QS Energy has developed and is now attempting to commercialize a disruptive and novel technology for the crude oil transportation industry that would increase pipeline throughput by significantly reducing the viscosity of heavy crude oils. A simultaneous and major benefit of the technology would also be to reduce the reliance on diluent use in transporting crudes by pipeline. The technology will likely have application beyond midstream (already enormous Total Addressable Market) if it is adopted by industry.
This summary will introduce the technology, briefly outline the company's history, and predict some near term catalysts, including industry adoption, that if successful will make QSEP an extremely rewarding investment.
The following picture is probably the simplest single illustration of how the technology works.
TECHNICAL SCHEMATIC FROM PHD THESIS OF TEMPLE SCIENTIST DU ENPENG, "Neutron scattering studies of crude oil viscosity reduction with electric field" (2015)
The following three are photographs of the actual device as fabricated.
EXAMPLE OF THE AOT. QSEP VP OF ENGINEERING SHANNON RASMUSSEN STANDS NEXT TO IT.
The device attaches to an oil pipeline after a pump station. Each device has a capacity of about 100,000 barrels per day, but when attaching to larger scale pipelines can be added in parallel. The technology works by applying a strong electric field to flowing crude oil, which polarizes the particulates (ashphaltenes, paraffin and sulfur particulates, etc.) forcing them to aggregate in short chains in the direction of the flow. This both significantly reduces the viscosity of the crude (ranging from 30-80%, with an average of 50% across various oil types), and alters the flow regime in the oil pipeline from turbulent to transitional or potentially laminar.
The reason it has this effect is because the total surface matter of particulates in the crude is significantly reduced (by their aggregation due to the electric field effect), so the feedstock has a much larger liquid portion, and fewer hydrocarbons crashing into one another (causing turbulence, and hence drag.) The effect can last from 12 to 48 hours, depending on the crude.
The above description may sound complicated, but the operations of the tech are pretty straightforward: "a special pipe that makes crude oil much more 'liquidy' for over 24 hrs." And there is an abundance of scientific evidence showing that it works as claimed; see links at the end. The tech was developed in partnership with Temple University.
The big question, of course, is whether this effect scales up to commercial operating conditions.
The commercial implications of reliable ~45% viscosity reduction of heavy crudes are provided in a pro forma analysis here: https://content.equisolve.net/qsenergy/media/cdb1ad618cc30b298b2396d1e0da3706.pdf (p. 4). The proposed numbers are quite extraordinary. Most of the benefit derives from a reduction in the use of expensive diluents needed to meet viscosity requirements for the transportation of heavy crudes. Simply cutting out, say, 10,000 barrels of diluent a day from a 100k/bpd pipeline would save vast sums of money daily (by the reduced need to buy, transport by pipeline, and refine out the diluent) and also allow that much more crude to be moved.
The investment thesis in the company is at this stage simply a binary play on the outcome of the company's attempts to commercialize this technology. If it is adopted by industry, without doubt the company becomes a multiple-dollar stock with a very bright future; failure to commercialize makes it a zero.
Given that the company has existed for many years, and has been attempting to actively market the technology for at least seven or eight of them, aside from understanding the tech, investors need to consider why they may now be actually able to execute on their ambitions.
The full history of the company and its various incarnations is beyond the subject of this write-up. Suffice to say that during 2015 and 2016, it was essentially taken over by activist shareholders who forced out former incompetent and 'lifestyle company' management and brought in an oil industry veteran, Jason Lane, formerly CEO of JBL Energy Partners, an independent E&P and mineral lease company, to truly bring the technology to market.
Three of Lane's most important moves have been to 1) develop an actual strategy for commercialization; 2) bring on board Shannon Rasmussen as VP of Engineering, a former consulting pipeline engineer for TransCanada who helped with the first (abortive) test of the tech on one leg of the Keystone, and 3) to fill the board with oil industry veterans. There has been good insider buying since then:QS Energy Inc (OTCQB:QSEP) Insider Trading Activity (SEC Form 4)
Note that the company has previously attempted *two* commercial tests of the tech, but in the first instance (TransCanada, ~2013) the test design and conditions were such that limited data was obtained (viscosity reduction was confirmed by a third party engineering firm, but the test design didn't allow isolating the drop in pipeline pressure to the effect of the AOT versus unrelated upstream and downstream factors) and in the second (Kinder Morgan, ~2015), idiosyncratic factors derailed the first test, and by the time they yielded good data, the need for the operator to expand capacity on that particular segment (carrying condensate) had receded. Basically it was a little science project as far as those companies saw it. Moreover, QSEP did not even have ownership of the data from those tests - meaning they could only say 'the data corresponded to laboratory results' or similar, and not actually publish the raw results. The two tests are a kind of comedy of errors that former management, with no oil industry background, is wholly responsible for.
