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Thursday
Dec162010

Steve Palmer: Go Long on Oil Equities



Source: Brian Sylvester of The Energy Report  12/16/2010
http://www.theenergyreport.com/cs/user/print/na/8127


Uranium gets just one mention in this article and thats about it, but unfortuneately there are no follow up questions.

AlphaNorth Asset Management President and CEO Steve Palmer believes further economic growth in China and the ongoing economic recovery in the U.S. will send oil prices over $100 a barrel in the first half of 2011. But he picks his oil equities knowing the oil price will play only a small role in determining any share-price appreciation. For him, it's about getting in early on companies with reasonable prospects for massive gains. In this exclusive interview with The Energy Report, Steve shares three of his favorite oily names with outsized potential.

The Energy Report: Briefly tell us about AlphaNorth Asset Management.

Steve Palmer: AlphaNorth Asset Management manages the AlphaNorth Partners Fund, which is a long-biased, small cap-focused hedge fund that just finished its third year in business. In 2010, we launched our first flow-through offering—the AlphaNorth 2010 Flow-Through Limited Partnership.

TER: Are there many flow-through funds like that out there, or are you carving out a niche for yourselves?

SP: We're carving out a bit of a niche for ourselves, in terms of performance. There are dozens of flow-through funds.

TER: How is that fund performing to date?

SP: Extremely well. The net asset value (NAV) per unit was $16.42 at the end of November. The initial NAV was $10. We had two closings—one in March, one in April. We do not pay premiums for the flow-through shares, as flow-through funds usually pay a premium, and we actually averaged a discount. Our lawyers have advised me not to talk about returns because the AlphaNorth 2010 Flow-Through Limited Partnership has not been around for at least a year. I guess people have to figure out the difference between $16.42 and $10 on their own.

TER: You invest mostly in Canadian companies listed on the TSX or the TSX Venture Exchange, both of which witnessed big gains in early December. A week later, however, profit taking was dampening some of that enthusiasm. Do you believe taking profits is the correct approach currently, and are you doing the same?

SP: No, quite the opposite. I've been quite confident that December will be a strong month. In my recent commentaries, I've noted that December is typically the strongest month of the year for Canadian small caps. If you look at the BMO Small Cap Total Return Weighted Index over the last 25 years, on only one occasion was it down in December.

TER: To a certain extent, you believe in market timing and the seasonality of the markets. You firmly believe the markets usually slow down in the summer and pick up again in the winter, at least here in Canada when the registered retirement savings plan (RRSP) cash flows in. Could you comment on that and your approach to timing market seasonality?

SP: I'm definitely aware of seasonality, but that's just one factor I consider when making investment decisions. When May comes around, for example, I'm not going to sell everything in the portfolio and go 100% cash. However, I'll be much more cautious at that point.

TER: Are you buying now?

SP: I've been fully vested since August, so I'm taking profits on some positions. I'm always buying and selling, taking profits on some and reinvesting in others with a better risk/reward balance. I intend to maintain a higher-than-average long position going into the new year.

TER: In a recent research report, you said cash is flowing out of equity mutual funds and into bond funds but you expect the situation to reverse. What's going on there and how is that phenomenon showing up in the market?

SP: Cash has been going out of equity mutual funds consistently for over a year. It's been piling into bond funds. I think investors are still focused on capital preservation as opposed to trying to earn an investment return. Investors are still very cautious. They lost a lot of money in the equity markets in the 2008 meltdown. A lot of people remember it quite vividly and are scared to put money back into equities.

TER: Is that creating some buying opportunities for you?

SP: Yes, it is. Ultimately, as the equity markets continue to do well, those people are going to come back. I'm starting to see that. I don't consider it much of a return when you can invest money and get only about 2%–3% for an entire year. There's a lot of risk in that. If you're a long-term investor, it makes no sense.

TER: I agree; 30-year Canadian bonds are selling at about 3.5% right now. That won't even keep pace with inflation.

SP: If inflation goes up, there will be a huge loss on those. Not a lot of people realize that you can lose money on a bond.

TER: You said investor reluctance is presenting some buying opportunities. Where are you finding value right now?

SP: Well, there's no particular trend. Recently, I've been focused on oil and uranium.

TER: About half of your equity positions are in resource-based companies. You said the other half is in technology and similar plays. How much of that 50% is in gold, oil and gas (O&G) and base metals?

SP: Due to some pretty strong performers in the resource space, that weighting is closer to two-thirds resources now. I will be reducing that over the coming months; but of those two-thirds, about 40% would be in energy, 20% base metals, 20% precious metals and 20% rare earth elements (REEs).

TER: You've said you're short on COMEX Gold. Are you long on oil?

SP: I'm long on a lot of junior oil equities but not on the commodity itself.

TER: Where do you see the oil price as long as five years out? Are we getting over $100?

SP: I think so; I think it will be over $100 in the first half of next year.

TER: What do you base that on?

SP: Continued strength in the markets and the economy and the fact that most forecasts are much lower.

TER: Do you believe now is a good time to buy junior oil companies?

SP: I believe so, but I like to buy companies that are not dependent on the oil price. I like to buy companies with attractive odds for discovering something big. I try to take the commodity aspect out of it because the hardest part is to predict where commodity prices will go. I focus more on the company's specific prospects, but it's always good to have the commodity working in your favor.

TER: Where are you with gas? Are you buying small O&G companies because they may be undervalued right now?

SP: No, I haven't yet. The key there is timing. At this point, what will turn the gas price around in a meaningful way is not apparent. Buying small-cap natural gas companies hasn't been a focus; but, at some point, opportunity will be there.

TER: Tell us about some O&G companies that have performed well for your fund.

SP: One company that has performed very well for us is Primary Petroleum (TSX.V:PIE)—a land play that's developing in Montana. We bought it at $0.08 and it's trading at around $0.84 now. One of the most attractive formations that companies are going after now is the Bakken. And the Bakken has been identified in Alberta. The theory is that it extends south into Montana.

Over the last several months, large companies have done a lot more work in that area and seem to be having some success in proving that theory. Primary was very early to assemble a large position there in Montana. Companies like Rosetta Resources Inc. (NASDAQ:ROSE) and Newfield Exploration Company (NYSE:NFX) have acquired significant land positions in Montana not far north of Primary's land. They've been drilling wells and one of the wells is in production now. They're in the process of acquiring more land, so the evidence continues to build that Primary's land could be very valuable.

TER: Primary has not yet tested its land but neighboring land is coming on at high production levels. Is that correct?

SP: We don't yet know the production capabilities. What neighboring companies are achieving has all been very secretive up to this point; but actions are telling the story. They're acquiring more land and expanding their drill programs. They wouldn't be doing that if they weren't getting good results from the initial wells.

TER: Has that theory led you to increase your position in Primary?

SP: Initially, I bought in at $0.08 in a private placement. It wasn't as much as I would have liked, so I began buying it aggressively in the market at $0.10–$0.15. I bought stock all the way up to $0.60.

TER: And you're just holding it now. I guess that means you believe there could still be some appreciation ahead.

SP: Yes. If it's proven that the Bakken extends onto Primary's property, the company is worth several dollars a share. That's the minimum.

TER: Steve, what are some other oil and gas companies that excite you?

SP: Canadian Overseas Petroleum Ltd. (TSX.V:XOP). I'm excited about that one; it's one we purchased in a recent private placement.

TER: Tell us about the company's projects.

SP: Canadian Overseas raised $130 million when it was valued at only $12 million, pre-financing. Its projects are all in the North Sea, where companies have been operating for decades. So, it's all a very well-known process—no different from western Canada, really. XOP will begin drilling those projects in March. The management team has a good track record of finding oil in the area; it has drilled five exploration wells before, four of which were successful. The P50 number for recoverable oil on its prospects is more than 100 million barrels (Mbbls.).

TER: Please explain to our readers what P50 means.

SP: The 'P' stands for probable and '50' represents the odds percentage. So, for Canadian Overseas, it means there is a 50% probability that 100 Mbbls. are there. If the company were to find 100 million barrels, it would be worth more than $1 billion. Right now, it has a market value of roughly $180M.

TER: What are the risks?

SP: XOP could be unsuccessful in its drill programs and/or the oil price could decline making its projects less economic.

TER: Are there any other oil plays you like?

SP: There's Simba Energy Inc. (TSX.V:SMB), which is a very early stage company that's assembled some land that's highly prospective for oil on Africa's west coast. Oil seeps all over the land, indicating that oil is there somewhere. A couple of major oil companies are drilling very nearby offshore.

TER: What's Simba trading at right now?

SP: It's trading at $0.08 a share; I got in at roughly the same level. Currently, the market cap is around $7 million.

TER: What will be the next catalyst there?

SP: The company is working to attain a production-sharing agreement from the government to drill on its property. That should come sooner than later but it's very hard to predict with African governments, particularly those where Simba is operating—Mali, Liberia and Ghana. It may get done, but it may never come—that's why it's a $7 million company.

TER: You must like either the thesis or the management?

SP: The thesis makes sense. Another company with a similar business plan is Centric Energy Corp. (TSX.V:CTE), which was pursuing oil in Africa also. Africa Oil Corp. (TSX.V:AOI) offered to buy Centric for $60 million on November 29.

TER: Do you have some parting thoughts on the O&G sector currently? What investors can expect over the next five or six months?

SP: Well, my market call on oil is that it will trend higher over the next five to six months. Gas is much more uncertain, so I don't particularly have a view on gas at this time. But the risk to the oil price is Asian growth rates.

TER: And to a certain extent a continued recovery in the U.S.

SP: A continued recovery, yes; but obviously it's going to be a slow recovery.

TER: How do you recommend people play oil and gas?

SP: Find good companies and get in at good valuations or through our fund. A lot of people don't have time or the expertise to identify the best prospects in the energy space.

TER: But the minimum investment in your fund is $150,000, right?

SP: I can waive that amount, and I have been accepting lesser amounts.

TER: Thank you for talking with us today, Steve.

SP: You're welcome.

Steven Palmer, with 15 years of experience in the investment industry, has been the president, CEO and a director of AlphaNorth Asset Management (AlphaNorth) since founding the firm in the fall of 2007. The company currently manages a long-biased, small-cap hedge fund. Prior to founding AlphaNorth, Mr. Palmer was employed at one of the world's largest financial institutions as VP of Canadian equities, where he managed assets of approximately $350 million. He managed a small-cap pooled fund from its inception in August 1998 to August 2007, achieving returns that Morningstar Canada ranked #1 in performance (35.8% over nine years versus 10.0% for S&P/TSX Composite Index and 13.0% for the BMO Weighted Small Cap Total Return Index) over the same period. Mr. Palmer also managed a large-cap fund that ranked in the first quartile of performance for years 1–5 and 10 at the time of his departure in August 2007. Prior to this, he worked as a portfolio manager at a high net-worth investment boutique. Starting his career as a research associate in January 1995, Mr. Palmer quickly progressed to research analyst. He has a BA in economics from the University of Western Ontario and is a CFA.

Want to read more exclusive Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.

DISCLOSURE:
1) Brian Sylvester of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following company mentioned in the interview is a sponsor of The Energy Report: Primary Petroleum.
3) Steve Palmer: From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.
Streetwise - The Energy Report is Copyright © 2010 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part.
The Energy Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report.
From time to time, Streetwise Reports LLC and its  directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.
Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported.
Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734.
Participating companies provide the logos used in The Energy Report. These logos are trademarks and are the property of the individual companies.
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Over in the options trading pit, we now have 59 winners out of 61 trades, or a 96.72% success rate.


sk chart 10 Dec 2010.JPG


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Tuesday
Dec142010

Kirk Wilson: The Alberta Bakken Trend

Source: Brian Sylvester of The Energy Report  12/14/2010
http://www.theenergyreport.com/cs/user/print/na/8102

kirk-wilson.JPG

The run on land in the expanding Alberta Bakken Formation play has given a leg up to the exploration and production (E&P) companies that got in early. In this exclusive interview with The Energy Report, Senior Analyst Kirk Wilson of Calgary-based Clarus Securities details the best and the brightest prospects seeking light oil in the western Bakken.

The Energy Report: Kirk, please tell us what you typically cover in the oil and gas (O&G) sector.

Kirk Wilson: I focus on high-growth, undervalued junior and intermediate O&G names—domestically and internationally. The majority of the companies I follow are based in Canada, but all companies that I follow are listed in Canada. They typically have a market cap range from $25 million to $2 billion.

TER: What issues or trends are driving Canadian E&P companies?

KW: There are a couple of trends and issues that investors need to be wary of when looking at Canadian names. One is the ability to secure land on a reasonable basis. Junior and intermediate companies need to get into plays early to get a large enough land position before prices increase dramatically. We've seen it happen in all the main oil resource plays; if a company is not in early with a low-cost basis on land acquisitions, it gets more difficult to be able to put together a meaningful land position.

The economics are another issue. With about 75% of the Western Canadian Sedimentary Basin being natural gas-charged, finding oil plays that deliver much higher netbacks is getting more difficult. There just aren't as many of them out there. Most juniors have been weighted towards natural gas. However, with the challenge in gas prices, it makes growth very difficult for companies that are focused on that commodity because companies don't have the cash flow to reinvest. The economics of plays are very important as well, as investors must recognize the capital that is required to participate in some of these oil-resource plays.

TER: One trend that has been under the radar until recently is the light oil play in the Alberta Basin Bakken that extends from Montana into Alberta and Saskatchewan. What's going on there?

KW: The industry is trying to find new places to exploit large oil resources. The Bakken in Saskatchewan, and even into North Dakota, has existed for decades, but it was not economically producible. Horizontal drilling, multi-frack applications and higher oil prices have made the Bakken a very economic play.

Companies have applied that technology to other known resources, such as the Cardium play at Pembina, the Viking Formation, and the Shaunavon formation in southwest Saskatchewan. Using that technology, the industry is trying to find new exploration plays. The Alberta Bakken, which stretches from Alberta into Montana, is one of these new exploration plays. I categorize it as exploration because there's been a minimal amount of drilling, so a minimal amount of data. It's still very early days.

There are a lot of analogies and similarities between the Alberta Bakken and the Williston Basin that allow companies to put it on their radar screen. It's about 4,500 to 6,000 feet deep in Alberta and into Montana. It's light oil believed to be 35 to 42 degree American Petroleum Institute (API).

