Hi Inceptus

I had forgotten about that post, it was quite a while ago. It was funny to go back and re-read it. I pretty much nailed todays flow rate a year in advance of someone finally drilling a proper horizontal well too. I called it at 3.2mmcf/d for a 4 stage horizontal, so an 8 stage should have been 6.4mmcf/d. I think the analysts were really setting the expectation way too low at 2 mmcf/d. They had to know they were going to blow that number out of the water. Had Forest only done the frac properly, we'd be a year ahead in the timeline.

The question in front of me now is should I continue to hold QEC today and continue to expect great returns going forward? To do that I have to understand the underlying value of the resource. This is basically a paper exercise I go through all the time.

The lastest "best estimate" of "recoverable" NG for the Utica on QEC/Talisman land is 17.487 TCF, and applicable to QEC is 4.280 TCF. Plus QEC has a 4.25% over riding royalty or 0.758 TCF. Effectively, this gives QEC just over 5 TCF of recoverable natural gas. Now keep in mind that this is based on only a 13.8% recovery rate. The OGIP best estimate number is 129 TCF. All of this data can be found on slide 14 in the last QEC presentation.

Now 5 TCF is 5 Billion mcf (1mcf = 1000 cubic feet), which is important to note because we buy and sell NG in mcf. This makes the later calculations easier. We've seen comments in the past (before the NSAI report) about the average costs per well being around $3-3.50/mcf. We need to keep in mind that this $/mcf number is based on the F&D costs per well divided by the eventual total output of the well. The eventual output based on the NSAI report is now higher than it was when the $3.50 cost was mentioned by MB. Overall meaning the F&D costs/mcf should be lower than what was previously quoted.

Another interesting point here is that the Lorraine would have even lower F&D costs since all the Utica work is effectively paying for the "Finding" part of the F&D costs.

So if we take a long term (20 year average) NYMEX NG price of say $5.50 (which I personally think is quite low), QEC should make a minimum "PROFIT" of $2/mcf of NG they pull out of the ground. I hope everyone can see that I'm being very conservative all the way along here. Note, we're also been told numerous times that we will get a premium to the NYMEX NG price, which we're not counting at all here.

5 Billing mcf (Utica) x $2/mcf = 10 Billion "profit" based on 13.8% recovery rate (assuming only 1 set of fracs per well)

Now there are 2 interesting comments I made in the line above... In the Barnett they're starting to get up to a 50% resource recovery rate, and that's based on re-fracing the same wells. You see, after the well is initially fraced, the proppant (usually sand) helps to hold open the cracks that have formed in the rock from the fracing process allowing the gas to flow out easier. Over time, these cracks or fractures tend to close up, kind of like a wound healing, which slows down the release of NG. Re-fracing the same well, opens up these cracks again, as well as new ones, and it's pretty much like getting a brand new well with similar flow rates to what you got years before when you did the original fracs. The other point was that the recovery rate used by NSAI is very low, and I think most people would agree that a number in the 20-25% rate seems more reasonable once the first 20-50 wells are drilled. That sounds like a lot of wells, but again, we're talking long term about drilling 10,000 wells in the Utica alone.

So...

5B mcf (at 13% recovery) x 2 (for a more reasonable recovery rate of 25%) x 2 rounds of fracs x $2/mcf profit = $40B in profit over the life expectancy of the field.

Now the Lorraine is thought to have even more NG in it, but it's thicker and will cost more to extract, but again the Finding costs will be low, and it may take a few years before they start to seriously drill and frac it, but it's going to come... For the sake of keeping the math easy, let's just take the number above and say we get the same long term recovery out of the Lorraine as we did in the Utica. So this now means the QEC land in Quebec is going to generate about $80B of profit over the next, lets say 20 years.

80B / 200M shares = $400/share

The profit/mcf could easily be low by anywhere from $1-$5/mcf depending on whether you think the average NG price will be $5 or $10 over the next 20 years, and how low the F&D costs get based on efficiency of drilling the holes. If we end up being $2 on the low side of the long term NG price, that doubles the value again to 160B. This puts us at $800/share. Don't forget we're supposed to get a premium to NYMEX as well...

Ok, so that's a hugely unrealistic pie in the sky number that could only come true if absolutely everything worked perfectly in this play and we waited 20 years for all the NG to be recovered... But remember what I said at the start of this, it's an exercise to see if we should keep holding QEC.

At this point I think each of us has to look at what we believe could come true and how long we're willing to hold the stock. Clearly QEC will be bought out long before we recover all the NG. Not everything above is going to come true. Nobody is going to pay today for the entire value of the resource either. We may not even start to drill the Lorraine before QEC gets bought out and therefore not realize the full value of what the Lorraine is worth when the buyout is offered. We should also expect an offering at some point to raise cash for the production drilling, diluting our shares.

For my own personal view, I believe that I'm looking at a 5 year or less hold period from today onward. I base that on an assumption that we'll get full tilt production drilling going within the next 2 years, and that's 1000 wells per year. In 5 years time that's going to give us 3-4000 wells drilled. That will also be about 5 of the 20 years of production, meaning we'll have actually started taking a good size portion of the resource out of the ground. We should also at that point have started to drill the Lorraine, giving us a higher valuation at that point.

So using my pie in the sky numbers over a 20 year period, assuming I hold it for 5 years from today, I feel pretty good about it being likely to get anywhere from $40-$80/share. From a current price today of $5, the $80 would be an 80% return, "compounded" year over year for 5 consecutive years straight. I honestly don't need to even get 1/4 of that to consider this particular investment a success.

So to answer the basic question, should I hold or buy more QEC here at $5, my answer is yes.

Hope you enjoyed the read.

Brym