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Thursday
Jul152010

Porter Stansberry: “We Can’t Live without Gulf Oil”

Gulf Oil Spill 16 July 2010.jpg

Source: Karen Roche of The Energy Report 7/15/10
http://www.theenergyreport.com/cs/user/print/na/6811

Tragic as the situation is, "everything is going to be okay" in the Gulf of Mexico, according to Stansberry & Associates Investment Research Founder Porter Stansberry. Porter, who built his reputation on finding safe-value investments poised to give his followers years of exceptional returns, also has a reputation as an independent thinker with a penchant for "out-of-consensus" viewpoints. He shares some of his contrarian opinions in this exclusive interview with The Energy Report. Porter sees no risk of bankruptcy or default with BP, the Macondo emerging as an enormously beneficial well, and more drilling there in the future because 1) there are no good replacements for oil and 2) "we can't live without oil from the Gulf."

The Energy Report: The major discussions on the energy front in the United States seem to lead to a single conclusion, that we have to start using domestically generated alternative sources of energy and stop relying on foreign oil. We all know the hot topic since April. What are your viewpoints on the impact of this disaster—not only on the Gulf of Mexico, but also on BP (NYSE:BP; LSE:BP), deep-sea drilling and on the energy sector?

Porter Stansberry: First, full disclosure. I have recommended to my subscribers Anadarko Petroleum Corp. (NYSE:APC), BP's partner in the well that's leaking in the Gulf, and I personally own shares in BP. I bought my stake in BP recently because I don't believe the total costs of cleaning up the spill will be material to the company's earnings over the next decade. I think BP today is a phenomenal opportunity for any investor who has the emotional wherewithal to handle some volatility.

If you look at BP's debt, it barely budged. BP's bonds fell a bit more than 20%, with prices never falling below $80. Currently BP's debt is yielding 5.9%. There's no real risk of a bankruptcy or default. Folks like Matthew Simmons saying bankruptcy was likely was simply laughable. BP generates $30 billion a year in cash from its operations, and the total cost of the cleanup will not exceed $30 billion. I just don't believe it. So I think BP is a fantastic buy at current prices, and I recommended Anadarko because the way my publishing company works, we're not allowed to recommend things that we own ourselves, and I think Anadarko is a lot less at risk. I gave what I think is the better play to my readers.

TER: How is Anadarko a better play?

PS: Anadarko has fallen more than BP has, and it has even less exposure to this well. It only owns 25% of it. Even if you assume that Anadarko will be responsible for 25% of the cleanup costs, in my estimation, you're still only looking at a total bill of between $3 billion and $5 billion. That's very affordable for Anadarko. But more importantly, Anadarko has a fantastic case in that it doesn't owe a penny of the cleanup because from what we already know, it seems 100% certain that BP was negligent in operating this well. Pretty much everyone who's looked at the facts has said so, including some independent guys I hired to look at the situation. So I think Anadarko will walk away from this thing without a penny lost.

It hasn't occurred to many people yet that this one well is producing about 30% of Anadarko's entire global production. I mean this thing is a monster, and they're going to get it under control. Meanwhile, Anadarko owns something like 3 million acres around this well. They are the largest independent operator in the deepwater gulf. And they're going to drill more wells eventually. I think we'll see a big turnaround in this whole process. I think the well can be cleaned up; I don't think that it's a disaster of the scope that people are saying. And I think the discovery will eventually lead to large increases in production for Anadarko.

Look at what happened in the Persian Gulf when Iraq's troops withdrew from Kuwait. You're talking about a much smaller body of water and you're talking about much, much larger volumes of oil that were spilled—in that case deliberately—into the water. Nobody paid to clean it up. They just left it. Nature took its course, the oil eventually was broken down and everything was fine. Going back there two or three years later, you couldn't even tell it had happened.

Listen, I am not saying it's not a tragedy; I'm not saying we shouldn't try to prevent it from happening, but I am saying it's not the end of the world. There have been spills this big in the Gulf of Mexico before, and they didn't destroy it. [Editor's Note: As of the date of this interview, (6/29/10), the Deepwater Horizon Gulf oil spill had not surpassed the Ixtoc 1 oil spill (6/3/79) in the Gulf.] Everything is going to be okay. But if you turn on the news right now, you'd think the entire Gulf of Mexico is a big boiling pot of oil and that the whole Gulf Coast will never going to be the same. I just don't believe those things are true.

TER: But perception is reality when it comes to regulation. In that context, why wouldn't this have the impact on oil that Three Mile Island had on nuclear?

PS: That's a good question, but if you believe the government is here to protect us, I just think that you're naïve. There's no doubt in my mind that the companies supposedly being regulated are easily capable of influencing those regulators, through lobbying or simply the essential corruption of the entire government-corporate structure, especially in the oil business. And then finally, like it or not, we can't live without the oil from the Gulf.

Will there be regulations? Sure. Is it going to be harder for smaller companies to be entrants into that marketplace? Absolutely. But is that bad for BP or Anadarko? No, it's good for them. If their costs go up, guess what else is going to go up? The price of oil will, so those are passed on to you and me.

TER: Meanwhile, in the wake of this spill, many people are talking more about alternative ways of getting oil. For instance, I've seen oil shale discussions on morning TV. How realistic is it to expect more production out of tar sands, etc.?

PS: Well, the Eagle Ford shale has a lot of condensate in it, which isn't necessarily oil, but actually in some cases is more valuable than oil because it's easier to crack it into gasoline. There's already a lot of natural gas liquid production today in various shales across the country, and I expect big increases in that.

I have an out-of-consensus view here, but my sources—all practicing oilmen in Texas who own land in the Eagle Ford and have drilled wells there themselves—tell me that they believe the Eagle Ford will be the largest single oilfield in the history of the United States. And they said oil, not natural gas. They're talking about natural gas liquids, which are just as good as oil—or as I indicated, even better in a lot of cases.

TER: That sounds like good news.

PS: Depending on your outlook, I'm afraid it means that natural gas prices will stay depressed for a very long time, but it's definitely going to be a big game-changer for domestic, onshore production. Just last month, Reliance Industries Ltd. (BSE:RIL), the biggest conglomerate in India, paid around $1.3 billion for 40% of Pioneer Natural Resources Co.'s (NYSE:PXD) Eagle Ford property. China hasn't bought anything in the Eagle Ford, but they will. I personally think they're likely to buy Petrohawk Energy Corporation (NYSE:HK). I have no evidence of that, just an instinct. Petrohawk has some of the best properties, but China is probably the only one willing to pay the very high price they're demanding. So that's the next deal I expect. You're definitely going to see a lot more deals.

TER: What stands out about Petrohawk?

PS: I think its first year's drilling campaign was in 2009, and they drilled something like 28 different holes without a single dry one. When you have no dry holes, the return on your capital from your drilling program is vastly higher. It's a whole new ballgame. It's just vastly more efficient and therefore the eventual profit margins from production will be even higher than they already are.

