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MGM Energy Goes Elephant Hunting With Big Oil In The Great White North

|Includes: ConocoPhillips (COP), HUSKF, IMO, RDS.A, XOM

A very large shale oil play is emerging in Canada's north which offers risk tolerant investors a high impact investment opportunity. While many other shale oil plays have shown up on investor radar screens the Canol oil shale has been stealth because the majors who control the play are not as prone to self promotion as junior and mid-sized companies. The result is a potential mismatch in the share price of MGM Energy(OTCPK:MGMCF),the single junior company involved in the play.

The Canol oil shale is very large in areal extent and very thick having excellent reservoir properties. For comparison purposes the Eagle Ford oil window covers 1,800 square mile while the Canol oil window is 20% bigger at 2,200 square miles. The Canol is also much thicker which results in oil resources per well which are approximately 10 times the Bakken and 4 times the Eagle Ford. Furthermore, unlike most frontier oil deposit there is the possibility for immediate cash flow as there is an under-used pipeline from Norman Wells to Alberta capable of carrying 50,000 bopd.

A confirmation of the magnitude of the resource was the 2011 and 2012 Canadian Government land sales in which Conoco Phillips (NYSE:COP), Shell (NYSE:RDS.A), Imperial Oil (NYSEMKT:IMO), Exxon (NYSE:XOM) and Husky (OTCPK:HUSKF) committed to spending over $600 million. These companies are seeking reserves that can move the needle on their stock price. They are the elephant hunters and they have come to the hunting grounds of a small company with a market capitalization of about $100 million. MGM was formed in 2007 to look for gas reserves to deliver to the now dormant Mackenzie Valley Pipeline project. As a result of luck and good management, MGM found itself with over 300,000 net acres in the play.

In June of 2012, Shell confirmed the quality of MGM lands by farming or buying into all of the MGM acreage. Further Shell made the very unusual step of agreeing to allow MGM to operate: Shell does not usually give a junior oil company its cheque book. This is a tremendous vote of confidence for Canada's legendary oil man, Clay Riddell, who is the CEO and principal investor and his management team which includes the former president of Conoco Phillips Canada.

The winter drilling season is just beginning and by the end of March, MGM will have completed and tested a well paid for 100% by Shell, Husky will have tested two wells drilled and cored last year and Conoco will have drilled three wells.

The size of the oil resources in place is reasonably well known as there is good well and seismic control. Wells have been drilled in this area since the 1920's. Resource estimates for the oil window vary considerably, but the most likely figure (P50) is 270 billion barrels in place with associate gas and NGLs of 272 Tcf and 38 billion barrels. The wet gas and dry gas window are also large, but all eyes are focused on the light,sweet crude.

How much of this immense bounty is recoverable is still speculative as well testing will be done in early 2013. However, early indications are favourable. The first discovery well in the area was drilled in 1920 and was a Canol oil well which blew out and sent oil 50 feet in the air. This is very unusual for tight shales and indicates that the shale is highly naturally fractured. Husky drilled and cored two wells last year and has stated that one well will not require hydraulic fracturing as it is naturally fractured. Husky seems to have some confidence in its results so far as it has applied to build a 40 km all weather road, permanent air strip and camp which will accommodate about 200. This will cost $60 to $100 million.

Early studies indicate that the Canol field will be economic at 3% recovery factor or higher. Recovery factors reported for other significant shale oil deposits vary from a low of 6% to a high of 24%.

While operating and capital costs are high in the North, the fiscal regime is extremely favourable. Royalties are 1% in the first 18 months escalating to a maximum of 5% in 6 years. In comparison royalty rates in Texas and Alberta are around 20% and unlike the Alaskan fiscal regime there are no other assessments.

A discovery would have a large impact on Husky's stock price and would be material to the super majors such as Shell and Imperial Oil. For MGM it would be a company maker. At the present time none of the companies' stock prices reflect this play.

Of course MGM has the most leverage to this shale oil play, but its shares currently only reflect the option value of its considerable natural gas assets (+/-700 Bcf) in the Mackenzie Delta which are not serviced by a pipeline. As a result, MGM stock is a free option to join a very big elephant hunt.

Disclosure: I am long OTCPK:MGMCF. 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.