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Summary

  • Solazyme's new product line addresses the growing drilling fluids market.
  • The company's product utilizes the whole microalgae cell in order to provide targeted lubrication.
  • The ability to proactively reduce friction allows for increased cost savings for drilling companies.

The Increased Demand For Drilling

There are increasing challenges for this new age of oil exploration. Independent producers will spend $1.50 drilling this year for every $1 they get back according to the article found here. Over in North Dakota's Bakken shale, it will take approximately 2,500 new wells a year just to sustain an output of 1 million barrels per day. The same amount of output in Iraq can be done with only 60 wells. All of this adds to costs that drilling companies would like to reduce in order to increase their returns. Part of this will come in the form of improved drilling fluids that can increase drilling efficiency.

According to the report found here, the drilling fluids and completion fluids market will grow from an estimated $10.6 billion in 2013 to $15.2 billion by 2018. This represents a compound annual growth rate of 7.5% from 2013 to 2018. North America currently holds the largest market for drilling fluids as it holds half of the world's oil and gas reserves. The United States has the largest number of shale reserves when compared to other regions of the world and the Gulf of Mexico continues to support rising offshore activity.

(Bakken Shale Oil Boom - Image Link)

Such growth for the industry comes with the caveat of widening environmental awareness. According to the same report, large investments have been made and extensive research has been carried out to develop non-toxic biodegradable drilling and completion fluids. The use of nanotechnology has been pursued in the development of these products. Herein lies the intersecting trends for renewable oil and bioproduct company, Solazyme (SZYM).

A Look At Solazyme's Encapso

Solazyme's latest product is geared to provide a renewable solution for Big Oil & Gas. On March 25, Solazyme announced the launch of a new product line named Encapso. Based on a prior article found here, Solazyme appears to be targeting large mud service companies such as Halliburton (HAL) and Baker Hughes (BHI).

Encapso is Solazyme's first high-performance lubricant marketed to oil field service customers. The product is the world's first encapsulated biodegradable lubricant designed to provide targeted delivery at the point of friction. Encapso makes use of Solazyme's microalgae-based technology, and individual microalgae cells range between 5 to 10 microns in diameter.

For the drilling industry, there are numerous challenges with traditional lubricants. These fluids can often lose effectiveness while circulating in the borehole. They can also stick to the drilled cuttings. As a costly issue for the industry, these traditional lubricants can even seep out through small fractures within the rock formation.

Solazyme's Encapso attempts to address these challenges by utilizing the company's existing technology platform. Solazyme manufactures oil-yielding microalgae through standard industrial fermentation practices. Encapso utilizes the dried powdered form of the whole microalgae cell which can be added to drilling fluids as an additive. As part of the fluid, the cells burst upon friction with the drill bit thereby providing targeted delivery of the lubricating oil. The following are a few key points about the product that investors should understand.

  1. Encapso is proactively added to the mud system prior to the occurrence of drilling problems. Because this targeted lubricant can be added at the onset of operations, this enables it to freely circulate without seeping into the surrounding rock formation. Therefore, Encapso prevents costly service delays. As a result, problematic drilling areas can be mitigated prior to their discovery and operations can be run in a smoother fashion.
  2. Encapso is anticipated to support gross margins in excess of 50%. Solazyme's "Oil Field Services" segment supports the company's second largest target margins. To date, Encapso is the only commercialized product within this market division. Only the "Skin & Personal Care" business division is expected to be more profitable for Solazyme with anticipated gross margins reaching higher than 60%.
  3. Encapso's shell protects the lubricant inside and provides targeted delivery. The primary advantage of an encapsulated product is the ability to shelter an oil up to the point of delivery. In the case of Encapso, such protection prevents issues with fluid loss due to rock formation seepage or by sticking to the drilled cuttings. Both of these issues are common problems with traditional lubricants. When friction breaks Encapso's shell, the oil is released thereby lubricating the area in which it is most useful.
  4. Solazyme's microalgae is naturally encapsulated. An algae cell by itself is fundamentally an encapsulated product. This suggests that limited downstream processing after fermentation is needed apart from a drying step. Because the company is able to utilize both the oil and the shell of the microalgae in a single product, Solazyme can increase its margins while effectively limiting its waste.
  5. Encapso's specifications can be programmed to meet the needs of its customers. One of Solazyme's strengths lies in its ability to control microalgae growth. By controlling the growing environment, the company can increase or decrease the composition of how much lipid or cell wall is produced. Through genetic recombination, the company can also program the cell to produce various kinds of tailored oils. This provides increased flexibility to client drillers who may require a specific formulation for a specific type of rock being drilled.

