How to become a successful oil baron

published 26 June 2012

The USA has had a strange relationship with oil. The first commercial oil well in the world was drilled in Pennsylvania in 1859. And for a long time after, oil was the catalyst for a formidable economic transformation. Industry thrived. And gas guzzling cars became the birthright of the average American.

In recent years of course, America has been something of a hostage to oil. It's proved enormously expensive (and painful) to import oil to meet the massive domestic demand.

But two new innovations are revolutionising the oil industry. I'm talking about fracking and horizontal drilling. And it could mean a fresh start for America's economic ambitions.

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Today, I am going to tell you about one company that plans to reap the rewards from these new techniques, and also how it could help you become an oil baron yourself.

America could be sorted for energy for 100 years

I'm sure you are familiar with these new drilling techniques. But let's just to recap, starting with horizontal drilling. Rather than simply drilling straight down vertically through the earth, it is now possible to steer the drill bit from the surface, turning it at 90 degrees so that it can burrow along a horizontal oil-bearing seam. It's a radical improvement. Today, 50% of the wells drilled in the United States are horizontal wells and they are reaping massive rewards. These wells are transforming the energy equation of the United States.

Fracking, too, though it is potentially damaging to the environment, is helping to transform the energy equation. This is the process of forcing water, mixed with various additives, into these underground structures, pushing apart the rock and creating cracks and fissures through which the oil or gas can flow.

Today, the USA is the world's third largest oil producer, generating 7.5 million barrels per day (mbpd). By 2017, according to Goldman Sachs, it will be the world's largest oil producer, generating 10.9mbpd. Amy Myers Jaffe of Rice University calculates that the USA could have two trillion barrels of oil waiting to be drilled, compared to 1.2 trillion in the Middle East and North Africa.

Based on current consumption rates, that is enough to provide all of the USA's oil requirements for the next hundred years, a fact to reassure US economic planners and worry non-US oil exporters.

Drilling where you know there's oil

For investors, this new oil boom has some clear attractions. Fracking and horizontal drilling (sometimes known as directional drilling) are being applied to existing oil fields, so this is not wildcat drilling or hopeful forays into virgin territory. This is drilling into oil reservoirs that are known to exist. Take the geological structure known as the Central Kansas Uplift: this has already yielded six billion barrels of oil - but at least that amount of oil is still thought to remain.

Production from this area has been falling because the oil has been hard to extract. But thanks to new technology this is changing. It can now be extracted, and it bypasses the expensive process of exploration. There is no doubt that oil is present. It is simply a question of getting it out.

This radically alters the economics of the business. Conventional oil companies expect to spend large sums on exploration that comes to nothing, recouping it from successful wells. But if you know that the oil is there in the first place then the exploration bill is minimal.

Thanks to drilling done in past decades there are libraries of data, available to all. Some new seismic work may be necessary, but this and all of the other necessary services and production infrastructure are established and at hand. Onshore drilling on known fields in the USA carries none of the political or development risks found elsewhere.

How to become an oil baron

Matt Lofgran is chief executive of Nostra Terra Oil & Gas (NTOG) which, with interests in Texas, Kansas, Oklahoma and Colorado, is one of the many prospectors now swarming over the USA's onshore oil and gas fields. He described the US onshore oil business as "a cross between chess and poker" when I met him in the City recently.

Matt then went on to explain to me how the oil game is played.

So if you want to become a modern day JR Ewing, here is what to do. First of all, Lofgran explained to me, get hold of all of that past data from the state library. Then buy your chosen leases at a cost of anything up to $20,000 per acre depending on prospectivity.

Next hire a drill rig. For a vertical well expect to pay $800,000-$1m; for a horizontal rig $1.3m-$2m. If you produce oil you can expect to pay 20%-25% of the revenues away in royalties, while you will have daily operating costs of up to $5,000 per well.

You can tinker with these figures for yourself. But even a small well that produces 50 barrels per day could repay your investment within just a year, leaving all the subsequent net revenue as pure profit.

According to Lofgran the industry looks for this one year pay-back but will be happy with three years.' In summary it is a business where the risks are not especially high and the financial returns can be very attractive. But don't expect to be alone. This is a competitive game. So before you try to negotiate your first deal, you had better brush up on your chess and poker skills.

The oil driller that could return 405% from here

Or you could simply invest in the penny shares that are reaping huge rewards from this new oil boom. I wrote up one of these outfits in my latest issue of Red Hot. Incredibly it has made a positive financial return on 22 out 23 recent wells, an almost unheard of success rate for the oil industry. I don't want to give too many details away. But as I told my readers three weeks ago, I am looking for a potential return of 405% on these shares.

To find out more about this great story, take a no-obligation trial of Red Hot Penny Shares.

Click here now.

Of course there are two oil stocks in particular that you should be really excited about. They are the subject of my Abandoned Oil report. Have you read it yet? Because we've had a great response so far.

Here's the story in a nutshell. One of these oil explorers is looking to tap an estimated 4 billion barrels of oil that has been left abandoned off the coast of the Bahamas. And then there's the big one a UK stock I expect to produce a six fold return as it drills off the coast of Namibia. There are five key drills coming up. And the excitement is really starting to build.

Click here to get involved now.

This article is taken from Tom Bulford's free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.

Information in Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Penny Sleuth is an unregulated product published by Fleet Street Publications Ltd.

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Tom worked as a fund manager in the City of London and in Hong Kong for over 20 years. As a director with Schroder Investment Management International he was responsible for £2 billion of foreign clients' money, and launched what became Argentina's largest mutual fund. Now working from his home in Oxfordshire, Tom Bulford helps private investors with his premium tipping newsletter, Red Hot Biotech Alert.