The Alberta Bakken is a good term but it can involve other formations like the Exshaw, Three Forks and Torquay. It may not be precisely in the Bakken, but it's in the same geologic age. Oil prices are now pretty consistently above $65; so, with proven technology and the ability to gain a meaningful land position, companies are now exploring and making this a new play that hasn't really been talked about in the past.

TER: Tell us a little bit more about the drilling economics of heavy oil versus light oil.

KW: A key consideration when comparing heavy oil and light oil is the viscosity. Light oil flows more easily than heavy oil, which means production rates are generally higher. That obviously helps the economics because there is a larger percentage of oil produced early in the life cycle of the well.

Then there are the light oil/heavy oil differentials. A company will receive—and this is a moving figure based on many variables—$10 to $15 per barrel less for heavy oil than for light oil.

Investors should also consider royalty rates. In Saskatchewan and Alberta, there are advantageous royalty rates compared to south of the U.S. border. That advantage comes from royalty incentives and royalty holidays. For instance, companies operating in the Blackfeet Nation in Montana pay ~30% royalties across the board. In Saskatchewan, the first 37,500 barrels incur 2.5% royalties if they're drilled on Crown land. In Alberta, 5% royalties are paid for 50,000 to 60,000 barrels of initial production.

TER: That's a remarkable difference.

KW: It really can be huge. Drilling and completion costs to get a well on-stream in the Viewfield area of Saskatchewan, where it's a little shallower, could be $1.7 million. The deeper plays down in North Dakota could be as high as $6.5 million per well. Alberta and Montana generally cost around $4 million per well.

The amount of developed infrastructure in those regions also plays into the economics of a play. The more developed infrastructure, as in Saskatchewan, the lower the full-cycle costs. Some areas have no infrastructure at all.

TER: The cost of doing business is lower in Saskatchewan and Alberta than North Dakota and Montana?

KW: Yes, but one must consider that production rates in North Dakota are sometimes multiples of those in Saskatchewan. While the costs are higher, the overall net-present values can also be higher in North Dakota depending on how much oil is going to be recovered and how quickly it is going to be recovered.

There are offsetting measures, but I would say Saskatchewan is probably the most developed, with North Dakota pretty close behind.

TER: What are some companies with exposure to the Bakken in Montana, Alberta and Saskatchewan?

KW: In North Dakota, there is Arsenal Energy Inc. (TSX:AEI), NuLoch Resources Inc. (TSX.V:NLR) and TriOil Resources Ltd. (TSX.V:TOL).

In Montana, there is Primary Petroleum (TSX.V:PIE), Rosetta Resources Inc. (NASDAQ:ROSE), Newfield Exploration Company (NYSE:NFX) and Anschutz Exploration Corp.

In Alberta, companies targeting the Alberta Basin Bakken include Crescent Point Energy Corp. (TSX:CPG), which has perhaps the largest land position. There is also Murphy Oil Corp. (NYSE:MUR), Royal Dutch Shell Plc (NYSE:RDS.A) and PetroBakken Energy Ltd. (TSX:PBN). On the smaller side, DeeThree Exploration Ltd. (TSX.V:DTX), Bowood Energy Inc. (TSX:BWD) and Argosy Energy Inc. (TSX:GSY) are three juniors that are playing that space.

TER: That's quite a list.

KW: In Saskatchewan, that list can be longer. Crescent Point and Petrobakken are the two big dogs there. In addition, there's Legacy Oil & Gas Inc. (TSX:LEG); Spartan Exploration Ltd. (TSX:SPE) has a big land position for its size; and Painted Pony Petroleum Ltd. (TSX.V:PPY.A) is active in the area. Then there are the trusts: ARC Energy Trust (TSX:AET.UN), NAL Oil & Gas Trust (TSX:NAE) and Advantage Oil and Gas Ltd. (NYSE:AAV; TSX:AAV).

TER: Could you delve a little deeper into some of those companies?

KW: Primary Petroleum has 190,000 net acres in Montana on two land blocks. Its western Montana land position is 170,000 acres and eastern Montana is 20,000 acres. And the company is still adding land. The company certainly has a very interesting and highly appealing land base perspective for those formations.

Right now, investors are watching offsetting activity by some larger companies. Just north of Primary, on the Blackfeet Nation, wells are being drilled by Rosetta, Newfield and Anschutz. Rosetta has drilled a number of wells already, and plans to get to eight wells this year. Obviously, drilling will continue into the New Year. Newfield also planned for an eight-well program this year. At least one of those wells is horizontal and is producing right now, which is a very interesting data point.

Data is being very closely held, but we do have verbal confirmation from Rosetta that the formation is over-pressured and oil-saturated. The company estimates that there are 13–15 million barrels of oil in place per section. To put that into context, in the Viewfield area of Saskatchewan, which is shallower and not as highly pressured, there are generally 4–5 million barrels of oil in place per section. So, the Alberta Bakken could contain up to triple the amount of oil in place. The key will be recovery and production rates. However, we've seen a lot of encouraging data so far.

Alberta is a little farther away from Primary Petroleum's lands, but some drilling has taken place and there are a couple of wells producing just across the border.

Primary's stock was recently trading in the $0.65 range. A risk evaluation of their resource indicates a $5 potential value. We don't have a lot of hard data and there are a lot of assumptions being made in that analysis, but if the play turns out to be analogous to the Saskatchewan play, there is a case to be made for at least $5 per share potential value for Primary.

TER: Acquiring land can be an issue. Primary's management must have gotten in on this pretty early to purchase 170,000 continuous acres in western Montana.

KW: It's a large land position, which is a notable achievement for Primary as it can be very difficult to put together this size of land base—it can take several years sometimes.

TER: What are some other companies?

KW: North of the border, DeeThree Exploration signed a joint venture with Encana Corporation (TSX:ECA; NYSE:ECA) for shallow gas several years ago. By good fortune they have a land base in southern Alberta, east of Lethbridge. DeeThree estimates at least 100 of its sections will be prospective for the Alberta Basin Bakken. In fact, any day now, the company is going to start drilling its first Bakken well. It's planning to drill two this year and follow up with at least four in the first quarter of next year. The company is in very close proximity to a couple of wells that have been drilled by other industry participants, such as Crescent Point. DeeThree has potential value of $2.90 per share if only one of every 10 sections are prospective for Alberta Basin Bakken. If they have 100 sections that are prospective, it could be nearly $30 per share of potential value for the company. That is a large upside for DeeThree. It needs to prove the play exists on its land, as does every company that's associated with the Alberta Basin Bakken.

TER: They need to create some faith. Some companies are shifting from gas to oil exploration. Where are they finding exploration success?

KW: The names that we follow are not necessarily shifting. Those companies had a predetermined goal to be involved in oil resource plays.

However, where some of the shifting is occurring is into the halo of the Pembina Cardium Formation where many junior companies are active. Names that we cover in that area include Daylight Energy Ltd. (TSX:DAY), Crew Energy Inc. (TSX:CR), Spartan Exploration and TriOil Resources.

To a certain extent, this is also occurring in the Bakken outside of Viewfield in southeast Saskatchewan. The companies we follow there are Spartan Exploration, TriOil Resources and Arsenal and NuLoch Resources down south in North Dakota. There are some companies that are chasing the Pekisko Formation, but it's not as widespread. Crew Energy in southern Alberta and Second Wave Petroleum Inc. (TSX.V:SCS) at Judy Creek are notable names.

Novus Energy Inc. (TSX.V:NVS) is a name we follow that's playing the Viking Formation in Saskatchewan.

TER: Novus is drilling in the Viking and the wells are coming on pretty strong?

KW: The company has drilled and has production history on at least 16 horizontal wells. There is a good statistical history of what to expect from a Viking well, between Novus and other industry players like Penn West Energy Trust (NYSE:PWE). Penn West is the big dog in the Viking play.

That information allows investors to take a fairly confident statistical view of what a company is going to get in the Viking. To be successful, to grow and to show value, a company needs a fairly large land base. Novus has definitely been a consolidator of land. The company has taken its land base from around 20 sections to 105 sections in just the last year. The play is also developed to the point that well intensity is going to be higher than it was before. This is recognized by Sproule Associates, which is the main reserve evaluator in the area. Companies previously believed that they needed three or four wells per section, but now it's understood that they need at least eight wells per section.

On that basis, Novus has an inventory of 560 drilling locations. That could grow if a higher number of wells are required. This statistic provides a lot of clarity about where production can go for this company. In the summer, Novus was producing around 700 barrels of oil equivalent (BOE) a day. It's now over 1,400 BOE a day. The company has doubled production and is on its way to 2,000 BOE a day by the end of this year.

TER: That is still a pretty small number.

KW: Pretty small, but growing. For the most part they are delivering on the growth that they forecast. Novus has done a very good job of building its land base, and is now getting some good well results.

TER: Continued well results are the catalyst for further growth?

KW: Yes, and delivering on consistent production, which comes from being able to meet expected results on a statistical basis.

TER: Let's dig deeper into some other companies that you like.

KW: Spartan Exploration is a junior that is showing a lot of growth this year. It was at about 400 BOE a day in the beginning of the year. Now it's up to about 1,800 BOE a day. The company's guidance indicates that it will be at 3,000 BOE a day by the end of next year. Spartan is focused on Cardium oil in the near term and has had very good drilling results there so far. This area will be the main driver of achieving 3,000 BOE a day.

However, it's the Bakken that may be the real upside catalyst for Spartan. It has 68 net sections in southeast Saskatchewan. The company has done minimal drilling on that land at this point. It is letting others de-risk its lands by drilling nearby or right offsetting. If it's proven that the Bakken Formation exists in an economically recoverable way, then Spartan has a very large land base relative to its size in southeast Saskatchewan. The potential from that area, which can be more than $8 per share on a risked basis, is getting very little consideration, if any, in their current share price.

TER: What about Second Wave's land base?

KW: Second Wave has a large land base at Judy Creek in northwest Alberta, where it is chasing the Pekisko Formation. It has 144 perspective sections of land, or a well inventory of 600 or more. The company has identified about 1.3 billion barrels of original oil in place on its lands. Second Wave is pretty much the only company playing the Pekisko at Judy Creek, which means the company doesn't have the same advantage as other companies by having competitors drilling wells and furthering technology. Second Wave is doing it pretty much on its own. Even so, the company has taken production up to 2,000 BOE a day from around 1,200 to 1,400 BOE a day earlier this year. It should be 2,800 BOE a day by the end of this year. That's 50% growth rate since the summer. There will be a lot more confidence once investors become comfortable that the company can get consistent production and recovery rates from these wells. The risk parameters associated with Second Wave will lessen, and the share price should respond.

TER: We've discussed some Canadian and U.S. projects. What are some interesting plays outside those borders?

KW: Gran Tierra Energy Inc. (NYSE:GTE; TSX:GTE) is a very interesting one. It's a relatively low-risk stock. It will basically have a flat production profile from their Costayaco Field in Colombia for the next two years. That should give it a lot of cash flow. Judging by current oil prices, Gran Tierra could be looking at cash flow in the range of $450 million. It also has about $200 million of working capital. That's a lot of capital to deploy, and the company recently started ramping up its exploration. It has had some success at Moqueta and is more actively exploring in southern Colombia. This month, Gran Tierra will drill its first exploration well in Peru. That's more high-risk, high-impact exploration. However, the company is targeting a play that could be as large as 1 billion barrels. It's got a lot of interesting exploration potential from those plays.

Another interesting play is in Namibia.

TER: West Africa is known mainly for their diamonds.

KW: True. Namibia is really not known at all for oil. What's very interesting is that Brazil and Africa have a historical relationship. UNX Energy Corp. (TSX.V:UNX) is very closely associated with the Brazilian company HRT (BM&FBOVESPA: HRT), which is an expert on the South Atlantic Margins. The company can show a lot of similarities to offshore Brazil, which has a number of multi-billion barrel discoveries.

TER: Like the Tupi oil field.

KW: HRT believes the west coast of Africa has similar geology to the east coast of Brazil. UNX has eight blocks of interest around a previous discovery called Kudu. On just one of those blocks, the company has a resource estimate of 2.3 billion recoverable barrels.

There are several catalysts for UNX. It is that it's getting ready to shoot a 3D seismic survey in the first quarter of next year. Also, the company hopes to get additional resource estimates on some of its other blocks, and sign up a joint venture partner to come in and drill. UNX wants to be carried for the drilling costs as offshore drilling is very expensive.

There are very few places in the world where you can find the potential for multi-billion barrel oil discoveries. There's a shorter list still of countries that have stable, democratic governments. This is one of those opportunities.

TER: Right.

KW: Epsilon Energy Ltd. (TSX:EPS) is another company that I want to discuss. It's focused in the Marcellus play in Pennsylvania with joint venture partners Chesapeake Energy Corp. (NYSE:CHK) and Statoil ASA (NYSE:STO; OSE:STL). Epsilon is being carried for the first $190 million of capital costs on the Marcellus play. Production from the joint venture should go from very little up to between 30–45 million cubic feet per day by the end of next year, and it could go higher. It's difficult to say at this point as well results in the area keep getting better.

Epsilon's lands are in Susquehanna County, Pennsylvania. Many publications say that this is the best, or one of the two best, counties for the Marcellus play. Cabot Oil & Gas Corp. (NYSE:COG) drilled three wells there and was producing in excess of 47 million cubic feet per day.

Epsilon is really a no-capital-risk play, counting on the expertise of two of the biggest and most technically advanced companies out there being able to deliver results in the Marcellus. Epsilon is very undervalued, in my opinion.

TER: Well, it is gas.

KW: It is gas, but on an economic basis, the Marcellus is perhaps one of the top two natural gas plays in North America.

TER: Do you have some parting thoughts for us?

KW: Investors need to be stock pickers. Oil is a stable commodity, but nothing's perfect and certain in this world. I would not necessarily look for a rising tide across the board from rising commodity prices. So, it's important that investors be stock pickers.

TER: Thanks, Kirk.

Kirk Wilson, CFA, is managing director and oil and gas analyst at Clarus Securities. He has over 14 years of equity research experience at Canadian investment banks, and over nine years of oil and gas industry experience with both domestic and international operations. Kirk has a B.Comm. from the University of Calgary.

Want to read more exclusive Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.