In my mind, horizontal drilling and the existence of liquids in these shales is the game-changer for the energy business, and I really don't think people appreciate how big a change it's going to be or how large the production from these fields is going to be. But there is one big hiccup in all of this.

TER: What's that?

PS: There are a lot of environmental concerns about the fracking process, and I don't think that they're going to go away. Thus, I anticipate much tighter controls going forward on the horizontal drilling technologies that these companies have been using, which will make drilling progressively more expensive. Right now a single well costs them about $5 million to drill, but it wouldn't surprise me at all to see the price increase significantly to $10 million or $15 million per well just because of the costs of using these chemicals and making sure they get cleaned up.

TER: Does this provide an investment opportunity—looking at the drilling companies as opposed to the oil producers?

PS: That's a tough question. When you can buy a drilling company at a 50% discount to the value of its rigs, it's a good buy, but drilling isn't a high-margin business, so they inevitable trade at a huge discount to book as soon as the price of the commodity falls. In my mind, that makes them really speculative for the average investor. I think it makes more sense just to buy the companies with the best acreage in the field, and sooner or later you're going to make a lot of money. Even if it takes a long time to get all the holes drilled, the resource is there.

I don't think most investors appreciate that there aren't any dry holes in these fields because they use seismic technology to look before they drill. They know the exact depth of the shale and once they know they're in it, they just drill sideways.

TER: You talked about how massive Eagle Ford is. Are other fields in the U.S. exciting much discussion?

PS: Absolutely. And they're pretty much all over the place. I think they have shale gas production now in 30 different states. The big ones are the Marcellus, Haynesville, Barnett and the Bakken. I think the difficulty is trying to produce these wells in a way that isn't very destructive to the environment, because horizontal drilling and the fracking process are very disruptive to groundwater supplies. They have to be really careful where they do this kind of drilling to avoid the risk of contaminating a large reservoir.

TER: Considering the contamination in the Gulf of Mexico, and the risks to groundwater in horizontal drilling for oil, why isn't there more focus on alternative energies? Or, considering that we have so much natural gas, why not focus on going to natural gas instead of oil?

PS: To get the natural gas out involves a lot of environmentally risky things, too, because these shales are tight rock formations, and you can't just drill a hole in them. You have to blast them apart, and blasting underground rock apart using high-pressure liquids inevitably risks busting through into underground aquifers, which can lead to a lot of problems. There are places where people can light their water on fire now when there's been drilling nearby.

So even natural gas is not risk-free, and I think it's absurd for the American people to believe that you can have natural gas at $4 and not take any risks in your discovery and drilling programs. I am not saying we should take silly risks. But look, how long have we been drilling in the Gulf of Mexico, and how many accidents have there been? The safety record's pretty damn good. Are we going to get rid of commercial airlines because sometimes they crash? You can't go on without taking any risks.

But as far as the answer to your more important question, we can't get off oil because oil is a fantastic source of energy; relatively inexpensive to find and produce, extremely dense and portable. There aren't any good replacements. Other ideas that people have put forward are not very workable. For example, the notion of powering the entire transportation infrastructure of the United States with electricity is complete nonsense. If everyone plugged in their automobiles and trucks, the entire grid would melt.

Where would that electricity come from? How many more coal-fired power plants would we need to build if everyone tries to plug in their vehicles? If you do the math, it's a very large number. We don't have the capital to build them, and couldn't survive the pollution from the coal. So there are no cheap and wonderful and easy solutions. Solar power is not going to amount to anything, despite Al Gore's claims to the contrary—certainly not in the next decade, and probably not in my lifetime. It's just too incredibly inefficient, and, of course, it doesn't work when the sun isn't up.

Likewise with windmills. How many windmills would you have to build just to replace the existing coal-fired power plants? It's an absurd number; it's not feasible; it's not economic. Not compared to a huge well like BP and Anadarko discovered.

TER: In our last conversation related to energy in December, you didn't really see anything happening in coal and natural gas, either, nor at that time, in the nuclear arena. You didn't see any of those as representing any realistic investment opportunities. Do you still feel that way?

PS: I tell you what I am getting very, very bullish on, the shares of a leading nuclear power company in the United States, Exelon Corp. (NYSE:EXC). I've recommended it to investors in my newsletter for many years. We bought it at $21/share or something like that after the correction in the tech boom in 2002, and it pays a really nice dividend, $2.10. We're getting paid 10% a year just to hold the stock, and meanwhile it's a regulated utility. There's no way it's going out of business, and if you buy it at the right price, it's a wonderful long-term investment.

It hasn't been at the right price for a very long time, but right now you can buy it for about five times cash earnings, and the yield on the stock is 5.5%. We're in the range where I would be willing to allocate capital to Exelon's common stock. It's the largest operator of nuclear power plants in the United States, and I certainly believe that going forward nuclear power is the only realistic alternative to coal-fired power plants. It's the only way to generate enough electricity at a reasonable price.

TER: Are there other nuclear facilities, or nuclear companies, that you also see as also being undervalued at this time?

PS: I am sure the large-cap nuclear stocks are all going to be pretty cheap. Another large operator I like a lot is Duke Energy Corp. (NYSE:DUK), which is probably roughly the same in terms of price and value as Exelon right now. I just happen to like Exelon better because I have owned it for longer, and it's actually cheaper than Duke when you look at it on an enterprise value basis. When you get 5.5% owning the best nuclear operator in the U.S., you don't have to look anywhere else.

TER: That's true. A moment ago, you said that nuclear is the only way to generate enough electricity at a reasonable price. If that's the case, do you foresee a play in uranium again, as there was three or four years ago?

PS: That's a whole different question. To tell you the truth, I just haven't looked at uranium. Some analysts I'm friendly with follow it, but I haven't been excited about uranium in a long time. At the New Orleans Investment Conference in 2007, I put up a chart on uranium and said, "This is the biggest bubble in the world." I was maybe 60 days early and the whole thing just collapsed. I am not saying you can't make a lot of money in uranium mining, because I am sure you can. To buy a uranium producer, though, you've got to really know a lot about the quality of the ore and that goes well beyond my expertise.

TER: Any other insights you would like to give to our readers?

PS: We have been in such a bizarre period since 2006. Nothing makes any sense in terms of economics or finance globally. It didn't make sense for people to be able to get a 30-year mortgage with no income, no job and no equity in the home. We haven't yet recovered from all of that and other nonsense that's been going on, and it continues. It doesn't make sense for General Electric Company (NYSE:GE) to be levered 30 times tangible equity. It doesn't make sense for America's largest and most important conglomerate to have that much debt. It doesn't make sense for a country like Italy, which has a horrible record of repaying creditors, to be able to borrow 110% of GDP. So we have all these things that just don't make any sense going on, and then people ask, "What should I do with my money?"

