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California fracking law a win for Zodiac Exploration (V.ZEX)

Peter Epstein, Epstein Research
1 Comment| September 20, 2013

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Before reading this Exclusive Interview with Zodiac Exploration Inc.’s (TSX: V.ZEX, Stock Forum) CEO, here’s my view on the new Fracking law in California.

Clearly, Occidental Petroleum Corp. (NYSE: OXY, Stock Forum), Hess Corp. (NYSE: HES, Stock Forum),Royal Dutch Shell (NYSE: RDS.B, Stock Forum)/Exxon Mobil Corp. (NYSE: XOM, Stock Forum) (through privately owned Aera Energy) had an impact on this law and it’s considered a win for the industry.

Of course, the industry can’t come out and say that it’s happy with it, but it probably is. This law is especially positive for Zodiac as the doors are wide open for a greater number of companies to enter or expand in the Monterey shale. Companies now know that they can explore and test multiple horizons without undue interference, for at least the next 15 months before the law takes effect. If exploration and testing activities prove successful, companies will gladly adapt to the requirements of the law in 2015.

From my conversations with industry contacts, it’s clear that politicians could have deliberated on Fracking for A LOT longer.

Instead, State officials sent a strong message that they want the taxes, royalties AND high paying jobs that come from further exploiting the Monterey shale. All that matters for Zodiac is that there’s virtually no limitation on its intermediate-term activities or the activities of neighboring players, most notably Aera Energy. Investors should recognize that this news greatly de-risks the overall Zodiac story.

Occidental Petroleum’s 2nd Qrt. Conf. Call Filled With Discussion of Unconventional Ambitions in California!

If one looks at OXY’s quarterly conference calls over the past few years, very little if anything was ever said about its unconventional activities in California. However, that changed dramatically on the July 30th conference call, which contained 15-20 minutes entirely devoted to California! OXY has both what I call, “conventional-unconventional” shale plays, that when drilled typically find oil, and, “unconventional-unconventional” activities, i.e. exploring and in some cases developing deeper and more complex oil shale horizons.

To be clear, Zodiac’s property largely falls into the deeper and more complex category.

Please consider the following 3 highlights from the July 30th conference call. These direct quotes are from Vicki Hollub, Executive Vice President, OXY- in charge of California operations.

“…we created 3 technical teams to better manage the complex geology of the reservoirs in California… the third team will focus on unconventional development opportunities to optimize recoveries from the Monterey and other key shale plays in California. This year, we will spend about 25% of the [$1.5 billion] capital program on our unconventional projects.”
This is telling, this year alone OXY is spending $375 million in California, specifically on unconventional plays.

Vicki Hollub continued, “…our unconventional opportunities include those reservoirs that have low permeability and require special recovery processes to flow. About 1/3 of our California production is from unconventional reservoirs. This year, we plan to drill more than 70 unconventional wells. We have drilled approximately 1,300 unconventional wells in California since 1998.”

Wow, OXY is already getting a third of its oil production in California from unconventional plays. It’s now clear that OXY is making a big push into the, “unconventional-unconventional” plays to support and grow this segment longer-term.
Vicki Hollub points to important discovery in the San Joaquin,

“Last year we made a significant unconventional discovery in the San Joaquin Basin. Continued appraisal, drilling and testing established reserves and resources of approximately 50 million BOE. The full development of this discovery is expected to require drilling 100 wells. In addition to the 50 million BOE we’ve established, we are testing and/or planning wells in late 2013 and 2014 that, if successful, will double this volume.”

Recent successes by OXY and last week’s news on California’s Fracking law is once again attracting tremendous attention to the San Joaquin basin.

The Main Event- Exclusive Interview with the CEO of Zodiac Exploration….

In addition to the excellent video interview in late August, 2013 of CEO Peter Haverson of Zodiac Exploration [ZEX.V / ZDEXF], the following interview was conducted on September 16th.

Several recent articles and investment blogs suggest that interest and activity in the Monterey shale has picked up in recent months. How is this any different from the perceived boom in 2010-11?

We are seeing a significant increase in both activity and interest in the San Joaquin basin from both the operational side and land side. We are holding discussions with large U.S. Oil & Gas producers interested in our sizable land position and seeking entry into the massive Monterey oil shale basin. This makes tremendous and logical sense given the huge success achieved in States such as Texas, North Dakota.

Unlike other U.S. oil shale basins, the San Joaquin basin in California is largely controlled by 4 or 5 majors. The availability of large land parcels in the heart of the oil shale fairway is scarce, putting Zodiac in a very enviable position. Our acreage is literally surrounded and checker-boarded by these majors.

