Re-published from Oilprice.com

Kenyan Oil, Hot and Getting Hotter: Interview with Taipan's Maxwell Birley

Kenya has become the hottest oil and gas venue in East Africa since big discoveries were made in the country's virgin oilfields last April. All eyes are on Kenya in 2013 to see how quickly--and economically they can develop those discoveries into production.

Nairobi based Taipan Resources Inc. (TPN-TSXV; TAIPF-PINK) is the 4th largest acreage owner in Kenya, and is getting ready to carry out seismic on Block 2B. They recently attracted Maxwell Birley as CEO. Mr. Birley has been instrumental in discovering more than 2 billion barrels of oil equivalent in his 30-year career—much of it in Africa and Asia.

In an exclusive interview with Oilprice.com, Taipan CEO Maxwell Birley discusses:

• Why Kenya is the hottest venue in East Africa
• Why 2013 will be a stellar year for Kenya
• Why the regulatory environment remains attractive
• Why Kenya outranks its neighbours
• Why infrastructure will be in place in time for commercial activity
• Why this venue is good for the juniors
• Why the Somalia security risk remains low
• What Taipan is really chasing

Interview by James Stafford of Oilprice.com

James Stafford: There were some major discoveries in Kenya last year. Could you give me some colour on these discoveries that has the market thinking Kenya is now one of the hottest exploration spots on earth?

Maxwell Birley: There are a couple—or 2 billion--reasons actually. First, two recent discoveries by Tullow in the Tertiary Lokichar basin of Kenya are in similar geological settings as the discoveries also made by Tullow in the Albertine Basin in Uganda, just to the west.

Uganda has over 2 billion barrels, and the discoveries are similar enough that one could assume the eventual size of the resources in the Lokichar basin could be in the billions of barrels range as well.
There are also other Tertiary basins in Kenya that are attractive. Based on geochemical work we recently did it's possible that the eventual hydrocarbon resource size for the whole of Kenya could be much higher than this.
Being specific the unrisked prospective resources for Taipan's acreage in Kenya is 530 million barrels. We also believe that this estimate will likely increase to approximately 1.0 billion on completion of our studies.