And the thing to do, my friends, is be very, very careful because there are tremendous panics and volatility to come. We are a long way from the lifeguards coming out and declaring the "all clear." So be very, very cautious; don't be upset about having a large cash position. I told my readers earlier this year that if they weren't prepared to put half their portfolio in short stocks, if they weren't prepared to truly hedge themselves this year, that they should be 50% in short-term Treasuries and 50% in gold. That's the only way to have a totally safe cash position, because you're hedged with the gold versus the dollar. I am happy to sit in that position for a long time until I see some terrific values.

TER: Porter, once again, we appreciate your time and your insights.

After serving a stint as the first American editor of the Fleet Street Letter, the oldest English-language financial newsletter, Porter Stansberry put out his shingle at Stansberry & Associates Investment Research, a private publishing company. Celebrating its 10th anniversary last year, S&A has subscribers in more than 130 countries and employs some 60 research analysts, investment experts and assistants at its headquarters in Baltimore, Maryland, as well as satellite offices in Florida, Oregon and California. They've come to S&A from positions as stockbrokers, professional traders, mutual fund executives, hedge fund managers and equity analysts at some of the most influential money-management and financial firms in the world. Porter and his team do exhaustive amounts of real world, independent research and cover the gamut from value investing to insider trading to short selling. Porter's monthly newsletter, Porter Stansberry's Investment Advisory, deals with safe-value investments poised to give subscribers years of exceptional returns, while his weekly trading service, Porter Stansberry's Put Strategy Report, shows readers the smartest way to book big gains during the ongoing financial crisis.

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, publisher of The Energy Report, conducted this interview. She personally and/or her family own the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: None.
3) Porter Stansberry: I personally and/or my family own shares of the following companies mentioned in this interview: BP. 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


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.

The latest trade from our options team was slightly more sophisticated in that we shorted a PUT as follows:

On Friday 7th May our premium options trading service OPTIONTRADER opened a speculative short term trade on GLD Puts, signalling to short sell the $105 May-10 Puts series at $0.09.

On Tuesday the 11th May we bought back the puts for just $0.05, making a 44.44% profit in just 4 days.



Accumulated Profits from Investing $1000 in each OPTIONTRADE signal 14 May 2010.jpg

Recently our premium options trading service OPTIONTRADER has been putting in a great performance, the last 16 trades with an average gain of 42.73% per trade, in an average of just under 38 days per trade. Click here to sign up or find out more.


Silver-prices.net have been rather fortunate to close both the $15.00 and the $16.00 options trade on Silver Wheaton Corporation, with both returning a little over 100% profit.

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
Jul142010

Mini Nukes Event in Arlington

Hyperion plant.jpg

EUCI Conference on Small and Modular Nuclear Power Reactors to Offer Complete Story on the Promising New Industry
 
Just one more week before the July 19-20 event in Arlington

Washington, D.C., July 12, 2010 - Promising an enlightening break from routine Small Modular Reactor conferences, EUCI says it has scheduled a unique slate of speakers that will address new information and the untold story of the promising industry. "Licensing is important, but there's much more to the story of this exciting and promising industry than just the licensing," said Vince Gilbert, Chief Knowledge Officer at Excel Services who is one of the speakers. "This conference will provide some interesting information and view points that have not been fully explored before." 
 
In addition to Gilbert, speakers will include Hyperion Power's CEO John Grizz Deal, Former Assistant Secretary of the USAF William C. Anderson, Hawaii Senator Fred Hemmings, High Bridge Associates' Phil Moor, The Chamberlain Group's Andrew Marchese, global law firm Hogan Lovells' Mary Anne Sullivan and Daniel Stenger, David Johnson of ABS Consulting, and Jay Harris from Bruce Power among others. Special panels are set to include the U.S. Nuclear Infrastructure Council's David Blee, The Pegasus Group's Ed Davis, Annie Caputo of the U.S. Senate Committee on Environment and Public Works (invited), Frank Caliva of the Department of Commerce's Office of Energy and Environmental Industries, Paul Murphy from Milbank, Tweed, Hadley & McCloy, and Ajay Kuntamukkala from Hogan Lovells.
 
EUCI's Small Modular Nuclear Reactor Systems Symposium will take place July 19-20 at the Hyatt Regency Crystal City in Arlington, Virginia. 
 
While the conference will cover all the leading technologies for the burgeoning SMR industry, special attention will be paid to those that have not been at the forefront of publicity yet offer new advancements in science and engineering, and benefits to the end user. One such example is the new sub-classification of SMRs known as Mini Power Reactors aka MPRs.
 
The Hyperion Power Module (HPM), under development at U.S. Los Alamos National Laboratory (LANL), is one of the designs categorized as a Mini Power Reactor (MPR). The 25 MWe reactor utilizes the known components of uranium nitride fuel and lead bismuth eutectic as a coolant that eliminates the need for a location near a source of water. Hyperion Power Generation Inc. is a New Mexico-based small business "spin-out" from LANL that is paying for and utilizing the "brain trust" of the lab through a CRADA (Cooperative Research and Development Agreement).

Hyperion Logo 20 Nov 09.jpg


EUCI is a leading power and utility training firm offering a number of pertinent conferences this summer including its "Nuclear Power Fundamentals" course in Chicago in July, and "Nuclear Power Plant Operations" and a "Nuclear Power Probabilistic Risk Assessment" course, both in Atlanta in August. More information can be found athttp://www.euci.com.
 

Press Contact:
David M. Hickey
EUCI, Training Producer
dhickey@euci.com
Phone: (720) 988-1239
Fax: (303) 741-0849
www.euci.com



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.

The latest trade from our options team was slightly more sophisticated in that we shorted a PUT as follows:

On Friday 7th May our premium options trading service OPTIONTRADER opened a speculative short term trade on GLD Puts, signalling to short sell the $105 May-10 Puts series at $0.09.

On Tuesday the 11th May we bought back the puts for just $0.05, making a 44.44% profit in just 4 days.



Accumulated Profits from Investing $1000 in each OPTIONTRADE signal 14 May 2010.jpg

Recently our premium options trading service OPTIONTRADER has been putting in a great performance, the last 16 trades with an average gain of 42.73% per trade, in an average of just under 38 days per trade. Click here to sign up or find out more.


Silver-prices.net have been rather fortunate to close both the $15.00 and the $16.00 options trade on Silver Wheaton Corporation, with both returning a little over 100% profit.

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.

Saturday
Jul102010

Uranium Stocks Update 11 July 2010

Uranium Spot Price Chart 11 July 2010.jpg

The average spot price for uranium has remained steady for most of this year as the above chart from u308.biz indicates with the long term uranium price currently standing at $60.00/lb according to uranium.info. The sector remains flat for uranium stocks with very little in the way of movement other than a general drift to lower stock prices.

