Investing Daily

“Most of the world’s heavy oil is similar to what is found in the Alberta/Saskatchewan belt,” reasons Chris Bloomer, Petrobank Energy & Resources’ (TSX: PBG, OTC: PBEGF) top executive on heavy oil projects. “What we learn from Kerrobert will have implications in many countries, from Venezuela and Colombia to China and Russia.”

Bloomer is referring to a project at Kerrobert, Saskatchewan, a joint venture between his company and Baytex Energy Trust (TSX: BTE-U, NYSE: BTE), one of the biggest heavy oil producers in Canada with 23,000 barrels a day of output. The project involves testing the efficacy of toe-to-heel air injection (THAI) in traditional heavy oil fields.

THAI is an in-situ combustion method for producing heavy oil invented by Dr. Malcolm Greaves in 1993 for which Petrobank holds the patent. THAI combines a vertical air injection well with a horizontal production well oriented in line to the vertical well.

Source: Petrobank Energy & Resources

Fed by air from the injection well, a combustion front sweeps the oil from the toe to the heel of the horizontal producing well. Estimates from experimental tests indicate that the process can recover as much as 80 percent of original oil-in-place while partially upgrading the crude oil in situ.

Petrobank has reported positive results from its test wells in the oil sands region. The oil produced was upgraded from 8 to 12 API degrees, and the company hopes to get a further 7-degree upgrade from its associated CAPRI (controlled atmospheric pressure resin infusion) system, which pulls the oil through a catalyzing nickel lining in the lower pipe.

Heavy oil is present all over the globe. In Saskatchewan, an estimated 20 billion barrels have yet to be recovered, in part because current technologies can’t get it. The CAD12 million Saskatchewan demonstration project is expected to produce 1,200 barrels per day; if successful Petrobank plans to license THAI to projects around the world.

Petrobank estimates are that it will cost USD20,000 per producing barrel to put a project together, whereas the average SAGD (steam assisted gravity drainage) project is USD60,000 per producing barrel. Including an upgrader puts you in the USD80,000 to USD100,000 per producing barrel. And because the oil is upgraded in situ, you’re producing 20- to 21-degree oil on the API scale rather than 9- or 10-degree oil.

THAI has the potential to solve the economics of heavy oil extraction in a relatively environmentally friendly way.

Between OptimISM and PessimISM

The Institute for Supply Management’s (ISM) factory index rose to 55.7 in October, reaching a three-year high and blowing away the consensus forecast. The report triggered a sharp but short rally yesterday as investors temporarily danced to this “beat.”

If you look a little deeper, however, a little of the luster comes off the report: The regional surveys don’t support the national, headline-grabbing number. Seven regions were down, while only two were up.

The ISM employment index also took a huge leap, to 53.1 in October from 46.9 in September. This ties July 2008 for the largest increase ever; July 2008 was also the last time we were above 50 on this index. Nonfarm payrolls declined by 128,000 during that month. The consensus expectation for October nonfarm payrolls right now is a decline of 175,000 following September’s loss of 263,000 jobs. It’ll be interesting to see whether Wednesday’s ADP private nonfarm payroll report confirms that employment is finally firming up, even more interesting to see what happens with Friday’s official Labor Dept statistics.

The ISM employment measure doesn’t actually “count” jobs--it’s a sentiment gauge, and so this surprising jump is also somewhat misleading. Consumers remain less optimistic about the state of the job market; a measure of confidence in the consumer job market was the worst it’s been in four months. At some point confidence will have to trickle down from managers to workers. The consumer accounts for 70 percent of GDP compared to 10 percent for the business sector.

Ahead of the Fed

The US Federal Reserve Open Market Committee begins its two-day meeting today; Fed watchers will be looking from subtle changes in language that may indicate when the central bank will begin reigning in its extraordinary efforts to support the economy.

A couple interesting factoids/coincidences are worth noting ahead of Wednesday’s interest rate statement. The Reserve Bank of India bought 200 tons of gold from the International Monetary Fund (IMF), about half of all the gold the IMF announced it would sell in September. This increases India’s gold holdings by 55 percent and further diversifies its reserves.

And the Reserve Bank of Australia (RBA), expectedly this time, raised its target interest rate by another 25 basis points to 3.5 percent, continuing to “gradually lessen the degree of monetary stimulus” now that the “risk of serious economic contraction has passed.” Monetary (and fiscal) authorities acted in concert as the crisis deepened, but it appears they’ll be acting on their own as we progress into “the new normal.”

Australia is an exceptional case; fiscal authorities there unleashed impressive spending efforts to stimulate the economy, and the country benefits tremendously from its proximity to China. For comparison sake, only 3 percent of Canadian exports go to China, while 75 percent head south to the US. Australia sends 24 percent of its exports to China, while only 6 percent head to the US.

Today’s Picture

Here’s a fascinating picture of the changing composition of that which backs the US dollar. You have to look hard at the extreme right side to see the radical change the Fed hath wrought with its efforts to prop up the economy. The bottom line according to the artist/analyst who created the graphic, John Paul Koning:

For the first time since WWI, Fed discounts, loans, and advances account for the largest component of assets backing the dollar. But in 2009, these loans include a host of emergency facilities created to deal with the credit crisis such as TAF, loans to fund the bankrupt assets of Bear Stearns and AIG, and more. Some of these loans are collateralized by risky and often undefined assets. Government debt as a proportion of all assets has fallen to its lowest level since World War II, while Agency debt and mortgage-backed securities have expanded their presence on the Fed’s balance sheet. The quality of your dollar’s back, it would seem, has become much harder to evaluate.