Is Petrobank’s THAI technology ready for the spotlight?
Bitumen barbecue has encountered setbacks; executives optimisitc
There aren’t many energy executives who will sprinkle references to Charles Dickens into a conversation about the public market and the way it values a company’s assets. But then again, John Wright, the CEO of Petrobank Energy and Resources Ltd. and Petrobakken Energy Ltd., isn’t most energy executives. “You know how Dickens said the law is an ass? Well, so are the markets,” he says.
Shareholders in both companies would agree with him, but perhaps, with all due respect to both Wright and the work of Mr. Dickens, Herman Melville might be a more appropriate 19th-century writer to be referencing. After all, Wright’s spent the better part of his career chasing his own version of Melville’s famous white whale. And now, after nearly a decade of pursuit, he has him squarely in his sights.
After nearly a decade of testing, trials and demonstration projects, it’s now make or break time for Petrobank’s patented Toe-to-Heel Air Injection technology, better known simply as THAI. In October, the company announced that it would embark on a corporate restructuring that would see its 57 per cent interest in PetroBakken distributed to shareholders, leaving Petrobank with approximately $100 million in cash, a few heavy oil assets and the THAI technology. If Petrobank is going to be a viable standalone entity – and Wright insists that it will – THAI is going to have to prove out.
Despite the confidence that both Wright and his COO Chris Bloomer have in THAI, that’s no sure thing yet. Indeed, the fact that the market currently assigns negative value to Petrobank’s assets underscores the skepticism that’s still out there about the technology. Bloomer admits that there have been some growing pains for the technology to date, as they work out the kinks in terms of how to prepare a reservoir for it and properly deploy it once it’s ready. It had to suspend its heavy oil recovery project in Conklin, Alberta, in 2011 after some disappointing test results, and was forced to back off its Kerrobert project in Saskatchewan in early 2012 after it tried to go too far, too fast. “We should have gone slower at the start,” Bloomer says. “We put a lot of air and a lot of energy into it, and we had operating issues. The reservoir was not ready to accept that amount of air.”
But Wright insists that they’ve learned their lessons from those experiences, and that the technology is ready for the spotlight. “Kerrobert has already told us that the next time we do this, it’ll be way cheaper. We over-engineered some stuff, and we didn’t have to. It’ll be better next time. There’s a lot of learning going on.” And he remains unfazed about THAI’s long-term prospects. “Here’s what I have no doubt about,” he says. “We put air in the ground and oil comes out. It’s done that from the first day we tried it in our first project, and it’s always done that. Everything else, to me, is engineering.”
It’s not difficult to see why Wright and the rest of his team get so excited about THAI. There was a time, after all, when both horizontal drilling and hydraulic fracturing were both seen as marginal and unproven technological innovations. Now both are industry standard, and Wright thinks the same could be true one day for THAI. Perhaps the biggest roadblock in its way is the fact that, in North America, it solves a problem that nobody has at the moment.
The genius of THAI is that it doesn’t use either natural gas or water to attack the underground deposits of heavy oil it targets. Instead, it uses air injection to create an underground combustion front that travels along the reservoir, working like a pad of white hot charcoal briquettes to loosen and upgrade the heavy oil that’s ultimately extracted through horizontal wells. “At Kerrobert, and even at Conklin, we’ve seen five to six degrees API of upgrade,” Bloomer says. “A six-degree upgrade can be worth $10 a barrel, easily.” In a world of refinery bottlenecks and widening price spreads, that’s an attractive proposition for just about any North American producer.
The problem is that even with that built-in upgrading, rock-bottom natural gas prices have effectively neutralized THAI’s biggest advantage. “The single biggest impediment to the acceptance of THAI is the ability to access cheap natural gas in Alberta and North America and the built-in reluctance to change,” Wright says. “If it’s so cheap, why go to a new process?”
That’s not a problem the company faces in the rest of the world, though, which explains why it’s been so aggressive in marketing its technology to state-owned oil companies like Petrobras, Petróleos de Venezuela SA and PetroChina. In countries where the easiest oil has already been extracted from their reserves of heavy oil (the cream, as Wright calls it) and natural gas isn’t abundant enough to support large-scale, cost-effective SAGD operations, THAI might be the best – or the only – game in town. “There are parts of the world where you don’t have water for steam, you don’t have gas for steam, and this is probably the only way you can get heat into the ground and produce the oil,” Bloomer says. “So it’s quite valuable.”