Long Term Price Indicator 11 July 2010.jpg

From time to time we see the odd sign that things are moving in this tiny sector or a recommendation to buy a particular stock hits the air waves which is all fine and dandy but the fizz soon dissipates as this sector is still not in vogue and therefore continues to be ignored. There are many examples of this lack of popularity as you are probably aware if you own some of these stocks including Cameco Corporation (CCJ) whose stock price has fallen from around $32.00 at the start of the year to close on Friday at $22.84. Another hot stock, Extract Resources (ASX:EXT) traded just a tad above $11.00 last September, closed on Friday at $6.95. Some of the smaller stocks have also been hammered and now trade at what appear to be silly prices. Is this a buying opportunity you ask? Well it could be, but until we some really positive signs of a turn around we prefer not to put any more cash into this sector. How long do have we to wait, maybe a year or so as this pattern of consolidation continues to move sideways.

Maybe there is a pleasant surprise waiting in the wings which would be most welcome, however, for now we will remain in observation mode until an opportunity presents itself.











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.

The latest trade from our options team was slightly more sophisticated in that we shorted a PUT as follows:

On Friday 7th May our premium options trading service OPTIONTRADER opened a speculative short term trade on GLD Puts, signalling to short sell the $105 May-10 Puts series at $0.09.

On Tuesday the 11th May we bought back the puts for just $0.05, making a 44.44% profit in just 4 days.



Accumulated Profits from Investing $1000 in each OPTIONTRADE signal 14 May 2010.jpg

Recently our premium options trading service OPTIONTRADER has been putting in a great performance, the last 16 trades with an average gain of 42.73% per trade, in an average of just under 38 days per trade. Click here to sign up or find out more.


Silver-prices.net have been rather fortunate to close both the $15.00 and the $16.00 options trade on Silver Wheaton Corporation, with both returning a little over 100% profit.

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.

Friday
Jul022010

The Hungry Dragon: China’s New Oil Market

The Hungary dragon 02 July 2010.jpg

By Marin Katusa, Chief Investment Strategist, Energy Division

If you ever happen to eavesdrop on a conversation between energy investors, two words are sure to crop up – China and oil. Usually, they’re used together and usually, it’s about China’s increasing presence on the global oil scene.

It’s a pretty safe bet that, as one of the world’s fastest growing economies, China needs a lot of energy. And with an oil appetite that grows by 7.5% each year, seven times faster than the U.S., the country’s reserves don’t even begin to compare to the consumption.

But fuelling the blistering pace of its economy is China’s number one priority, and it is on a mission to lock down its energy interests all around the world. The emerging powerhouse has often felt that it was the last one onto the energy playing field with a lot of catching up to do.

Today, Chinese national oil companies (NOCs) are setting up shop everywhere from the Middle East all the way to the oil sands of Canada, and they’re open for business. The three NOCs – CNPC/PetroChina, Sinopec and CNOOC Ltd – are slated to produce a record breaking one million barrels daily. That’s Australia’s daily fuel consumption!

It isn’t just their oil production that’s going through the roof. Since 2009, China has committed nearly US$25 billion into corporate and asset acquisitions. China isn’t going it alone either, and fully realizes the importance of forging partnerships with other international oil companies to develop oil fields.

And with Beijing firmly behind them, they’re only doubling their efforts this year. Chinese NOCs accounted for nearly 20% of all global deal values in the first quarter of 2010. This share will only get bigger as the year carries on and energy security continues to dominate the agenda.

Armed with strong finances, an aggressive approach, and implicit government backing, Chinese companies are well placed to spearhead the nation’s mission of diversifying its international energy portfolio. The latest thing to catch their attention: the mysterious oil elephants of East Africa.

Hunting for Elephants: Fortune Favours the Bold

Africa might be the last place left on Earth where elephant deposits – very large oil and gas deposits – remain to be found. But contrary to popular belief, the real money in African oil is not in the West nor the North, but thousands of miles away in East Africa.

It is here that one of the last oil elephants of the world waits. A lack of significant discoveries and long-term instability left the region largely unexplored and ignored for the last 50 years. Until last year, when Irish giant Tullow Oil found over two billion barrels under the waters of Lake Albert, Uganda.

The excitement running through the region’s oil market at the moment is palpable. The first annual Eastern Africa Energy Week held this year in Nairobi, Kenya, was resplendent with the heavyweights and superstars of the oil business; prominent amongst them were delegates from China’s CNOOC, who were out in full force. That they were all there to study strategies, policies and regulation, and the critical issues facing companies in the market shows exactly how seriously they’re taking East Africa.

In a region where the market is populated largely by smaller-cap firms hoping to get in on the ground floor of emerging energy-nations, the takeover potential is enormous. It’s no surprise then that CNOOC is jostling with the big names of oil exploration in Africa – Tullow, Total SA, and Anadarko – to get a slice of what could be an energy goldmine.

But East Africa will be no cakewalk for oil explorers. They will face a multitude of challenges and there is risk by the bucket in each venture. Only those companies with the right project locations and the right people to execute business plans in the difficult working conditions of East Africa will survive to win the jackpot. So pick your portfolio wisely and buckle up for this jungle ride… it’s going to be intense.

[Ed Note: If you aren’t already investing time in understanding the developing opportunities in energy and energy-related investments, you risk missing one of the most important big trend profit opportunities of the next 20 years. Casey Research offers several research services that are dedicated to the sector, including our baseline Casey’s Energy Opportunities. Sign up today and you’ll get 12 issues, including Chief Investment Strategist Marin Katusa’s carefully researched picks, for just $39 a year – just over $3 for each issue. Add to that a 90-day 100% money back guarantee, and it’s a no-brainer. Details here.]






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.

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Thursday
Jul012010

Michael Blum: ABCs of MLPs

Source: Brian Sylvester of The Energy Report 7/1/10
http://www.theenergyreport.com/pub/na/6697

Interested in long-term, high-yield investment plays with certain deferred tax advantages? Master limited partnerships (MLPs) may be for you. Even through the recent downturn, most MLPs were able to maintain distributions and fund capital projects—especially investment-grade names. MLP units are traded on public exchanges just like corporate stock. "The difference," says Wells Fargo Senior Energy MLP Analyst Michael Blum, "is that MLPs are structured as partnerships." In this exclusive interview with The Energy Report, Michael explains the ins and outs of MLP investing and provides some names to get you started.

For a list of MLPs, check out The Energy Report's new MLP Directory.

The Energy Report: Some of our readers may not know how MLPs work. Please give us an overview of the sector and some advantages and disadvantages of investing in MLPs.

Michael Blum: Master limited partnerships are high-yielding publicly traded entities, which trade on major exchanges similar to a corporation. The difference is that MLPs are structured as partnerships; they don't pay corporate taxes at the partnership level and investors avoid double taxation. Investors receive cash distributions instead of dividends.

