Ridgeline Energy Services Inc. (TSX.V: RLE) (RGDEF.PK) is looking more and more like the ringer in the contest to treat waste water from both Hydraulic Fracking operations and industrial wastewater. The one-two punch that puts them light years ahead of any competition is its low cost process and high treatment rate. The company currently treats 2,000 cubic metres of water daily from a 4-reactor installation using just 300 watts of power per 7,000 litres of water.
There are two categories of water in the drilling of oil and gas wells that employ hydraulic fracking as a way to stimulate production: Frac water, which is the water that is injected under intense pressure with a mixture of chemicals designed to create porosity in shales and other host rocks, and produced water, which is the water that is often encountered in reservoirs underground that comes to the surface as part of the production phase of oil and gas.
Frac water is easy for the company. Frac chemicals in wastewater from that process typically constitute no more than 1% contaminants, so Ridgeline's process deals with those quite easily.
Produced water, however, is another story.
Produced water is a term used in the oil industry to describe water that is produced along with the oil and gas. Oil and gas reservoirs have a natural water layer (formation water) that lies under the hydrocarbons. Oil reservoirs frequently contain large volumes of water, while gas reservoirs tend to have smaller quantities. To achieve maximum oil recovery additional water is often injected into the reservoirs to help force the oil to the surface. Both the formation water and the injected water are eventually produced along with the oil and therefore as the field becomes depleted the produced water content of the oil increases.
Historically, produced water was disposed of in large evaporation ponds; however this has become an increasingly unacceptable disposal method from both environmental and social perspectives. Produced water is considered an industrial waste and coal seam gas (CSG) producers are now required to employ beneficial re-uses for produced water.
In the Dakotas, produced water can be up to 300,000 parts per million chlorides, or salts. That means 30% of the water by weight is a solid. If you need to dispose of that by injecting it into disposal wells as slurry, you will likely recover less than 55% water, driving the costs of treated water higher. In the Dakotas, they are able to still drill easily for freshwater supplies which is cheaper than treating water at this point.
To drill wells and for the process of hydraulic fracking, lots of water is required, and as soon as you're trucking water from a distance of greater than 40-odd miles, you're bumping up against prohibitive economics.
Increasingly, the solution is to treat and reuse the available water for drilling and fracking, while bringing the "produced" water from hydrocarbon production up to a level of purity that is at least "agricultural" quality. In other words, not quite good enough for people, but certainly for cows and crops. The treated water can be used in the process of hydraulic stimulation or discharged without special permits as clean water.
The problem has been in the cost of treating water. Lots of treatment processes out there; most of them are too expensive to deploy and run. Ridgeline's process - scalable, modular, and highly mobile - can process water at a cost of on average, $0.02 per gallon.
"We work with a large number of oil and gas exploration and production companies, many of which you will recognize: EOG Resources (NYSE:EOG), Devon Energy (NYSE:DVN), Progress Energy Inc. (NYSE:PGN), Enbridge (TSX,:ENB NYSE:ENB) and ConocoPhillips (NYSE:COP) to name a few", said company CEO Tony Ker on a recent conference call with investors on July 24, 2012.
Currently, the wastewater generated from these methods is pumped back into the earth into approximately 147,000 Class II disposal wells designated by U.S. regulatory agencies. The environmental agencies in the U.S. and Canada as well as citizens of both nations have demanded that oil and gas producers treat this water in such a manner as to not contaminate groundwater and/or aquifers that provide drinking water for large numbers of people on the North American continent.
Dennis Danzik's Approach
Ridgeline's water treatment technology was developed by Dennis Danzik, a lifelong research and development scientist with a background in plastics and polymers. Danzik had been successful in developing technologies to oxygenate liquid food waste for the purpose of turning it into fuel. When Ker approached Danzik to see whether the process could be modified to treat water, Danzik discovered that it could. At the time Ridgeline had as its client oil and gas heavyweight EOG Resources, and so the company set about treating the wastewater from its drilling operations with apparent success. Ridgeline licensed Danzik's technology, and then in January this year, Ridgeline acquired all of the shares of Danzik Hydrological Sciences, LLC ("DHS") in exchange for 34.6 million shares of Ridgeline.
Danzik is now the largest single shareholder of the company, and that's a good thing. The company has signed a total of 7 new water treatment deals since January.
Santa Fe Springs
The company's flagship operation for treating water from multiple oil and gas producers is its Santa Fe Springs water treatment facility in Santa Fe Springs, California. It is operated as part of a management agreement and asset purchase agreement in April this year executed with Lakeland Processing Company. Lakeland's chemical-based water treatment approach limited the quantity of water it could actually treat to less than 15 million gallons per year, despite being permitted to discharge 75 million gallons of treated water into the Los Angeles County Sanitation District (LACSD).
With Danzik's technology, the company will be able to grow that capability to much higher levels. According to the company's 2011 Annual Financial Statement,
The Santa Fe Springs site is considered a pretreatment facility prior to releasing wastewater to the LACSD. The discharge allowance is presently at 75,000,000 gallons per year. Lakeland was processing less than 15,000,000 gallons per year as the lack of treatment capability meant discharge levels exceeded the permitted 75,000,000 gallons reached. The Santa Fe Springs site's current treatment process is limited and predominantly involves the use of chemical additives. Ridgeline's technology, as tested over the past months at this facility, has demonstrated significant improvement. Ridgeline's water treatment technology has the ability to reduce the level of contaminants discharged, which will enable the Company to treat much larger volumes of water under LACSD permit limits. Based on the results of Ridgeline's testing at the facility, the new water treatment technology is expected to allow RUSA (Ridgeline USA) to increase discharge rates from a current maximum of 75,000,000 to in excess of 200,000,000 gallons per year by being permitted to handle additional waste streams that were previously not permitted by the Lakeland facility. This is management's forecast and actual results may vary from such forecast depending on the actual efficacy of the processes and the transition from the existing process to the new technology. In addition, the Santa Fe Springs site allows access to produced water and drilling fluid treatment from the Los Angeles basin and off shore platforms along the California coast.