In other words, this technology COULD have been brought to market years ago if it had been in competent hands.
PROSPECTS FOR COMMERCIALIZATION AND NEAR TERM CATALYSTS
The company is right now — as of late February 2019 — preparing to make its first serious installation test project on the midstream pipeline of a major oil company. The "demonstration site" that has been devised is an extremely unusual development, given that it involves a very large oil company providing QSEP access to their infrastructure for initially six months, and then an anticipated three years, for the purpose of showcasing the AOT to other potential customers. QSEP also retains full access and control over key data from the test, which they'll be able to publicize to demonstrate the effects of the AOT. The conditions of the installation is discussed in recent shareholder updates.
In any case, the AOT has been through a period of extensive testing prior to this installation (expected to be announced very soon, as of late Feb 2019). It is, of course, not certain that the data coming off the pipeline will validate the previous laboratory results of extremely effective viscosity reduction — but any outside observer must at least consider this a very reasonable, and even likely, possibility. Why?
Because Lane and Rasmussen, the two individuals with the relevant industry experience, knowledge of the technology, and access to the previous test data, have made it their full-time, professional focus to see the adoption through. Even securing a major new test, under such ideal conditions (QSEP ability to publicize AOT data and a highly cooperative major oil company partner who is allowing potential customers access to the demonstration site) is indicative of a certain level of conviction on the part of the partner company. Clearly if the previous two tests had shown nothing of promise, things would not have gotten to this point. Why even bother testing it again, if it showed no promise? So, as those not privy to the internal goings-on, the fact that this demonstration site has been developed at all is a very important indication of the commercial viability of the AOT.
The introduction of disruptive new technologies to the oil industry — and the midstream crude transportation space in particular — is a very difficult affair. Immense preliminary efforts have gone into the orchestration of the upcoming test. When the data comes off the pipeline, the name of the partner is published, statements from the partner company endorsing the AOT emerge, and deals begin to flow and with those deals revenue, this company will quickly be worth at least an order of magnitude beyond its current valuation.
There are two ways to play this opportunity: the more speculative approach of buying now, before the data emerges and contracts are signed (only for those who have reached the requisite conviction level after studying the technology and the story - if there's time for that); or the safer approach, where you simply learn the story first, understand the technology, know what certain results must signify for industry adoption, and be ready to pull the trigger when the data comes out (and/or contracts come in). I am more inclined toward taking advantage of the speculative opportunity now, given the extraordinary returns that are available in 'unknown and unknowable' situations — but of course this comes with the risk of loss of principal if the technology fails to prove its commercial potential.
There's little doubt that major investors in the oil patch, once becoming aware of QSEP's story, will be watching and waiting if they are not already. Vast capital will quickly flow into the company's stock if it can show ~10% throughput increases in an operating pipeline, as lab and field results indicate.
BALANCE SHEET, FINANCING, REVENUES
QS Energy's balance sheet at first glance looks like a train wreck. Except for a few months of contract income from the brief TransCanada test in ~2013, the company has made basically no revenue from its technology and has survived for decades via dilutive equity financing. The company most recently raised about $1 million from private placements around the end of 2018, and based on the warrants from that round of fundraising, plus others over the course of last year, might expect around another $1 million in cash from investors during 2019. At a burn rate of roughly $1 million a year, this gives them a runway of until perhaps late 2020 to either 1) go back to the market for more dilutive equity fundraising, or 2) convert potential customers to paying customers and thus fund the business from retained earnings. (They also have the potential to use a newly created class of preferred shares to raise money that would be convertible to public equity, but again, if their aspirations to commercialize the technology are unsuccessful, this route would be either infeasible or still dilutive.) It is also worth noting, mitigating the liability/asset mismatch on the balance sheet, that the company's two main forms of liabilities are convertible notes that will ultimately be turned into company equity, and deferred liabilities (primarily payments to the technology partner, Temple University) that are not due until the company is cash flow positive.