To be eligible as an MLP, the partnership has to receive at least 90% of its income from what's called qualifying sources (natural resources, real estate rents and dividend income). For practical purposes, MLPs are involved mostly in the energy sector—of the 91 publicly traded MLPs, 71 are involved in energy. Most energy MLPs provide midstream services (i.e., they handle various commodities for a fee). Many MLPs operate pipelines and storage facilities, so they generate pretty stable cash flows with little direct commodity risk.

MLPs distribute available cash flow—cash left over after paying debt service, maintenance, etc.—at the end of each quarter to their unit holders. Therefore, MLPs have pretty high yields, averaging between 6%–8%.

TER: Explain the tax advantages.

MB: The basic value proposition for an MLP investor is a low double-digit annual total return consisting of a 6%–8% yield with 3%–5% annual distribution growth and certain tax-deferred advantages. Investors are required to pay tax on only 20% of that distribution, typically. The rest of the tax is deferred until the investor sells the security, which could be many years in the future. From a tax perspective, it can be very efficient for investors.

TER: Does that mean that MLPs are long-term investments?

MB: Yes, I would consider them long-term investments; they certainly own long-lived assets. About 70% of MLPs are owned by retail investors, and retirees own them for the income.

TER: Recent healthcare legislation will tax dividends for people making more than $200K/year but will not affect MLP distributions. I suppose this makes MLPs even more attractive.

MB: Yes, the recent 3.8% tax on interest dividends, annuities, etc., which also includes families earning more than $250K. This will not impact MLPs in terms of their distributions. On a relative basis, yes, the MLPs become more attractive.

TER: What are the risks?

MB: MLPs present some additional tax-filing burdens that you don't find with C-Corp investments. MLP investors receive K-1s instead of 1099s because they're partners in a partnership–not corporate shareholders. MLPs also have relatively low liquidity in terms of trading volume, so they're not easy to trade in and out of if you want to take large positions. Large MLP positions shouldn't be held in IRAs or tax-free accounts because they generate unrelated business taxable income (UBTI), which triggers tax consequences if it exceeds $1,000 per year.

In terms of actual investment risk, there are some legislative risks. For example, many of these are oil and gas companies and current, proposed legislation could impact them. MLPs are also very reliant on access to capital markets; when those markets become stressed, the MLPs tend to trade poorly.

TER: So, were MLPs a bad place to invest in the 2008 market crash?

MB: Everywhere was a bad place to be in 2008, including MLPs. But if you just owned MLPs for income, about 80% maintained or increased their distributions during that period. MLP prices declined precipitously in line with the market. From that perspective, it was not a great place to be.

TER: But unit holders still received distributions. Are you saying that MLPs are pretty much bulletproof in terms of economic downturns?

MB: Nothing's bulletproof, but certainly most MLPs that own pipeline assets have very stable cash flows and have—over many different economic and commodity-price cycles—been able to maintain and even grow their distributions. Some MLPs have more commodity price risk, and some of those were forced to cut or eliminate distributions during the last downturn.

TER: You said there is a legislative risk. Is there an MLP lobby?

MB: The National Association of Publicly Traded Partnerships (NAPTP), a trade association, represents publicly traded limited partnerships. They lobby on behalf of the MLP sector; and, historically, have made a good case for leaving MLPs' tax status intact.

TER: In your research, you said a lot of an MLP's performance is determined on a macro level. Moody's recently downgraded Greece's credit to junk and oil prices are projected to be relatively soft through 2010 and into early 2011. How will that affect the MLP sector?

MB: We have a relatively cautious near-term outlook on MLPs for those reasons. The correlation between high-yield credit spreads and MLPs is quite high. Because MLPs are yield products, they move in sympathy to yield spreads. MLPs pay out most of their cash flows in the form of quarterly distributions, yet they're growing by acquisitions and new pipeline and asset investment. They must have access to debt and equity markets to fund those investments. MLPs are very sensitive to happenings in the equity and credit markets. Credit spreads are continuing to widen due to Eurozone issues, which could put more pressure on MLP prices. Commodity prices also play a role, as some MLPs have direct commodity exposure. Generally speaking, MLPs move in sympathy with commodity prices because they are energy companies; so, weaker oil prices imply lower MLP prices.

TER: Given that many MLPs are energy companies, will the Gulf of Mexico (GOM) spill impact the sector?

MB: Very little. Only a handful of MLPs have direct exposure to the Gulf.

TER: You follow a number of segments within the MLP sector: large- and small-cap pipelines, upstream, propane and shipping. Please provide an overview of these sectors and the investment opportunities there.

MB: Let's start with pipeline MLPs. There are different types of pipeline MLPs—crude oil; natural gas; natural gas liquids (NGLs), which are produced in association with natural gas, and refined product pipelines. They all have different characteristics but, in general, they generate mostly fee-based cash flows. Sometimes they're driven by volumes, but often they're regulated with automatic adjusters for inflation. Generally, pipeline MLPs are the lowest risk; sometimes their growth is more modest, but still relatively healthy at 3%–5%.

Gathering and processing MLPs collect and process—remove impurities—and separate the NGLs. The natural gas is then pipeline-ready, and is shipped via larger pipelines to consuming markets. NGLs are shipped on a separate pipeline grid for their markets. NGLs include ethane, propane, butane, isobutene and natural gasoline; and each has its own distinct market. Ethane is used by the petrochemical industry to make plastics. Propane is also used in that industry, primarily as heating fuel for homes. The others are used in the refining and gasoline-production industries. Gathering and processing MLPs have higher yields and more risk, as they have more direct exposure to commodities and natural gas production trends.

Upstream MLPs are traditional oil and gas producers actively drilling for oil and gas. Upstream MLP properties differ in that the reserves they own are typically mature, low-decline assets. . .the boring stuff. They make good MLP assets because they throw off relatively predictable cash flows. Upstream MLPs also have the most commodity exposure and, typically, the highest yields; however, they do hedge for several years out to mitigate that commodity price exposure.

Propane MLPs distribute propane via propane-delivery trucks to residential tanks. Companies are able to adjust their margins as propane prices change, so there's not much direct commodity exposure; so propane MLPs have been pretty defensive investments in downturns. The main risk is weather; these MLPs are dependent on cold winters.

Shipping MLPs cover domestic and international shippers—oil, liquefied natural gas (LNG), etc. Local shippers ship refined products and crude oil only around local markets, up and down rivers and between states.

TER: It seems like they were created as a way to invest in infrastructure.

MB: Yes, Congress created MLPs with these special rules to encourage energy infrastructure investment. Over the last five to seven years, there's been a multi-billion dollar buildout in natural gas pipelines. The MLPs have been spending most of that capital and building most of those pipelines. So, in terms of attracting private capital to build the U.S. pipeline infrastructure, it's worked.

TER: Have you seen corresponding growth in the number of MLPs over the last few years?

MB: Tremendous growth. In 2000, there were 18 energy MLPs and the sector's market cap was $16 billion. Today, there are 71 energy-related MLPs with a combined market cap of about $180 billion.

