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Oil Price Impact – It’s better than you may think!

Shawn Bartholomae, CEO of Prodigy Exploration Inc., LLC

Shawn Bartholomae, CEO of Prodigy Exploration Inc., says that the sudden and sharp drop in crude prices may sting at first, but it won’t last long. In the very near future the price to drill will become more efficient resulting in higher profit margins over time. This scenario will hold true for Silver Tusk Oil, a sister company to PEI, more so than most.

Profit margins and break-even points are relative not only to the price of oil but also to the cost of conducting business. As oil prices drop, producers will renegotiate their inflated oil service contracts, forcing the drilling companies to slash workforce wages and cut perks to bring their costs in-line with depressed crude prices. The growing demand for oil remains strong, which will provide a “floor” preventing prices from going so low that profit margins cannot return to a profitable state. But, you ask, what is the floor and is it the same for everyone? Apparently not, and I’ll explain below.

How oil prices dropped to $46 a barrel isn’t a complete mystery as most claim. Will prices climb over $100 a barrel again in the near future? The answer is unquestionably, YES! Historical patterns tell us they will and there are many reasons for oil prices to reach triple digits once more. With that being said, our focus should not be so much on the price of oil as it should be on profit margins associated with the price at hand.

So, how do we handle the 55% drop in oil prices we’ve seen over the past several months? This has been shocking for most investors, but not entirely for oil bears and bulls alike. How on earth did it fall so hard, so fast? There’s plenty of speculation ranging from the Saudi’s desire to crush the U.S. shale industry to the U.S. conspiring with the Saudis to flood the market in order to bankrupt an aggressive Russia and an obstinate Iran.

All theories aside, the fact remains that the collapse of oil prices are a reality regardless of the reasons. However, let’s not make the fatal mistake of failing to recognize that it is also the very prelude for the industry’s next Bull Run. This drop in price may very well be just what the industry needs and we are about to experience the longest Bull Run in history. Is this a practical outlook? Yes! Shawn Bartholomae, CEO of Prodigy Exploration and Sr. Partner at Silver Tusk Oil Co., says the timing is impeccable as we are on the outset of a political setting that benefits our industry. As you will recall, Republicans took control of Congress in the 2014 midterm election which transformed the political dynamic in Washington and gave the GOP new power over the President’s final two years in office. Additionally, Republicans won Senate seats allowing them to assemble a majority of more than 52 seats expanding their margin in the House to levels not seen in decades. Further, they have won key governor races also supporting the oil industry, particularly in Texas! The sweep left Democrats without a majority in either chamber for the first time since 2006. Our country is making a statement and it would be reasonable to assume that our next President will also be Republican!

A Republican influence will undoubtedly support the industry overall and particularly bolster returns to oil and gas investors alike.

But what happens if oil prices remain low for longer than expected? It’s not all bad; in fact, it may be even better for smaller developers than if prices had never dropped at all. This is particularly true for Silver Tusk and partners, and I’ll explain why. But first, let me say don’t panic over “the sky is falling” premise! These types of analysts and journalists are claiming that the price of oil will remain low with devastating repercussions to the industry, the economy, and investors, especially those in oil and gas. Quite frankly nothing could be further from the truth! Why do they do this? That’s an unknown; however, this is what they’ve done every time prices have dropped in the past and then inevitably prices return to an all-time high or at least to a price that has profit margins back at a level where every facet of the industry is prospering again. You would think their reactions would differ from the past as these price cuts provide the most enlightening facts as to why energy prices will not remain low for an extended period of time. So how long will prices remain low? The answer is simply “not long” as in just a few months.

How do I know? I know because oil and gas price patterns historically repeat themselves. Oil prices drop and in return development costs decrease, which re-inflates profit margins making it profitable for developers once again, even while oil prices are down. This too will foster the industry’s next Bull Run! Without mixing words, NOW is the time to start drilling as many wells as possible particularly those likely to produce both oil “and” gas, which is precisely what Silver Tusk Oil Co. is doing.