DISCLOSURE:
1) Brian Sylvester of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Novus, Primary and Royal Dutch.
3) Kirk Wilson: ): I personally and/or my family own shares of the following companies mentioned in this interview: Spartan Exploration. I personally and/or my family am paid by the following companies mentioned in this interview: None.
Streetwise - The Energy Report is Copyright © 2010 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part.
The Energy Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report.
From time to time, Streetwise Reports LLC and its  directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.
Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported.
Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734.
Participating companies provide the logos used in The Energy Report. These logos are trademarks and are the property of the individual companies.
Streetwise Reports LLC
P.O. Box 1099
Kenwood, CA 95452
Tel.: (707) 282-5593
Fax: (707) 282-5592
Email: jmallin@streetwisereports.com

......................................................................................

On www.silver-prices.net we have started an Accumulator, which is just for fun, so you may want to check in from time to time to have a chuckle as we wrestle with it.



Over in the options trading pit, we had a number of stops triggered , but we walked away with an average gain of 32.7% so we now have 59 winners out of 61 trades, or a 96.72% success rate.


sk chart 10 Dec 2010.JPG


The above progress chart is being updated constantly. However, to see exactly how it is going, please click this link.

So, the question is: Are you going to make the decision to join us today, before we decide to cap membership.


Stay on your toes and have a good one.

Got a comment then please add it to this article, all opinions are welcome and very much appreciated by both our readership and the team here.



To stay updated on our market commentary, which gold stocks we are buying and why, please subscribe to The Gold Prices Newsletter, completely FREE of charge. Simply click here and enter your email address. (Winners of the GoldDrivers Stock Picking Competition 2007)

For those readers who are also interested in the silver bull market that is currently unfolding, you may want to subscribe to our Free Silver Prices Newsletter.

For those readers who are also interested in the nuclear power sector you may want to subscribe to our Free Uranium Stocks Newsletter, just click here.
Monday
Dec132010

Best Wishes for Christmas and the New Year

Chritmas Uranium 14 Dec 2010.JPG

Team,

We Wish you all a Sparkling Christmas and a Golden New Year. Have a really good break and come back full of beans and ready for action as 2011 will be volatile and hopefully exciting in the uranium stocks sector.

We are spending the week before Christmas and Christmas at a lakeside retreat, where along with a few friends we will have all of the team under one roof, which is not easy to do these days. We wont be doing any blogging over that period, but we are allowing one whole lap top to accompany us and we will keep an eye on things just in case.

We haven’t forgotten about The Accumulator and we may just make a move tomorrow, if you do decide to follow us in, then please only use a tiny, tiny amount of your funds as this is meant to be a 'fun' thing, thanks.

Merry Christmas and a Happy New Year to you all.
Monday
Dec132010

Not Many Shopping Days Left

You can make this purchase without even leaving your seat, its different, valuable, inexpensive and could prove to be beneficial to them for years to come.

Subscribe for 6 months - $499

 

Subscribe for 12 months - $799

 

Thursday
Dec092010

Identifying Top Seeds in the Potash Boom


Source: Karen Roche and Brian Sylvester of The Energy Report  12/09/2010
http://www.theenergyreport.com/cs/user/print/na/8074

As growing middle classes in developing nations feed the need for fertilizer, how to increase production has become the real issue in agriculture. Major potash producers are lining up to fill that need. The Energy Report spoke with Adrian Day Asset Management Chairman and CEO Adrian Day and Wellington West Capital Markets Analyst Rob Winslow to get their take on the potash sector, and which companies have the sustainable competitive edge.

The Energy Report: Adrian, in our last interview with you, while discussing the sustained commodity boom that you foresee, you said you were talking about the whole shebang—from precious and base metals to uranium, oil and gas to geothermal. You also included agriculture, noting that you expect agricultural assets to be among the best-performing assets over the next decade. Would you expand on that thought for us?

Adrian Day: Absolutely. As you may recall, we also talked about how China has been driving the resource market and will continue to drive it for the next decade. Even if China's economic growth slows from 9.5%–5%, the demand for resources will still be very dramatic—much higher than now. As China becomes more industrialized, increasingly more people in its massive population will move up into the middle classes.

Middle class people want houses with electricity, running water and indoor plumbing. They want to have cars, as well as bicycles, which takes copper, aluminum, platinum, rubber, oil, etc. And as more Chinese go from eating the chickens and goats they raise in rural China to an urban environment, they lose their taste for goat meat and want beef instead. Cows consume more wheat than do goats. That's just an example. The point is, the basic factors driving all the resources are also driving agriculture.

TER: As Wellington West Capital Markets' agricultural expert, Rob, what underpins this rush toward potash companies, including the failed BHP Billiton Ltd. (NYSE:BHP; OTCPK:BHPLF) bid for PotashCorp (NYSE:POT; TSX:POT), the upcoming transaction between K+S Aktiengesellschaft (Fkft:SDF) and Potash One Inc. (TSX:KCL)?

Robert Winslow: Whether you're looking at fertilizers or farm equipment, really what underpins all the agricultural (ag) cycle is the grain complex. If you were to pull up a chart of the corn, wheat and soybean prices, for example, you'd see that grain prices bottomed out in early June, down to around the cost of production in the U.S. Corn Belt. They started rallying from there, spurred a little by dollar weakness but also by the supply/demand situation globally. We're in the neighborhood of 50%–55% above those June lows.

TER: Has the hike been more a function of growing demand or supply shortages?

RW: We had some supply shocks, particularly on the wheat side. In western Canada, it was very wet; in Russia, it was very hot and dry. As a result, two of the world's three-largest wheat exporters saw their production cut by about 20%. That showed us how tight the stocks-to-use ratio became globally, which is the metric we use—it measures supply/demand for any given commodity.

TER: Could you elaborate on what that stocks-to-use measurement tells us?

RW: It tells us supply/demand levels are down to those last seen in 2007 and early 2008 when the grain complex rallied, as well. The bottom line is we get to a situation where we have insufficient inventory to protect us from supply shocks. That will drive up grain prices. As grain prices go, farm income goes. As farm income goes, so go expenditures on seed, fertilizer, chemicals, tractors, short-line equipment, you name it. The entire complex rides on the back of those grain prices.

TER: That would bode well for a company you told us about the last time we talked, Adrian. You described it as one of your favorites in the general resource area.

AD: Yes, Sprott Resource Corp. (TSX:SCP). If you buy Sprott, which is quite a liquid company, you get it at a discount to NAV. Net asset is about $5.20. The stock's been trading at about $4.65. You also get great management—Kevin Bambrough and company—and a great balance sheet. As you know, Sprott has direct and indirect investments in different resource areas—buying whole companies, sponsoring companies or growing them. When the companies reach a certain level, ideally it'll spin off a certain amount of the shareholding into a public company.

TER: You said it's currently in gold, oil and gas, agriculture and fertilizer. Tell us about the last two on that list.

AD: The agriculture play is very interesting, a joint venture (JV) with First Nations—One Earth Farms Corp. First Nations owns more than a million acres of farmland. It'll be a big business, one of the largest commercial farms in North America—really quite staggering. It's still a private company, but it's selling some shares in a secondary offering, raising $40M–$80M. If it brings in the maximum, it will take Sprott's stake down to 24%. In a year or two, it'll IPO. That's what it's trying to do—take a direct investment, build up the company and IPO it.

TER: News has been coming in pretty fast and furious on the potash front; and, Rob, you recently raised your targets on several potash juniors. Without discounting the demand factor, what can you tell us about the rationale behind that decision?

RW: The impetus for that was the bid by K+S for Potash One. On the back of that, we also raised the targets on Allana Potash (TSX.V:AAA), Intercontinental Potash Corp. (TSX.V:ICP) and Western Potash Corp. (TSX.V:WPX), as there's a scarcity factor that needed to be embedded in the valuations of those companies. We're seeing consolidation in the space, with the big players coming and buying up the juniors. When that happens, obviously, the value of those left standing—presuming they're still quality assets—tends to go up.

TER: How did your targets on these three companies change?

RW: We raised Allana's target $0.15 to $1.15 (and have since raised it again to $1.20) and we rate it as a strong buy. Intercontinental is $1.50/share and Western Potash is $1.05. Among the three, I have a more favorable view on Allana and Intercontinental than on Western Potash because the former two are advantaged juniors.

TER: What do you mean by "advantaged" juniors?

RW: They have some edge, a sustainable competitive advantage that makes them stand out from the crowd. For example, Allana's potash concessions are in Ethiopia's Danakil Depression.

TER: What makes that special?

RW: The potash deposit there may be as shallow as 150 meters or so, which suggests the possibility of an open-pit operation. That would cost less than sinking a shaft in Saskatchewan, where the company would likely have to go down to a depth of 1 km. That's more than $1 billion just to get the shaft down. Parts of the Danakil Depression potash deposit appear to be 600–700 meters, so solution mining would be possible there also.

TER: Some of our readers may know, Saskatchewan supplies one-third of the world's potash demand. But, apparently, Ethiopia has one of the world's largest potash deposits—up to 150 million tons (Mt.) concentrated in the Dallol area.

RW: That area, in the Danakil Depression, has enormous potash potential. Water has been running down from the surrounding mountains for millennia, carrying minerals to this low-lying basin. Over time with heat and evaporation, it has produced this giant dish of salt. When you go far enough down into the layers, you reach salt containing a tremendous amount of potassium—that's the potash. I've never seen anything quite like it; it's remarkably hot and salty.

The Danakil Depression is among the hottest places on earth. I was there not long ago, and it was 114°F in the shade. The idea with solution mining is to inject a heated solution (or water) down into the salt bed, dissolve the salt, bring it up to surface, and then use wind or solar to evaporate it. At the surface, you can heat up your water quickly with solar panels. Considering all of that, operating costs are potentially materially lower than in a solution mine—or any other kind of mine—in Saskatchewan.

TER: That would clearly be a competitive advantage. Compared to conventional mining, solution mining means not only lower capex requirements but also operation scalability and a quicker timeline to production—not to mention less technical risk and environmental impact.

RW: There's even more to the Allana story. It's quite a bit closer to one of the largest importing nations in the world. Depending on the year, India ranks as the second- or third-largest potash importer in the world. If Allana gets this mine built and the proper infrastructure in Ethiopia to get it over to the coast, transport alone could be $20 or even up to $40 cheaper per ton. So, once the infrastructure is in place, the cost of those logistics on a run-rate basis would be significantly lower than they would be in western Canada. That's another reason we like Allana. It's also lower on a price-to-NAV valuation on our comp table.

TER: As a Canadian-domiciled company, one might expect to see French and English banners on Allana's website but it has English and Chinese banners.

RW: Of course, China is interested in potash all over the world, but a Chinese investor has put in a modest amount of capital and bought some equity in Allana, about $2 million. The company's also negotiating with this investor to put up something like 35% of the capex to help finance the project. In turn, Allana has committed to give this partner discount-to-market prices on potash until it gets its capital back. The terms have yet to be finalized, but it's an interesting way to finance the project. The day the Chinese actually put up $300M will be the day we're excited. Right now, it's not concrete; it's just in negotiations. Even so, a lot of things separate Allana from some of the others.

TER: It sounds as if there's minimal jurisdiction risk in Ethiopia.

RW: Ethiopia is not Canada. Having said that, it's interesting; it's almost paradoxical. Africa welcomes the Chinese with open arms. They're the largest investors in Africa. They promise infrastructure. They'll create jobs. They want to stimulate the economy. There's a lot of collaboration between the African nations and China. I met with some government officials when I was there, and the government's conviction is pretty strong. It wants to produce potash—the goal is to produce 2 Mt. annually by 2015. It's racing toward potash production and is more focused than anybody else out there. The government's going to spend money on infrastructure. It's talking about an $8 billion rail system that, obviously, would facilitate getting potash to the coast for export. China probably will be constructing most of that railway.

TER: Wherein lies the paradox?

RW: You don't see the Chinese doing a heck of a lot in Canada's potash space, and I think that's primarily because they don't want to get egg on their face. Think of what we saw with BHP in its bid for PotashCorp. I suspect the Chinese view Canadians as slightly protectionist when it comes to some of these strategic resources.

TER: Right. You weren't too hot on the BHP takeover attempt, anyway. In August, The Globe and Mail quoted you as saying that a successful takeover by BHP would "complicate the situation for Canadian junior potash companies in a number of ways, making access to capital somewhat more challenging for them." Further to your comment about that protectionist sentiment, PotashCorp, after all, is the world's largest fertilizer company by capacity, producing all three primary crop nutrients—phosphate, nitrogen and potash. As the world's leading potash producer, it accounts for about 20% of global capacity—a national treasure.

RW: Yes, and frankly I think China would find it more difficult to get something done in Canada than it would in Ethiopia. As I said, Ethiopia's government is looking for investment with open arms. That's the paradox.

TER: China's investment will do a lot for Ethiopia's GDP, too—2 Mt. at $500/ton. What's the story with Intercontinental?

RW: It's early days yet, but it's looking at producing a specialty fertilizer called potassium sulphate (SOP) by extracting potassium (K) from polyhalite. It has to mine the stuff—polyhalite's an unusual mineral, but it has a lot of K in it—and bring it up to surface. But if it all pans out, Intercontinental could be among the world's lowest-cost SOP producers.

Most SOP producers use the Mannheim process, mixing potassium chloride (KCl), or regular potash, with sulfuric acid in a big furnace. Some fancy chemistry goes on when it heats up, and SOP comes out the other end along with some byproducts. The SOP cost will fluctuate with the price of potash, but it can be costly.

In contrast, the conversion process that Intercontinental Potash proposes would use the polyhalite the company mines as its input instead of KCl. Suppose the polyhalite costs $60–$70/ton to mine and conversion takes it to $180–$200/ton to produce SOP. If you're using the Mannheim process to produce SOP, you're buying KCl at approximately $400/ton in the marketplace, which already puts you at a disadvantage compared to a competitor who can use a much-cheaper raw material input. That's a really interesting project, and one of the lowest-cost producers in the world delivering a high-margin potash product makes for a really compelling story.

TER: Is potash garnering about $500/ton now?

RW: It depends on where it's being sold. In Brazil, I believe it's a little bit over $500. In parts of the Midwest, in the Corn Belt, it's approaching $500. In Vancouver, I believe it's $400. So it depends. Wherever you are in the world, there's a slightly different price because you have to factor in the transportation cost.

TER: Getting back to your advantaged companies, why isn't Western Potash in that category?

RW: We raised our target on Western Potash, too, but we're less optimistic on its prospects given that it's maybe the fourth or fifth junior in the Saskatchewan Basin. Over the past couple of years, BHP has acquired Anglo Potash Limited and Athabasca Potash Inc.; and now, Potash One is bidding for K+S. Already these three juniors are arguably further advanced than Western Potash. Plus, you've got the brownfields, the incumbents and the big players—PotashCorp, The Mosaic Company (NYSE:MOS) and Agrium Inc. (NYSE:AGU). They could well expand their capacity for potash in the basin in western Canada.

