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Technology and Innovation Impact on Unconventional Energy

TOM BUTCHER: I'm here today with Shawn Reynolds co-portfolio manager of Van Eck's Global Hard Assets Strategy.
Looking back over the past several years, what do you think are the most important innovations that you have seen in the unconventional energy space?

REYNOLDS: Two of the technologies have been around in basic form for decades. For fifty or sixty years, both horizontal drilling and fracking have existed. But what has changed recently is that these technologies have been combined and optimized in order to squeeze the most out of that sponge.

The way I like to think about it is that you have this horizontal shale that might be a 100 to 200 hundred feet thick. If you drilled vertically through the shale, there might be a little bit of oil that would come to the borehole and eventually make it to the surface, but you have only accessed the first 200 hundred feet. You know that more oil and gas is in there, but not a lot of it is coming to the borehole. If you vertically fracture that borehole, then a little bit more comes up to the surface. But now, with the new technology, you can go into that same borehole and drill horizontally so that you stay within that formation for not just a hundred feet or two hundred feet, but a 1,000 to 10,000 thousand feet. You can now fracture all of it and have economic volumes of oil coming into the borehole and making it to the surface.

It has been the combination of those two technologies [horizontal drilling and fracking] that really allowed this to happen. The most fascinating part of it to me, and it may sound kind of basic, is that if you go back 15 years most wells were drilled vertically. The whole idea behind drilling vertically was to keep weight off the drill bit. Just like any drill, if you push too hard, it will bind up so you have to keep weight off the bit when you drill vertically. But when you turn that corner, and you switch to horizontal drilling, you have to put weight on the drill bit. That is a big deal, and you also have to make sure that when you drill horizontally that you are staying within the zone that you want to be in. Drillers now have the ability to snake the drill through because not all beds are completely flat and horizontal. They can undulate through the shale, as there are usually faults. Sometimes, they have to drop down a hundred feet, and directionally steer the drill to stay within a horizon that may be more than a mile and a half down and two miles out.

BUTCHER: Are the E&P [exploration and production] companies also optimizing based on their use of different types of sands and fluids? What else can they optimize?

REYNOLDS: That is the fracking aspect of it: the sand and the fluid combination. Each situation calls for a unique recipe given that every rock differs and has varying chemical compounds and chemical makeup. You really need to understand how you can maximize the fracture stimulation, which is actually putting the cracks in the rock, and then keeping those cracks open, while not damaging the rock. The amount, size, and quality of the sand and the chemical makeup of the fluid that actually transports the sand into the rock determines what then comes back out. The fluid will always interact with the chemical makeup of the rock, and sometimes it can damage the formation and shut it down. There is a real art and science to figuring out the perfect recipe for not just the different formations on a geographic basis, but even different parts the same formation in the same basin.

BUTCHER: Are people in general drilling much faster as well?

REYNOLDS: Absolutely. Quite often, you start off doing a lot of scientific work and exploration. It may take 30 to 40 days to get the first well down. But now, they have gotten the timing down to 10, seven, or sometimes even four days to draw some of these wells. This is a big progression in terms of productivity.

BUTCHER: Do you think we might see any sort of radical advances in the next couple of years, or a Black Swan event that we had not even thought about before, that might help us?

REYNOLDS: I think it is fair to say we have seen a Black Swan event. Seven or eight years ago no one would have predicted that we would have been able to add 5 million barrels a day to production in just five years. That is staggering. I do not think that has ever happened in the modern history of the oil industry. Going back to the 1970s, no country outside OPEC has ramped up production that quickly.

At this point, I see production technology as more evolutionary today. I think we will continue to work on more precise drilling for fracking techniques. The tools that take the different logging measurements, such as resistivity, sonic, and nuclear, are getting better all the time. The resolution is improving so that you are actually able to measure on a millimeter basis and that just makes everything more precise and more accurate.

BUTCHER: With the importance of technology, when you are looking at the valuations of various E&P companies, do you look at the technologies that they deploy as part of the valuation process?

REYNOLDS: Absolutely. Technology is a critical part of what we do every day. Particularly right now with oil prices down. Cash flow is at a premium and balance sheets are stretched for many companies. It is really important for companies to continue to push the edge on technology to lower costs or to raise returns. But if you have a stretched balance sheet and your cash flow is really tight, you are not going to push the envelope on technology. You are going to continue to do exactly what you did yesterday and last year because you know it works and will provide a bridge to the next cycle.

But if you have a great balance sheet with some cash flow, I would continue to push on technology. We have seen time and time again that the companies that push technology are the ones that raise returns, do a better job in drilling, and add big chunks of reserves. At the end of the day, this is how the most value is created.

BUTCHER: Technology is one of the factors that make a top-rated unconventional E&P company. What are the other factors?

REYNOLDS: Using technology not just to drill, but to get you in the right position to begin with. That gets back to having some good geologic work. But then also having a management team that embraces all this. We talked about how the traditional business model has done a 180. A lot of the individuals that are running the companies now have been around since we were doing more conventional stuff, and they have had to embrace this different view of the geology, risk parameters, and just day-to-day operations. They need to bring it all together and to drive it as a new business model and strategy.

It has been fairly impressive how quickly the industry has adapted. Look at the majors versus the U.S. independents. The majors are still stuck in the old model, trying to drill in deep water in megaprojects, which we are now finding out don't work and didn't work with oil at $100 a barrel. While the independent E&P companies are now showing that they can be successful, drill great wells, and grow with oil at $30 a barrel.

BUTCHER: Thinking about this in the current environment of low oil prices: Is the ability of the top ranked E&P companies to change what they are doing quickly one of the reasons they are surviving?

REYNOLDS: They're certainly more nimble. A lot more nimble than they were the 15 years ago, a lot more nimble than the majors. It's the business model, the business strategy, and the ability to throttle on and throttle off with shale. When you have the conventional stuff, you found it, you knew how much was there, and you knew you had to replace it. You're always out drilling for new replacements. With shale, you know what the reserve and resource potential is. You have to work the engineering problem around it, with prices and costs, and get it to an economic state. There's certainly a lot more flexibility to throttle on and off than in the past.

BUTCHER: Shawn, thank you very much.

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