The quality of our acreage was validated last year when Aera Energy LLC, one of America’s largest private Oil & Gas producers, entered into a joint venture with us on a block of approximately 19,600 net acres. This JV not only validates our core acreage, but also demonstrates that large companies are prepared to make large investments into world class basins.

Given the very difficult and varying geology of the Monterey shale, how does Zodiac know that its property is in the, “fairway?”

Zodiac has had a team of highly experienced geo-scientists studying not just the Zodiac property, but surrounding lands as well. There is a plethora of data from previous wells drilled and by collecting this data and piecing it together; the team was able to map out maturity windows for each zone being studied. A maturity window is a depth and associated temperature required for the generation of oil. Zodiac’s property lies within these multiple-zone maturity windows that were verified by the 2 wells drilled by Zodiac to date. Results of a third well drilled by Aera Energy remain confidential at this time.

Zodiac’s farm-out to Aera Energy LLC implies a very strong valuation of the farmed out acres, yet the market is valuing Zodiac’s entire land package at close to zero. Please explain the importance of the Aera Energy deal?

The Aera Energy farm-out in October, 2012 was an extremely significant event for Zodiac. For some reason, the investment community has not given our company proper credit for this highly attractive deal. The area of interest covers ~19,600 net acres directly adjacent and east of Zodiac’s remaining ~52,000 net acres. In order for Aera Energy to earn an assignment of 50%, it has to drill 2 vertical wells and two horizontal step-outs.

From the expenditures incurred on Zodiac’s own wells, we estimate Aera Energy’s program will cost a total of $45-$55 million. The fact that Aera, (a 50/50 JV between Exxon and Shell), was willing to undertake this level of expenditure for a 50% stake in ~19,600 acres validates the importance of Zodiac’s other property.

How much time and money might a major save by acquiring Zodiac’s land package vs. starting from scratch?
Investors should appreciate that we entered the San Joaquin Basin in the early stages and have spent approximately $85 million in land acquisition, seismic, drilling and technical work since early 2009. We’ve demonstrated the initial viability of our land and the presence of multiple oil-generating horizons. It would be impossible for us to replicate this position today without having to pay significantly larger sums of money, notwithstanding the tremendous value of the data we have amassed over this time frame.

How should one compare the stage of development of the Monterey and other oil-heavy shale basins in North America?

The Monterey is a world-class, renowned oil generating source shale located in southern California. Where it is located close to surface it has been producing high quality oil for decades. Oil companies have prudently focused on these shallower horizons as they are the low hanging fruit. However, with depletion and increasing oil prices, producers are chasing the Monterey deeper.

In comparing California’s oil shale exploitation to similar deposits in other States, there are some significant differences. There were many smaller oil companies involved in the other basins and consequently any success was heralded by a press release, which brought more companies and eventually an oil bonanza.

For instance, the North Dakota Bakken is currently producing ~800,000 barrels of oil a day, and is widely known and talked about in the media, whereas a few years ago it was largely unknown. A similar story can be told of the Texas Eagle Ford oil shale play. In order to unlock the code of these and other basins, lessons had to be learned, capital spent and mistakes made. New technology was developed and employed and along with it grew a plethora of experienced people and service companies.

The same has not been the case in California as the land is largely controlled by a handful of majors and private companies and services are not as plentiful. Understandably, there’s a great deal of secrecy around what key players are up to. Importantly, lack of press releases do not equate to lack of progress. Politics aside, most knowledgeable observers believe that breakthroughs are happening, in many cases without fanfare, and that unlocking the code is a question of when, not if.

2010 analyst days held by OXY and Venoco Inc. generated a great deal of excitement in the Monterey shale. What’s happened since then?

You have to appreciate the sheer size of the Monterey oil shale basin, believed to hold greater than 15 billion barrels of recoverable oil according the U.S. Dept. of Energy. Massive resource plays take time, both technically and logistically, to properly develop. In 2008, there were only a few wells drilled into the Eagle Ford and at that time some were writing it off. By 2010, there were over 1,000 wells drilled into the same formation. A similar story can be told of the North Dakota Bakken.
Of greater importance, wells initially costing $10-$13 million in the Eagle Ford, now cost half as much.

The main reason being that operators have completed their science projects, where learnings have been made, technology has been developed and employed, and oilfield services are now plentiful. Greater efficiencies come with increased volume. While still early days, there are currently some very large seismic programs in progress close to our acreage. In addition, there are several wells in various stages of drilling.