TER: Can you explain the difference between general and limited partners?

MB: MLPs are structured with a general partner and limited partners. The general partner controls and manages the MLP and, typically, owns a 2% equity interest. The limited partners provide capital. General partners own incentive distribution rights; that is, they're entitled to an increasing percentage of incremental cash flow as they raise the distribution to limited partners at incremental rates. This provides incentive for the general partner to raise distribution levels to limited partner unit holders. Almost all MLPs have a general partner. In recent years, some MLPs formed without general partners and incentive distributions rights (IDRs). Or some MLPs eliminated their general partner or IDRs.

TER: Basically, it's like a managing partner. What's the maximum they can own?

MB: I don't think there's any maximum; most own only a 2% interest, but the incentive distribution rights entitle the general partner to receive up to 50% of incremental cash flow. They start out at 2%, then, when the distribution reaches a certain level, the general partner is entitled to 15% of the incremental cash, then 25%, and then 50%. Most general partners own a large percentage of limited partner units, as well; so they are aligned with the limited partner unit holders from that standpoint.

TER: In a recent research report, you wrote: "For investors that are more cautious in their macro outlook we would focus more on the large-cap defensive pipeline names." You named the following companies in your research: Enterprise Products Partners L.P. (NYSE: EPD), Kinder Morgan Management, LLC (NYSE:KMR), Magellan Midstream Partners L.P. (NYSE:MMP), Sunoco Logistics Partners L.P. (NYSE:SXL). Tell us about those names.

MB: During periods when there's more risk aversion, the investment-grade pipelines tend to outperform on a relative basis. Enterprise Products Partners is the largest MLP in the sector. It has a franchise position in pipeline and storage, and fractionation in the NGLs market. We think EPD can grow distribution about 6% annually for the next several years. A lot of that has to do with where its assets are located, as well as some expansion projects it's pursuing. EPD is expanding a pipeline out of the developing Haynesville shale and its NGL assets at Mont Belvieu, Texas, which is the premier market and pricing point for NGLs. EPD is very well-positioned and cash flows are very stable, in our opinion.

TER: What constitutes an investment-grade MLP?

MB: There are only 13 investment grade-rated MLPs, which are primarily the large-cap pipeline MLPs. The rest of the MLPs are non-investment-graded or "junk." The yields on these MLPs are higher because there's more perceived risk and, as a result, their cost of financing is higher for both debt and equity. To the extent that an MLP can move from non-investment-grade to investment-grade, that should improve its valuation and capital cost. It's a big advantage.

TER: Alright, what's the yield from Enterprise Products?

MB: 6.6%.

TER: How long will that continue?

MB: In general, we forecast the stock should continue to yield somewhere around 6%–7%, with roughly 6% annual distribution growth. We think that's sustainable for several years.

TER: What about Kinder Morgan?

MB: Kinder Morgan is another one of the franchise MLPs in the sector. It has a large natural gas pipeline business, a refined product pipeline segment and a terminal storage business, wherein they store and handle various materials for a fee, as well as an oil production company. The cash flows are also relatively stable. Kinder Morgan Energy Partners, L.P. has two securities, Kinder Morgan Energy Partners (KMP) and Kinder Morgan Management (KMR). KMR pays a stock dividend instead of a cash distribution. As a result, KMR, which pays the stock dividend, does not generate a K-1. It eliminates a lot of tax-filing requirements that some investors don't want to deal with. We think the distribution there is secure and is probably going to grow around 4%. We prefer KMR to KMP because it priced more attractively and the distribution is based on the same assets and underlying cash flow stream.

TER: Magellan?

MB: Magellan Midstream Partners is a refined product pipeline and storage company. Again, stable cash flows, very strong balance sheet, in our opinion. What attracts us to Magellan is its acquisition prospects. The oil majors such as Chevron Corp. (NYSE:CVX), Exxon Mobil Corp. (NYSE:XOM) and ConocoPhillips (NYSE:COP) and others have announced plans to sell some of their midstream assets in the U.S. as a way to raise cash. We think the MLPs and Magellan in particular, due to the elimination of its IDRs, are well-positioned to acquire some of those assets. This should lend itself to higher distributions in the future.

TER: What's the yield on Magellan?

MB: The yield at present is 6.4%.

TER: And Sunoco?

MB: Sunoco is also in the refined product and crude oil pipeline and storage business. What's unique there is the company has a lot of organic opportunities. It has assets in the Gulf Coast and Northeast that are in growth markets. As a result, SXL is spending money to expand its asset base. Therefore, you can point to visible 10%+ distribution growth for the next couple of years. You've got a stable yield at 6.5% with 10%+ growth in distributions. We think that'll enable the partnership to outperform.

TER: Are there some other companies you would like to talk about in that space?

MB: The other one I might mention is Energy Transfer Partners. The company is principally a natural gas pipeline company. It has a number of interstate pipelines and also a large Texas intrastate pipeline system. What's unique about Energy Transfer is that management has done a really good job of positioning the company in many of the emerging natural gas shale plays in the U.S., such as the Barnett, Haynesville, Fayetteville and Woodford. ETP has many of the new pipelines that are delivering supply out of these new basins. Going forward, the partnership has a number of pipeline projects that are coming into service in 2011. So, as those come into service, we think you're going to see a step up in cash flows and, therefore, increases in the distribution. That stock has a very healthy yield right now of 8%.

TER: What are some of the smaller-cap MLPs that you like?

MB: I would first highlight a gathering and processing MLP, Regency Energy Partners L.P. (NASDAQ:RGNC). This company is going through a transformation. It originally owned mostly gathering and processing assets. Through acquisitions and organic expansion, RGNC added significant pipeline and compression assets—all of which are fee-based. It now generates roughly 70% fee-based cash flows and is only 30% exposed to gathering and processing. The partnership hedges its commodity exposure, so there is very little volatility in cash flows. Over time, we think this company has a good chance of becoming an investment-grade credit-rated company by virtue of adding the fee-based cash flows, strengthening the balance sheet and growing in absolute size. If it does achieve investment grade, we think you'll see a revaluation where the MLP will be revalued like a pipeline MLP, such as Kinder Morgan or Enterprise. Right now, it's yielding about 7.8%; but the thesis is that, at some point, that becomes a 6%- to 6.5%-yielding stock.

TER: Who decides if an MLP is investment grade?

MB: It's all up to the rating agencies but, in general, you have to have a certain size and scope, your cash flows have to be of a certain stability and your balance sheet has to be of certain metrics. From a size perspective, I think it's $250 to $350 million in EBITDA. From a balance sheet perspective, it means having a debt-to-EBITDA ratio of 4x or less; and from a cash flow-stability perspective, probably 70%+ fee based. By the end of 2011, we think Regency will meet all those requirements, but its rating will still be up to the rating agencies.

