It all started with a handwritten note on the margins of a long-forgotten report, in French, from a well-site geologist who many years ago was on a rig drilling into the Paris Basin for conventional oil.
“That was our first clue,”says Craig McKenzie, president and CEO of Toreador Resources (TRGL). “The geologists were writing about uncontrollable oil flows from the Liassic shale and eruptions due to over-pressurization.
“Rock was erupting into the well-bore because the over-pressured oil was pushing everything out of its way," he adds. "When you see this being repeated over linear distances of 50 miles or more, you get excited that this is not a one-off, but this is basin wide.”
That was the "Eureka!" moment for McKenzie and his team that the Liassic shale in the Paris Basin had the potential to be something very special.
It’s big. It’s simple. It’s over-pressured, which generally means bigger flow rates. It’s been known since the 1950s.
The Paris Basin is the perfect example of the biggest mega-trend I see happening in oil and gas for the next 20-30 years: The export of shale technology around the globe, which should create dozens of discoveries for the industry, and many 5-10 baggers for investors who are able to ride this wave.
And the good news for investors is that -- so far -- many of these plays are being discovered by junior E&Ps (exploration and producers).
That can also mean a rocky ride for investors; juniors are by definition more risky and volatile. Toreador’s story is no exception.
Back in 2007-08, the company had a suite of European assets, including some production in France, but the company had nearly $110 million in debt with a $40 million market cap. Then the crash of ’08 hit, and some tough decisions needed to be made.
One of those decisions was about management. Shareholders asked McKenzie, who was previously president of British Gas Trinidad & Tobago and later CEO of Canadian Superior, to step in as CEO of Toreador in January 2009.
“We treated everything in the company with extreme urgency,” recalls McKenzie. “2009 was a no pain/no gain year – we sold prized assets of the company in Hungary and Turkey, and were very aggressive in buying down the debt and disciplined in our spending. We focused the company to one set of assets in France, and wanted to make the base business sustainable.”
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“The one investment we did make was in the Paris Basin,” he adds, referring to an area of roughly 100 by 150km east/southeast of Paris, where Toreador already produces 900 barrels per day of oil (from conventional reservoirs).
It was a good choice. But it took some original thinking.
“The big majors had been drilling here in the late 1980s, with as many as 18 rigs, and they all had a common view of the source rock," McKenzie says. "But the thinking was that oil had migrated [up from the source rock shale] to conventional traps. These major oil companies exited because there were just small discoveries.
“We think the reason they didn’t find any large conventional plays is that the oil is still in the source rock," he continues. "There are no obvious signs of long distance (oil) migration or seepage at the surface. And through historical analysis we know it’s still over-pressured.” (Unlike water, oil migrates up.)
So the new board of directors reasoned they needed to focus on understanding the Paris Basin better, and management started to acquire as much data as it could.
“We went searching for old cores in core boxes all across France, in warehouses, searching shelves, and plugging them,” McKenzie says. This would be the same as splitting core in mining. Some of the core they were able to secure was just the size of a thimble of thread.
“We started getting back silica and high limestone content from our analyses of the cores. The silica meant brittle shale, which means a favourable response to fracking. Also, the limestone is important for shale oil in contrast to shale gas. We’re happy to have silica, but gas molecules are small and go through rock much easier. Oil molecules are bigger and polarized – limestone is good for that.”
I asked McKenzie if his peers or the locals thought they were crazy.
“We weren’t crazy, we were different – in the beginning people didn’t pay us much attention, and then by the end of last year, people started asking questions. Now people are really beginning to appreciate what we’ve been doing for the last 20 months.”
So the team set to work analyzing an ever-increasing amount of raw, unconnected data.
“Over 200 wells have penetrated shales in the Paris Basin,” McKenzie says. “Of the 200 plus, we focused on the 60 in the deepest part of the basin. It’s also the most mature rock, the most cooked of the organic matter. In industry terms, it’s in the oil window.”
He gives me a quick layman geology lesson:
“Think of all that organic matter, settling for millenia, and it all sagged under its own weight. So in the centre it’s the deepest. It looks like a series of stacked plates now. There is a window of 440-470 degrees Celsius in which oil cooks perfectly, and that’s what’s happened here. With all the well penetrations you can start mapping out the depths, and at some point [the Liassic shale formation] comes out of the ground, 50-100 miles away, but [the oil] hasn’t cooked.”
The Bakken play in North America also has stacked plates – which are layered geological formations – and three are producing formations. At this early stage, it also looks like the Paris Basin would most likely have three producing formations.
The data that McKenzie’s team rounded up came from the late 1950s to the early 1990s. Because everyone was drilling through the Liassic shales to reach deeper targets, Toreador was just after incidental information from the drillers and the mud loggers. And it all started to make sense after reading a series of handwritten notes in French from geologists made 20-60 years ago.
“Last year we were sure we had something. We started talking to people in the Williston Basin [the Bakken play in North Dakota]. We were sure that the rock in the Paris Basin was analogous to that in the Bakken/Williston Basin.
“We retained RBC Capital Markets [its sister firm, Dominion Securities, is Canada’s largest securities firm] to undertake a review of strategic alternatives," McKenzie adds. "We opened a formal bid round for partnering, and engaged 40 companies. All of them did their own technical audits of the play, and not one of them walked away because of holes in our logic. They all agreed with our conclusions.
