‘Oil is a funny thing. It is likely to turn up in the most unlikely places.‘So said wildcatter turned billionaire J. Paul Getty 50 years ago. The term wildcatter comes from the early days of the American oil industry. Lone operators searched and drilled exploration wells in areas not known to hold oil. The wells were a gamble, some calculated, some wild, but always with staggering stakes. It’s still going on today. More on that shortly.
Getty drilled his first well in Oklahoma in 1916. A few years later he was a millionaire.
‘The atmosphere was identical to that which historians describe as prevailing in the California gold fields during the 1849 Gold Rush,‘ he reflected years later in his book How to Be Rich.
‘In Oklahoma, the fever was to find oil, not gold, and it was an epidemic. There were few, indeed, who were immune to the contagion. Fortunes were being made – and lost – daily. It was not unusual for a penniless wildcatter, down to his last bit and without cash or credit with which to buy more, to drill another hundred feet and bring in a well that made him a rich man. A lease which sold for a few hundred dollars one afternoon sometimes increased in value a hundredfold or even a thousandfold by the next morning.‘
Getty was still going decades later. A half share in a Saudi Arabian/Kuwaiti lease turned out to be one of the biggest oil fields of all time. It was in arid, almost uninhabited and unexplored desert. It would turn Getty into the richest private citizen in the world.
Of course, today, the Middle East and oil are almost synonymous. But at the time Getty’s move was a huge gamble. The odds of a major strike were 50-50. He had to pay almost $10 million up front for the concession, and a million a year to the cash-poor Saudis even if no oil was found. If he struck oil, the royalty on each barrel would be the highest in the world. His peers thought it was an insane risk.
Half a decade passed and $30 million spent with nothing to show but five empty holes. Getty decided to drill one last time before pulling out and giving up. Then – bang. The strike changed the world. The Middle East went on to become the major producing region of the world. Saudi oil replaced the declining American oil industry for the next half a century. The cost of energy was low for the booming American years of the 1950s and 60s.
Now compare that to today. In Scoops Lane this week Vern Gowdie – editor of Gowdie Family Wealth – reported that his main concernis the ‘energy in versus energy out’ equation. Or as Vern put it, how much energy is used to extract the energy source? ‘For example, if to extract 10 gallons of oil requires one gallon of oil, the Energy Return on Energy Invested (EROEI) is 10:1.‘
In Getty’s day, the EROEI was 100:1. Today, it’s 17:1. Vern cites a recent book, Life after Growth by Tim Morgan, that has this ratio continuing to decline and drive up the price of energy.
Unconventional sources like shale oil and tar sands have a very tight EROEI of 5:1 and 3:1 respectively. For Vern, this could put a big headwind on economic growth. Energy costs could become an even larger burden on the general economy. This is a very different picture compared to low cost barrels Getty enjoyed in his day.
But it also dangles a huge carrot in front of any energy company that can bring in a producing well with high margins. That’s why they’re scrambling for one of the last frontiers of energy – Africa. The hunt is on.
Resource analyst Jason Stevenson reports in his latest issue, The Thrill of the Wildcat, that, ‘Tanzania is an under-explored hot spot. Recently there have been some big oil discoveries by Statoil ASA [NYSE: STO] and ExxonMobil [NYSE: XON] (five out of five successful wells) in offshore Tanzania. As such, a flurry of super-majors have swarmed into the region.‘
Often, the small oil and gas explorers – the wildcatters of today – are there before the majors move in. They operate with low cash but on potentially lucrative leases. They can sell out at a huge premium if things go their way.
And some Aussie firms are right in there amongst it all. Here’s what leading Sprott resource analyst Rick Rule told The Australian back in October:
‘Australians are particularly effective explorers and developers in Africa, but Australian investors tend to be more attracted to companies with Australian assets,‘ said Rick. ‘We are impressed with the success of management teams in other countries and believe that success deserves a premium – a premium which mercifully we don’t have to pay.‘
The under-pricing Rick identified on junior resource stocks won’t be around forever. If you’re bullish on oil, frontier energy explorers could deserve a look.
for The Daily Reckoning Australia