These estimates are for only 2 blocks in Kenya, if this is reasonably extrapolated to other blocks across the country one can easily forecast very significant hydrocarbon resource sizes indeed.
James Stafford: What's the easiest and most challenging thing about working with the Kenyan government and in the Kenyan political climate?
Maxwell Birley: The Ministry of Energy is always ready for a meeting. They listen to our concerns and take the appropriate action. They quickly follow up and give us the support that we need with other Ministries. In the field the local administration is also very helpful. We have regular meetings to make sure our work continues without a hitch.
With regard to the political climate, there is an election coming up in March 2013. We're making arrangements so that we do not have a slowdown in seismic operations during that period. The last elections in 2007 were associated with some “geographically limited” security issues, however these were located far from our areas of operation, so we are not expecting the elections to have much impact on our operations.
James Stafford: The Kenyan government is reviewing its oil and gas regulations. Among the suggested amendments is one that would see the National Oil Corporation (NOC) get a 25% interest in oil properties that foreign firms are operating in Kenya, but this would put the government in a precarious position vis-à-vis attracting investors. How do you see this playing out in the end?
Maxwell Birley: The government is reviewing the terms that shall apply for licences/contracts that will be granted in the future. Oil companies will review all the terms on offer at the time of bid submission and compare them to the attractiveness of the acreage.
James Stafford: In November last year, Kenya expelled Norwegian Statoil, after revoking its exploration license. Is Nairobi increasingly ‘policing' exploration, and what will this mean for investors in the near/medium term?
Maxwell Birley: One of the main functions of the Ministry is to regulate the companies undertaking exploration activities in Kenya. We feel confident, as in many other countries where we have worked, that if you carry out your commitments in the timeframe of the PSC then your license is 100% secure. If we decide to go into the next phases of exploration on Block 2B we can continue to explore for hydrocarbons on the block for another 4.5 years without concerns to the validity of our contract.
James Stafford: How does the industry view the financial terms offered by Nairobi in oil and gas?
Maxwell Birley: We believe the terms are reasonably attractive, at least for an oil discovery. The reason that only a few exploration wells were drilled in the past was due to the lack of exploration success—and this was driven by the lack of understanding by the oil companies of the basins. It wasn't because of financial terms offered by the government.
Now that a discovery has been made and our knowledge is increasing, we are going to see a significant increase in drilling activity and therefore reserve additions to the country.
James Stafford: Is Kenya becoming more a game for the majors rather than the juniors, and do you think we will see more joint ventures in the near future?
Maxwell Birley: In our opinion there is a place for small companies at every stage of the development of an oil province. But it's definitely good news for those juniors with large land positions already in the country. The early movers--i.e. the companies like Taipan that acquired their acreage before the oil was discovered—will benefit from the recent oil discoveries. Most of the more prospective acreage has now been leased and therefore the competition for land is increasing.
As large volumes of oil are discovered, the large independent and Majors will start to notice the country more and more. The Majors—due to their size and complexity—tend to be exploration risk averse and prefer to concentrate on large, lower-risk developments.
James Stafford: How would you like to see Nairobi interact with the energy sector moving forward? And how does Kenya compare with other venues in the region like Ethiopia, Tanzania, and Sudan?
Maxwell Birley: There is no doubt that Nairobi is a premium location for business, tourism and families. This is illustrated by the fact that many multi-nationals operating in the sub-Sarahan African region have their head offices in Nairobi. Regarding interaction, it is the oil industry that will need to develop an active and well respected industry body so that broad industry issues can be discussed at the higher levels.
James Stafford: Kenya is clearly the East African leader in oil infrastructure, and is now starting the Lamu Port-South Sudan-Ethiopia Transit corridor (LAPSSET) project. But it will cost $25 billion for the roads, the 1200 km pipeline and 120,000 barrel-per-day refinery. How feasible do think this project is and why? Is it feasible in the timeframe projected by Nairobi?
Maxwell Birley: The resources in Uganda and to some extend south Sudan must be exported. A pipeline through Kenya seems to be the most feasible.
Regarding the time line, having 2.5 billion barrels sitting in the ground just west of Kenya in Uganda is a really strong motivation to build the pipeline quickly. In South Sudan I think they started pumping oil back up north again now, but I think they will want to go through Kenya in the near future.
Whether it's LAPSSET or the Tullow consortium someone is going to build a pipeline through Kenya to the coast in the next few years. We think the pipeline will be located within 175 kilometres from our acreage. The pipeline will be good for everybody in the region but it should be particularly positive for us.
So when we make a discovery on Block 2B, the pipeline will be in the construction phase. In the interim we'll truck the oil by bowser the early production from the fields. Then, depending on the size of any discoveries, we'll build a connecting pipeline into the pipeline from Uganda. I think we're in a very fortunate position now.
James Stafford: In terms of exploration what are the ‘sweet spots' in Kenya?
Maxwell Birley: Definitely the Anza Basin. Currently, the proven sweet spots are in the Tertiary sediments of the rift basins of Uganda and Kenya. More specifically to Kenya in the Lokichar Basin as proven by the Ngamia and Twiga wells by Africa Oil.
These basins form part of the larger East African Rift system. This is a very extensive rift system and many new plays will be discovered in the next few years. The Anza Basin is the largest of these East African rift basins and 10 times the size of Uganda's Albertine Basin and Kenya's Lokichar Basin. This rift contains Jurassic, Cretaceous and Tertiary sediments.
Taipan is exploring for oil in the south eastern end of the Anza basin. Located on block 2B we have proven more than 9,500 feet of Tertiary section on the block. From the geochemical modelling we have undertaken we see the same oil source rocks in the Anza Basin that are present in the Lokichar basin, which are highly likely to be mature for oil generation on Block 2B. In addition we also believe that more oil discoveries will be made in the Cretaceous and Jurassic basins if you can find favourable places to drill.
James Stafford: What has Taipan's proprietary technical work in Block 2B in the Anza Basin demonstrated so far?
Maxwell Birley: The Anza basin has proven oil-prone Cretaceous source that in places is potentially in the gas window (Bogal gas discovery), however our technical work has also demonstrated that the basin has an active Tertiary lacustrine (lake) oil source that is in the oil window. Consequently, the Anza basin has an excellent chance of being a much more significant oil producing basin than the small rift basins that have so far been discovered.
James Stafford: And that's what you're really chasing here—with these roughly 10 million acres in the Anza Basin—the tertiary play...
Maxwell Birley: Agreed. What we're primarily chasing in Block 2B is the same Tertiary oil play that Tullow inherited originally in Uganda. The discoveries there were the main reason Africa Oil and Tullow drilled the Ngamia and Twiga oil wells in Kenya—which have also been very successful. Of course, don't overlook the fact we also have a secondary Cretaceous oil play in the block, that appears to be broadly analogous to the Cretaceous plays present in the Muglad Melut basins of southern Sudan and is the main focus of exploration efforts in Block 10A, operated by Africa Oil Corp.
Regarding the rest of our acreage, in Block 1 for example where we have a 20% interest in a 31,781 Km2 block we are chasing older Cretaceous, Jurassic and Permo-Triassic plays. The block is located in an extension of the successful Ogaden Basin of Ethiopia and Somalia. We think the block will be very prospective as it is surrounded by oil seeps and a well that recovered oil on test.
The 2 blocks combined makes us the 4th largest acreage holder in Kenya. In terms of near-term drilling and catalysts in the region, we have Tertiary, Cretaceous and Jurassic plays on Block 1 and Block 2B that will be drilled in the next 12 to 18 months.
James Stafford: Tell us what 2013 will look like for exploration in Kenya?
Maxwell Birley: Ten exploration wells should be drilled in Kenya in 2013. Based on the previous success rate it is expected that a significant number of these will be discoveries. Tullow will continue drilling wells on Blocks 10BB and 13T on the west side of the country to find more oil in that string of pearls.
Also we shall shortly get the results of the Paipai-1 well which is currently drilling in northern part of the Anza Basin. The well is testing Cretaceous & Jurassic plays, with a potential 121 million barrels. Other wells including Sabisa and Kinyonga also expected to be drilled in 2013.
James Stafford: For Kenya, a discovery at Paipai-1 would prove that oil discoveries of Sudan extend into Kenya. What would it mean for Taipan?
Maxwell Birley: There have already been Cretaceous gas discoveries in Kenya. Taipan believes that if you can find the Cretaceous that has not been buried too deep it will be prospective for oil. However we think the Paipai well is very high risk as it seems likely to be a recent tectonic inversion structure and therefore may be breached by recent faulting. We think we can find on Block 2B Cretaceous structures that are oil prone that have not been breached by recent faulting. So if that well does come in then it is going to be good news for the Anza Basin in general, but if dry it will not write off the Cretaceous potential in our block. Having said that I should point out that this is not our main focus at this time.
James Stafford: What about other prospects, like the Kinyonga well?
Maxwell Birley: Kinyonga is the next big prospect that is going to be drilled by Africa Oil Corp. and that is very meaningful for us. Kinyonga, which is on Block 9, will be located relatively close to our block, is both Tertiary and Cretaceous prospect. It has an unrisked resource estimate of 320 million barrels prospective, and it is one of the largest prospects in Africa Oil's portfolio of drilling targets. Africa Oil also has another prospect called Pundamilia which is even closer to our block. This prospect has a unrisked resource Best estimate of 402 million barrels and a High estimate of 952 million barrels which I believe is the largest prospect in Africa Oil's portfolio.
James Stafford: And what is the status of Kinoyonga?
Maxwell Birley: The timeline Africa Oil report for Kinoyonga is the 2nd half of 2013.
James Stafford: That would be a pretty big corollary for Taipan ….
Maxwell Birley: I think that even prior to getting those drilling results; investors are going to become more aware that the Tertiary play extends into our block. This was proven by the Hothori well which encountered 9500 ft. of Tertiary sediments. Better than this based on seismic data we estimate that in parts of the block there could be greater than 15,000 feet of Tertiary sediments.
James Stafford: What can we expect from Taipan over the next six months?
Maxwell Birley: Taipan has contracted BGP to acquire up to 800 kms of 2D seismic survey and Arkex to acquire a block wide FTG survey both over Block 2B. The seismic will commence recording in January 2013 and the FTG in February. Both surveys will be completed and interpreted prior to the 1st June deadline to complete the work. We expect to enter the first additional exploration period and are planning on drilling a well late 2013 early 2014.
Taipan has a 20% interest in Block 1 where Afren has recorded 1900 kms of seismic data.
After the seismic has been processed and interpreted the company will commence preparations for well to be drilled in late 2013/early 2014.
James Stafford: What do you expect to learn from this North Eastern data?
Maxwell Birley: We will be acquiring world class seismic data with an extremely high fold in Block 2B. We may record data with fold as high as 540 (other operators in Kenya usually only record at 60 fold). We will do this so that we get excellent signal to noise ratio and seismic data improvement. This will then enable us to predict with some certainty the areas that have high shale to sand ratios. This in turn will indicate where the Tertiary lakes sediments were deposited. This will dramatically increase the chances of drilling a successful oil well.
James Stafford: Let's close off then with a note on security and Taipan's potential concerns in that area...
Maxwell Birley: Our acreage is in a remote region with very few inhabitants. We always take the appropriate health and safety precautions for example we've carried out detailed security risk assessments and we have visited the areas on a number of occasions. We work with other operators and security companies to ensure we have good local information.