So, Western Potash is late to the game by comparison and the cost of capital is significantly higher than it is for the brownfields. This isn't to say the stock price can't go higher, because clearly it went through our target; but we're somewhat tempered on our optimism. A lot of things have to go right for that Western Potash mine to be built and we're just not persuaded it's likely to happen.

TER: Back to you, Adrian. You've brought us up to speed on Sprott. What are some of the ag companies you like?

AD: We favor companies that actually produce somewhat more than do the explorers. So, some of those we like include farmers and agribusiness companies like Cresud (NASDAQ:CRESY) in Argentina, which raises wheat, corn, soybeans, beef and dairy cattle. Cresud exports a lot to China, which says an awful lot about China's need for agricultural commodities. It has evolved from a country that met all of its own needs and actually exported agricultural products. Now, China has to import wheat from halfway across the world.

In addition to agribusiness companies that produce, we like Bunge Ltd. (NYSE:BG; NASDAQ:BG), which had its origins in Brazil and still has most of its assets there but is headquartered in New York now. Bunge buys, sells, stores, processes and transports crops to make staple foods, food ingredients and animal feed. Its corporate brochure contains an eye-opening statistic from the United Nations—that global food production will need to increase 70% by 2050 to feed a larger and more prosperous world population.

How to increase production has become the real issue in agriculture. Of course, one way is with fertilizer. We have to use fertilizer if we're going to feed people; there's no way around it. This is a well-known story, and the fertilizer companies are going to do remarkably well over the longer term. The fertilizer stocks got a little expensive in the wake of BHP's bid for PotashCorp. Now that it's been withdrawn, I would wait for a pullback.

Right now, my favorite potash is a great company—Mosaic. Germany-based K+S is another good company. Various fertilizers already comprise about 85% of revenues for K+S, which looks to expand its portfolio with the Potash One transaction soon. I also like Syngenta AG (NYSE:SYT), which is also based in Germany. If we're going to feed people, we have to find a way to increase our core production not only with fertilizer but also with genetic engineering of seeds, etc. I know it's controversial, but that's the only way we're going to do it.

TER: Any other companies?

AD: There are also explorers. For instance, Lara Exploration Ltd. (TSX.V:LRA) isn't a phosphate explorer but it has some phosphate exploration in its portfolio. So, I like diversified companies that give me exposure to different areas.

TER: Adrian, you're a commodities bull no matter how you cut it—in this case, with agribusinesses. And you've given some strong bullish signals on the ag sector too, Rob.

RW: We're obviously bullish on grains and fertilizers. We're bullish on grains because we think the supply/demand situation could remain tight for some time. USD weakness also tends to drive these commodities higher because they're denominated in U.S. dollars. For example, it takes more dollars to buy a bushel of corn as the USD devalues. In our view, a number of factors support robust grain prices and, therefore, a strong ag sector for investors.

TER: Thank you very much, gentlemen.

A British-born writer and money manager who graduated with honors from the London School of Economics, Adrian Day has made a name for himself searching out unusual investment opportunities around the world. As president and CEO of Adrian Day Asset Management, he generously shares his thoughts, opinions, insights and analyses via Barron's, Forbes, Bloomberg Markets, Kitco, Casey, The Stock Advisors, Dick Davis Digest, MSN Money, Financial Times, The Daily Reckoning, The Herald Tribune, The New York Times and, of course, The Energy Report—among others. A frequent speaker at international seminars and a regular guest on CNBC and The Wall Street Journal Radio Network, he has been interviewed by Money, Straits Times, Good Morning America and others. He also writes the quarterly Portfolio Review newsletter for clients, serves as editor of Adrian Day's Global Analyst and has authored three books on global investing: International Investment Opportunities: How and Where to Invest Overseas Successfully and Investing Without Borders and the just-published Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks, which is now available in hardcover and e-book formats.

As an analyst with Wellington West Capital Markets Inc. in Toronto, Robert Winslow, CFA, covers 16 companies wearing his "Agriculture and Special Situations" hat. Before joining Wellington West, Rob served as an equity research analyst with Orion Securities Inc. (Toronto), strategy consultant with Bain & Co. (Toronto and Brussels), and senior engineer with Caterpillar Inc. (Dallas). Rob earned his master's in science degree in engineering at Texas A&M, and his MBA from Cornell.

Want to read more exclusive Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.

DISCLOSURE:
1) Karen Roche and Brian Sylvester of The Energy Report conducted this interview. They personally and/or their families own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report or The Gold Report: Allana Potash and Lara Exploration.
3) Adrian Day: I personally and/or my family own shares of the following companies mentioned in this interview: Sprott. In client accounts that I manage in addition to these stocks, we also own. I personally and/or my family am paid by the following companies I mentioned in this interview: None.
3) Rob Winslow: I personally and/or my family own shares of the following companies mentioned in this interview: Allana Potash.
Streetwise - The Energy Report is Copyright © 2010 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part.
The Energy Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report.
From time to time, Streetwise Reports LLC and its  directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.
Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported.
Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734.
Participating companies provide the logos used in The Energy Report. These logos are trademarks and are the property of the individual companies.
Streetwise Reports LLC
P.O. Box 1099
Kenwood, CA 95452
Tel.: (707) 282-5593
Fax: (707) 282-5592
Email: jmallin@streetwisereports.com

Over in the options trading pit, we had a number of stops triggered , but we walked away with an average gain of 32.7% so we now have 59 winners out of 61 trades, or a 96.72% success rate.


sk chart 10 Dec 2010.JPG


The above progress chart is being updated constantly. However, to see exactly how it is going, please click this link.

So, the question is: Are you going to make the decision to join us today, before we decide to cap membership.


Stay on your toes and have a good one.

Got a comment then please add it to this article, all opinions are welcome and very much appreciated by both our readership and the team here.



To stay updated on our market commentary, which gold stocks we are buying and why, please subscribe to The Gold Prices Newsletter, completely FREE of charge. Simply click here and enter your email address. (Winners of the GoldDrivers Stock Picking Competition 2007)

For those readers who are also interested in the silver bull market that is currently unfolding, you may want to subscribe to our Free Silver Prices Newsletter.

For those readers who are also interested in the nuclear power sector you may want to subscribe to our Free Uranium Stocks Newsletter, just click here.
Wednesday
Dec082010

Kevin Smith: Yield and Shield Demand Underpinning MLPs

Source: Brian Sylvester of The Energy Report  12/07/2010
http://www.theenergyreport.com/pub/na/8039

Master limited partnership (MLP) yields are down due to unprecedented investment demand in the space and the bullish distribution growth outlook, according to Raymond James Analyst Kevin Smith. Focusing on upstream MLPs, he says "consolidation is sure to continue." In this exclusive interview with The Energy Report, Kevin talks about one MLP he rates a strong buy, as well as some others with positive outlooks.

The Energy Report: Kevin, let's talk about MLPs. What's your near-term forecast for MLP yields? It seems they are being compressed some right now.

Kevin Smith: We've had significant yield compression over the last 12 months due to a myriad of factors. With the 10-year Treasuries getting down to such low levels and the uncertainty in the stock market, there is strong overall demand for "yield and shield." People like MLP investments. Historically, they've performed well and people are uncertain about further tax implications going forward. Investors appreciate a tax-sheltered vehicle that produces a lot of income. We have seen great demand, as well as significant distribution growth through the whole MLP sector in general.

I closely cover the upstream MLP space. We haven't seen many distribution increases in that subsector over the last year, though we did see Linn Energy, LLC (NASDAQ:LINE) increase its distribution last quarter, and I think we will see more of that going forward. But, yes, yields have definitely tightened over the last 12 months.

TER: All right, so yields are down in 2010 but how do they directly compare with 2009 yields?

KS: That's a great question. In 2009, the yields were averaging roughly 9%. Now, they're down to about 7%. So, we've seen a yield compression of about 200 basis points.

TER: But year-to-date, the MLP sector is up 18%. So, even though the yields are less robust than they used to be, people are still coming into MLPs in a fierce way.

KS: Well, you've seen distribution growth and yield compression. And we've seen a lot of new sector in-flows—fund flows with different ETFs and closed-end funds—putting money into the MLP space.

TER: How is the extra money that's pouring in to the MLP market changing things?

KS: Well, extra investor demand is definitely driving up prices as far as valuations and driving down yields; it's also boosting demand for new MLPs. Additionally, we are seeing new MLPs being formed in both the midstream and the upstream space. We've seen a significant amount of acquisitions in this space and investor demand, as well as lowering cost of capital through lower yields, which will spur activity in this space.

TER: In a recent report on MLPs and energy in general, you talked about ethylene plant outages and the impact those outages could have on natural gas liquids (NGLs). What's the update there?

KS: That's primarily Darren Horowitz's area, but what we've seen is some unexpected downtime at ethylene plants during the second quarter and that lowered ethane pricing. We've seen a strong boost in NGL production from some of these shale plays, specifically the Eagle Ford Shale and, to a lesser extent, the Granite Wash and the Marcellus. These shale plays have significantly increased NGL production in the U.S., and one of the largest mixes of the NGLs is ethane. It is roughly 45% of the NGLs production.

Chemical companies primarily use ethane to produce plastics. So, when a series of ethylene plants shut down, that ultimately lowered the demand for ethane in the second quarter. Now, some people are worried that U.S. ethane production will exceed demand and that the chemical companies won't be able to ramp-up fractionator facilities in order to turn it into ethylene, which is used to make plastics.

But we have seen ethane prices strengthen in the third quarter and going into the fourth quarter as these plants have come back online, boosting demand.

TER: What are some MLPs that could be affected by that?

KS: Enterprise Products Partners, L.P. (NYSE:EPD) is definitely well positioned to take advantage of the bullish ethylene environment and some of the others. Williams Partners, L.P. (NYSE:WPZ) is going to be positively impacted, as well as any other gas processors. However, I am more focused on the upstream MLPs than the midstream ones.

TER: What are some of the trends going on right now in the MLPs space?

KS: In the upstream MLP space, we're continuing to see massive size acquisitions and divestitures. The upstream MLP space has done over $2 billion in acquisitions this year, which is pretty sizeable considering the collective market cap is roughly $14 billion.

I believe there still is an enormous amount of consolidation in the E&P space that will take place over the next 5–10 years. Just look at the U.S. stripper wells, which are basically marginal wells that really don't have a lot of production growth but are maintaining stable production profiles and generating a ton of cash flow. They supply roughly 5% of the U.S. onshore production of oil and about 7% of the natural gas. In a lot of ways, these assets have no business being in an exploration and production (E&P) C corp but it makes a lot of sense for the upstream MLPs to hold these assets because it's a tax-efficient vehicle. This is a way for E&P C-corps to monetize properties and redeploy that capital into what they are really being paid to do, which is drill, find new reserves and increase production.

I think a lot of these shale gas producers will continue to divest their mature properties and monetize those producing assets to help fund their capital spending programs. That pace has the potential to pick up in 2011 because most of the oil and gas E&P companies aren't going to be hedged as effectively as they were going into this year. We saw a nice little spike in gas last year in November and they were able to lock into hedges. So, the hedging profiles for most the E&P companies are going to have lower strike prices and, therefore, they'll have less operating cash flow, all things being equal. And they'll most likely have to divest more properties to maintain the sort of spending levels the company is used to. Historically, E&Ps reinvest roughly 130% of their cash flow, so the question becomes: Where do they get the excess cash? We think a lot of it is going to come from property divestitures.

TER: Could you briefly summarize the upstream, midstream and downstream MLP spaces?

KS: The upstream MLPs are the oil and gas production companies; they're the ones that go out and drill the wells and actually produce the hydrocarbons.

The midstream segment kind of picks up the oil and gas to process them, which basically cleans and separates them, and then ultimately transports them down to the downstream segment—the refiners and end users—and even the utility companies—depending on whether it's an oil or gas product.

Historically, the upstream space was not seen as being suitable as an MLP segment due to its declining production profile. But the industry has done quite a bit to offset that. The industry has packaged upstream properties into MLP vehicles with four or five years of hedged production. They then try to do a certain number of acquisitions every year, as well as a little bit of organic growth to offset the natural production decline associated with the underlying assets.

TER: Within that space, what are some companies you're recommending to institutional and retail investors?

KS: We've been recommending Linn Energy, which is our only strong buy-rated name in the upstream MLP space currently. The reasons are threefold: 1) The partnership's unparalleled organic growth potential due to its horizontal Granite Wash drilling program; 2) Linn has one of the best hedge books in the industry with approximately 100% of its natural gas production hedged through 2015; and 3) The partnership has an extremely active acquisition program, targeting transactions in the $300–$500 million range. In this time of constrained liquidity for E&P C-corps. Linn is really one of a handful of companies that could finance it and get that size of a deal done. But the main reason we like Linn is because of its organic growth potential. It is drilling horizontal Granite Wash wells that have payback periods of six–nine months; so, essentially, it's buying EBITDA at less than 1x while trading on an EV/EBITDA basis of closer to 9x—so, highly accretive transactions.

TER: That sounds positive. You also have a buy rating on El Paso Pipeline Partners, L.P. (NYSE:EPB) with a target of $38. What's supporting that rating?

KS: Well, that's our dividend discount model—which uses our distribution-growth assumptions and discounts that back based on our cost of capital assumption. El Paso Pipeline Partners is blessed with a significant amount of dropdowns from its parent, El Paso Corporation (NYSE:EP), and we think, because of the El Paso C-corp's financing needs, EP will continue to drop down pipelines at a decent pace. The partnership will continue to deliver significantly high distribution growth; it also has a high coverage ratio and a very sustainable business model on the pipeline, very stable earnings in gas and cash flow.

TER: Are there any near-term catalysts for an uptick in the price?

KS: Well, the company recently announced a $1 billion dropdown; so, we would expect maybe two–three more dropdowns in 2011. But, as far as near term, it's probably going to integrate the assets it has at this point. So, don't expect El Paso to do anything until maybe late Q111 or early Q211 at the earliest.

TER: What is a dropdown?

KS: That is where the MLP's parent company, in this case El Paso, sells assets to the partnership, El Paso Pipeline Partners.

TER: Besides Linn and El Paso, are there some other companies that have a positive outlook?

