Over the last few days I've been buying stock in a company that, I have to admit, I'm not sure I should be buying. 

First of all, I have a tendency to stretch when things are going well.  I don't know if its hope or greed or just too much enthusiasm, but I tend to make poor purchasing decisions during big runs. And right now, with PotashCorp up over 240 and with Western Canadian Coal up a remarkable 20% yesterday alone, is quite the run.

Second of all, I have a tendency to make poor decisions on natural gas investments. I think the problem is that I work in the industry, and so I have trouble seeing the forest through the trees.

So take this post with a grain of salt.  I may look back on this in a few months and shake my head.

A Junior Swimming in the Horn River Pool

I've been buying a company called Result Energy. 

Result (RTE) has about 40 sections of land (100% working interest) in the southeastern corner of the Horn River basin in Northeastern BC.  On Monday this week Encana announced at the energy conference here in Calgary that they  think they could achieve production of 1bcf/d from the Horn River basin.   There are a number of majors that have been buying up land in the basin.  Along with Encana, EOG, Apache, Nexen and Quicksilver, and Talisman have built up land positions.

Elephants...

According to Nexen, the net pay of the shale at Horn River is about 50% thicker of the Barnett shale, the prolific shale play in Louisiana.  After looking at an Encana presentation, I'd put the land size of the play area at about twice that of Barnett. 

Apart from Encana, Nexen has been throwing around some big numbers.  Nexen estimated that their Dilly Creek land has between 3-6tcf of gas in place, assuming 20% recoveries.  That is a lot of gas. 

But can they get the gas out?

A lot of gas  is only good if you can get it out for less then the going rate.   Shales are very tight, the gas is trapped in invisible pores and adhered onto the shale rock.  To get the gas out you have to basically explode the rock with vast amounts of water, sand and other fluids.  Either that, or you bring in the explosives (I just read that explosives are looking like the way to go with the Montney play down south of Horn River).  

Early signs at Horn River are that they can it out, and you wouldn't see majors like Encana or Nexen increasing budgets by hundreds of millions if the expectation  wasn't positive.

AKnowledge of what needs to be done t get the gas out of a shale gas play has greatly improved with the exploitation of the Barnett and the other shale gas plays, and those techniques are clearly being applied to the early test wells. In first-quarter 2008, Apache drilled three horizontal wells with initial test rates of 8.8 million cubic feet per day, 6.1 million and 5.3 million. Nexen described in a news release in April that they drilled and fractured a horizontal test well and that the results show that you get about 1 million cubic feet per day for each frac, which was consistent with what other industry players were seeing.  Nexen went on to point out that the optimal horizontal well design would have 6 to 12 fractures, which implies you'd get between 6-10 million cubic feet per well.

What's interesting to me about those numbers is that the companies don't really know what they are doing yet, and yet the flowing numbers are pretty big.  To use the Montney play as an analogy (the Montney is a tight gas basin in British Columbia, a little south of Horn River, that is a couple years ahead in terms of development), producers there recently determined that they could increase production 15% per well simply by using carbon dioxide instead of nitrogen in the frac.  Simple improvement, but big improvement.  To use another example, I was at a presentation this week where the presenter showed a chart of Barnett Shale completions versus time.  In the last 5 years wells have improved their flush production by 4x.  That's all due to experience and productivity.  The point here is that these are extremely early days at Horn River, and the flow numbers should get better, not worse.

A very expensive elephant...

Costs are going to be expensive at first.  There is no infrastructure up there.  Its muskeg, so its wet and winter access only.  The number I've been hearing floated around the most is $10M per horizontal, which is by no means a cheap well.  That compares to about $8M per horizontal in the Montney region when that play was just starting out.  Note though that at Montney costs are down to $4.5-5M a horizontal in the 18 months, so once these majors figure out what they are doing, and what is the best way to do it, costs will come down.

What about Result?

I think that the upside here is pretty obvious, so I'll briefly touch on it, but I want to focus on the downside. 

The upside is that they have 40 sections of land in a basin that is prospective for what Nexen says could be 100-200Bcf per section.  Result themselves estimated that with 30% recovery their lands could contain around 60bcf/section.  Estimating 60% of the land as prospective, that would give Result over a tcf of recoverable gas in the ground.

And if that's the case, this won't be a 55 cent company in a few years.

The Downside

But nothing is so easy.  So here are the downside points, and they are not insignificant.  

• The Company currently owns 40 sections at 100% working interest within the southeastern portion of the Horn River Basin. The Company’s lands are prospective for both the Middle Devonian shale gas play and the underlying Keg River platform gas play. Based on comparable figures recently announced by area operators and B.C. government sponsored studies, Result estimates the potential shale gas resource on these lands at between 100 and 200 bcf per section.
• Results land is on the south-eastern edge of the play.  Therefore chances are the shales are going to be thinning out on those lands.  Result in their April presentation explained as much through one of the slides.  The bright side is that the shales in the basin appear to be so thick that thinning shales could still be pretty thick.  But without question, the thinner the shale, the less the gas.
• The play is still years away from commercial production.  The time-line I hear is 3 years.  As I mentioned earlier, there is no infrastructure, there is no pipeline capacity.   With the gas that’s up there, no doubt this will come, but it will take time.  But Result is not going to be producing gas from Horn River in a few months.  At best they will be drilling a couple test wells next winter.  So stock-wise, there is plenty of time for the stock to drift back lower.
• Its going to cost big money.  Result is a junior in the land of giants, which is great from a resource perspective, but not so great on the cost side. The costs are going to be huge, especially to begin with.  
• It will take a while to get it right.  As I already pointed out, it took a few years to get the Barnett shale producing at the rates we are seeing today.  Shale is harder to work with then regular rock. You frac it in one direction and it shatters, while you frac it in another and it does nothing, or worse, gets tighter.  The technology learning curve is going to take some time.

Anyways, the bottomline to me is that the potential is huge but that the risks are as well.  With 40 sections of land, and with land up there going for as much as $2,000 an acre, you could choose to value Result’s land position at $50M, which would put the stock above where its trading at.  But as I said, there is much unknown about their land position, its closer to the edges then the middle, and the shale may thin in that direction.  Moreover, valuing based on land value is not really the point here.  Either the gas is there or its not.  Doing anything more then eyeballing a value is difficult.  

 

I bought the stock because I want to see how this plays out over the next few months.  If we continue to see big flow numbers come out, and if the land rush continues during the next BC government land sale, we may see further upside here.  If not, it may turn out that I’m buying near a temporary peak.  The position I bought is not overly large, its only enough to get my feet wet and keep my attention.  Time will tell if the decision was a good one.