To mitigate the risk, we have 50 to 60 armed police on the seismic crew to supply physical security. More importantly we have excellent support from the government and local authorities. We are in the process of undertaking some CSR water projects so that local people benefit from our activities. We also have a team from the area that is in the field communicating continuously to ensure that the local community understands what we are doing and observes the benefits of working with Taipan.

So in summary, we take it all pretty seriously. There are risks, however, it's a place where you can work, so we're being very respectful and careful to nurture successful relationships.

James Stafford: Has Kenya's intervention in Somalia had any impact on exploration in the border area?

Maxwell Birley: Yes, it has ensured that oil companies can undertake their work in relatively safe conditions.

James Stafford: Mr. Birley, best of luck. Thank you for your time and we will check in with you later in the year.

Source: http://oilprice.com/Interviews/Kenyan-Oil-Hot-and-Getting-Hotter-Interview-with-Taipans-Maxwell-Birley.html

Another chance to sell oil futures

Two weeks ago, when oil was at $84, I recommended to sell oil futures before oil price falls to $79 and even lower. After this recommendation, oil actually fell down to $76 and could bring a 10% return. Today, oil is approaching $83, as we predicted five days ago. Therefore, a good time to sell oil futures is coming again. Below I reproduce some details of the model predicting oil price.

In May 2011, we predicted oil (WTI) price to fall to the level of $70 per barrel by the end of 2011. This is a monthly revision for September 2011. We consider the average oil price of $84 per barrel what is equivalent to the producer price index of 244 in September. (Actual estimate will be published by the Bureau of Labor Statistics in the middle of October.)
Figure 1 compares our prediction with actual oil price in 2011. In August 2011, the predicted price is a bit higher than the measured one. In any case, we expect the price to fall by approximately $5 per month to the level of ~$70 in December 2011. We also expect the price to slowly fall through 2016 and put the uncertainty bounds for the long-term trend in oil price. The level of oil price in 2016 is between $30 and $60 per barrel. These bounds are also shown in Figure 1.

This part is the prediction of the current growth in oil price given days ago.

A week ago, when oil price was at ~$79 per barrel, we recommended buying oil futures. The intuition behind this idea was that $79 is approximately $5 below the expected price for September. This is a disequilibrium which should be recovered in the short run. Today, oil price is at the level of ~84. This is the equilibrium level for September. A small hike in oil price is possible during the next few days. However, at a two-week horizon, oil price should fall again. Therefore, I recommend selling now and buying in approximately two weeks or when the price will be around $75. It will grow to the level of ~$82 to $85 in October or November.

Figure 1. Oil price prediction in 2011. The price is expected to fall by $5 per month between June and December 2011. The price level is ~$70 in December 2011. We also show the range of expected price evolution by 2016.

Oil price and deflation

The current turbulence in financial markets and the expectation of a poor economic performance (i.e. recession) in the biggest economies has been accompanied by a dramatic fall in oil price. We have predicted this drop several months ago and expect the price to fall to the level of $70 per barrel by the end of 2011. We will address this prediction when the Bureau of Labor Statistics publishes the PPI and CPI estimates for July 2011. Here we would like to highlight the influence of oil price on the PPI and headline CPI.

The price index of energy comprises approximately 10% of the headline CPI is highly correlated with oil price. The surge in oil price observed since the beginning of 2011 (Figure 1) has been the most important driver of the elevated consumer price inflation. Accordingly, many economic and financial experts expect a period of hyperinflation in the near future. However, oil price has been falling. This fall resulted in a negative rate of monthly inflation in June 2011. In July, the monthly rate of inflation is likely to be positive because the price index of energy (oil) did not fall much relative to June.

The monthly rate of inflation is an important but only a transient indicator of the overall price change. Therefore, we have calculated the annual rate from the curves in Figure 1, where red line is the original price index (black line) shifted by one year ahead. The ratio of black and red line is the rate of oil price inflation, as shown in Figure 2. The rate of inflation is characterized by two peaks in 2008 and 2010. Obviously, the rate of inflation is defined by two factors: the current level of oil price and that one year ago. The difference between black and red line can be considered as a crude estimate of the inflation rate. When red line is above black line, the rate of inflation is negative. Otherwise, the rate is positive. What can we expect in 2012 with the price index of oil falling through the third and fourth quarters of 2011? Almost inevitably, the rate of (oil price) inflation will be negative through 2012. Since other components of the headline CPI also demonstrate the tendency to fall one can expect a period of deflation in 2012.

Figure 3 presents our estimate of the oil price evolution in 2011. We expect the price to fall by $6 per month to the level of $70 in December 2011. We also expect the price to fall through 2016 and put the uncertainty bounds for the long-term trend in oil price. The level of oil price in 2016 is between $30 and $60 per barrel.

Figure 1. The (producer) price index of oil (domestic crude petroleum). Red line is the original price index shifted one year ahead. The ratio of black and red line is the rate of oil price inflation shown in Figure 2.

Figure 2. The annual rate of oil price growth.

Figure 3. Oil price prediction in 2011. The price is expected to fall by $6 per month between June and December 2011. The price level is $70 in December 2011. We also show the range of expected price evolution by 2016.

Re-published from Oilprice.com: Interview with Emperor Oil CEO Andrew McCarthy

Oilprice.com re-publishes some of my posts and this is the first time I do the same with an article from their site.