KS: Yes, we're very positive on EV Energy Partners, L.P. (NASDAQ:EVEP) and Legacy Reserves, L.P. (NASDAQ:LGCY)—but for different reasons. EV Energy Partners has a large private equity sponsor in EnerVest Management Partners Ltd. We believe that over the next few years, as the private equity funds mature, EV Energy Partners stands in line to acquire those assets. It also made a strong play into the Barnett Shale recently; so, we are going to be closely watching both the organic production and the integration of those assets as we see upstream MLPs venture into different areas of more mature production. As the Barnett's production profile rolls over, and the producing assets have got four–five years of production history, we wouldn't be surprised to see more C-corps exit out of the Barnett as that capital goes to work in more emerging shale plays.

Legacy Reserves, which is consolidator of Permian Basin properties, had another strong year of acquisitions in 2010; announcing and/or completing more than $250 million in acquisitions. As you may know, the Permian Basin is one of the hottest basins in the U.S. right now due to the oily nature of the basin. Additionally, operators in this area have recently started targeting new formations for horizontal development near Legacy's acreage. Due to the partnership's organic growth program and its highly accretive 2010 acquisitions, we expect Legacy will be able to increase its distribution in the first half of 2011.

TER: Some MLPs are acquiring their general partners (GPs), and it's certainly something that they're doing in advance of the carried interest legislation making its way through the House. What's the status of that legislation?

KS: I haven't heard any updates, but everything the National Association of Publicly Traded Partnerships has said is that the legislation wasn't written to impact publicly traded partnerships and that it's working diligently to make certain that doesn't impact them. We've seen a lot of consolidation of the GPs at the LP level but, for the most part, that's been more in line to minimize any sort of capital advantages, as well as to allow for further distribution growth.

TER: Will that continue?

KS: I think it will. I think GPs will continue to be bought by the LP unitholders. The pace and timing are always uncertain but, once partnerships get into the high splits, it becomes difficult for them to have a cost-of-capital advantage. In fact, there is usually a cost-of-capital disadvantage.

TER: Does that mean there's a structural problem with the vehicle itself?

KS: No, some of the MLPs that I like the most are LLCs; they don't have GPs. Linn Energy is a great example. The company was formed as an LLC and, therefore, doesn't have a GP. So, all investors share in the distribution growth equally. The problem for companies that have IDRs is that once they get into the high splits, it becomes prohibitive for them to do further accretive transactions.

TER: Do you typically change ratings on MLPs after they buy their GPs?

KS: Obviously, it depends on the multiple at which they took out the GP and how much leverage and debt they had to take on. Once they've eliminated the GP hurdle, they should have a positive outlook going forward because it kind of lowers the bar on the cost of capital for further acquisitions. It's become a necessary evil in a lot of ways after a company gets into high splits.

TER: What are some MLPs that you could see taking out their GPs?

KS: That's something that Williams Partners would ultimately look at, at some point in time. There are others that Darren works on, but none of the other upstream MLPs is likely to do that in the near term.

TER: Well, a recent Raymond James research report cites Crosstex Energy, L.P. (NASDAQ:XTEX) as being one. Why would it make sense for Crosstex to buy its GP?

KS: For the same reasons—once its GP gets into the high splits, it needs to purchase the GP in order to increase its distribution effectively.

TER: Do you have any parting thoughts on the MLP sector?

KS: Over the long term, the MLP sector offers a very attractive risk/reward proposition, especially when you consider the tax-deferred portion of the yield and the fact that you're going to see a significant amount of retirees looking for yield and shield. So, we remain bullish on MLPs even though yields have tightened quite a bit. At this point, you might want to slowly add to positions rather than jumping in feet first because we wouldn't be surprised to see more attractive entry points down the road. But we also think you're going to continue to see institutional money flow into this space once those institutions look at the track record and growth potential of MLPs. It's pretty darn compelling.

TER: Right, but institutions are already coming into the sector in an unprecedented way. It's the biggest shift from retail to institutional investors this sector has ever seen.

KS: We also saw a pretty big shift in 2008, and then we saw an exit. I think institutional investors are slowly waking up to MLPs as an asset class. They are trying to find an area that can top this on a risk-adjusted basis and they are having a tough time. Therefore, they're jumping in and getting over the accounting burden of the K1s versus the 1099s.

TER: You said you saw a fair shift or inflow of capital from institutional investors in 2008, but then they left. It's as if they came in only for the short term. Do you fear a similar thing could happen again?

KS: In 2008 and 2007, they came in with a lot of leverage and ultimately got blown out when things went badly. But institutions are not leveraged to the gills the way they were in 2008. And I think we've seen a smarter and more-stable class of investors on the institutional side. From everything I've seen, people are in it for the long term.

TER: Thanks, Kevin, we appreciate your insights.

Kevin Smith, who has been with Raymond James for four years, is an exploration and production (E&P) analyst that specializes in upstream MLP partnerships. Previously, he worked for Wells Fargo in its E&P Corporate Lending group in Houston where he was responsible for credit analysis for mid- and large-cap E&P companies. Prior to joining Wells Fargo, Kevin was a power trader at Reliant Resources for three years where he traded electricity on the company's East power desk. Kevin holds a bachelors degree in business administration (BBA) from Baylor University and a masters of business administration (MBA) from Texas A&M University. He is an avid tennis player and jogger.

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DISCLOSURE:
1.) Brian Sylvester of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2.) The following companies mentioned in the interview are sponsors of The Energy Report: Enterprise Products Partners.
3.) Kevin Smith: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. *Regulatory Disclosures for Kevin Smith as of 12/6/10*
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Over in the options trading pit we had a number of stops triggered, but walked away with an average gain of 32.7%, so we now have 59 winners out of 61 trades, or a 96.72% success rate.



sk chart 19 Nov 2010.JPG



The above progress chart is being updated constantly. However, to see exactly how it is going, please click this link.

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Stay on your toes and have a good one.

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Wednesday
Dec082010

Rick Rule: Caution, Extreme Volatility Ahead

Source: The Energy Report  12/07/2010
http://www.theenergyreport.com/pub/na/8048

Rick Rule and Sam Kirtley in Auckland recently.JPG

Always well ahead of the pack, legendary investor Rick Rule presages major volatility in the energy markets. "I can guarantee this," he says, "over the next two years, we're going to experience unbelievable volatility." In this Energy Report transcript from his Dec. 3 webcast, Rick dissects the gamut of energies—from fossil to alternative—revealing an interesting paradox that is a "game-changer" for uranium, why he calls alternative energy "the alter ego of rare earths" and an international wild card in oil. Christmas comes early for knowledge-hungry investors, as Rick's altruistic counsel presents nothing short of a gift. To find out how to profit from the coming turbulence, read on. (This article covers the energy-sector portion of Rick's interview. Read Rick's thoughts on precious metals on The Gold Report.)

Jeff Howard (CEO, Global Resource Investments): Ok ladies and gentlemen, I'd like to welcome you to today's broadcast. I've got Rick Rule here and we're going to spend a little bit of time talking about energy. First off, uranium—uranium prices had a tremendous move a few years ago, going up from, what?—$8 a pound to well over $120. Prices backed off considerably to $40/lb. around July, and since have moved up to about $61/lb.—a 50% increase in six months. Did we miss the boat or what?

Rick Rule: We haven't missed the boat but, to me, being 50% up means 50% less attractive. When we talked several broadcasts ago, I thought uranium stocks and uranium prices were table-pounding cheap. They are no longer table-pounding cheap, but I think they have room to go up. Later in this discussion, we're going to talk about the energy sector generally but let me lead off by saying that, for five years I've been very, very bullish on energy—all forms of energy. To me, uranium is one of the most attractive forms of energy.

One of the things that's interesting is that, although new plant construction is not progressing well in Europe and North America, it is progressing better than I had anticipated—and I was bullish—in East Asia. New plant construction in the People's Republic of China, South Korea, Japan and Taiwan is progressing well despite the fact that the long-term prognosis for uranium doesn't supply existing plants, let alone new plants. That sets up an interesting paradox in uranium; if you're building or financing a plant now, what you have to do to secure financing of the plant is obtain long-term contracts that give you enough uranium supply to amortize the loan out over 15, 20 or 30 years or for the duration of the term. Interestingly, that means the long-term price of uranium (i.e., contracted uranium prices) is above and sometimes substantially above the spot price; thus, uranium consumers are paying a premium over market to lock in long-term supplies. This is important because for the first time in my career, relatively small companies that make a significant uranium discovery can finance the discovery into production without selling it to a multinational mining company because these consumers—large power companies and utilities—are willing to assist in financing the mine in return for an offtake agreement. This is a game-changer for the uranium exploration sector.

The second thing that makes uranium particularly attractive to me is that vast amounts of money were raised in the stupidity of the uranium bull market that occurred four–five years ago. As is normal, most of the money was wasted but some was spent intelligently. As a result of the 25-year bear market that existed in uranium prior to the bull market, not much exploration had been done for 25 years. Consequently, there was lots of low hanging fruit and the money that was raised has begun to find it. That means we're in a discovery cycle in uranium at the same time the long-term outlook for uranium producers is the brightest it's been in my 57-year lifetime. This is a very bullish set of circumstances looking forward—just 50% less bullish than it was six months ago because the price of admission has gone up.

We are extremely attracted to the uranium business in the next five-year timeframe, though the rising tide will not float all ships. Remember that most of the 500 companies purportedly looking for uranium four years ago were run by management teams that couldn't even spell uranium. The benefit associated with the market conditions that I'm describing will be extremely constrained to a very small group of companies, probably no more than 20.

JH: Ok, so those are the sectors that have done very well in the last year or so. Let's talk about some of the sectors that haven't done as well because that's usually what you migrate toward. Alternative energy jumps out as one—geothermal and hydro developers have actually done fairly well in the field from what I can tell, but not in the market. Considering the BP Plc (NYSE:BP; LSE:BP) oil spill back in spring and everyone talking about reducing our dependence on fossil fuels, you'd think this market would have gone on fire. But it hasn't happened. What's the outlook?

RR: Well, I think energy is where it's at for the next five years. I think energy prices are going to surprise people to the upside, and all forms of energy—nuclear, alternative, oil and gas (O&G) and the great bête noire, coal—are going to work. I think they're going to work for a couple of absolutely inescapable reasons. We've talked about this in the webcast before, but there are two billion people around the world who aspire to the lifestyle that we enjoy and that lifestyle requires energy. Unlike 20 years ago, those people can increasingly afford to compete with us for those energy supplies. That's a long way of saying that people in central India would enjoy the lifestyle you have and, increasingly, at least their children are competing with your children on a very, very direct basis; more per-capita demand for energy spread over literally billions of capitas. Not enough energy to go around, so the price is going to go up—no doubt about it.

On the supply side, there are also challenges, at least challenges if you're a consumer. The thing that carries the day is oil and gas, particularly oil because it can be used as a motor fuel. Most people believe oil is produced largely by the big multinational oil companies—Royal Dutch Shell Plc (NYSE:RDS.A), Exxon Mobil Corp. (NYSE:XOM), Total (NYSE:TOT), Chevron Corporation (NYSE:CVX) and Eni S.p.A. (NYSE:E). That's not true; most oil worldwide is produced by national oil companies (NOCs)—companies controlled by politicians—the people who can't deliver the mail, can't deliver you future energy security. This is exacerbated by the fact that some of the national oil companies that have large supplies of oil and generate large free cash flows are not—and have not for a decade—reinvested enough working capital to sustain their current production. In fact, they've looted the patrimony of their oil business to fund politically expedient domestic programs. The countries I'm referring to include predominantly Mexico, Venezuela, Ecuador, Peru, Indonesia and probably Iran. Those six countries generate between 20%–25% of global export supply.

Within the next five years, I believe that group of countries will cease to be petroleum exporters. Unless—and this is the wild card—Iraqi production kicks up to replace that supply (something that, from a political point of view, looks doubtful now) or the Saudis, Kuwaitis and the United Arab Emirates are able to increase their supplies enough to offset these declines, we have a situation wherein 20%–25% of global export crude supply comes off the market while demand for export crude is increasing 1.5% per year. Dramatically reducing supplies in the face of steadily increasing demand can only do one thing to oil prices—push them higher. And as oil prices go higher, I believe it will raise all energy pricing.

While demand for oil as motor fuel is increasing, worldwide demand for electricity is also increasing and this phenomenon is not limited solely to emerging markets. The United States and some parts of Western Europe are facing electrical energy shortages. Brownouts have become common during summertime peak demand in the U.S. So, increased demand for electricity is no longer limited to citizens of countries that you can't pronounce; it's happening right here in the good ol' USA. So, although energy, electricity, oil are nowhere near as sexy as rare earth elements (REEs), unpronounceable commodities, gold or silver, I think these prices have to go higher—not just can go higher, but have to go higher.

Let's start off with alternative energy, which is sort of the alter ego of rare earths. The fundamentals in this sector are extraordinary, but the market performance has been terrible—the mirror opposite of REEs. I am attracted particularly to the alternative energies that actually work and work without subsidies, meaning geothermal and run-of-river hydro.

Money will be made in wind and solar because the population demands these uneconomic sources of energy in their quest to be green. But, as we've discussed before, these forms of energy have very real problems. In the case of solar energy, the insurmountable problem is night; it relies on the sun. Wind power, on the other hand, requires constant and steady wind, which isn't something that exists in many places around the world. However, there will be money to make in both wind and solar.

Nobody ever went broke underestimating the stupidity of various governments, but the real money will be made in industries that do not require subsidies, particularly geothermal. The geothermal stocks have performed poorly for a variety of reasons. Two years ago, expectations for the stocks probably got ahead of themselves; but, more importantly, these are very capital-intensive businesses. A lot of money has to go in the front end before cash flows are developed, and it's the analysis of future cash flows that causes these stocks to go up. I suspect most of the front-end money needed to establish the validity of the sector has now been contributed, and I expect geothermal news flow will be extremely attractive over the next six months.

In the next two years, I expect the geothermal industry will continue to consolidate and rationalize. In fact, my fear in the geothermal industry is that consolidation takes over before it has a chance to mature and give us the values that we want. I see all the current geothermal juniors, at least those we follow, selling at substantial discounts to what I believe is the net present value (NPV) of their realizable cash flows. We are starting to see that by off-balance sheet deals; two geothermal juniors recently made off-balance sheet funding deals with large utilities and/or power producers that value the companies' assets at strong premiums to the net asset values (NAVs) suggested by their market caps. So, I am very, very attracted to the geothermal side.