(click to enlarge)

Solazyme recently completed field trials to demonstrate the efficacy of Encapso in real-world well operations. Shown in the graphic above, Encapso was utilized in various formations including the Williston Basin, the Permian Basin, and the Denver-Julesburg Basin. There, Solazyme demonstrated impressive results including triple-digit increases to penetration rates and deeper drilling depths. The following are two testimonies taken from clients found in a company video found here:

"In our testing, Encapso demonstrated its ability to reduce friction, reduce the drag, decrease the torque, and improve the penetration rate. It is a revolutionary formulation."

-Frank Schuh, Inventor of Horizontal Drilling

"Because [Encapso] is liberated at the point of contact, I may be able to drill this well with two bits instead of five. Well every time I trip a bit out of the ground, it costs me $1 million dollars."

-Philip O. Johnson, Senior Drilling Engineer

When it comes to drilling, efficiency is the name of the game as time equates to money. The quote shown above by Johnson fully illustrates this concept as he talks about the costs of raising a drill bit out of the borehole. This requires disassembling and reassembling drill pipe segments in a systematic fashion in order to reach the drill bit, which could be thousands of feet below ground. Because Encapso can limited the factors which induce friction during a drilling operation, client can protect valuable equipment, increase their drilling control, and ultimately reduce costs.

According to Solazyme's press release found here, Encapso enabled one driller to increase the rate of penetration from 2 ft/hr up to 40 ft/hr. Presumably this was done in a horizontal well during a phase of directional drilling. Such increases to productivity enable drillers to accomplish their tasks in a more cost-efficient manner. This leads to cost savings which can directly attribute a greater value to Solazyme's proprietary product.

A Look At The Company Now

As of the closing price on March 28 of $11.21, Solazyme currently carries a market capitalization of $776 million. The company recently priced a secondary stock offering of up to 5.75 million shares at a price of $11. Assuming the full exercise of the underwriter option upon completion of the offering, Solazyme will support a market capitalization of $840 million at the current price.

With the completion of the latest stock and subordinated note offerings, Solazyme will have approximately $370.3 million in cash and short-term investments using the latest figures as of December 2013. The typical manufacturing facility with 100,000 MT of capacity costs somewhere between $150 million to $200 million. In consideration of the partnership model Solazyme now utilizes, it is a reasonable to expect that Solazyme will be able expand its production capacity by at least another 200,000 MT of capacity. Depending on the contributed capital from partners, this amount could be larger. With the opening of the Moema facility, Solazyme will have approximately 122,000 MT of capacity for its commercial operations.

While historically Solazyme has generated between $30 million to $50 million in revenue over the last several years, investors can expect for this to dramatically change starting in 2014. This will occur as the company emerges from its development phase into a new phase of high-volume commercial operations. Assuming upon the target average selling price of $2000/MT to $3000/MT as suggested by the company's graphic found here, Solazyme's new production facilities will be able to support annual revenues in excess of $240 million once they ramp up to their nameplate capacities. Such capacity provides a strong case for revenue growth in the years to come.

Final Thoughts

It is much too early to determine what the market impact of Encapso will be for the drilling industry. However, Solazyme's initial field trials suggest that Encapso may become a larger part of the company's future in a way that many investors have not accounted for. This is also reiterated by the fact that Oil Field Services has been designated as a whole new market segment for Solazyme.

What should be most surprising is the fact that Encapso appears to require very few modifications to Solazyme's existing manufacturing process. Because of the company's expertise to control the algae growth conditions and tailor its oil output as I wrote about in my article found here, Solazyme's ability to create an encapsulated lubricant likely came with considerable ease.

Above all, the oil field service market appears to support lucrative margins as the demand for drilling fluids continues to grow. Most importantly, the entry into this market allows for Solazyme to sustain its environmentally-friendly agenda while capitalizing upon the growth of the Oil & Gas industry. It may be the match that few ever thought possible, but its remains yet another promising prospect for this rapidly growing biotechnology company.

Source: 5 Things To Know About Solazyme's Encapso