High Risk Investing - The New Trend in Energy: Interview with Emperor Oil CEO Andrew McCarthy
Risk perception isn’t what it used to be. Ask the swelling ranks of Canadian junior oil and gas companies braving high-risk venues like Sudan, Iraq and even Yemen.
Technological advances and the shale revolution are making risk easier to digest. And political risk is no longer limited to developing countries. Plus, risk is increasingly relative: Ask anyone who’s been caught up in the politics of the Keystone pipeline.
Sudan is a case in point. While instability and a very fragile peace with South Sudan remains a threat, there is also growing optimism. The philosophy is this: Sudan and South Sudan will come to terms for the sake of economic growth, and oil will get them there. The prize: An estimated 5 billion barrels of oil.
In an exclusive interview with Oilprice.com publisher James Stafford, Emperor Oil CEO Andrew McCarthy reveals:
• Why investors are hitting up high-risk regions
• Why Africa is more opportunity than risk
• How political risk is no longer limited to developing countries
• Why Shale WILL live up to the hype
• Why conventional oil is still a great investment
• And why human ingenuity will prevail
Emperor Oil (TSXV: EM.V) is an international oil and gas company with a focus on the Middle East and North Africa. Most recently, the company has renegotiated the terms of a joint venture gas deal in Turkey and introduced a significant conventional oil project in Sudan.
James Stafford: Oil and gas juniors are now setting up shop in high-risk countries like Sudan, Iraq and even Yemen. What’s behind this new era of risk, and are we likely to see more of this?
Andrew McCarthy: This question creates an opportunity for risk comparison – is it less risky to drill a mile below the ocean surface and create the kind of disaster we saw BP (NYSE: BP) deal with in the Gulf, or do we continue to look for work in regions that have accessible resources and are anxious to advance their economic position along with the health and welfare of their community?
James Stafford: So you are saying that on a comparative level even North America has become a political risk? And that in this balancing act, volatile places like Sudan do not necessarily pose any greater political risk?
Andrew McCarthy: Yes, there are always risks associated with any investment. The US halted all exploration in the Gulf of Mexico for extended periods following the BP disaster. This is a risk that few would have foreseen when exploration and development began in a country whose level of political risk is considered to be negligible.
James Stafford: Furthering your point, there have been a number of other unforeseen political risks, both in the US and Europe…
Andrew McCarthy: Certainly. The US banned all exploration and production in the Marcellus Shales in the State of New York. The US has also stalled the construction of Keystone XL pipeline that would link the US to Canada’s oil sands. In Canada, we have seen the province of British Columbia place a moratorium on offshore drilling. Across the Atlantic, we have also seen Europe place a moratorium on all shale exploration and development.
James Stafford: What is your message to investors who still view Africa and the Middle East as too risky?
Andrew McCarthy: Based on all of these North American and European developments, is it any less risky than operating in developing countries?
James Stafford: Which brings us to Emperor’s operations in Sudan. When South Sudan declared independence in July 2011 it took with it some 75% of the known oil resources. Since then, the situation between Juba (the capital of South Sudan) and Khartoum (the capital of Sudan) has been tense and even bloody. How will this affect exploration and extraction?
Andrew McCarthy: Well, now we have healthy competition due to the secession of the south and the need for both countries to maximize their economic opportunity. The skirmishes fought in the spring were quickly squelched when both countries realized the impact it was having on their economy and their people. Rather than fight over existing production they have chosen to expand their resource development so that there is a larger pie to share.
There have certainly been many difficulties over the years but the country recently emerged from a democratic process that the South secede in a diplomatic fashion. Both countries are now keen to advance, and the competition to succeed is healthy and beneficial. Of course, one also has to remember how truly enormous this country is and how remote some of the areas are in which much of the oil reserves are located.
James Stafford: There is also the question of infrastructure. South Sudan is seeking alternatives to transiting oil through Sudan, and Juba is extremely optimistic about the prospects of a new pipeline from South Sudan to Kenya. This is all part of Kenya’s massive regional infrastructure plan—the $24.7 billion Lamu Port-South-Sudan-Ethiopia Transit corridor (LAPSSET). How feasible is this pipeline? What are the implications for Khartoum?
How much would Khartoum stand to lose in transport revenues if this pipeline is realized?
Andrew McCarthy: I think this is an unnecessary undertaking that will be difficult to finance for many different reasons. Pipelines are exorbitantly expensive to build and would seem especially unnecessary given the fact that they could face similar problems to those which they have just overcome in Sudan [in terms of prohibitively high transit fees].
It is doubtful that a new pipeline would have any negative effects in Sudan. If anything it would likely cause the country to push for further exploration and production so as to maximize the infrastructure already in place.
James Stafford: The International Energy Agency (IEA) forecasts a drop in Sudan’s oil production through 2017. This contradicts Sudan’s own projections that it could double production in the next two years. How realistic is this?
Andrew McCarthy: I think that they are more than realistic. The main pipeline and port in Sudan is more than capable of handling the capacity. The resources are proven and available.
James Stafford: Despite the problems between Juba and Khartoum, Emperor seems confident that development and production will proceed without interruption. Can you tell us more about your recent progress in Sudan that boosts this optimism?
Andrew McCarthy: Emperor has signed an MOU to acquire a 42.5% interest in concession Block 7 in Sudan. The other 57.5% is owned by the country’s energy company, Sudapet. Block 7 is 10,000 sq km in size and tens of millions have been spent on the property. The property has 3 discovery wells which have been drilled, capped and are waiting for production. Initial production will be shipped by truck using existing roads which connect the property to the country’s main pipeline, located approximately 60kms away. A tie-in pipeline will be constructed during the second phase of development.
James Stafford: Beyond Sudan, another key area of focus for Emperor has been Turkey, a key strategic player in Middle East oil and gas, where oil majors like Chevron Corporation (NYSE: CVX) and ExxonMobil (NYSE: XOM) have significant interests. What can you tell us about Emperor’s recent activities here?
Andrew McCarthy: Emperor has a JV agreement with a partner in the Catalca Block in Turkey’s Thrace Basin. A major gas discovery was made on the property, which is located 30 kilometers west of Istanbul and only 5 kilometers from the natural gas pipeline supplying the country. The short-term plan is to complete the discovery well and connect it with the pipeline tie-in located only 5kms away. The long-term plan is to drill 5-10 more wells and expand the resource significantly.
James Stafford: In high-risk countries, what should investors look for risk mitigation?
Andrew McCarthy: Management with experience and diplomatic skills; a country with a history and commendable track record in negotiation and resolution; resource potential; development costs; production curves.
James Stafford: Certainly, the reverse would be true as well?
Andrew McCarthy: Yes. In Sudan, for instance, Canadians have an excellent reputation for quality work. They embrace the community and are willing to share their technologies and knowledge with the local people. Canadians are seen as net contributors and effective partners whose relationships are valued.
James Stafford: How are technological advances contributing to the juniors’ readiness to operate in risky territory?
Andrew McCarthy: With ever improving technical advantages in extraction methods I believe we will see more opportunities for resources which have a lower cost structure. Shale oil and gas developments will continue to evolve and conventional oil will have to compete on a cost level. Traditional extraction methods won’t have the same exploration budgets nor will they be able to compete unless the extraction is simple and inexpensive. I believe this is why we are starting to see a renewed interest in Africa and South America.
Energy reserves are abundant, they are often defined by past work and are inexpensive, efficient and safe to extract. This creates a significant advantage that can in many cases offset the political and geopolitical risk that was once associated with these parts of the world.
I also see the world becoming a safer place. Modern communication has improved access to information and changed people’s basic needs to wants and desires. Resource development creates employment and wealth – the cornerstone from which luxury and comfort is attained. Energy development is fundamental to advancing social, economic, health and safety standards for the world.
James Stafford: On a broader level, does natural gas have much further to fall, or have we seen the bottom?
Andrew McCarthy: I think we have seen a bottom in North America but Europe’s moratorium on shale exploration and China’s environmental concerns and air quality issues create a huge demand for natural gas, which in turn creates a long-term, sustainable model for natural gas exploration, development and export.
James Stafford: Will the shale revolution live up to the hype?
Andrew McCarthy: I really don’t believe the hype has even started yet. Unfortunately, the uninitiated are still focusing on the concept of ‘fracking’, while this is in fact one of the oldest technologies. We’ve been ‘fracking’ oil and gas wells since the 1930s. What has changed and continues to change is the technology applied – do you know they actually use CAT scan equipment to check shale porosity? It’s truly a fascinating region of science. The shale oil developers refer to 2010 like its ancient history and there is no reason to expect this rapid pace of development and advancement to slow.
James Stafford: While shale is currently the hot item, which sector will be the next big thing for energy investors?
Andrew McCarthy: Conventional oil is an excellent place to invest if you can find opportunities in areas that have excellent resources and are overcoming or mitigating their political risk. I think that technology stocks which are focused on the energy sector create wonderful investment opportunities. We are in a technological revolution in this industry. When people speak of peak oil they should first realize that the issue is energy – not oil. And in order to talk about a peak we have to eliminate the human factor – man’s creativity, ingenuity, invention and design always has and always will prevail.
Source: http://oilprice.com/Interviews/High-Risk-Investing-The-New-Trend-in-Energy-Interview-with-Andrew-McCarthy.html