Unfortunately, there aren't many names to play; and those of you who require momentum, immediate gratification or sort of a rationalization or justification regarding near-term share price advance will not like the geothermal sector whatsoever. Those of you who remember the success we had buying uranium stocks early in the last decade—when nobody cared about them—and selling into the spectacular run-up that followed might have more of a sense of humor about geothermal stocks. I think those of you who do have that patience will be very, very well rewarded, particularly juxtaposed against the risks you will take.

JH: Let's talk about the gas market wherein the North American shale plays have somewhat kept the lid on gas prices for the last year or two, and everyone thinks it's going to happen for the foreseeable future. So, does that limit investment opportunities in natural gas or can we still make money here?

RR: Oh, absolutely not. I think natural gas is where I'm really going to concentrate. I suspect I am two years early, but I've found that being two years early definitely increases my ability to negotiate private placement deals with very attractive pricing teams and with full warrants, in particular.

Jeff, what you say about natural gas prices being on hold is true. The technology associated with the North American shale plays has really been a game-changer in natural gas. Natural gas critics say, "Rick, we aren't going to see $10 or $12 gas again for a long term, like 10 years or 12 years." I think that's right, unless we see a huge debasement of the dollar; but what's interesting to me is we don't have to see $10 gas. If we see $6 or $7 gas, some of these producers will make astonishing amounts of money.

If you are producing gas and selling it in a $3.50 market and making a cash margin, if not profits—let's say, for instance, that at $3.50 gas you are making $0.50 per million cubic foot (MCF) in cash flow—not profit but $0.50/MCF in cash flow—that's your cash margin on sunk costs. And let's say you're buying this company at 50% of book when the company is enjoying the $0.50 margin, you, the new buyer, are buying costs that were sunk by earlier investors at much higher costs. If the gas were to go from $3.50 a thousand cubic foot (TCF) to, say, $6/TCF, the price you're receiving for your gas just about doubles; your margin goes up just about fourfold or fivefold. That is tremendous internal torque, but what's more important is that some of these companies have 800, 900 or 2000 proved, undeveloped locations that have no NPV at $3.50/TCF because you wouldn't drill them. But they could be worth $40,000, $50,000 or $60,000 per location at $6–$7/TCF. So, in addition to having the leverage associated with the cash flows off the developed reserves, the real torque is in proved, undeveloped locations.

How do we turn this into money at Global? What we'll try to do is find the best of the unloved in Canada—companies below the radar screens in Canada with market caps below $400 million, that are gas- rather than oil-centric, that have enough oil or liquids-rich production that we can finance them and they can drill off their liquids-rich lands in the next year and a half or two while gas is in the doldrums. We can get partial ownership of the proved undeveloped gas locations, which will have extraordinary value three–four years from now.

We have identified several companies in Canada, though we haven't yet talked them into doing financings at these prices. They're uniformly selling at 50%–60% of book, and they're extremely leery to issue equity to us at these prices; but we suspect we can hold out longer than they can. In one case, this company is selling for 20% of the price it was selling for three–four years ago. In another case, the company is selling at—I'm not kidding you—10% of the price it sold for four–five years ago.

Compare and contrast this with the market performance we've seen with more-popular sectors. Does it make sense to you that a better risk/reward parameter can be found buying a profitable, well-capitalized company in an out-of-favor sector at 50% of book, selling at 10% of its price four years ago or buying a very hot sector at 10x book 7x or 8x the price it was four–five years ago?

I believe the real money is made by skating well ahead of the pack, and that's what we're trying to do in conventional oil and gas. I believe oil prices will go higher and that oil prices drag gas prices higher. I also believe currently low gas prices will constrain both shale and conventional gas drilling and that the flush production that haunts the gas markets now will go away as rigs get stacked in response to these low gas prices. I expect the snapback in gas prices two–three years from now will be dramatic. By dramatic, I don't mean to $10–$12; I mean to $5 or $6. A snapback in gas prices to $5 or $6 could give us tenfold returns on some of these highly unpopular gas producers from their current market caps. Next year, if I'm able to negotiate private placements in companies at 50% of book with full warrants at small premiums to the price at which we do financings, I believe we'll enjoy or at least have the potential to enjoy 10-for-one returns with full warrants, which can be a 15, 16 or 17-full return over the three–five year timeframe. I'm extremely excited about this opportunity.

JH: Earlier, you mentioned coal; we don't talk about the black stuff very much. Give us your thoughts on the coal markets.

RR: Well, it's extremely unpopular. Politicians rail against it, the media points out that it's a four-letter word, but that may be intended in the pejorative sense rather than the literal sense. And while all that's been happening, the price has doubled. People say all kinds of bad things about coal but when they walk in and hit the switch, they want the light to go on; without coal, the lights don't go on. Many parts of the world do not have access to lights that go on and they want the lights to go on, and they want steel. They want all the things that energy produces.

Right now, both India and China are critically short on coal supplies for their existing electrical infrastructure, which they're trying to grow as we speak. Despite everything bad you read about coal—I'm not trying to say there aren't certain aspects of carbon pollution that aren't bad—but despite everything you read about it, the demand for coal is running substantially ahead of supply. People want steel and electricity, and the rising tide in energy prices is going to float all ships, including the coal ship.

So, we will be looking at all forms of energy, including coal, on a going-forward basis. Some of you remember the success Sprott Resource had in the 2007–2008 bear market, when successes were hard to come by, and it achieved a fivefold return on its shares in PBS Coals, prior to being taken over by Russian steelmaker OAO Severstal (CHMF:RU) in a very bad market. We'll be looking for opportunities to participate, particularly in export grade and, of course, metallurgical coal on a going-forward basis, despite the fact it's unpopular or perhaps because it's unpopular, but profitable. We'll be looking carefully at the coal markets going forward.

JH: You mentioned volatility earlier. Let's talk about your feel for this market; it's been a wonderful time over the last three months. What do you think? Where are we?

RR: Volatility is the most important part of today's discussion. I can't guarantee anything with regards to energy prices; I have my superstitions. I can't guarantee anything about oil or gold prices. What I can guarantee is this—over the next two years, we're going to experience unbelievable volatility—unbelievable volatility. I believe we're one-half or two-thirds of the way through a commodities super cycle, in a secular bull market; the broad economy is in a secular bear market. I think the collision between secular bull and bear markets is going to resemble that of two very large weather systems. . .we are in for a period of absolutely unbelievable turbulence.

In the last couple of months, we've seen a 20%–25% upsurge in precious metal (PM) prices. For those of you predisposed to believe that PM prices were going to go up, this doesn't feel like volatility to you. It feels like a rational or justified response to your brilliance; but believe me, some of this is volatility. For some reason, people aren't as sanguine about 20% downmoves as they were about 20% upmoves, but we're going to get a lot of both. And over the next two years, I suspect that 20% moves will be considered "tame" moves.

I think we're going to see 30%, 40% and 50% moves attributable solely to volatility, not to underlying events. The underlying events are already baked in the cake. Specifically, I think we'll see moves in the junior market up and down of 20% for no reason whatsoever simply because in the near term there are more buyers than sellers or more sellers than buyers. I think 50% moves are probable rather than possible. Now what does this mean for you? Given that volatility will occur, in my mind you have two choices: 1) Accept, embrace and use it; or 2) Get waxed. Those are your choices. Our theme has been that of contrary or victim—the choice is yours, that's the way it works with volatility.

What is volatility? In markets, volatility is a series of repeated sales. Buying goods on sale is always preferable to buying goods at retail. Volatility will give you precisely the opportunity to do that. It also does something else—it gives you the ability to mark up the goods you bought on sale and sell them to other people for a price that is substantially dearer than the price that you had to pay. To do that, you have to manage your own temperament, be disciplined and pay attention to reality—not the noise of the market. It's human nature when you buy a stock for $2 and see it go to $4 that a couple of pleasant circumstances occur. In the first instance, you feel smart; that's nicer than feeling stupid. In the second instance, when you see it on your statement, you like that stock; it went up, that stock gives you pleasure. It is fighting that instinct that causes you to make money. If a stock goes up, if a stock doubles, for any other than truly spectacular reasons, you need to understand as a consequence of doubling, the stock is precisely half as attractive as before it went up. The fact that it went up makes it less attractive on a going-forward basis. It is dearer, and you have to fight your tendency to like the stock that's gone up. You have to make yourself take profits.

At the same time, the stock that you liked at a $1 falls to $0.50. When you look at that stock on your statement, it makes you feel stupid. You see this stock on your statement, which may be a bargain, but to you it's a dog, a mistake, maybe evidence of your own failings and frailty. Never mind failings and frailty. If nothing else has changed, it is precisely twice as attractive at $0.50 than it was at a $1. Most people's temptation will be to sell the stock that's twice as attractive rather than hold the stock that's twice as attractive.

The nature of profiting from volatility is being on the other side of the trade. When panic is in the market and good companies are priced down, you have to have the courage to not only stay the trade but also increase the bet. During periods when you're completely sanguine and really aggressive you need to shake yourself and say I need to take some profits here. Everybody remembers how bullish they felt in 2006, how we all confused the bull market for brains; and everybody has to remember how they felt in September, October and November of 2007 when the market went no bid. We didn't feel so smart then. Had we simply felt a little less smug in 2006 and a little more aggressive in 2007, we would all be substantially wealthier than we are today.

Bear that in mind because this market is going to be extraordinarily turbulent and volatile; it, consequently, will give you extraordinary opportunities to either make or lose money. Whether you make or lose will not be a function of the market. Volatility is not a risk; it is a tool. The risk is located east of one of your ears and west of the other. It will be a function of your response to the volatility whether the next two years are extremely pleasant or unpleasant for you.

JH: Ok, thanks Rick. We have to go back to work.

Note: This article covers the energy sector portion of Rick Rule's interview. Read Rick's thoughts on precious metals on The Gold Report.

Rick Rule, founder and CEO of Global Resource Investments, began his career in the securities business in 1974 and has been principally involved in natural resource security investments ever since. He is a leading American retail broker specializing in mining, energy, water utilities, forest products and agriculture. Rick's company has built a national reputation for its specialist expertise in taking advantage of global opportunities in the oil and gas, mining, alternative energy, agriculture, forestry and water industries. This article is based on his Global Resource Investments webcast, Friday, December 3.

Want to read more exclusive Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.

DISCLOSURE:
From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.
Streetwise - The Energy Report is Copyright © 2010 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part.
The Energy Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report.
From time to time, Streetwise Reports LLC and its  directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.
Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported.
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.............................................................................

Over in the options trading pit we had a number of stops triggered yesterday, but walked away with an average gain of 32.7% so we now have 59 winners and out of 61 trades, or a 96.72% success rate.



sk chart 19 Nov 2010.JPG



The above progress chart is being updated constantly. However, to see exactly how it is going, please click this link.

So, the question is: Are you going to make the decision to join us today?


Stay on your toes and have a good one.

Got a comment then please add it to this article, all opinions are welcome and very much appreciated by both our readership and the team here.



To stay updated on our market commentary, which gold stocks we are buying and why, please subscribe to The Gold Prices Newsletter, completely FREE of charge. Simply click here and enter your email address. (Winners of the GoldDrivers Stock Picking Competition 2007)

For those readers who are also interested in the silver bull market that is currently unfolding, you may want to subscribe to our Free Silver Prices Newsletter.

For those readers who are also interested in the nuclear power sector you may want to subscribe to our Free Uranium Stocks Newsletter, just click here.



Wednesday
Dec082010

Christmas is coming up fast, need a Pressie?

You can make this purchase without even leaving your seat, its different, valuable, inexpensive and could prove to be beneficial to them for years to come.

Subscribe for 6 months - $499

 

Subscribe for 12 months - $799

 




Or you could battle through shops for hours and buy a cardigan, make sure that they like colour before you flash the plastic. Please check our trading record here.

Wednesday
Dec012010

Uranium Participation Corporation: Making Steady Progress

Uranium Part Chart 02 Dec 2010.JPG

Uranium Participation Corporation (U) hasn't doubled since July, along with some of the other uranium miners, however, it is ticking along nicely. 'U' has experienced had some profit taking but has now recovered. Some of the fizz was taken out of the indicators recently as 'U' corrected, so its fingers crossed for some steady progress on the back of rising uranium prices. Also note that the volume can be erratic at times, however, the liquidity is good.

Uranium Participation Corporation is an investment holding company which invests substantially all of its assets in uranium, either in the form of uranium oxide in concentrates ("U3O8") or uranium hexafluoride ("UF6"), with the primary investment objective of achieving appreciation in the value of its uranium holdings. The mission of the Corporation is to provide an investment alternative for investors interested in holding uranium. Denison Mines Inc., a wholly owned subsidiary of Denison Mines Corp., is the manager of Uranium Participation Corporation.

The target price for 'U' has been raised recently bu some analysts as follows:

Uranium Participation Target Raised To C$10.50 From C$9.70 By Salman >U.T

Uranium Participation Target Raised To C$9.40 From C$8.75 By Dundee >U.T

Uranium Participation Target Raised To C$9.25 From C$7.75 By RBC >U.T

November 16, 2010 -- Uranium Participation Corporation ("Uranium Corp") reports its net asset value at October 31, 2010 was CDN$758,838,000 or CDN$7.14 per share. As at October 31, 2010. Market Capitalization is $881.41, 52 week range is $5.08 - $8.52.

Uranium Participation Corporation's securities are listed and trade on the Toronto Stock Exchange. Its common shares trade under the symbol U. 

Meanwhile back at the ranch during our knockabout sessions we have toyed with the idea of running an Accumulator whereby we make a trade and then use the total proceeds for the next trade and so on. So the stake and any profits are rolled into the next move, if you would like to comment on this idea, then please click here.

Over in the options trading pit the team have updated the progress chart to include closed trades, now 53 winners and out of 55 trades, having been stopped out of a trade with a profit of 41.84% made in just 8 days. We currently have a number of open positions which we are pleased to say are all in positive territory.

sk chart 19 Nov 2010.JPG



The above progress chart is being updated constantly. However, to see exactly how it is going, please click this link.

So, the question is: Are you going to make the decision to join us today?


Stay on your toes and have a good one.

Got a comment then please add it to this article, all opinions are welcome and very much appreciated by both our readership and the team here.



To stay updated on our market commentary, which gold stocks we are buying and why, please subscribe to The Gold Prices Newsletter, completely FREE of charge. Simply click here and enter your email address. (Winners of the GoldDrivers Stock Picking Competition 2007)

For those readers who are also interested in the silver bull market that is currently unfolding, you may want to subscribe to our Free Silver Prices Newsletter.