All this sounds encouraging but what about our economy and the impact of plummeting oil prices? Overall, it seems most investors are concerned, which is a normal reaction. After all, the oil industry is a major producer of jobs and wealth for the U.S. contributing approximately $1.2 trillion to U.S. GDP and over 9.3 million permanent jobs, according to a study from The Perryman Group. The oil industry does not generate all those funds and/or jobs. Instead, they are derived from the multiplier effect the industry has on local economies. Given this, it’s clear why a 55% drop in oil prices is cause for concern by some, but not for all!

While Texas is known as the US capital for oil and gas development, does this mean the State could suffer economically from oil prices nose diving? The answer is absolutely not. Regardless of what you may read elsewhere, the falling price of crude hasn’t had a negative impact on the state’s economy and it likely never will.

A more pertinent question is how does $46 oil affect other large developers with enormous blocks of Bakken shale acreage in North Dakota? They are saying West Texas Intermediate (WTI) crude needs to remain above $60 a barrel for their companies to stay in the black, that is; of course, if the contractors and other oil field service costs remain inflated, which is not the case. On the other hand, the larger developers holding shale acreage in south Texas say their companies can remain profitable with oil as low as $45 a barrel as they strategically drive oil service contracts down. The minimum price to maintain profit is forever changing. As development prices decrease, so does the minimum price needed to maintain profits. How does this occur? The larger developers are left with the task of lowering the cost of doing business by ceasing exploration and slowing infield development which translates to a decrease in rig activity but not necessarily production. Larger developers typically have dozens of rigs running so price cuts must trail the decline of oil prices to once again make it economical to drill. If not rigs get parked placing tremendous pressure on drilling companies to lower costs.

These price cuts spill over to the smaller companies as well. Again, this is the optimal time to drill in an attempt to establish as much production as possible preceding the industry’s next Bull Run. Question is, is this happening, are the rigs being parked resulting in a significant price cut? YES!

In just the last few weeks, rig counts have dropped quite rapidly. The latest Baker Hughes rig count reflected the total number of US rigs in operation (including both oil and gas) fell again last week to 1,750 as of Jan 9th 2015, down another 61 rigs from 1,811, which is down from 1,842 the previous week. This is down from 1,920 for the week ending December 5.

Oil rigs in use fell by 37 the week before last, while gas rigs increased by two. For the week ending December 12, the number of oil rigs in use fell by 27, which at that time was the single largest weekly decline in two years. The following week, the number of rigs in use fell by 18. These reports are released each week.

The drop in oil rigs is already lowering the cost of development! The price of West Texas Intermediate touched down as low as $48 a barrel for the first time since June 2004. But this is no reason to panic and here’s why! Take a look at history once again. Back in December 2001, WTI crude was priced around $25 a barrel and steadily climbed to $82 per barrel by 2006. Shortly thereafter prices dropped to $68 a barrel before skyrocketing to an all-time high of $143 a barrel in July of 2008, just two years later. Then, within six months it spiraled to $43 a barrel in 2009, even lower than it is now! And then what happened? By April of 2011, prices steadily increased to $115 a barrel, again just two years later. The cycle is starting again and we know that the best time to invest in oil and gas is when development costs are down and profit margins have re-inflated as they always do thereby allowing for maximum gain during the next Bull Run.

Nevertheless, the Fed Beige book says the outlook for North Dakota remains optimistic and that they expect oil production to continue to increase over the next two years. What are they thinking? Don’t they worry about the break-even price of oil? Secondarily yes, but this is the best time to prepare for the industry’s next Bull Run which is expected to be the longest in history. These very same developers recall drilling for oil when it traded in the upper teens. Even then profit margins came back into perspective and not long afterward prices started flourishing once again expanding profit margins at a rate otherwise not possible.

This would not have been the case had they not continued to drill while crude prices were down. Shawn Bartholomae makes it simple, history is our strongest future indicator! We don’t need a crystal ball or some oracle to tell us what history is already making abundantly clear!

