It takes water to produce energy and energy to produce clean water. That nexus creates a number of profit possibilities. Sometimes, they are not so obvious. But often, a company that possesses expertise in water treatment will possess a related expertise in the energy field. The connection between water and energy is at least as old as the process of pumping water into old oil fields to boost production.

But the connection between these two precious fluids is changing quite a bit.

Let's take a look at one of the less-obvious connections...

You may not realize this, but two-thirds of oil discovered stays in the ground. The average recovery rate is only about 35%. What if we could recover more of the oil we've already discovered?

If the recovery rate improved to 50%, the world's recoverable oil would increase by 1.2 trillion barrels. It would double today's proven reserves, says the IEA. That much oil makes even a cynical old oilman catch a gleam in his eye and starts his heart aflutter. Indeed, lots of big brains churn away at this problem day and night.

"It's the prize for the next half century," says Howard Mayson, vice president for technology at British oil giant BP, quoted in this morning's Wall Street Journal. BP relies heavily on enhanced-recovery methods. These methods aim to improve that oil recovery rate.

As The Wall Street Journal reports:

"Enhanced recovery is a lifeline for the biggest oil companies, such as Exxon Mobil Corp. and BP, which are under intense pressure from shareholders to keep ramping up production and gaining access to fresh reserves. But that's hard to do when the companies are shut out of the oil-rich Middle East and places like Russia. So they rely more and more on existing fields, some of which have been producing oil already for decades."

It is like squeezing a sponge ever tighter to extract the most of what you can get. The old method is to simply flood the reservoir with water. The idea is to create enough pressure to make it easier to pump the oil out. It is not very efficient, but it works for a time. It is also becoming a bigger problem to secure the water supply. That's why we see oil companies buying water rights out West. Currently, the shale oil plays consume a lot of water.

Instead of using water, some companies will pump the reservoir with carbon dioxide. Companies used to store carbon dioxide in old unused reservoirs. Using this method of enhanced oil recovery, they put that carbon dioxide to work. BP uses this method out in its Prudhoe Bay reservoir, to great effect. Recovery rates there are 60%. Now Prudhoe Bay, which people in the 1980s once thought would cease pumping oil in 30 years, looks to be good for another 50 years.

The WSJ describes another method BP uses: "flooding reservoirs with polymers that expand like popcorn when they come into contact with hot rocks, thus flushing more oil out of difficult-to-reach nooks."

The name of that polymer is BrightWater. One company has a patent on this material and makes it for a profit. That company is Nalco Holding (NLC:NYSE), a company I recommended several months ago to the subscribers of Capital & Crisis. BP uses BrightWater in Argentina and Pakistan. "BP says the additional oil the new technology will produce over the next 20 years is roughly equivalent to finding a major new field," reports the WSJ.

"Nalco," you say, "but isn't Nalco is one of the world's largest water purification companies for industrial companies?" This is what we mean by energy-water nexus. The two are related. And Nalco sits right in the middle of that nexus.

Last year, Nalco's energy services segment was a bright spot. Sales grew 17% organically for the year. In the fourth quarter, sales were up 23% despite the steep oil price decline. In that segment is Nalco's enhanced oil recovery (EOR) business.

CEO Erik Fyrwald commented on this business in a quarterly conference call. "We are in with a lot of oil companies explaining and talking to them about it," he says. "We believe as oil prices come back up, [EOR will be a] really big growth opportunity, just delayed for a period of time."

The delay stems from the fact that many oil companies slashed their exploration and production budgets last year, when oil and gas prices were falling. But it seems inevitable that as the big oil reservoirs dwindle, the EOR business will be big down the road. Of course, EOR is only one of the many valuable things Nalco does in the energy-water nexus. It is no wonder why Warren Buffett's Berkshire Hathaway is the biggest shareholder.

Nalco is a long-term buy.

Regards,

Chris Mayer
for The Daily Reckoning Australia

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BHP Billitons's oil projects showed up in a research report we reviewed yesterday. The report tried to answer the question of where future global oil production would come from. There is a 32 million barrel per day gap between what the world produces today (about 87mbdp) and where the International Energy Agency reckons the world will be in 2030 (117mbpd).

In other words, the world needs another OPEC if oil supply is going to keep up with demand. OPEC currently produces 32mbpd. The IEA says OPEC can double that figure if it invests about US$2.4 trillion in exploration and production. OPEC is not as sure. As you can see, the gab between global production capacity and global consumption is, ahem, pretty tiny right now.

Source: BHP Billiton, IEA

According to BHP's oil man Mike Yeager, BHP's cost of production for a barrel of oil is between $6 and $12 a barrel. For the last three years, production at BHP's various oil fields has hovered around 300k bpd. That makes it the world's 25th largest oil producer, according to the company, which is not bad if your main business is mining.

It's an axiom that the mining business and the oil business don't mix. Energy exploration and production sucks up the capital, while project life is uncertain and cash flows variable. There are lot of known unknowns, and on the exploration side, some unknown unknowns.

But BHP Billiton does know that oil production increased to 378k per day last month, and 415k per day last week. It knows that the fifth LNG train from the North West Shelf is scheduled to begin production this year. It knows that its Neptune field in the Gulf of Mexico, though delayed this week, should begin cranking out 50kbpd in June of this year.

It also knows that by this time next year the Shenzi field in the Gulf of Mexico should begin producing about 100kbpd and that by 2010 the Pyrenees field in Western Australia should produce about 96kbpd. And there are more projects in LNG on the way, too.

That is a lot of good news for an oil company that's not an oil company. By market value alone, BHP Billiton is bigger than BP (NYSE: BP) and not far behind Exxon Mobil (NYSE: XOM) and Royal Dutch Shell (NYSE: RDS.A). If the company is valued as an energy company and not just a miner, then yet another reconsideration of its value may take place. Rio Tinto should be worried about that. All that energy translate into cash for a bid sweetener.

BHP Billitons's cost of production is going to rise. There is huge cost inflation across the entire oil industry as projects move further off-shore and deeper underwater. But this is an example of Australia's exposure to straight-forward bull markets in energy and resources. The businesses aren't easy, but they are not conceptually complicated.

What's so astonishing about Australia's resource economy right now is how it's filtering down from gold and oil to base metals, bulk commodities, and even lead. "The great minerals land grab by China Inc continues with Hunan Nonferrous Metals Corp looking to buy one of Australia's best untapped lead deposits," reports Kevin Andrusiak in today's Australian.

Lead?

"Yesterday Hunan launched a takeover bid for Perth-based Abra Mining, saying it is prepared to spend just $67.3 million to control one of the nation's best untapped lead deposits. Hunan, which has received the backing of the Abra board for the takeover play, has offered 83c for 70 per cent of the remaining Abra scrip it does not already own."

Hunan's offer puts a 44% premium on Abra shares. A 44% premium on lead. If lead gets that kind of premium, what would BHP's oil and energy reserves (1.3boe) and its resource base (3.5boe) command? The resource grab is well and truly on, and it's moving at the speed of lead.

Dan Denning
The Daily Reckoning Australia

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