For those readers who are also interested in the nuclear power sector you may want to subscribe to our Free Uranium Stocks Newsletter, just click here.


Tuesday
Nov302010

Adrian Day: Long on Gas, Longer on Oil

At first glance this looks like an oily article but it does get to uranium and uranium stocks a little further into the article which may be of interest to you.

Oil Demand about to take off 1 dec 2010.JPG


Source: Karen Roche and Brian Sylvester of The Energy Report  11/30/2010
http://www.theenergyreport.com/cs/user/print/na/7985

Even if the pace of China's growth slows dramatically, count on the commodities boom to continue, says Adrian Day Asset Management Chairman and CEO Adrian Day. That bodes well for oil, as China's huge population will at least double per-capita consumption of oil over the next decade—maybe even drive it up fivefold. In this Energy Report exclusive, Adrian discusses Indian and Chinese demand and why he isn't worried long term about natural gas.

The Energy Report: Adrian, you recently published Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks, your first book in 28 years. Why write a book now?

Adrian Day: I think the topic is remarkably crucial and important. Everybody understands the main drivers behind the increase in resources prices but most people, including those in the business, aren't yet fully grasping the scale of the resource shortage that I see coming. They know China's demand is going up. They know it's more difficult to get permitting and more difficult to find new deposits. But I don't think they really appreciate the extent of the problem.

TER: What is the most important thing for people to know?

AD: One of the keys is to really understand what kind of investor you are because what you buy and how you trade depends on that a lot.
Can you tolerate risk? Or, will you panic if stocks decline 50%? Rick Rule, one of my friends in the business, keeps telling us that volatility is a fact of life. How you use volatility determines whether you're successful. Make volatility your friend.
How much time are you willing to devote?
And frankly, how much money do you have to invest? If you don't have a lot of money, perhaps you want to be invested in one or two mutual funds. The more money you have, the more you can invest in different sectors and different areas.
So, the first thing is that people have to know themselves.

TER: You talk about this enormous resource shortfall. Surely, the U.S. doesn't appear to be on the brink of any boom. Why is it so big, especially considering that there was no shortage 5 or 10 years ago, when our economy was booming? Even China isn't growing at the rate it was.

AD: It doesn't matter whether the U.S. is booming or not. It doesn't matter whether Europe is booming or not. China has been driving the resource market and will continue to drive it for the next decade. That's what really matters; that's why I say it doesn't really matter if China's economic growth slows from 9.5%–5%. The demand for resources will still be very dramatic, and much higher than it is now. Just think about it. Everybody in China wants the same things we do. They want houses with electricity and running water and indoor plumbing. That takes steel and copper. If they move from a rural area into the city, at some point, they want a car. That takes aluminum and platinum, rubber for the tires and, of course, oil to run it. Obviously, cars are much more resource-intensive than bicycles and China is changing from bicycles to cars.

When countries industrialize, they tend to go through a characteristic pattern. Typically, the demand for commodities—resources—starts to grow as the GDP increases. It starts from a very low base and slowly over a period of 10–15 years, or even longer, begins to gather momentum to double that level. When the GDP reaches a certain level, the industrializing economies hit that takeoff point. Then the demand for resources starts to accelerate. It took longer for Germany and America 100 years ago, but it was over 10 years for both Korea and Japan that demand accelerated until the economy industrialized and matured, and then the demand reached a plateau. The demand doesn't decline; it reaches a plateau. The critical thing is that demand for resources increases and accelerates at that takeoff but it increases on a per-capita basis. Just to give two examples if I may.



Look at Japan and Korea at different stages—Japan starting in the '60s, Korea starting in the '80s. Per-capita consumption of oil as they started to industrialize went from a very low base of less than one barrel per person per year to two barrels, then up by another half-barrel per person per year. At that takeoff point, over a decade it shot up to 15 barrels per person. The typical oil consumption of all industrialized countries around the world varies from about 14–15 barrels per person. The U.S., of course, is an outlier as it is in many things but if you look at Denmark or Japan, Germany, Britain or Canada, if you look at a sparsely populated or a densely populated country, a green or not-so-green country, it's about 15 barrels of oil per person per year. That's what it takes to run a modern industrial society.

TER: And where is China's demand for oil now?

AD: From less than half a barrel per person 15 years ago, China now is at about 2.7 barrels per person. Already this year, it has surpassed the U.S. as the #1 consumer of oil in the world. But now, it's at that takeoff point. Suppose for a moment that China doesn't go to 15 barrels per person. Suppose it only goes to a third of the world average, which is a pretty conservative assumption. Suppose it takes longer than 10 years. That's still more than doubling China's oil consumption on a per-capita basis.

China represents 20% of the world's population. So, unless its industrialization reverses—not slows down but reverses—the demand for resources is about to accelerate.

TER: So slow acceleration brings an evolving country to a tipping point, after which the demand grows exponentially.

AD: Absolutely. And we could look at copper. . .at all of the resources. The pattern of consumption would be similar. It has much more significance than what happened in Korea or even Japan, because it's China—due to the population.

TER: How do the other BRIC countries figure into your equation?

AD: India is a long way behind. India today is about where China was 10 years ago. As China's economy reaches a mature stage—mature in terms of the consumption of commodities, which probably will be 10–15 years from now—India will be just about at that takeoff point.

TER: So, we have two tidal waves coming?

AD: Absolutely. India right behind China, and then Brazil and another country with a large population, right behind India.

TER: Why aren't the general investment markets seeing this?

AD: I think that in very long-term, dramatic trends, people always tend to be playing catch-up. You see it with individual companies with big discoveries that continue to grow. The stock price goes up, but it's still good value because investors also generally have difficulty with a big trend getting ahead of them. Their understanding of it is always lagging.

TER: What makes your book different?

AD: It's very accessible. My book is very much a primer, if you like, not aimed at experts in the field but rather for educated investors who don't really know much about resources. I think it is particularly helpful perhaps for newer investors, or investors who are new to resources, because I try to write without jargon. I try to make it understandable to ordinary, intelligent people who know a little about investing but don't necessarily know anything about resources. I don't cover every single resource out there but I cover the main resource areas in separate, short chapters. In the energy area, we cover oil and gas, of course, plus uranium, coal and geothermal primarily.

TER: You've talked a lot about quantitative easing (QE) in the U.S. in conversations, lectures and interviews. How does that factor into the trend toward higher commodities prices?

AD: There are always two major areas to consider any time you look at commodities—the supply/demand factors and the overall economic environment. Other things being equal, a declining dollar means higher commodity prices. More money being put into the system and low interest rates also mean higher prices for commodities. Well, guess what? We've got a falling dollar, more money being put into the system and low interest rates. So, we have the perfect economic environment on top of the perfect supply/demand situation.

TER: An accelerant on the flames.

AD: I have no doubt that, at some point in the next few years, we're going to see an upward, albeit temporary, correction in the dollar. I have no doubt that we're going to see a slowdown in China. When China's GDP growth drops from 9.5%–5%, 4% or 3%, everybody will think the world's ending—but that's still pretty good, positive growth. But it wouldn't surprise me if we had setbacks. Let's not forget that during the U.S. industrialization from 1870 to the start of World War I, the U.S. had a depression, a recession, strikers getting shot in the streets—all sorts of problems. Think of England's industrialization after the Napoleonic War, from 1815–1840, when Britain transformed from an agrarian to an industrial economy. Again, recession, deflation. . .all sorts of problems going on intermittently. I have no doubt that will happen in China, too; but if you take the big-picture view and don't let these setbacks scare you, you'll look back to see that they only last a short time.

TER: Right.

AD: Resources are more cyclical than most things and there are basic economic reasons for that. If you look back in history, the longest sustained periods of rising prices for commodities across the board always can be identified by a new source of demand—not a shortage. So, if you look at resources from 1870–1914, you see a long, upward move in resources. The same goes for the period from 1815–1840.

Investors must understand major market drivers and why the industrialization of China, and the growing middle class that goes with it, are so important. People in cities use more resources than people in the countryside. Middle-class people buy things that use more resources than poorer people, etc.

If we come into a slowdown, look at whether those major drivers have reversed and are no longer valid. Is this the end or just a temporary slowdown? If you agree that this is a long-term super cycle, don't let the corrections scare you.

TER: What basic strategies do you tell people to employ?

AD: The main strategic advice I give to people is to be really careful not to sell out too soon. I believe this is a multiyear bull market in resources. We'll see resources prices go much higher. I don't want to sound as if I'm waving my arms because I don't normally talk that way. Still, over 5, 10, 15 years, I think prices will go higher than we can imagine right now. Part of that will be in deflated dollars, of course; but if you buy quality companies with sound balance sheets that own resources in the ground in good jurisdictions, avoid the temptation to sell when the stock moves a little bit. You may not have the opportunity to buy back.

TER: When you say a bull market in resources, how do you define resources?

AD: I must admit I switch around a bit between the words "resources" and "commodities," but in this context I'm talking about everything from precious metals to base metals to energy—oil, gas, uranium, geothermal—as well as agriculture. I think agricultural assets will be among the best-performing assets over the next decade.

TER: What is your macro perspective on the growing demand, specifically for energy resources?

AD: Energy is a key ingredient as a country industrializes and its economy grows, and as it moves from a rural to an urban society. It needs energy for power and transportation, so the demand for energy will go up as much as the demand for any other commodity. China gets much more of its power from coal than do other countries and plans to get more from uranium than other countries.

TER: Wind or solar?

AD: Surprisingly to some, China also gets a higher percentage of its power from renewable sources than most of the green countries around the world—everything from wind to solar to biomass. And it's going to need every energy source it can get. Just to give you one way of looking at the potential—in China, one third of the people rely on traditional biomass fuels for cooking.

TER: What sort of investment opportunities in coal can you tell us about?

AD: The problem is that the "purer" coal companies, such as Teck Resources Ltd. (NYSE:TCK; TSX:TCK.A, TSX:TCK.B), are not exceptionally cheap right now. Probably one of the best ways for the ordinary investor to get exposure would be through one of the large diversified resource companies like BHP Billiton Ltd. (NYSE:BHP; OTCPK:BHPLF), clearly not exclusively coal but a very large coal producer. It's very close to the main market in China and is expanding its coal.

TER: China and Mongolia have massive coal resources. Do they really need to expand nuclear?

AD: Absolutely. They've gone from being a net exporter of coal to a net importer. Most of their coal mines tend to be rather old, extremely dangerous. So, China's own deposits of coal are in no way a solution to China's power needs.

TER: How rapidly will China expand its nuclear energy resources?

AD: It has more than 40 power plants on the drawing board currently or in various stages of production as part of a process that will be staggered over the next seven or eight years. Some are being built already, some are in development and some are still on the drawing board. This compares with 13 currently in operation and a further 23 under construction, but as many as 120 have been proposed beyond those. This phenomenal growth will mean huge demand for uranium.

TER: China has uranium mines. Will it have to import uranium, too?

AD: Oh, absolutely. There simply isn't enough uranium that we know about in China to feed its own demand. It just signed a 20-year contract to buy uranium from Cameco Corp. (NYSE:CCJ; TSX:CCO), and it's making these deals around the world.

With nuclear energy, one component that's a little different from other sources is the plant itself. The largest part of cost from discovery through to output is the capex for building the plant. Relative to other power sources, operating costs tend to be low once you build a nuclear plant. The cost of uranium as a percentage of overall cost of that power for 20 years is extremely low; but, by the same token, a nuclear power plant cannot switch to coal or gas. So, once you've put all those billions of dollars into building a plant, it's critical to get the uranium—at almost any price. I won't say it doesn't matter how much, but it is certainly not a project killer if uranium runs up to $300/lb. The uranium price is far less important than the dependability of supplies.

TER: So, why hasn't the price of uranium gone up?

AD: Well, China's big demand increase for its nuclear plants won't really start until 2015, 2016. India and other countries haven't really started yet. At the same time, we have excess supply now. Kazakhstan, which is acting as a swing producer, has a lot of excess capacity; so it can increase its production relatively easily as the price moves up and pull back if the price goes down. That's the main reason uranium is fairly low. That said, because markets tend to look ahead and discount, I don't think we're going to have to wait until 2015 to see shortages start. In the second half of this decade, we'll see a real supply/demand imbalance. At that point, prices will go up.

TER: Is there enough uranium exploration underway to address that shortage to some extent?

AD: There's a reasonable amount of exploration. Uranium has certain attributes—both real and imagined—that differ markedly from, say, gold or copper. Few people want a uranium mine next door, so it takes a lot longer to get exploration permits. Several current deposits in the U.S. could be mined but they're still in the permitting stage.

Another issue is that exploring for an economic uranium deposit is technically more difficult. With a big open-pit copper operation, you can miss the core of the deposit by half a mile but still mine the deposit. With many uranium deposits, it's a bit like looking for a needle in a haystack—they tend to be extremely rich but very small.

TER: What are some uranium companies you like?

AD: On the exploration side, I like to minimize risk and prefer the simplest, most direct investment with the least downside. But rather than look for a pure-uranium exploration play that may or may not find an economic deposit, and may or may not get the permits even if it finds one, I prefer more broadly diversified explorers that have exposure to uranium. Altius Minerals Corporation (TSX.V:ALS) has two uranium exploration joint ventures (JVs) with other companies. So, if the uranium price goes up sufficiently you'll get the exposure.

TER: What else is Altius invested in?

AD: Gold, iron ore, nickel and uranium are the four main products. It has the large royalty in Voisey's Bay, a gold mine in production in another JV and also phosphates. Everything it does is JV, so it's low risk.

TER: Any other uranium explorers you want to talk about?

AD: I don't do much with the explorers. I look more at producers and other companies in the uranium business. In uranium, Canada's Uranium Participation Corp. (TSX:U) is a good way of buying. It's a closed-end fund, so it trades at a premium and sometimes a discount. You should avoid buying when the premium is too high. But that holds uranium, so it's a direct play on the uranium price. You don't have the exploration risk, but you don't have the upside either.

TER: How about among the uranium companies themselves?

AD: AREVA (PAR:CEI) is an explorer and producer that's JV'd with Cameco on many of its projects and is part owner of Cigar Lake. It also has other exploration projects. More importantly, in JV with other companies, it builds power plants and also is involved in depleted uranium disposal—really a one-stop shop for uranium.

TER: It's virtually integrated.