TER: Another one you seem to like is Blueknight Energy Partners L.P. (OTCPK:BKEP), a small-cap pipeline MLP.

MB: This is what we would call a 'speculative outperform-rated stock.' This is a turnaround story. The parent company of the MLP was originally a company called SemGroup Corporation, a private oil trading company in Tulsa, Okla. They had an MLP called SemGroup Energy Partners L.P. (OTC:SGLP). The parent company went bankrupt and was the MLP's primary customer. Control of SemGroup Energy Partners was acquired by Vitol, a global energy trading company, and the name of the MLP was changed to Blueknight Energy. The company's assets are crude oil storage and pipeline and asphalt storage. It's a relatively a low-risk, fee-based business. Right now, the MLP is not paying a distribution and, in our view, has too much debt. Our thesis is that Vitol will recapitalize the company by year-end. In doing so, Blueknight would reinstate additional distribution at $1.25 per unit, which should cause the stock to rebound nicely.

TER: What about some upstream MLP names like Encore Energy Partners (NYSE:ENP) and Legacy Reserves (NASDAQ:LGCY)?

MB: I'll start with Legacy. Legacy was created from a third-generation, family owned oil and gas business located in the Permian Basin in West Texas, which is one of the oldest oil-producing basins in the country. The two families took their Legacy business and put it into this MLP. The advantage is that these families have been operating in the Permian Basin for many years, so they know all of the well and oil-reserve owners in the region. Over time, they've been able to make acquisitions in the Permian Basin to grow cash flows. LGCY is mostly an oil company, so it's tied to the oil price. The partnership hedges about 70% of its cash flow for the first year out, and then decreasing levels going forward. Overall, we believe it's a well-managed, disciplined company with very attractive assets for this asset class.

Encore Energy Partners is interesting. Its general partner parent company was acquired by another publicly traded oil and gas company called Denbury Resources Inc. (NYSE:DNR), which has since announced plans to sell Encore. We think a number of MLPs, private equity firms and others will be interested in it. Encore has very attractive long-lived assets, mostly oil in the Permian Basin and Rocky Mountains. There's potential upside tied to a takeout of the MLP.

TER: How does a gathering and processing MLP differ from an upstream MLP? And what are some of your picks in the gathering and processing space?

MB: An upstream MLP is an actual oil and gas producer, whereas the gathering and processing company gathers the gas from the wellheads, processes it and strips out the NGLs, which are produced along with natural gas to ensure it meets pipeline-transport specifications. Some of our favorites? One we talked about already is Regency. Another would be Targa Resources Partners L.P. (NYSE:NGLS), which has gathering assets in several basins in North Texas, West Texas and South Louisiana. Over time, the volume on those assets has proven to be relatively steady even in what's been a difficult gas-price environment. Targa also has NGLs, pipeline and storage and fractionation assets, which lends a fee-based nature to some of its cash flows. So it's a better mix of overall cash flows and provides some growth opportunities (e.g., the partnership is expanding one of its fractionation facilities in the Gulf Coast right now).

TER: Fractionation?

MB: The NGLs are separated from the natural gas at a processing plant. They're in a mixed form. They're called mixed NGLs or Y grade. They're then transported to a fractionation facility where they're separated into the individual purity components. The ethane, propane butane, etc. are then sold to their individual markets. It's all part of the NGLs energy-value chain.

TER: Your research talks some about Energy Transfer Equity, L.P. (NYSE:ETE) Tell us about that one.

MB: Energy Transfer Equity is the general partner of Energy Transfer Partners. To make it even more confusing, it recently acquired the general partner interest of Regency Energy Partners as well. ETE now owns two general partner interests in MLPs. A general partner is attractive because its growth rate in cash distributions is 2x or greater than that of the underlying MLP, typically. You get a lower yield; but, in many cases, your total return could be higher than owning the underlying MLP. Also, in many instances, the management team owns a large percentage of the general partner, so your interests are more aligned if you own the general partner units. ETE is interesting because, on the one hand, Energy Transfer Partners, one of the MLPs it controls, has some future growth prospects tied to new pipelines going into service. On the other hand, Energy Transfer's management is very active in the acquisition market. The team plans to use Regency, potentially, as a vehicle for acquisitions. If it's successful, you could see cash-flow growth accelerate at ETE.

Michael J. Blum is a managing director and senior analyst at Wells Fargo Securities covering energy master limited partnerships. He began his Wall Street career in 2000 at First Albany Corp. as an associate analyst covering alternative energy securities and joined Wells Fargo in 2001. Since 2003, he has been following master limited partnerships and integrated natural gas securities at Wells Fargo. Before joining the sell side, he spent a year as the investor relations manager for a publicly traded internet startup during the dot-com boom. Michael has been recognized twice as a Wall Street Journal "Best On The Street" winner, ranking in two categories in 2010: No. 3 for the oil and gas producers sector and No. 5 for oil equipment, services, and distribution; he also ranked No. 4 for oil equipment, services, and distribution in 2007. In 2010, Michael was ranked as the No. 1 MLP analyst in the Greenwich Associates survey of institutional investors. In 2009, Michael was named the No.1 oil and gas pipelines analyst by Forbes magazine and was ranked as the No. 3 analyst for the master limited partnership sector in a survey conducted by Institutional Investor magazine. Michael graduated magna cum laude from the University of Pennsylvania with a BA in English literature and a minor in economics.

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DISCLOSURE:
1) Brian Sylvester of The Energy Report conducted this interview. He personally and/or his family own the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: None.
3) Michael Blum: 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.

To view price charts for all companies rated in this document, please go to
www.wellsfargo.com/research or write to:
7 Saint Paul Street, 1st Floor, R1230-011, Baltimore, MD 21202
ATTN: Research Publications