Drilling for oil in the last several years has become easier and more efficient but production costs have gone through the roof. Why? There are a few reasons for this but the primary reason is high oil prices. When oil service firms like Halliburton and Schlumberger negotiate contracts with developers they take the oil price and demand into consideration. The higher the oil price, the higher the demand, the higher cost for their services which equates to higher costs for everything associated with the industry, such as labor, pipe, equipment, administrative costs, engineers, geologists, and drilling costs. Furthermore, when prices drop development costs do as well which brings the “break-even” price down with it as I mentioned previously. The larger developers know how to accomplish this task. They simply don’t engage new drilling contracts unless it is economical which has a rippling effect on other oil field services. What happens next is simple. Drilling companies drop their rates to keep their rigs active. As this occurs the drop in drilling costs becomes highly competitive dropping rates even further and profit margins come back into focus even if the price of oil falls to an unimaginable $30 a barrel.

Typically this doesn’t occur all at once but cutting costs is not far behind the dwindling price bringing the profit margins back into full perspective quite rapidly. Even if oil prices remain low for a lengthy period, profit margins will remain intact! For Silver Tusk and our partners the timing couldn’t be better. Why? First, we are at the very early stages of our newest development, which means we will drill the majority of our wells while development costs remain low. As oil prices make their comeback as they historically have, our profit margins will expand at an accelerated rate. This reduplicating pattern seems unbreakable, like an echoing cycle repeating itself one scale up from the last.

Shawn Bartholomae says if we had been at the later stages of this development with numerous wells already drilled at higher costs, the opportunity would not have the same benefits. Secondly, I don’t think anyone expected oil prices to drop so suddenly or sharply but Silver Tusk is prepared. How? It’s in our strategic development. We are developing in a region which typically yields a high percentage of gas compared to oil. Pursuing this production balance is vital in maintaining a steady revenue stream. Silver Tusk Oil planned a portion of our development in a specific region where the natural gas being produced is more likely to have a much higher BTU rating which, in turn, will yield a much higher price than spot market. This strategy is already working. A prime example is the recent success of the Margie Sanders #1. The gas from this well is very potent generating a bonus of $1.50 extra per MCF. In other words, if NYMEX Natural Gas is $3 per MCF, we will be getting roughly $4.50/MCF from the gas produced by this well, and similarly from another well not far off the JD Kilcrease #1! Additionally, it appears our geological analysis is correct now that we have encountered the same formation in a 3rd well, the Kilcrease Bowles #1, which will be tested this week. Silver Tusk Oil is taking full advantage of this situation by establishing as much production as possible as we approach the next Bull Run!

So where is the floor? How far can oil prices fall before they’re completely uneconomic or so low that profit margins could never recover? Once again, Shawn Bartholomae says to look back to look ahead, history gives us the answer!

Consider this—fracking boomed in the U.S. back in the mid-1980s when a barrel of oil fetched around $23. When adjusted for inflation, this equates to $50 a barrel at today’s prices. That boom went bust after prices fell to around $8 a barrel, which is worth around $18 in today’s money. It seems that $20 a barrel would be a bust at least for the time! And we are presently at $48 a barrel. Are prices going any lower than $48 a barrel? Maybe, but not by much. Why not? The growing demand won’t allow it! We are currently at $48 a barrel and profit margins will re-inflate at this price and, perhaps, even lower. Even a $30/barrel price could swing profit margins back to a range allowing developers to continue in the black. But at the end of the day it doesn’t appear the price of oil will continue to fall much lower, nor will it stay down. If you take a look at previous price drops, they are short lived compared to price increases which typically have lengthy runs. The fact is prior to 1998 the average price has steadily increased. See Exhibit B

An upward march in energy prices should take place over the next year; but, keep in mind we don’t necessarily want the price of oil to increase as rapidly as it dropped defeating the purpose of adjusting profit margins that are needed for the industry’s next Bull Run. Now is the time to gain as much momentum as possible. The irony in all this is simple, as long as we are successful in finding and producing oil and gas while development cost are down we are setting the stage for much higher returns than if development cost remained high while prices stayed up around $100 a barrel. Overall, we benefit from the drop in oil prices. It may be unpleasant at first as we experience a drop in revenue from existing production but that’s minor given the fact that we are at the early stage of our development. Shawn Bartholomae, CEO of Prodigy Exploration Inc. and Sr Partner for Silver Tusk Oil Co., says the long term benefits are superb if we continue drilling to establish as much production as possible. And, as a small company, we are perfectly positioned to do just that!