Re-published from oilprice.com

The End Game for Oil & Gas Juniors: Interview with Chris Cooper

By James Stafford | Wed, 13 February 2013 23:19 | 0

The oil and gas game can be a tricky one for junior companies, but if played right the pay-off can be massive. At a time when juniors are risking a lot in volatile venues in the Middle East and Africa, Canada’s Aroway Energy (ARW) is planting its feet firmly in homeland soil and in conventional plays.
Why? Because for the smaller juniors this is not a long-term game and blowing all your capital to drill a single unconventional well in a risky frontier won’t pay off. Canada still has plenty to offer for juniors, even though you have to kiss plenty of frogs to find the prince. The end game, after all, is merger and acquisition.

In an exclusive interview with Oilprice.com, Aroway CEO Chris Cooper discusses:
• How to make or break a junior oil and gas company
• Why rail is becoming more attractive than pipeline transit
• Why most juniors won’t make it big in risky frontiers
• Why Keystone XL will get the green light
• Why oil and gas prices will increase
• Why the smaller juniors will stick to the conventional plays
• How the asset market is heating up … and what is ideal
• Why having control of infrastructure is key to success
• Where Canada’s oil and gas industry will be in a decade
• What every junior’s goal should be
Interview by James Stafford of Oilprice.com
James Stafford: Junior oil companies have been storming the scene with some bold investments in tricky frontier areas. Where do you see this going and what will the next phase for the juniors be? Where will the action be, in conventional or unconventional plays?
Chris Cooper: I am a big believer in the conventional plays. I find that the non-conventional plays are turning into more of a game for the intermediate-size companies primarily as a result of the capital that is required to exploit the resources. Horizontal wells with multi-stage fracturing is an expensive game. I find that the conventional plays expose juniors to a less risky scenario with higher returns on investment and longer-term production more often than not.
Given the current state of the capital markets and the scarcity of funding, I think the smaller juniors will continue to play in the conventional arena.
James Stafford: What’s the ideal partner for a junior company, and what can make or break it for a junior?
Chris Cooper: As far as make or breaking a junior, I believe you need to minimize the company’s risk by drilling wells that are going to give you good internal rates of return and steady production; a good mix of development and exploration wells. It is also very good to have a good operator that is responsible in keeping a control on costs.
James Stafford: What separates the good management teams from the mediocre in the Canadian junior oilpatch?
Chris Cooper: Management teams that have built and sold companies in the past have a responsible, methodical approach to how they run their businesses. More often than not, these teams do not try to re-invent themselves by drilling wells and formations that they have not done in the past. They continue to focus on what they know best, whether it be drilling in the Peace River Arch, chasing Leduc wells, or focusing on cardium wells. They often do not stray from their formulas and that is why they are good teams.
James Stafford: More Canadian oil is now being marketed by rail. Can you put the rail versus pipeline transport comparisons into perspective for us from a Canadian operating perspective?
Chris Cooper: A lot of companies, including Aroway, are capitalizing on the benefits of moving their oil via rail as opposed to pipeline. I think it will increase our netback, our profit per barrel, by several dollars immediately.
For instance, before we purchased our West Hazel Property in Skaskatchewan, the owners would truck to Talisman or another big operator that was pipeline-connected. Then, once the oil got to the pipeline-connected operator, they had to pay a certain amount of money to get it in the pipeline for diluents to meet pipeline specifications. Then they had to pay for the pipeline tariff and then they got the price the pipeline operator provided wherever they were on the pipeline.
So for example, the last month we got $53 to $54 a barrel, after the blend-in tariff for our West Hazel production, which is probably the lowest you’re going to see for a long time. Our netback on that oil was still greater than $20 a barrel. But for that $53.32 a barrel we sold, if transported by rail, we remove the pipeline tariff, we remove the blend for the diluents and we get $9 more added to the netback value.
So what we’ll end up doing is trucking our oil from the field to a company called Altex Energy, which is partly owned by Shell Canada. Shell owns all the railway cars and all these railway cars get filled up with heavy crude and shipped down to their Port Arthur facility on the Gulf Coast. At Port Arthur what typically happens to our crude--because it’s somewhere between 11 and 13 degree oil—is it goes straight into bunker fuel for ships.
So the refinery doesn’t have to touch it in some cases and that’s where we get a pretty substantial bump. Then you’re not subject to pipeline apportion and issues. It just opens up whole new markets for you.

At the end of the day we will get somewhere around $66 or $63 a barrel this month and then we’re going to bump that up by another $9 next month by taking all the crude we have in West Hazel by rail. So our netback will be $35 to $40--and that’s just the West Hazel crude.
James Stafford: What is the market like for assets right now, from a junior’s perspective? What’s the ideal prospect?
Chris Cooper: Asset sales are heating up. We are finding that there are a lot of assets being marketed through companies like Sayer and NRG Divestments. There are also several larger brokerage firms representing companies for “strategic alternatives.”
As an example, Aroway just picked up a great producing asset in Saskatchewan for $10,000/flowing barrel. The market for similar assets in Saskatchewan at that time was about $40,000/flowing barrel. Companies need to exercise patience and do their due diligence. Not to mention kissing a lot of frogs to find these types of assets. They are out there.

James Stafford: A lot of North American juniors are hitting the riskier frontiers with all they’ve got these days—from Iraqi Kurdistan to Sudan, even Somalia. Why are they willing to take this risk and is it paying off?
Chris Cooper: With higher risk comes higher reward, but I don’t think it is paying off in the broader sense. Sure, there are 2 or 3 juniors that have hit home runs, but more often than not a junior is going into those types of plays with only $5 or $10 million in the treasury and they blow this after drilling just one well. I have always believed there is great opportunity offshore, but the risks are lower and infrastructure and political stability in North America is in place. There is plenty of opportunity in North America.
James Stafford: Related to this, where do you see Canada’s oil and gas industry 10 years from now?
Chris Cooper: I see the oil and gas industry in Canada continuing to grow with the advancement of new drilling techniques and new innovations in exploiting existing pools to increase the recoverability. We have a stable political system in place which enables business opportunity to grow in Canada.
James Stafford: We hear a lot about Alberta, but what kind opportunities are we looking at in Saskatchewan?
Chris Cooper: Saskatchewan is definitely open for business. The royalties paid in Saskatchewan are very low and the production opportunities are very good. We are actively looking for new opportunities in Saskatchewan.