But the crunch time for the company is really this year. The current demonstration project with the major oil company partner simply *must* show successful results; failure to do so must mean that the technology is either still not ready for prime time, or will *never* be ready. The latter would be a far more reasonable conclusion, given the extensive preparations that have gone into the test. Thus, there's only a binary outcome now for QS Energy.
That said, investors must use their imagination to properly grasp the unique circumstances they're looking at with QS Energy. If the technology performs as both the CEO and VP of Engineering expect — that is, roughly in accordance with laboratory and previous pilot results — this means that a single contract for a ~100,000 barrel per day line is worth tens of millions annually in recurring revenue (again, see their pro forma revenue analysis based on viscosity reduction figures that correspond with prior, real results in the lab and in the field). One such contract will quickly lead to more, on larger pipelines, and QS Energy will be rapidly multiplying its recurring revenue income streams — a royalty on every barrel of oil that passes through an AOT (they will also likely be selling units outright in some circumstances).
Given the remarkable operational and financial improvements the technology is expected to deliver to pipeline companies, once the technology is adopted by industry QSE will have difficulty fulfilling orders quickly enough. This will make it an extremely rapidly growing business with enormous margins, huge operating leverage, and an impenetrable moat until at least their patents expire. Within just a few years, one could easily imagine annual recurring revenue in the nine figures, and expansion of the business segments AOT is used in (i.e. beyond midstream to upstream, downstream, offshore, etc.) — and with that sort of EPS growth, one can only imagine the valuation multiple the market will assign. By that stage investors will likely expect the story to end with a buyout by a major oil company.
The above is by no means a full explanation of the technology or the commercial potential of the opportunity. Interested investors are invited to conduct their own due diligence. Following are a number of links to assist in that effort.
The article represents the opinions of the author and is based on publicly available information. It was neither endorsed nor authorized by QS Energy and the author is not being compensated by the company in any way.
RECENT SHAREHOLDER STATEMENTS/UPDATES
ON THE SCIENCE OF THE AOT
Application of Electrorheology to Improve Crude Oil Flowing Properties Through Pipeline (2016) — This is the most recent, best one-stop-shop for a scientific explanation of how the AOT works in theory and practice, with data from multiple live tests, from prototype to commercial scale. The materials below are for more serious detail and background. This paper should be considered must reading.
Electric Field Suppressed Turbulence and Reduced Viscosity of Paraffin Based Crude Oil Sample - Test results of the device (in lab) on Saudi oil. "At 270C, With an Electric Field Of 6176V/Cm, the Flow Rate of the NAPD Sample was Increased 108.4%. The Viscosity was Reduced by 52.03%"
Electrorheological Fluids - Scientific American (1993) — an introduction to the field and its basics, with mention of Rongjia Tao.
Rongjia Tao - Constitutive equations for electrorheological fluids based on molecular dynamics (1999) — The basic science and mathematics seems to be worked out here.
Reducing the Viscosity of Crude Oil by Pulsed Electric or Magnetic Field (2006)— One of Rongjia Tao's first major paper on this technology and its sets out its theoretical basis.
Huang Ke - Electrorheology for energy production and conservation (2010) — the dissertation of one of Tao's students, 2010. Goes through the basic science for this effect and has some schematics of a prototype device.
AOT viscosity reduction tests in China using certain Chinese crude oil samples (2012) — This is a translated report by PetroChina showing the effect of the device. These results are also reported in Du 2015.
Du Enpeng - Neutron scattering studies of crude oil viscosity reduction with electric field (2015)— the dissertation of another of Tao's students, 2015. Basic science here as well of course, but it goes through the tests all the way up to a test on the Keystone pipeline, which shows a viscosity reduction of 33%. This has an interesting section on how they identified the effect at NIST.
Suppressing turbulence and enhancing liquid suspension flow in pipelines with electrorheology (2015) — this was written after some years of actual testing of, first, prototypes, and then a commercial-scale unit on the Keystone. The key new idea here is not just the reduction of viscosity, but 1) the reduction of viscosity in the direction of flow, and 2) the way in which the effect actually increases in viscosity perpendicular to flow (because it aggregates the particles into chains), which turns a turbulent flow regime into a laminar one, even with a high Reynolds number. Obviously this has significant implications for flow improvement.
APS physics - Increasing Oil Flow in the Keystone Pipeline with Electric Fields (2015) - A general overview.
Disclosure: I am/we are long QSEP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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