I trust this practical viewpoint alleviates any concerns one might have regarding the recent market changes and clarifies the development opportunities at hand giving investors a reason to look forward to a prosperous future in oil and gas. In the very near future, Silver Tusk Oil Co. will embark on another new development proposing the drilling of several vertical gas wells on acreage strategically close in proximity to their most recent successes! Shawn Bartholomae says this may be the best time to invest in oil and gas, both markets look very strong going forward! The fact remains that Silver Tusk Oil Co. and Partners are in a development to establish as much oil and gas production as possible while development cost are down thus preparing for the industries next Bull Run!

Shawn Bartholomae
CEO, Prodigy Exploration Inc.
Sr. Partner, Silver Tusk Oil Co.

Education

Gaining an understanding of the complex work that goes into the exploration and production of oil and gas can be a hefty job. While hardly a comprehensive list of the elements this works entails, the links and stories below are provided to give you a general understanding of how the petroleum industry functions and how the advances in the technology available for implementation has changed this occupation for the better.

How and Where Oil Was Formed

Geologists generally agree that crude oil was formed over millions of years from the remains of tiny aquatic plants and animals that lived in ancient seas. There may be bits of brontosaurus thrown in for good measure, but petroleum owes its existence largely to one-celled marine organisms. As these organisms died, they sank to the sea bed. Usually buried with sand and mud, they formed an organic-rich layer that eventually turned to sedimentary rock. The process repeated itself, one layer covering another.

Then, over millions of years, the seas withdrew. In lakes and inland seas, a similar process took place with deposits formed of non-marine vegetation.

In some cases, the deposits that formed sedimentary rock didn't contain enough oxygen to completely decompose the organic material. Bacteria broke down the trapped and preserved residue, molecule by molecule, into substances rich in hydrogen and carbon. Increased pressure and heat from the weight of the layers above then caused a partial distillation of the organic remnants, transforming them, ever so slowly, into crude oil and natural gas.

The oldest oil-bearing rocks date back more than 600 million years; the youngest, about 1 million. However, most oil fields have been found in rocks between 10 million and 270 million years old.

Trap, Reservoirs, Seal, Source and Timing

The physical geology of the earth has gone through several changes over time and many of these changes can create oil and gas. Considering that marine environments are prime geologic areas for the sedimentation needed to produce oil and considering that the surface of the planet is roughly 75% ocean covered it would seem that the production of oil would be prolific. The good news is that it is. The bad news is that during the times of oil formation most oil is not trapped. Understanding this, we can see that in oil exploration finding productive traps is the name of the game.

The 5 components of oil and gas traps vary in complexity but not in importance. Each one of them is mandatory in order to be successful. The 5 components are that you have to have biogenic source rocks that are deposited with significant organic material that doesn't have enough access to oxygen to decompose. These rocks must be covered until the overburden pressure and heat cause the break down of the molecular matter in the source rock in a geothermal environment that will form oil and gas.

As this oil and gas migrates upward along cracks and fissures, due to it’s lighter density, it must encounter an impermeable cap rock or seal. In that area, there must also be a reservoir rock that has porosity and permeability characteristics that will allow the oil to rest there instead of seeping around the seal. The geometry of the reservoir rock has to be as such that the reservoir and the sealing rock form a trap. Finally, all of this has to take place with a concurrent timing where the trapping seal is in place over the reservoir at the time of oil migration and the structure must keep each of these things in place until the time the prospect is discovered.