Petrobank intends to capitalize on that value by signing licensing agreements with its partners, a strategy that could be wildly profitable if it begins to scale up. Generally speaking, a licensing agreement would see Petrobank receive a five to 10 per cent royalty on production along with an option to acquire a working interest in the play. “A lot of these resources are tied up by national companies, and there are some places where you just don’t want to expose your own capital,” Bloomer says. “But we can leverage ourselves into those areas at a very low risk by licensing our technology.”
The upside associated with Petrobank’s licensing strategy could be substantial. According to Bloomer, there are an estimated nine trillion barrels of oil – yes, trillion – in depleted heavy oil reserves around the world, the ones where the cream has already been skimmed off the top. And while the company plans to deploy its THAI technology through licensing agreements (and could ultimately spin the revenue from those agreements out into an independent entity called Arcan Resources the same way it did with Petrominerales and will with PetroBakken), it will also apply it to its own properties.
That’s another avenue of value creation for the company, given that it enables it to stay out of bidding wars over prospective light sweet crude plays in favor of heavy oil assets, which are currently the ugly duckling of the Canadian energy sector. “We would value an asset a lot differently than a conventional oil and gas company would,” Peter Cheung, Petrobank’s CFO, says. “While we may not pay for that upside (because that’s the value of our technology), we can certainly be a bit more aggressive than others.”
All of this, though, depends on the results at Kerrobert, which is why company executives, analysts and investors are all watching it so intently. It’s effectively a miniature version of the giant fields in Europe, Asia and South America that could prove to be gold mines for Petrobank if THAI works as planned. “Probably five per cent of the oil was taken out,” Bloomer says. “From the conventional sense, that’s a depleted resource – there’s no other way to get the oil out. But we’ve come in, and we have wells producing oil far in excess of what any conventional well had ever produced in tha area.”
In other words, Petrobank is effectively de-risking the technology for prospective clients at Kerrobert, and despite the hiccup last year it remains confident that it will ultimately prove out. Bloomer expects the production there to reach 1,000 barrels a day – the financial break-even point for the project – within six months, and thinks it will grow from there. “If we can get Kerrobert up to even half of its nameplate capacity – 3,500 barrels per day – we’d be going pretty aggressively in terms of a second THAI project, a third THAI project and a fourth THAI project all along the Kerrobert trend in Saskatchewan,” he says.
Wright says he’s not suggesting that THAI is a finished product yet, or that there won’t be incremental improvements along the way as it’s deployed in different regions and oil fields. “I have no doubt that we’ll find things and tweak things and adjust our operating strategy. There are so many moving parts: well trajectory and orientation and length and completion method, pressures and temperatures and chemicals and all the other stuff that go into the process. We’re going to play with that forever – literally, it’ll be being played with in 100 years.” But, he says, “The reality is that we’ve already cracked the code. Air goes in, oil comes out. Game over for that.”
What about Petrobakken?
By spinning out its 57 per cent stake in PetroBakken to its shareholders, Petrobank CEO John Wright says the company is doing everything it can to unwind the discount that’s been baked into the prices of both. But by yielding its majority stake in PetroBakken, Petrobank is also exposing PetroBakken to the possibility of a takeover, hostile or otherwise. That’s a legitimate concern, given the discount that it trades at both to its peers and the intrinsic value of its assets.
Wright’s not worried, though. “If you’re in a public company and you worry about that every day, you’ll die prematurely,” he says. “You’re for sale every day.” More importantly, the complexity associated with PetroBakken’s operations acts as a de-facto poison pill that any acquirer would have to contemplate swallowing. “Our asset base at PetroBakken is one that has 10 years’ worth of development sitting in it, but it’s 10 years of drilling the most technically complex wells anyone is drilling and applying leading-edge technology and running up to 20 rigs at a time in the field,” Wright says. “We call it a widget factory, but it’s a pretty high-tech widget factory.”