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The Commodity Investor Q&A

With Matt Badiali, editor, S&A Resource Report
Wednesday, July 2, 2008

Q: I've read some articles on shale gas. What is the big deal with this stuff? – H.B.
A: Shale is the world's most common rock, formed from mud and clay deposited at the bottoms of lakes and ocean basins. Shale looks like the slate you see in chalkboards or on roofs, (slate is actually shale that was "cooked" in the earth).
Clay and mud are tiny – much smaller than sand. So it's hard to tap shale deposits. (See the next question, about the Bakken Shale, for more details.)
Some shale is full of old plants and animals. These shales become the source rocks for oil and natural gas. In the past, it didn't make sense to drill shale for either oil or gas. Shale presented technical challenges that were beyond most of the industry. However, that began to change in 1990, when oil-service giant Schlumberger began focusing its attention on the natural gas in shale.
The company estimates that shale contains 500 billion to 780 billion thousand cubic feet (MCF). We consume about 23 billion MCF per year, so that's about 20 to 34 years worth of natural gas. Today, one MCF sells for more than $13. So the reward is in the trillions of dollars.
The Barnett Shale became the proving ground for shale technologies. Barnett is in the Fort Worth Basin of Texas, which underlies the entire region west of the city of Fort Worth. The Barnett Shale holds between 25 billion and 250 billion MCF.
I'm not targeting companies that are just Barnett players for investment. However, I am interested in companies that learned how to drill the Barnett and are now leasing land in the many new shale regions.
Investors can take a look at companies operating in the Huron Shale in southern Ohio, the Fayetteville Shale in Arkansas, and the Ootla in Canada.
Q: Why can't we pump all the oil out of the Bakken Shale? – D.S.
A: The Bakken Shale, the granddaddy of the shale oil fields, underlies northeastern Montana and western North Dakota. A recent government report put the amount of oil in the Bakken Shale between 200 billion and 400 billion barrels: enough to eliminate our oil imports for at least 45 years.
However, the report also says we can only recover about 3 billion to 4 billion barrels of that oil with current technology. That's a terrible recovery rate... around 1% or 2%.
The problem with the Bakken Shale – and with many of the shale deposits around the world – is "permeability."
Some reservoirs are like a glass of grape juice and ice cubes. You stick in a straw and suck up the juice around the ice cubes. That's a permeable reservoir.
However, some reservoirs are like clusters of grapes. You know there's a lot of juice in there, you just can't get it out. You have to stick the straw in each grape, suck a little, and then move to the next one. That's an impermeable reservoir.
Impermeability is one of the problems facing by companies working in the Bakken Shale and other "unconventional" oil fields. You need a way to put the straw through as many grapes as possible.
It took a long time for oil companies to realize that drilling straight down wasn't the best way to do that. The solution is directional drilling. In directional drilling, the well is drilled at an angle using a computer to help guide the drill bit.
I visited a well in south Texas where the bit went down deeper than a mile, then turned west and drilled horizontally for more than a mile. I was amazed... Here was this thick steel drill casing, steered by an engineer in a truck miles away. Now nearly all the big drilling and service companies, like Schlumberger, Halliburton, and Baker Hughes, offer steerable drilling in three dimensions.
In 1990, only about 40 rigs, or 6% of all the rigs in the U.S., were drilling horizontally. As of last month (according to the Department of Energy), 519 rigs, or 28% of the total, were drilling horizontally.
That makes it much easier for oil companies to get more out of their shale deposits. And as this technology advances, I think more of Bakken's "grapes" will yield oil.
Some excellent companies are drilling in Bakken, including XTO Energy (XTO). But while XTO is adding reserves, you're going to have to pay up for the growth these days. I told readers of the S&A Oil Report about the company last July, and we're up 41% so far.
Good investing,

Market Notes
Natty makes a new high... U.S. Natural Gas Fund up 75% this year.
Wall Street breaks down... Lehman Brothers, UBS, JPMorgan, Credit Suisse, Citibank, and Merrill Lynch plunge to new lows.
Nobody's buying... anything. Lennar (homes), Brunswick (boats), Ford (cars), Diageo (booze), Best Buy (electronics), Reynolds (smokes), Macy's (clothes), and Starbucks (lattes) hit new lows.
Market Watch
Symbol Price
S&P 500 1221.53 +1.3% +10.1%
Oil 37.77 +1.5% -2.8%
Gold 135.20 -0.1% +13.4%
Silver 27.93 +0.4% +47.9%
US-Dollar 80.67 -0.8% +8.1%
Euro 1.32 +0.6% -12.1%
Volatility 19.39 -9.2% -8.2%
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10-Year Yield 3.00 +1.4% -9.6%

World ETFs
Symbol Price
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Japan 10.58 +1.0% +7.4%
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S. Africa 70.85 +3.9% +22.9%
China 45.06 +1.4% +0.1%
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Sector ETFs
Symbol Price
Oil Service 136.18 +1.5% +14.8%
Big Pharma 64.13 +0.6% -3.3%
Internet 72.13 +0.7% +22.3%
Semis 16.03 +2.1% +28.9%
Utilities 31.21 +0.3% +1.6%
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Alt. Energy 9.95 +1.4% -4.4%
Water 18.31 +1.1% +12.2%
Insurance 16.07 +1.2% +18.3%
Biotech 20.58 +1.1% +27.1%
Retail 19.65 +0.1% +28.4%
Software 24.59 +0.9% +24.1%
Big Tech 53.73 +1.0% +21.9%
Construction 12.99 +2.1% +13.3%
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Consumer Svcs 67.26 +0.8% +23.3%
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Industrials 63.25 +1.6% +19.7%
Basic Mat 73.57 +1.6% +21.6%
Real Estate 55.24 +1.4% +23.8%
Transportation 91.17 +1.4% +25.6%
Telecom 22.48 +1.1% +17.1%

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