James Stafford: Do you lend any significance to Canadian media reports that the Cabinet is reviewing some new legislation that would set stiff payouts for the oil industry for accidents?
Chris Cooper: Personally, I think it is part of the grand plan to help the approval process. My theory is that the Canadian government will lay out a plan for big fines and then push to have the pipelines approved. The construction of pipeline projects creates jobs and would be good for the economy.
James Stafford: Do you think this is simply a carrot for the protesters at a time when the Enbridge hearings are raising tensions?
Chris Cooper: There will always be protesters.
James Stafford: What do you see happening to energy markets in 2013?
Chris Cooper: I see the price of oil and gas both increasing. They are depleting resources….it’s an inevitable function of supply and demand.
James Stafford: What are your views on the Keystone XL Pipeline? Do you think it is likely that Obama will approve its construction, and if so how will this affect your business?
Chris Cooper: I think he will approve it. The Governor of Nebraska gave the new route the okay. I think now that Obama has been re-elected he will go ahead and approve. Again, that is a lot of job-creation for an economy that is struggling. More pipelines are good for Canadian producers as it helps get our oil to market.
James Stafford: What are Aroway’s top three plays, and why?
Aroway plays

Chris Cooper: Our current plays all have different risk and production profiles. We have a large inventory and land spread in our JV lands in the Peace River Arch, which provide a healthy mix of development and exploration risk. Very big upside in this play.
Our West hazel production play is a very stable, long-term production scenario that we feel will provide great cash flow and netbacks to the company. For little investment we feel we can substantially increase production at West Hazel.
Aroway Primary Plays

Our Kirkpatrick Lake and Little bow lands in central Alberta are also very prospective properties that have the ability to turn into new core areas for the company. All our properties are oil focused and are highly prospective.
James Stafford: What can we expect from Aroway in 2013?
Chris Cooper: I am confident 2013 will be a big growth year for Aroway. We will continue to drill on our existing properties and leverage our production and financial position to take advantage of existing and upcoming opportunities in the sector as far as acquisitions and potential farm-in opportunities. We are confident it will be a big year for our shareholders.
James Stafford: 2013 has been touted as the year of the merger and acquisition. As one of the hottest investments around at the moment, do you think that Canadian junior oil & gas companies, like yourselves, will become a favoured target for larger oil companies looking to expand?
Chris Cooper: I think I can speak for most junior companies when I say, ‘I hope so’. There are a lot of big companies that need to fill the production gaps in their natural depletion, thus in some cases forcing big companies to do that through acquisition. I think the goal for most juniors is to be taken over by a bigger company at a nice premium for the shareholders.
James Stafford: Thanks for your time Chris. For those of you interested in finding out more about Aroway please visit their website at: http://www.arowayenergy.com/

Good time to sell oil futures

In May 2011, we predicted oil (WTI) price to fall to the level of $70 per barrel by the end of 2011. This is a monthly revision for September 2011. We consider the average oil price of $84 per barrel what is equivalent to the producer price index of 244 in September. (Actual estimate will be published by the Bureau of Labor Statistics in the middle of October.)

Figure 1 compares our prediction with actual oil price in 2011. In August 2011, the predicted price is a bit higher than the measured one. In any case, we expect the price to fall by approximately $5 per month to the level of ~$70 in December 2011. We also expect the price to slowly fall through 2016 and put the uncertainty bounds for the long-term trend in oil price. The level of oil price in 2016 is between $30 and $60 per barrel. These bounds are also shown in Figure 1.

Re-published from Oilprice.com: Oil Prices Could Drop Substantially: An Interview with Michael Levi

This article is re-published from Oilprice.com and is in line with my prediction from 2007 that oil price would peak and then fall down to $30 to $60 in 2016.

Oil Prices Could Drop Substantially: An Interview with Michael Levi

There's been plenty of talk about potentially radical US foreign policy changes as a result of the shale boom. While one shouldn't expect any dramatic US foreign policy move away from the Middle East, factors are influencing a greater focus on Asia. Only one thing is certain in this transforming world: The shale boom is real and the implications are many and difficult to predict.

In an exclusive interview with Oilprice.com publisher James Stafford, energy security expert Michael Levi, the David M. Rubenstein Senior Fellow for Energy and the Environment and Director of the Program on Energy Security and Climate Change at the Council on Foreign Relations (CFR), discusses:

Why oil price stability is still all about the Middle East
Why the oil and gas industry is heading towards transformation
Why oil prices could drop substantially
Why the US shale boom is real
Why the shale oil boom won't lead to major US foreign policy changes
Why Keystone XL is pretty much non-essential
Why we won't see any radical change in renewables in the next five years
The best way to achieve meaningful results on climate change

James Stafford: What is the number one threat to energy security today?

Michael Levi: I am not a huge fan of using the word 'energy security' because it means different things to different people, and that makes it very easy for people to talk past each other. What I would say the number one risk to the stability of global oil prices--which can have big economic and security ramifications--is the potential for major conflict in the Middle East and instability in oil-producing countries.

James Stafford: Are there any other regions that have this same destabilizing potential?

Michael Levi: The Middle East is always the place where focus is rightly drawn, because it is the place where you can have outsized disruptions. One of the things that I tend to emphasize is the need to focus and prioritize concerns, and it is very easy to get [drawn into] every 100,000 or 200,000-barrel-a- day change somewhere in the world that might have big consequences for one particular country, but does not necessarily have outsized global consequences or national consequences that policymakers need to think about. If I spend my time trying to think through what policymakers should be paying attention to, my focus, when it comes to disruptions to the oil system, tends to come back to the Middle East.

James Stafford: The UK-based think tank Chatham House has published a new report seeking to demonstrate how the oil and gas industry is under significant pressure that will lead to a transformation. How do you see a potential transformation of the industry taking shape?

Michael Levi: I think it is important to start with a distinction, particularly one that is important in the US: the oil and gas sectors, to some extent, are becoming two genuinely separate sectors, rather than one integrated one.

In the past, most natural gas was produced as associated gas together with oil, and that made oil and gas as a single entity very clear, something that made a lot of sense. Now you have a lot of non-associated gas; gas being produced separately, often by companies that do not engage in much oil production. They really have distinct challenges and opportunities, and as a result, different sets of pressures.

