Last week saw Eco Atlantic Oil & Gas (LSE:ECO) reveal that samples recovered from its first two oil discoveries at its 15pc-held Orinduik block offshore Guyana are mobile heavy crudes with high sulphur content. With Eco – alongside Orinduik’s operator and 60pc owner Tullow Oil (LSE:TLW) – taking a considerable hit on the update, investors were clearly disappointed by the news. Eco is currently trading at 55p on the mid, having shed 50% of its value over the last week. However, this selling looks like a disproportional overreaction, with the market underestimating the potential commercial impact of a heavy oil discovery and the additional many prospects on the Orinduik block, coupled with Eco’s strong balance sheet.
Heavy crude oil with high sulphur content remains pivotal for many oil refineries, with significantly large numbers around the world continuing to produce such petroleum at scale profitably. In short there remains a great deal of demand globally for heavy oil and since Orinduik continues to boast vast amounts of as-yet-unexplored upside, this could mean the dip in Eco’s share price potentially presents an exciting buying opportunity.
What is heavy crude oil?
Let’s begin by looking at what heavy crude oil is. When it comes to pricing oil, the two main differential points are weight and sweetness.
The heavier oil is in relation to water, the more difficult and more expensive it is to get out of the ground, with alternative processes often being required. This perhaps explains last week’s reaction to Eco’s news, but just because oil is “heavy” it doesn’t mean it is not commercially valuable.
Oil’s heaviness is defined as its API gravity – oil with an API Gravity of 20 or more is defined as ‘light’ as it will float on water while that with an API Gravity of less than 20 is defined as heavy as it will sink. To put it another way, heavier oils tend to be more viscous than lighter oils, meaning they are ‘thicker’ and more resistant to flow. To express this more generally, look at the chart below from Hapco. As the liquid become move viscous in relation to water as you move down the table, their ability to flow decreases – the same concept applies to oil as it becomes ‘heavier’. Jethro viscosity was measured at 125cps, meaning it is mobile.
Meanwhile, the less sulphur that oil contains, the ‘sweeter’ it is thought to be. This is because sulphur is an impurity that must be removed during processing when crude is broken down into its fractions through distillation.
As heavier oil tends to contain more impurities like sulphur, it requires more distillation to create the highest-value end products like gasoline, diesel fuel, heating oil, and jet fuel. As a result, it is generally preferred by refineries and light crude oil tends to sell for more on the market than heavy crude oil – look at how West Texas Intermediate tends to trade at a premium to its heavier cousin Brent.
However, there is still a massive market for heavy crude oil. Some simpler refineries can only operate with light crude oil, of which there is now an abundance thanks to the US shale boom. However, more complex refineries have been slower to catch up and still need both light and heavy crude oil– often blending them to create a broader range of products.
Swathes of refineries around the world have sizeable secondary conversion capacity including hydrocrackers, cokers, and desulfirsation units. This allows them to process the lower-cost heavy and sour oil into universally-used end products like residual fuel, heavy gas oil, diesel, and heating oil that require distillation at the highest temperatures. The diagram below, borrowed from the US Energy Information Administration, highlights the various oil products that are created at different temperatures during the refining process:
A global shortage of Heavy Crude Oil?
While shale output continues to rise, there are now even concerns of a global shortage of heavy sour crude oil. According to S&P Global Platts, this is being driven by ongoing OPEC production cuts as well as unplanned sanctions on Venezuela and Mexico- key suppliers of economic medium and heavy grade barrels.
‘This shortage is having a big impact on key market outcomes including trade flows, the dynamics of crude price differentials, and refining margins,’ said the Oxford Institute for Energy Studies in March 2019.
Likewise, a recent Bloomberg article reported that Spanish oil company Repsol is looking as far away as Western Canada for heavy crude oil for its European refineries amid dwindling supplies from its regular suppliers. According to the publication, sources said the firm – which is operator of the Kanuku block adjacent to Orinduik – is looking to use rail to transport as much as half-a-million barrels of heavy crude oil a month from Alberta to Montreal before loading it onto tankers bound for Europe.
The lengths the firm is now looking at to secure heavy crude oil supply is a testament to its ongoing importance.
Thanks to this ongoing demand, there are many examples of large fields producing or either looking to produce heavy crude oil with high sulphur content profitably around the world. As Eco highlighted in last week’s announcement, these are present across the North Sea, the Gulf of Mexico, the Compos Basin in Brazil, Venezuela, and Angola. A few notable examples include:
-EnQuest’s (LSE:ENQ) Kraken field in the North Sea, which delivered 32,776boepd of gross heavy crude oil production and is expected to deliver between 30-35,000boepd for the entire year. It is also the most significant asset in the company’s portfolio;
-Equinor’s (NYSE:EQNR) producing Mariner field in the North Sea, which is expected to deliver more than 300 million boe over the next 30 years and has up to 3 billion boe in place;
-Equinor’s Peregrino field off the shore of Brazil, which is expected to enter production by the end of 2020 and has a production capacity of 100,000bopd; and
-Enauta’s 50pc owned and operated Atlanta field off the south cost of Brazil, which boasts two producing wells and 112 million boe in 2P reserves.
The big opportunity for Orinduik
What all of this significant interest shows is that there is still major demand for the sort of oil present at Orinduik’s Tertiary age discoveries – called Jethro and Joe – meaning they still have a great deal of commercial potential. This is why the partners at the Guyana block – which also include Total – have sought a third-party consultant with heavy crude oil development expertise to provide an initial assessment of several potential development drilling and production scenarios.
What’s more, Eco said that the Jethro-1 discovery continues to benefit from high pressure and temperature – both of which increase efficiency and oil mobility to mitigate the heavy crude oil challenge. As co-founder and chief operating officer Colin Kinley added:
‘We are very encouraged by the initial analysis of these wells and good parameters that define potential pathways to recovery […] Horizontal well technology can allow excellent access to these thick fields and generally reduces the need for multiple additional wells, leading to lower development cost per barrel.’
These indicators are encouraging and warrant consideration from investors who may have been distracted by the mention of heavy crude oil at Orinduik alone
It is also worth reiterating that the Orinduik partners have only just got started at their block. As per the article we published last month highlighted, Orinduik covers 1,800km2 in shallow water and is adjacent to ExxonMobil’s Stabroek Block. Here, 6 billion barrels of recoverable oil equivalent is estimated to span 14 discoveries.
A new CPR released in March 2019 put Orinduik’s estimated gross unrisked prospective resources at nearly four billion barrels of oil equivalent across a total of 15 leads. Eco’s 15pc share of this figure comes in at 596.4 million barrels of oil equivalent. Jethro and Joe have de-risked these Tertiary prospects – and even added newer prospects – and a new CPR and follow-up drilling programme are expected in the beginning of the year.
Excitingly, just one-billion of these estimated barrels are expected to be found in Orinduik’s Tertiary horizons. The three-billion-barrel balance is thought to be located in a deeper Cretaceous play. This horizon, which the Orinduik partners are yet to open up, is expected to hold older lighter oil such as in Liza discovery on the neighbouring block.
If the Orinduik partners can demonstrate a plan for producing their heavy crude oil economically and deliver further positive drilling progress (particular in the Cretaceous play), then the upside from Eco’s current 55p share price could be exciting.