 13, 2007

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