For the natural gas industry, at least in the US, the big challenges are low prices in the glut of gas on the market that is not being matched by demand. A big part of this is certainly idiosyncratic; there are people who are drilling to hold leases and cash flow, and they are doing that en masse, which is a problem for the whole industry.

At the same time, they have not been able to coalesce around the efforts to boost demand.
The oil world is a completely different story and you have pressures from different directions right now. On the one hand, you have a surge in opportunities for development in countries where geopolitical risks are relatively low. In the US, Canada, and Brazil you may need to still worry about regulatory changes, but you are not worried that terrorists will come and capture your workers.

At the same time, for a lot of the companies, that is not enough and they are still looking globally, and they still face challenges from nationalism and unstable regimes. On top of that, they are entering a period in which there is probably more uncertainty in prices than there has been for a long time. You have this collision of growth and supply from
outside OPEC, together with potential Iraqi growth and substantial investment from within OPEC that really opens up the possibility of a big, if temporary, price drop in the next five or
so years. That complicates the outlook for companies, on top of everything else.

James Stafford: Really? You believe that prices could drop in the future?

Michael Levi: I think prices could drop substantially. If you look at the most recent IEA report or the most recent OPEC outlook, you see that if all currently planned investment goes ahead, then at prices resembling current ones, supply would greatly outstrip demand.
Either countries will pull back with production and investment in OPEC and allow supply to match demand at relatively high prices--and I think that is the most likely outcome--or they will not be able to decide who has to pull back, and there will be an excess of supply on the market that pushes prices down quickly. That is self-correcting, because low prices cannot sustain the big gains in North American production. But you can still have temporarily low prices that really shake things up for some producers, depending on the properties of their investment.

James Stafford: Speaking of the IEA report, predictions that the US could pass Saudi Arabia to become the world's largest oil producer by 2017 have come under a lot of criticism. What do you think of the IEA's predictive mathematics?

Michael Levi: Predictions are always wrong in one way or another, and I am not going to second-guess those who have thought to a much greater depth in these analyses. There is a range of estimates out there, but the IEA ones are relatively modest.
The bigger issue is: what are the implications? Everyone likes to talk about how their projections show that the world is being reborn anew, and will be fundamentally different from what it was in the past.

There is a temptation to oversell, and I think it is reasonable that people react negatively to efforts to oversell the consequences of the changes going on in energy.

James Stafford: What are your views on the shale boom? Do you believe it can live up to the hype?

Michael Levi: It depends on what hype we are talking about. I think the shale boom is for real. I think that a lot of the criticism that we do not know long-term production rates and so on are important to look at. But even if you assume that returns on wells are substantially lower than most people think they are right now, our projected output is still quite high, because producers' economics are dependent primarily on what happens in first few years after they drill. We know roughly what happens in the first years after producers drill.

The hype that says that this will all replace coal without any government intervention, gas prices will be $3 forever, or that we will be the dominant exporter in the world, are out of contact with reality. We have temporarily depressed prices, they will rise a bit. Hype always has the ability and the tendency to outstrip reality, but in this case, reality is pretty radical itself.

James Stafford: Could the shale boom lead to a change in US foreign policy priorities, away from the Middle East?

Michael Levi: An economic analyst will typically tell you that the US shale boom will fundamentally change US vulnerability to energy events in the Middle East. But not every policymaker listens to their economic advisors.

I do not think that US policymakers will step back and say, 'We need to revisit our strategy in the world, because of this oil boom.' I do think that what is happening will weigh on ongoing
discussions that already exist about future US priorities.

The most obvious one is the discussion from the US Department of Defense over how much to shift from the Middle East to Asia. Within that existing debate, I have no doubt that people who want to see more of a shift will emphasize what is happening in US energy. I think it will have some influence, but ultimately, I do not see a radical change as being likely.

James Stafford: Now that Barack Obama has won a second term, what do you see happening with the Keystone XL Pipeline? Will it go ahead? Is it essential to US energy security?

Michael Levi: I made a prediction once on the Keystone XL Pipeline, so I have lost my license to make future predictions. The Keystone XL Pipeline is non-essential to US energy security; it is also not disastrous to climate change. It has been overblown by both sides in the debate. It is one pipeline that would carry a modest, but non-trivial amount of crude, and that would help create economic incentives to increase production, again, by a modest but not earth-shattering amount.
The more fundamental question is whether the US is going to let economically-rational infrastructure go ahead. I think if you replicate a pattern like the one that some would like to see for Keystone and you start blocking pipelines all over the place, then that becomes a larger economic problem.

In the end, will it make the US more secure in any meaningful way? I doubt it. Prices for Canadian oil rose more during the Libya conflict than the prices for Brent Crude, or WTI. It is hard to say that Canada gives the US potentially more security aside from in extreme circumstances.

James Stafford: One would have thought that the natural gas boom would be good for the environment, but the cheap gas prices have also hit coal prices, and we are seeing Europe sucking up unused US coal. Is this a trend we can expect to continue?

Michael Levi: I think it is a trend we can expect to continue to some extent, particularly if Europe does not make stronger moves away from coal. The state of our knowledge about global coal markets is pathetic. All we can say right now is, directionally, more gas in the US means cheaper coal, which leads to more exports, but we are still far from being able to really put quantitative meat on those bones, and making some meaningful net assessment.

James Stafford: What do you believe is the best way to achieve meaningful results on climate change? How much of an influence will Hurricane Sandy have on this debate?

Michael Levi: I think Hurricane Sandy has put the debates into a prominent place, which is essential to moving it forward.
Ultimately, I still believe that carbon pricing in one form or another is essential to achieving deep cuts in economically-sensible ways. That can come in the form of a tax, resurgent cap and trade, or clean energy standard; there are all sorts of ways to do carbon pricing. In the long haul, I think you come back to that, particularly if you care about doing this is an economically-efficient way.

James Stafford: What changes in public interest on climate change have you noticed over the years? Do you think that at this rate climate change will ever gain the support it needs to be effectively tackled?

Michael Levi: Ever is a long time. I think we are back in a building phase. If you look at the first decade of this century, you had a solid 5 or 6 years that was really about building broad support for action on climate change, about test driving different approaches, and by the time you got to 2008, there was actually pretty broad support, particularly in the Senate for action on climate change. You had 2 presidential candidates competing to see who had the best climate strategy. Then you had the financial crises. You had intense polarization. You had a deep, deep recession, and climate action became a much lower priority.
A lot of people got used to saying in early 2009 that we would come back to climate change when the economy got better. The only mistake that people made in that analysis was thinking that that was only a couple years off. It turns out that it is even further off.
One of the emerging barriers to action on climate change is that doing things to exploit oil and gas have been set up as 100% incompatible with serious efforts to deal with climate change. That stark choice makes it very difficult to build coalitions that will move anything forward. We have actually moved in the last couple of years into a considerably more difficult situation than we were even 4 years ago, when a candidate like John McCain could say, 'I support oil and gas production, and I support a strong cap and trade system.' The president talks about things like that today, but gets considerably weaker support for it, and that ultimately needs to change.