AD: That's right. The problem with AREVA is that it's owned mostly and controlled totally by the French government, so you can't be sure what's going to happen from day to day. But CEO Anne Lauvergeon is first-class, well respected around the world. It's a great company. I like AREVA.

TER: Any others?

AD: Among the smaller producers, I think Paladin Energy Ltd. (TSX:PDN; ASX:PDN) in Australia is a good company with a lot of upside potential.

TER: What intrigues you about the renewable sector?

AD: With growing consumption for energy, we're going to need to get it from every source we possibly can. I'm not a big greenie, but I don't like pollution anymore than anybody else. The more green sources we can get the better. Some of these are also renewable, which is the best of all. Solar is not renewable in the sense that you get rid of the solar panels when they run out after 10 years or so.

TER: But geothermal. . .

AD: The best of all worlds because geothermal has a very small environmental footprint. When the plant is running it doesn't disturb much of the environment. It's essentially permanent, totally renewable with no toxic byproducts. It's a small sector, though, and obviously you don't produce geothermal energy in California and ship it off to China. So, the China story doesn't come into play with geothermal except to the development of its own geothermal resources; and China's demand for energy generally will affect the economics of power everywhere.

TER: Do you follow any geothermal companies?

AD: The largest pure play is Ormat Technologies Inc. (NYSE:ORA), which isn't particularly inexpensive right now. Chevron Corporation (NYSE:CVX) is the largest U.S. geothermal company but, obviously, you don't buy Chevron just for geothermal exposure. Some juniors in the middle include Ram Power Corp. (TSX:RPG) and Magma Energy Corp. (TSX:MXY), both of which are well diversified country wise. Ram has a good balance sheet; Magma has significant capital needs in coming months. But both have access to capital, which is critical.

A lot of very small companies are capital-constrained. You don't get government grants until you've spent the money, so they're in a Catch-22. If they could only get the money to explore, they could get the government grant to pay it back; but they're too small to get access to capital. Thus, many of them have been taken over on disadvantageous terms, which I think soured people a little on the entire sector. The whole geothermal area is starting to bounce back, but it had declined dramatically over the last 18 months.

TER: So, it's a buying opportunity.

AD: I think so. They've come off the bottoms quite significantly, but I still think this is a very good time to buy them. Magma's at about $1.47—up from about $1, down from about $2.

TER: Has Magma worked out its differences with singer Bjork, who was among the Icelandic celebrities opposing its purchase of HS Orka?

AD: Very interesting story. Magma now owns essentially all of HS Orka, which is the largest geothermal source in Iceland. Ross Beaty, Magma's CEO, did offer to sell Bjork either one-fourth or one-third of the power plant if she wanted to pay him at cost, no profit. She said, no. He didn't understand; she didn't want to own it—she just didn't want him to own it. So has it been solved? Yes, the near-term situation has been solved. A government panel was set up to investigate and ruled that everything was in accordance with Iceland's rules.

TER: You said this is a near-term solution?

AD: Yes. No question, there is a fundamental issue in Iceland about foreign financiers coming into the country. It had a bad experience in the credit crisis in 2008, which left underlying sentiment against foreign financiers. There's also an underlying sentiment against foreigners taking over its key assets, energy being one. They don't have a lot in Iceland. Geothermal is just one of the things they do have.

Ross has said publicly and he keeps repeating it—he wants an Icelandic partner. And he's not only willing to sell a minority, 25%, 33%, but at his cost. He said he doesn't want to take a loss but doesn't want any profit, either. So far, no one's stepped up.

TER: An Icelandic partner makes sense.

AD: Yes, in part to defuse the political situation there. In any country, it's always good to have a local partner; and frankly, to free up some money and put it to work in Magma's Chilean and U.S. properties.

TER: Does Magma have power agreements in place for those U.S. projects yet?

AD: Not yet. Ram is a little more advanced in its U.S. projects. It has a better balance sheet and it has the power agreements, though it, too, will have to juggle to ensure it has the necessary capital for its development and exploration projects at the right time over the next few years.

TER: Plus an existing power plant in Nicaragua, that's doing something like 10 megawatts. Ram is also developing larger operations there, isn't it? How is that progressing?

AD: Things are developing well, pretty much on schedule. There are always delays in this business, but no extraordinary delay. Ram has a very broad portfolio and acquired Sierra Geothermal Power Corp. this summer, which gives it more early stage property to develop.

TER: Are there any other opportunities for geothermal investment?

AD: For those who are more aggressive and can tolerate the volatility and higher risk, some of the smaller U.S. companies are good buys. US Geothermal Inc. (NYSE.A:HTM) and Nevada Geothermal Power (TSX.V:NGP), for example, are probably the largest of the small ones. But remember, the smaller companies are also potentially nearer-term takeover targets; and when a company is taken over because it can't raise money, the sale doesn't necessarily command a good premium.

TER: Can you give us your high-level viewpoint on oil and some investment opportunities in that space?

AD: My high-level viewpoint on oil is not all that different from what I see for copper, zinc and everything else—a huge demand increase from China. It will need oil to fuel its cars, and it also uses oil in power generation, just not as great a percentage as other countries. Now, there is no meaningful substitute for oil, and certainly not for China. Yet, this huge demand increase for oil is building but we're not finding sufficient new sources of oil to replace what we use, let alone to meet greater demand.

We discovered the most oil way back in the mid-1960s when we discovered oil in the North Sea and Alaska at the same time. Those were huge fields. Looking back, this was closer to World War I than it is to today. From then to today, it's been a fairly steady decline with a few peaks and valleys. But on rolling three- or five-year basis, we are finding less new oil every year.

In the early 1980s, oil demand surpassed oil production. And annual oil consumption has exceeded that of discovery every year since, by an increasing amount. All of these big fields, including offshore Brazil, are wonderful. And many oil fields last a long time, so I won't say we're running out of oil anytime soon. But we can see an impending problem coming, because we've stopped discovering as much as we did previously and we're using more than we produce. Clearly, we're reaching the point where oil demand will greatly exceed production and the oil price has to go up.

TER: Does that mean the investment opportunity in oil is more due to the prospect of higher prices than new discoveries?

AD: Yes, I think so. The exploration and production (E&P) companies are always exploring and finding new sources, but many of those simply aren't significant in a long-term global view.

TER: If the oil price is going to go up, why not just go with big, heavily oil-focused players like BP Plc (NYSE:BP; LSE:BP), rather than look at options like the Canadian tar sands?

AD: Good question. It varies but the big global companies tend to be vertically integrated, exploring, refining and selling, and a higher oil price doesn't necessarily benefit them across all operations. Some are actually oil-price neutral. The large integrated oil companies also have an enormous replacement issue. Independents like Apache Corporation (NYSE:APA), EOG Resources (NYSE:EOG) and Devon Energy (NYSE:DVN) have nowhere near the serious replacement issue as Exxon Mobil Corp. (NYSE:XOM). For the global majors, most oil-reserve improvements come from either acquiring other companies or revising existing reserves—not new discoveries.

That can go on for only so long. I don't invest much in the big integrated companies other than short-term moves when they get oversold. If I were to pick any company, it would probably be BP because a much larger percentage of its revenue comes from E&P than refining. But even BP has a huge replacement problem.

So then, the next thing to look at would be the large impendent E&P companies. There are some very good companies in that space. Devon is one of the best—great balance sheet, less than 20% debt to capital, growing production. It recently sold all its offshore assets, including those in the Gulf of Mexico, shortly before the Deepwater Horizon disaster. It also sold a lot of other offshore assets around the world to focus on North American onshore. Devon is one I like.

We also own Chesapeake Energy Corp. (NYSE:CHK) and Encana Corporation (TSX:ECA; NYSE:ECA), which also has some oil sands, and those are very long-lived assets. They are high-cost assets, too; so as the oil price moves up, you have much greater leverage with oil sands than with traditional oil producers. The U.S. will likely continue to have much greater access, so it won't have the supply problem buying oil from Canada that it might have with Saudi Arabia, Venezuela or a host of other countries.

TER: Do you have some specific oil sands companies that you like?

AD: Canadian Oil Sands Trust (TSX:COS.UN), which is a unit trust, is one of my favorites. I also like Cenovus Energy Inc. (TSX:CVE; NYSE:CVE), which was created when Encana separated its gas assets (in Encana, now a pure gas play) and its tar sands assets (in Cenovus). Suncor Energy Inc. (TSX.V:SU; NYSE:SU) is a good company, too, but I think it's a little expensive right now.

TER: But Canadian Oil Sands looks good now?

AD: The other ones I would wait for, but at roughly $26, Canadian Oil Sands is a great long-term buy, and it's cheap relative to the rest of the sector. When we think of oil trusts, we think of something like the ARC Energy Trust (TSX:AET.UN) or something that pays a high and dependable yield. That never was the COS story, though it sports a very nice yield—over 7% currently. Still, uncertainties over the end of favorable tax treatment for unit trusts—despite that it's not an issue with Canadian Oil Sands—affects all the trusts.

TER: Would you be interested in an ETF for exposure to higher oil prices?

AD: No. GLD, the gold ETF, is a great way to play gold and Uranium Participation Corp. is a great way to directly play uranium, though the latter is a closed-end fund—not an ETF. The problem with commodity ETFs is that, by and large, they invest in futures contracts, not the commodities themselves. With some commodities, oil particularly, you have very high contangos—the difference between forward and spot prices. So, they're continually rolling over contracts at higher prices. Oil is a classic example; while the oil price is up this year, the oil ETF has actually lost money—over 11%. They're always buying high and selling low, which is not exactly the road to successful investing.

TER: Are you long on gas?

AD: We are definitely long on gas, but even longer on oil. We'll have to wait a bit for gas. Because of the new shale that's come on, we've gone from what everybody saw as a permanent gas shortage to a permanent gas glut. Many gas producers have since started shifting over to more oil; for example, EOG was exclusively gas and liquefied natural gas (LNG). Last year, it made a decision to go 50/50 oil and gas. A lot of these companies are backing off development in some of their gas fields due to the low price and the glut.

Ironically, I think a new source of gas like shale—which means a dependability of supplies—also means people will be more willing to put the capital into gas-fueled fleets of buses and so on because they know we can get the gas.

TER: Do they expect the glut to go on forever?

AD: While there's no doubt that the shales have been remarkably and unexpectedly successful, there's still an open question as to how long many of them will last. The decline rates—going from the first to subsequent years of production—have been very, very fast. . .much faster than with conventional oil. We don't really know yet how long the tail will be. There's a lot of debate in the industry about that.

TER: How would an investor play the natural gas sector?

AD: Encana is good. Some of the trusts are good, such as ARC, which are both oil and gas. For the more aggressive investor, some of the smaller Canadian oil companies that are a bit capital-constrained are good plays.

TER: Any other companies you'd like to talk about?

AD: One of my favorites in the general resource area would be Sprott Resource Corp. (TSX:SCP). If you buy Sprott, which is quite a liquid company, you're getting it at a discount to net asset value (NAV). NAV is about $5.20; the stock's been trading at about $4.35. You're also getting great management—Kevin Bambrough and company—and a great balance sheet.

Sprott has direct and indirect investments in different resource areas, buying whole companies, sponsoring companies or growing them. The four main areas it's in now are: 1) gold, primarily gold bullion; 2) oil and gas; 3) agriculture; and 4) fertilizer. When the companies reach a certain level, ideally it will spin off a certain amount of the shareholding in a public company. Sprott is extremely disciplined and has done this a few times already—with Orion Oil & Gas Corp. (TSX:OIP), for example, which started trading on the Toronto Stock Exchange almost a year ago.

Sprott also has JVs, including one in phosphates with Altius, and owns shares in Lara Exploration Ltd. (TSX.V:LRA). The agriculture play is very interesting—One Earth Farms Corp.—a JV with First Nations, which owns more than a million acres of farmland. It's going to be a big business, one of the largest commercial farms in North America. It's really quite staggering. It's still a private company, but it's selling some shares in a secondary offering, raising $40M–$80M. If it brings in the maximum, it will take Sprott's stake down to 24%. In a year or two, it'll IPO. That's what it's trying to do—take a direct investment, build up the company and IPO it.

TER: Any other comments to wrap this up?

AD: We need energy for a modern industrial society and we need lots of energy for an agrarian economy to industrialize. We need all these sources—oil and gas, coal, uranium and geothermal. We're probably going to need a few solar panels and windmills, as well.

Adrian Day, a British-born writer and money manager who graduated with honors from the London School of Economics, has made a name for himself searching out unusual investment opportunities around the world. As president and CEO of Adrian Day Asset Management, he generously shares his thoughts, opinions, insights and analyses via Barron's, Forbes, Bloomberg Markets, Kitco, Casey, The Stock Advisors, Dick Davis Digest, MSN Money, Financial Times, The Daily Reckoning, The Herald Tribune, The New York Times and, of course, The Gold Report—among others. A frequent speaker at international seminars and a regular guest on CNBC and The Wall Street Journal Radio Network, he has been interviewed by Money, Straits Times, Good Morning America and others. He also writes the quarterly Portfolio Review newsletter for clients, serves as editor of Adrian Day's Global Analyst and has authored three books on global investing: International Investment Opportunities: How and Where to Invest Overseas Successfully, Investing Without Borders and the just-published Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks, which is now available in hardcover and e-book format.

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DISCLOSURE:
1) Karen Roche and Brian Sylvester of The Energy Report conducted this interview. They personally and/or their families own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report or The Gold Report: Lara Exploration, Nevada Geothermal and Ram Power.
3) Adrian Day: I personally and/or my family own shares of the following companies mentioned in this interview: Altius, Magma, Sprott, Devon and Encana. In client accounts that I manage in addition to these stocks, we also own Chesapeake, Arc Energy, Canadian Oil Sands, EOG, BHP, Cameco, Ram Power, Uranium Participation Corp., SPDR Gold Trust and Areva. I personally and/or my family am paid by the following companies mentioned in this interview: None.

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Meanwhile back at the ranch during our knockabout sessions we have toyed with the idea of running an Accumulator whereby we make a trade and then use the total proceeds for the next trade and so on. So the stake and any profits are rolled into the next move, if you would like to comment on this idea, then please click here.

Over in the options trading pit the team have updated the progress chart to include closed trades, now 53 winners and out of 55 trades, having been stopped out of a trade with a profit of 41.84% made in just 8 days. We currently have a number of open positions which we are pleased to say are all in positive territory.

sk chart 19 Nov 2010.JPG



The above progress chart is being updated constantly. However, to see exactly how it is going, please click this link.

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Stay on your toes and have a good one.

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