So to have a trap you need to have Source rocks, Reservoir rocks, a sealing impermeable overburden, a trapping mechanism and the correct sequence of timing.

Source Rocks

Most geologists agree that oil and gas form from the preserved soft parts of ancient organisms that were buried, and then broken down and converted into petroleum by the combined effects of heat and time. Buried organic matter is called kerogen, and a petroleum source is any rock that contains enough kerogen to generate oil or gas. Most source rocks are shales with a total organic content (TOC) of at least 3%.

Kerogen is converted into oil when exposed to heats above 50 to 70 degrees Celsius (122 - 158 degrees Fahrenheit). Around 120 -150 degrees Celsius (248 - 302 degrees Fahrenheit) the oil is cracked to become gas. This “oil window” of temperature generally lies between the burial depths of 1000 to 3000 feet. As the oil and gas are formed the hydrocarbons are expelled to lower pressure areas. This expulsion of fluids and gas is called a migration and the importance of the time of migration will be covered in a little bit.

Seals

As oil migrated from high-pressure, high-heat, high-density areas it will make its way upward until it reaches the surface unless it encounters a seal. Seals are only common in the feature that they are impermeable. Permeability is a concept that is key to understanding in both regards to seals and reservoirs. Permeability is the ability for fluids or gases to flow through a substance. In the case of a seal, the migrating oil comes in contract with a layer that it can’t flow through as a result it is forced to move around the seal, if it can.

Seals are normally rock layers with low permeability. In most cases these are sedimentary layers that have undergone some degree of metamorphism. In some cases, igneous layers, sediments with smectite, or other clays, or the dynamic metamorphosed faces of faults can serve as an impermeable seal. In some cases, the very shale that functions as a source rock can serve as a seal for it’s self.

Reservoirs

If a rock has enough porosity, the ability to hold fluids, and permeability to flow oil or gas, then it is a potential reservoir. Although it may not be very much, most rocks, in particular sandstones and conglomerates contain pore space. If enough pores are present, the pores are large enough, and they are interconnected so that fluids flow through them (i.e., the rock is permeable), then the rock is a potential petroleum reservoir.

With sandstones, a porosity of 18% or more is usually needed for an economic oil reservoir, and 12% or more for a gas reservoir. Less porosity, perhaps as little as 9%, is needed if the sandstone is also fractured. Because of fracturing, limestone and dolomite reservoirs can have much lower porosities than sandstone reservoirs.

Porosity and permeability are important, but a petroleum reservoir needs to contain hydrocarbons as well. In most rocks, the pores are filled entirely with a salty solution called formation water, but in a few some oil or gas is present as well. A general rule of thumb is that 40% or more of the pore fluids must be hydrocarbons (i.e., the water saturation is less than 60%). If the water content is greater, then oil tends to stay behind and the reservoir produces only water. These types of reservoirs are said to be "wet". If the water saturation is less, then the reservoir may be "productive".

Traps

Traps are the mechanism that allow for the accumulation of migrated oil and gas in reservoirs under seals. There are several types of traps but the general designations are Structural traps, stratigraphic traps and combination traps.

Structural traps form due to changes in the earth’s crustal composition as result of the pressures and stresses of tectonic movement. In a simplified form, as the earth’s crust moves, forces cause different reactions in the land due to its differing composition and some of this works to form traps.

Some common types of structural traps are anticlines, domes and fault blocks. Stratigraphic traps are formed by layers of deposition that were formed on the surface and have been covered by other layers over the years. Some common types of stratigraphic traps are lenses, depositional or erosional pinch-outs and carbonate reefs. Combination traps are a manifestation of both structure and stratigraphy being in play. Some common examples are eroded or deformed anticlines and salt dome traps.

Timing

All of the elements come together in the concept of timing. In looking at a play, the order of the other concepts as well as understanding the geographic history is very important. All of these elements have to be in place at the proper time in order to trap and fill a reservoir, as well as keep it in one piece until it is tested.

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