James Stafford: How can this change?

Michael Levi: I have a book out next spring, talking about this. The first step is for each side to recognize that accepting a lot of what his opponents want will not fatally undermine what it wants. Oil and gas will need to understand that serious action on climate change will not fundamentally undermine what they want to accomplish in the next decade or two. People who want to take action on climate change need to fundamentally understand that expanding access to US oil and gas production will not fatally undermine their own goals. Compromise is not an oxymoron.

The second thing that needs to happen is there needs to be some rebuilding of trust. That is difficult; you do not just do it by hanging out more at the bar. You need to do small deals that show that you can work together.
You can think of all sorts of ideas; you could tie royalties from increased oil and gas production to financial support for renewable energy. You could provide support for carbon capture and storage demonstrations that support enhanced oil recovery. You can work to improve environmental permitting so it is easier to build pipelines and power lines that take renewable energy to places where they can be used.
There are a host of things that are small (but not trivial) win-wins that might help rebuild confidence. Ultimately, both sides need to accept that a political deal is better than trying to go for an outright win.

James Stafford: What role do you see renewable energy playing in the future?

Michael Levi: In the near future, renewable is cost-competitive in niches, but it is still not broadly competitive in the US economy. It has a potential to be.
Renewables have cost and intermittency challenges. There is important progress that is being made in renewable energy. I think a lot of that story has been buried in the oil and gas discussion in the last couple of years, but we are seeing record-low prices across the board, and we are seeing record-high deployments. It is important to remember that we still need government support in all these areas if you actually want to see costs come down meaningfully.

James Stafford: How do you define the ‘near future'?

Michael Levi: I do not see a radical change in the relative price of renewable energy and fossil fuels in the next 5 years. Ten years is more difficult to predict, but I would be skeptical. When you start to look ahead one or two decades, particularly when you add in policy uncertainty, it is very difficult to predict what will happen.

James Stafford: Can the US afford to turn its back on nuclear energy?

Michael Levi: If you mean by turning its back, you mean a phasing-out of nuclear energy, I do not think that is sensible to do. Nuclear energy provides 20% of our electricity, and the marginal cost of production is extremely low for existing power plants. The real question is can the US afford to turn its back on nuclear in the future as a source of zero-carbon energy growth? The answer is: we do not know, because we do not know what the alternatives will be, or if there will be significant alternatives. So you want to keep nuclear alive as an option; that means trying to figure out ways to bring down costs, particularly financing costs. It means looking for ways to resolve, or at least partly resolve the waste questions, and it means looking for ways to potentially innovate on small modular reactors to provide a different economic model and a different construction model for nuclear power.

Comparing and modeling Chesapeake Energy and Chevron prices

It is difficult to deny that there exist general feelings of oil as a driver of economic growth. My own experience shows that any visible market analyst does not miss any opportunity to comment of changing oil price. An intriguing thing about these comments is that any big change in oil price is perceived as a danger for real economic growth, independent on the change sign. Skipping the question of oil influence on the entire economy, we would like to address the question of the driving forces behind the prices of energy companies. The pricing power of companies associated with Energy category of the S&P 500 list (we focus on this list in our articles) is of interest for many investors. Here we compare the price evolution of Chesapeake Energy (NYSE: CHK) and Chevron (NYSE: CVX).

In our previous post we presented a pricing model for Halliburton (NYSE: HAL). Also we have been routinely reporting on similar models for ConocoPhillips (COP) and ExxonMobil (XOM). All these models were based on our general concept that the evolution of a share price can be (quantitatively) decomposed in a weighted sum (or difference) of two CPI/PPI components. This concept was elaborated in a series of papers three years ago starting with the one predicting share prices for a COP and XOM since the early 1990s.

For Halliburton, we have exercised several models. The most basic model included the core and headline CPIs, where the core CPI, CC, was a proxy to an energy independent (dynamic) price reference and the headline CPI, C, played the role of energy price, which supposedly, moves the prices of energy companies. Therefore, we assumed that the difference between these two CPIs might express the energy pricing power relative to all other goods and services. As an alternative, we have tested two more pricing models for Halliburton with the core CPI the consumer price index of energy, E, and the producer price index of crude petroleum, OIL, together with the overall PPI. We have found that the best model for HAL includes CC and E with the standard model error of $3.55 between July 2003 and February 2012.

For this article, we have estimated three different models for share prices of two energy companies: Chesapeake and Chevron between July 2003 and February 2012. Figure 1 compares the evolution of actual monthly closing prices since 2003. The upper panel demonstrates that Chevron has a much better performance since 2009 and is currently at its historical peak ~$100; Chesapeake Energy has been fluctuating around $20. In the lower panel, we have displayed these prices as normalized to their respective peak values since July 2003. Chesapeake is now only at 34% of its peak in 2007. One might suggest that the difference in the overall behavior should be rooted in the driving forces behind these prices and thus can be caught in our models by the difference in defining CPIs.

All three studied models allow for different coefficients for defining CPIs, time lags and linear trend. The latter is an obvious component since we expect all share prices to rise with real economic growth. All three models are shown below with the standard errors estimated for the same period in Table 1:

CHK(t)= 3.68C(t) – 1.82CC(t-1) – 9.45(t-2000) – 185.01

CVX(t)= 2.07C(t) – 3.96CC(t-12) + 13.74(t-2000) + 208.52

CHK(t)= 172CC(t-6) + 0.39E(t) – 9.89(t-2000) - 235.34

CVX(t)= -2.65CC(t-12) + 0.25E(t) + 15.96(t-2000) + 277.77

CHK(t)= 1.11PPI(t) + 0.026OIL(t-12) – 6.75(t-2000) – 50.18

CVX(t)= 1.18PPI(t) – 0.044OIL(t-7) + 0.36(t-2000) – 138.25

Table 1. Standard model errors

Company	C and CC	CC and E	PPI and OIL
CHK	3.74	3.34	4.04
CVX	5.85	5.83	5.45

Figures 2 through 4 depict the observed and predicted prices for the three models. Table 1 implies (the lowermost standard model errors are highlighted) that the best CHK model is associated with the consumer price of energy and the core CPI. On the other hand, the price of CVX share is likely driven by the producer prices and, specifically, the price of oil. Therefore, the shares of energy companies not only demonstrate various time histories but are likely related to different goods and products. The investor could foresee the evolution of both prices if to project the defining CPIs and PPIs.

For CVX, the current price is at the expected level and any rise in oil price will likely reduce the price seven months later. The current price level of CHK is slightly undervalued. We will be reporting on both companies and expect an interesting comparison with oil price fluctuating in a wide range.

Figure 1. Relative performance of CHK and CVX. The upper panel shows actual prices and the lower one – the prices normalized to their respective peak values since 2003.