“We received a number of bids, and chose not to go with a super major, private equity, or North American independent [producer]. We chose Hess (NYSE:HES) as it had the right scale, the right Bakken know-how, and they’re reportedly spending $5 billion in Williston Basin over the next five years, so they’re aggressive.
“And we liked the way our teams worked together," he continues. "They replicated all our work, going down to the warehouses themselves and doing their own testing. With their experience and value in the market, they know how to do business internationally. They set up offices around the corner from us here in Paris.”
Toreador’s deal with Hess can be as much as $265 million to earn 50% of Toreador’s acreage. So they obviously think the play has great technical merit. While many investors are looking at this play’s success as a given after so much due diligence -- Toreador’s stock trades at 6-7x its Net Asset Value (NAV), vs. a multiple of one or less for most oil and gas producers -- McKenzie isn’t counting his chickens just yet.
“There is still risk. After all this analysis, I can tell you lots of different technical things about the play – but I can’t tell you that there is one single long-term completion, because there isn’t.”
Scott Hanold, managing director of energy research for RBC Capital Markets, agrees: “While there is still substantial opportunity, we still have to prove this play works economically, which is a big hurdle. Based on the current stock price, investors are already valuing $11 for this shale play as the conventional producing assets are worth about $4. If the shale is not productive and Hess walks away, where does this stock go? Probably close to that $4-5 level.
“However, with success, we could see TRGL shares double or more," he adds. "Recent land deals in the Bakken – a similar play – were done at around $10,000/acre compared to a few hundred an acre just a couple years ago. That clearly shows how quickly exploration success and technology can create value. The key here is to get the first wells down and find out exactly what they have.”
McKenzie says its first well is expected to spud in January, and it will be continuous drilling until a first phase – which commits Hess to spending at least $50 million – is finished. He expects the first two wells to be vertical, but there is no decision on Wells 3-6 yet.
“We’ve effectively picked the locations, but not how to drill them yet,” he says. “When do we go horizontal and frack? Right now we think Well # 3, but if we hit what we want on the first two, we could do it there.
“It depends on logging, coring, and how fast we do the analysis," he continues. "We don’t know the orientation of the natural fracking, and how much it’s naturally fracked, and that will determine how we have to set up the frack design. Note also that the vertical wells will have the flexibility to be re-entered and continued horizontally. We’ll have maximum optionality.”
McKenzie adds that Toreador and Hess will be looking for variability spatially (how patchy or consistent is the formation), but doesn’t expect much, so they could do horizontals very quickly. He voiced his opinion that, if all goes according to plan, the market could see the first IP (Initial Production) rates in late Q1 2011.
Vermilion Energy (VETMF.PK) also has a land position in the Paris Basin. According to its recent quarterly results, it continues to successfully produce oil from two old vertical wells that it re-entered and fracked in the shale – which contributes to Toreador’s sky-high valuation – but Vermilion has thus far not announced any oil flow rates.
Even if the play does work geologically, RBC’s Hanold says there could be other challenges in the Paris Basin, like the lack of energy services (drillers, frackers) and the fact that the landowners do not own the mineral rights.
“There is not as big of an incentive for landowners in France as the government owns the royalty rights,” he says, “Whereas in North America you can quickly become rich if a company drills a big successful well on your land.”
So what kind of well profile does McKenzie expect to see, and what would be his best guess on IP rate and economics?
“We’re using 400 bopd (barrels of oil per day) for a 30 day IP with a 50% decline first year,” McKenzie says, adding that the Banc de Roc formation in the Paris Basin looks to be very similar to the middle Bakken at Elm Coulee in eastern Montana.
“That’s more pessimistic than what’s happening in Elm Coulee. Continental (NYSE:CLR), Brigham (BEXP),with that type curve, are looking at EURs [Estimated Ultimate Recovery] of 500,000 barrels, on a well that costs $7 million, giving $14-$15 per barrel F&D [Finding and Development], and 12 million barrels of resource per section [one square mile = one section].
“We think [the amount of Original Oil in Place, or OOIP, in the Paris Basin] can go higher, but we’re basing at 12 million per section.”
He anticipates that fracking will take a “typical Bakken approach,” and be done by a multi-stage frack over a 5,000 feet lateral distance.
“We don’t know exactly what kind of technique or how many fracks; we’re just starting to science that, but we are working on getting the data to figure it out.”
The Paris Basin has gone from obscurity to front page news in the global oil patch in just over a year. As a result, there has been a staking rush, and getting land now is very competitive. Toreador has up to 1.6 million acres awarded and pending, and McKenzie says there is a lot of competition for smaller land blocks closer to the edges of the play.
(Toreador’s ground is the pale yellow color.)
“We’re still seeing small players chasing us, but a lot of the U.S. independents have too much on their plates to worry about France," McKenzie declares. "The larger independents don’t see the acreage size to jump into the game now into a new country. In this phase, the Paris Basin is still frontier, despite its enormous potential.
“A lot of the bigger players are sitting on the sidelines to see how this works out," he continues, "but that will change with positive results. Then we’ll see larger companies be happy with smaller land positions – but the shale gas plays of eastern Europe are there as well, and they have larger parcels available.”
That change McKenzie is talking about could happen at the end of March 2011. With estimates as high as 96 billion barrels of oil resource generated for the Paris Basin, it’s a big play the world will be watching.
And it all started with a little note.
Disclosure: I am long TRGL.