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The Honolulu Advertiser
Posted on: Sunday, October 30, 2005

Appalachia's low-yield oil wells pumping gold

By ROGER ALFORD
Associated Press

"No one expected oil prices to do what they've done," says Kentucky oil man Frank Lynch, above. Investors are buying his company.

ROGER ALFORD | Associated Press

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SOMERSET, Ky. — Steam rises. Valves hiss. And the flame atop a smokestack flickers like a candle in the breeze as one of the nation's smallest refineries tries to stay ahead of crude production in central Appalachia.

New wells are going in every day throughout the region, thanks to an oil rush powered by record high prices. With crude selling for $60 a barrel, even the traditionally slow-producing oil fields in the mountains of Kentucky and Tennessee, where most wells churn out one to two barrels a day, have become lucrative.

"No one expected oil prices to do what they've done," said Frank Lynch, president of Somerset Oil in this southern Kentucky town 80 miles south of Lexington. "With the high-dollar crude, all of a sudden we were thrown into the big game."

Somerset Oil had gone about its business almost unnoticed for decades. That changed last year when crude jumped beyond $20 a barrel and kept on rising.

Now, Lynch said, he expects the supply of crude from local wells to his refinery to increase from 2,800 barrels to 5,500 barrels within the next month and to 7,500 by the end of March. Not huge numbers by Texas standards, but respectable enough to catch the attention of investors.

Able Energy, a Rockaway, N.J.-based distributor of home heating fuels, has agreed to buy Somerset Oil and related companies for $9 million. Able also agreed to assume debts of $10.5 million, increasing the value of the transaction to $19.5 million.

Somerset Oil, which has 160 employees and has been in business since 1930, is one of the biggest buyers of Appalachian crude, dealing only with small producers within driving distance of the refinery. Last year, Somerset Oil purchased some $40 million worth of crude, primarily from the mountain regions of Kentucky, northern Tennessee and southwestern Virginia.

"For years and years and years, they've suffered," Lynch said of independent producers in central Appalachia. "Now, they're getting their dues. If they keep drilling and keep hitting the way they are, the sky is the limit. I have no idea how far we could go."

That rosy outlook has drillers flocking to central Appalachia hoping to cash in, reopening old oil wells and punching new ones as fast as they can. Convoys of trucks carrying crews to work on wells are common on highways in the region.

Oil was first discovered in Kentucky near Monticello in 1815.

Lynch said the last oil boom in the region began in 1982, when crude rose to $32 a barrel. It was short-lived. By 1984, Lynch said, crude was back down to $13 a barrel and producers who invested heavily went under financially.

Virginia Lazenby, who operates about 600 oil wells in the area around Beattyville, Ky., said crude prices had fluctuated so much in the past decade — at times, as low as $8 a barrel — that producers were afraid to drill new wells in central Appalachia. She said the price had to be at least $18 a barrel for an operator in the mountains to break even.

"Appalachian crude has been down for so long that everybody was simply holding on," she said.

Now, Appalachian producers are flourishing. Statistics from the Kentucky Office of Employment and Training show about 843 people working in the crude, petroleum and natural gas industry in the state with a payroll of $8.5 million in the first quarter of this year. That's up from 736 employees in the first quarter of 2004.

A larger supply of crude will allow Somerset to look at expanding its retail operations. The company currently has 13 Somerset-brand service stations in 11 counties and supplies gasoline and diesel to 33 other stations.

"It lessens dependence on imports and it employs a lot of American workers," Lazenby said.

Lazenby said she doesn't expect crude to stay as high as it is now but still settle at a lofty $40 a barrel. "That, in my opinion, is good enough," she said.

It costs about $150,000 to drill a new well, and so many producers instead reopen old wells abandoned because of low production. That can be done for as little as $5,000 a well.

"Even a well that produces one barrel a day will generate about $20,000 a year," Bill Goodwin, president of the Tennessee Oil and Gas Association, said.