According to Tony Ker, "In the month of June we did $0.5 million worth of business, and the average price we got was $0.18 per gallon. At a cost of $0.02 per gallon, we'll make a 50% margin easily. We want to be in an area where there are lots of companies operating and we control the flow, treatment and distribution of water. I believe there are opportunities to consolidate operations like the one we acquired in Sante Fe all over the world."
Besides oil and gas generated wastewater, there is a parallel opportunity of comparable size available in the treatment of wastewater from other industries as well. It is estimated that upwards of $35 billion are spent annually in North America on equipment to treat wastewater in the industrial, municipal and agricultural wastewater markets, according to Ker. And Ridgeline's other business units have some significant potential as well.
James Yeager, the company's CFO reported on the July 24 conference call, "Ridgeline Environment subsidiary was up about $1 million to $11.2 million and that is an increase of 10%. Ridgeline GreenFill, one of our newest subsidiaries, was up roughly about $1 million as well to $2.1 million and this reflects an increase of about 97.5% over the prior year's revenues. GreenFill opened two additional treatment sites during the year, which contributed to the increase in its revenue.
Tony Ker stated, "RGI's process and technology benefit communities and our clients. The municipalities we serve realize a new source of revenue, and the treated soil meets an ongoing demand for landfill cover and capping or decommissioning material. At the same time, our clients benefit from lower transportation costs and reduced liability. An added benefit is that our approach is better for the environment since we treat the soil for reuse. Under conventional methods, contaminated soil may be stored indefinitely in industrial landfill sites."
Obviously the path to becoming the dominant provider in oil and gas-related wastewater treatment is not without peril. There are some significant hurdles to overcome, and risks that exist that may limit the company's penetration into the oil and gas and industrial wastewater treatment space:
1)Always at the forefront of new technology risks is the possibility that somebody else with deeper pockets and more entrenched in the industry may suddenly roll out a superior wastewater treatment technology of their own.
2)It is possible that major oil and gas companies may adopt cheaper solutions that don't necessarily involve wastewater treatment, but instead focus on disposal solutions. Sending wastewater into stable geologic formations is one such example, though there is growing skepticism about those structures' ability to contain the contaminants completely;
3)The risk of commodity price degradation as a result of deteriorating economics may slow the rate of deployment of the company's technology, and may result in diminished revenues in the near and/or long term;
4)The company does not have any patents on its technologies or processes, so there is a risk that existing technology companies may "reverse engineer" the technology and processes, and thus manifest competition for the same technology in a limited marketplace;
5)The company is heavily reliant on the originator of its technology and processes, Dennis Danzik, and as such, there is a risk that if due to unforeseeable circumstances he is unable to continue oversight of the execution of the company's business model, the company may experience interrupted growth.
Double Revenue Every Year
The company reported financial results on July 24th. It announced revenue of $15.5 million up 38% from the previous year. The company expects to reinvest its free cash flow for expansion into the foreseeable future which will limit profit potential, but should see the annual revenue rise dramatically.
"I think we can double our revenue every year for quite a while", said Ker. Regulators appear to be mobilizing to support such a projection, as evidenced by this excerpt from a GMP Securities communication to clients:
IN SITU OPERATORS FACE NEW WATER RULES
New, stricter water disposal limits are being considered by the Alberta Energy Resources Conservation Board (ERCB) in an effort to improve produced water recycling and minimize disposal at oilsands in situ operations. The ERCB's draft directive, Water Disposal Limits and Measurement and Reporting Requirements for Thermal In Situ Oil Sands Schemes, is also intended to improve the measurement and reporting of water use. Many current operations will be able to meet the requirements of the directive however some may need to make design changes to their facilities to meet the finalized directive, and will be allowed three years to do so. All new operations must be designed to meet the final directive requirements. The regulator is requesting feedback on the draft directive until Sept.14, and if adopted, the new rules will introduce water use, water productivity and produced water recycling formulas for comparing operations' performance.
On the aforementioned conference call with investors, Dennis Danzik indicated the company's priority was 'to get to the point where we are installing a facility every four to six weeks and we are on track with that plan and allowing us to grow through increased throughput. Secondly, to increase our manufacturing capability from one facility per month to three facilities per month by the end of this year and we are certainly on track to meet that goal. Third, initiate manufacturing and construction of our storage systems by October of this year. Fourth, increase our industry presence by operating state-certified laboratories in the U.S. and eventually Canada. And what that - the purpose of that effort is so that we give very experienced sales executive team a large array of field tools on which they can rely and our customers can depend on."
Current Low Market Cap is the Opportunity for Investors
Ridgeline's share price as of last week's close gives it a fully diluted market cap of just under $75 million, or 5 times revenue. While the company still operates at a loss, the growth curve based projections, and assuming the risk factors are manageable, could be parabolic. That makes the current price an attractive entry level for risk tolerant portfolios, in my opinion.