ZEX.V has gone from above $1 per share in 2nd quarter, 2011 to 10 cents today, Sept 18th. What are some of the possible reasons?

The last financing completed was at just over $1/share, supported by the fact that Occidental Petroleum had issued a favorable press release about the potential of the San Joaquin Basin. In addition, Zodiac had commissioned a Sproule resource report in mid-2010, which focused on the oil shale potential for the Company’s Jaguar block. The report showed a, “best estimate” potential 4 billion barrels of oil in place on a block covering approximately 31,000 net acres.

The drop in the share price to 10 cents is largely due to drill results at Zodiac’s two wells that did not meet market expectations. Technical difficulties led to much higher expenditures than originally anticipated. Oil production from our second well was achieved, although not at economically sustainable rates. A marked decline in industry news flow out of the Monterey and a very weak Venture Exchange did not help. Still, the drilled wells delivered proof of multiple stacked oil producing shales on our acreage.

Zodiac is actively pursuing additional farm-outs, joint ventures and other corporate initiatives. Can you describe the process and level of interest?

Zodiac currently has ~$17 million in cash, zero debt and a significantly reduced cash burn rate. Experience gained in the development of other prolific oil shales, such as the Bakken and the Eagle Ford, has shown that they required time and many drilled wells to reach commercial potential. Development of the San Joaquin basin is no different.

Zodiac sees the inevitable movement of companies from other States into California’s San Joaquin basin. Since Zodiac has already drilled and demonstrated the existence of multiple oil-generating horizons and acquired a vast amount of valuable data, it is prudent for companies enjoying success elsewhere to seek entry into California’s oil shale. For the majors, the time-value of money alone makes Zodiac’s acreage and data especially attractive. An acquisition, farm-out or JV with Zodiac offers a prospective partner a multi-year head start.

That head start can mean the difference between success and failure and the difference between getting into the Monterey relatively early, or possibly having to pay tens of thousands of dollars/acre in the future.

Some investors fear the politicians and environmentalists in California. Can you comment on Zodiac’s experience in the State?

Zodiac followed the prevailing engineering design and permitting process on all its wells drilled in the San Joaquin Basin. There were no mishaps of any kind and no damage to the environment from the result of its wells, which included fracking operations. As various groups become more educated about the fracking process, they are beginning to become much more tolerant and understanding about the impacts. Certainly there might be additional regulations to ensure there well designs are adequate and executed to comply with prevailing regulations.

Last week’s announcement of a new law in California on Fracking is extremely important for the investment landscape for Oil & Gas companies looking to do business in the State. The law appears to be business-friendly, industry-friendly and an important precedent to laws and regulations to follow. California is open for business and stands ready to collect industry taxes and royalties to help balance the budget.


Although perhaps not obvious unless one is paying attention, Zodiac Exploration has been significantly de-risked in 2013. Of course the biggest de-risking event in the past 12 months was the Aera Energy Farm-out. Since then, OXY has made its intentions clear in the San Joaquin basin. It is expanding it’s exposure to the most difficult and highest potential reward unconventional targets. Majors are watching intently and in fact are making plans to enter or expand in the basin in coming months. That’s why Zodiac’s property is the subject of keen interest.

As important as OXY’s bullish revelations on July 30th were, equally important was last week’s news on the Legal/Regulatory front. The new Fracking law provides considerable clarity on the Political and Regulatory environment through early 2015. Thereafter, the forecast is for a relatively business-friendly, job-supportive and trust-but-verify arrangement with industry. Fence-sitting companies should take note, the cost of playing poker in the San Joaquin is going up.

In light of the above, Zodiac’s shares appear even more attractive. With less uncertainty on Fracking and a clear bullish signal by OXY, not to mention the strong oil price, the option value of the company’s ~72k net acres is higher than it was 2 months ago. I’m now comfortable with a $1,000/acre valuation as a conservative base case assumption. Together with cash and the NPV of Zodiac’s tax pools, that equates to about 30 cents per share. Management continues to entertain relatively advanced discussions with multiple parties regarding strategic initiatives including joint ventures, farm-outs and outright sales of select property or the entire company.

Now is probably not the time to sell shares or attempt to trade in and out of a position. Exciting news could come at any time, while fundamental downside in the share price below 10 cents appears quite limited, (supported by cash + the NPV of tax pools worth ~9-10 cents per share). More and more activity and new entrants into Zodiac’s region is an important development. Good news for one is good news for all.

READERS PLEASE NOTE: Zodiac Exploration is a Stockhouse client.

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