Additional Information Available Upon Request

I certify that:
1) All views expressed in this research report accurately reflect my personal views about any and all of the subject securities or issuers discussed; and
2) No part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by me in this research report.
Wells Fargo Securities, LLC maintains a market in the common stock of Energy Transfer Partners, L.P., Enterprise Products Partners L.P., Kinder Morgan Energy Partners, L.P., Kinder Morgan Management, LLC, Legacy Reserves, L.P., Regency Energy Partners, L.P., Targa Resources Partners, L.P.
Wells Fargo Securities, LLC or its affiliates managed or comanaged a public offering of securities for Encore Energy Partners, L.P., Energy Transfer Partners, L.P., Enterprise Products Partners L.P., Kinder Morgan Energy Partners, L.P., Legacy Reserves, L.P., Regency Energy Partners, L.P., Sunoco Logistics Partners L.P., Targa Resources Partners, L.P. within the past 12 months.
Wells Fargo Securities, LLC or its affiliates intends to seek or expects to receive compensation for investment banking services in the next three months from Encore Energy Partners, L.P., Energy Transfer Equity, L.P., Energy Transfer Partners, L.P., Enterprise Products Partners L.P., Kinder Morgan Energy Partners, L.P., Legacy Reserves, L.P., Regency Energy Partners, L.P., Sunoco Logistics Partners L.P., Targa Resources Partners, L.P.
Wells Fargo Securities, LLC or its affiliates received compensation for investment banking services from Encore Energy Partners, L.P., Energy Transfer Equity, L.P., Energy Transfer Partners, L.P., Enterprise Products Partners L.P., Kinder Morgan Energy Partners, L.P., Kinder Morgan Management, LLC, Legacy Reserves, L.P., Regency Energy Partners, L.P., Sunoco Logistics Partners L.P., Targa Resources Partners, L.P. in the past 12 months.
Encore Energy Partners, L.P., Energy Transfer Equity, L.P., Energy Transfer Partners, L.P., Enterprise Products Partners L.P., Kinder Morgan Energy Partners, L.P., Kinder Morgan Management, LLC, Legacy Reserves, L.P., Regency Energy Partners, L.P., Sunoco Logistics Partners L.P., Targa Resources Partners, L.P. currently is, or during the 12-month period preceding the date of distribution of the research report was, a client of Wells Fargo Securities, LLC. Wells Fargo Securities, LLC provided investment banking services to Encore Energy Partners, L.P., Energy Transfer Equity, L.P., Energy Transfer Partners, L.P., Enterprise Products Partners L.P., Kinder Morgan Energy Partners, L.P., Kinder Morgan Management, LLC, Legacy Reserves, L.P., Regency Energy Partners, L.P., Sunoco Logistics Partners L.P., Targa Resources Partners, L.P.
Energy Transfer Equity, L.P., Energy Transfer Partners, L.P., Regency Energy Partners, L.P. currently is, or during the 12-month period preceding the date of distribution of the research report was, a client of Wells Fargo Securities, LLC. Wells Fargo Securities, LLC provided nonsecurities services to Energy Transfer Equity, L.P., Energy Transfer Partners, L.P., Regency Energy Partners, L.P.
An affiliate of Wells Fargo Securities, LLC has received compensation for products and services other than investment banking services from Blueknight Energy Partners, L.P. in the past 12 months.
Wells Fargo Securities, LLC received compensation for products or services other than investment banking services from Energy Transfer Equity, L.P., Energy Transfer Partners, L.P., Regency Energy Partners, L.P. in the past 12 months.
Wells Fargo Securities, LLC or its affiliates has a significant financial interest in Blueknight Energy Partners, L.P., Energy Transfer Equity, L.P., Legacy Reserves, L.P., Sunoco Logistics Partners L.P., Targa Resources Partners, L.P.
Wells Fargo Securities, LLC, is acting as financial advisor to Denbury Resources Inc in the announced exploration of strategic alternative surrounding its ownership interest in Encore Energy Partners, LP.
BKEP: Risks to our valuation range include counterparty credit risk, lower crude oil and asphalt volumes, and rising interest rates.
ENP: Risks to the units trading below our range include a dependence on acquisitions to fuel growth and partially offset the depletion of reserves, the inability to hedge at favorable prices, and rising interest rates.
EPD: Risks to EPD trading in our range include weakness in the petro-chem industry, low or negative frac spreads, and a decline or delay in deepwater GoM production.
ETE: Risks to ETE trading in the range include (1) unsuccessful execution of an acquisition or an organic growth project; (2) potential conflicts of interest; (3) competition in the Texas-Louisiana natural gas market; and (4) a decline in natural gas prices.
ETP: Risks to ETP achieving our valuation range include: (1) execution risk related to integrating acquisitions and completing organic growth projects; (2) negative outcome from third-party litigation; (3) competition in the Texas-Louisiana natural gas market; and (4) abnormally warm weather.
KMP: Risks to the units trading in our valuation range include (1) delays/cost overruns on expansion projects and (2) rising interest rates.
KMR: Risks to the units trading in our valuation range include (1) a final resolution to the SFPP rate case, (2) delays/cost overruns on expansion projects, and (3) rising interest rates.
LGCY: Risks to the units trading below our range include a sustained decline in crude oil prices and dependence upon acquisitions to fuel growth.
NGLS: Risks to the units trading below our valuation range include a slower-than-forecasted rate of dropdown acquisitions, a decline in commodity prices, and rising interest rates.
RGNC: Risks to the units trading below our valuation range include a slower-than-forecasted rate of dropdowns, a decline in commodity prices, and rising interest rates.
SXL: Risks to the units trading below our valuation range include customer concentration, refinery turnarounds, and rising interest rates.

Wells Fargo Securities, LLC does not compensate its research analysts based on specific investment banking transactions.
Wells Fargo Securities, LLC's research analysts receive compensation that is based upon and impacted by the overall profitability and revenue of the firm, which includes, but is not limited to investment banking revenue.

STOCK RATING
1=Outperform: The stock appears attractively valued, and we believe the stock's total return will exceed that of the market over the next 12 months. BUY
2=Market Perform: The stock appears appropriately valued, and we believe the stock's total return will be in line with the market over the next 12 months. HOLD
3=Underperform: The stock appears overvalued, and we believe the stock's total return will be below the market over the next 12 months. SELL

SECTOR RATING
O=Overweight: Industry expected to outperform the relevant broad market benchmark over the next 12 months.
M=Market Weight: Industry expected to perform in-line with the relevant broad market benchmark over the next 12 months.
U=Underweight: Industry expected to underperform the relevant broad market benchmark over the next 12 months.

VOLATILITY RATING
V = A stock is defined as volatile if the stock price has fluctuated by +/-20% or greater in at least 8 of the past 24 months or if the analyst expects significant volatility. All IPO stocks are automatically rated volatile within the first 24 months of trading.

As of: 6/25/2010:

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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.
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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.
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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.

The latest trade from our options team was slightly more sophisticated in that we shorted a PUT as follows:

On Friday 7th May our premium options trading service OPTIONTRADER opened a speculative short term trade on GLD Puts, signalling to short sell the $105 May-10 Puts series at $0.09.

On Tuesday the 11th May we bought back the puts for just $0.05, making a 44.44% profit in just 4 days.



Accumulated Profits from Investing $1000 in each OPTIONTRADE signal 14 May 2010.jpg

Recently our premium options trading service OPTIONTRADER has been putting in a great performance, the last 16 trades with an average gain of 42.73% per trade, in an average of just under 38 days per trade. Click here to sign up or find out more.


Silver-prices.net have been rather fortunate to close both the $15.00 and the $16.00 options trade on Silver Wheaton Corporation, with both returning a little over 100% profit.

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
Jun292010

Greg Gordon: Big Deregulated Utilities, Pt. II

Greg Gordon 23 June 2010.jpg


Source: Brian Sylvester and Karen Roche of The Energy Report  6/29/10
http://www.theenergyreport.com/cs/user/print/na/6669

Big deregulated utilities pay solid dividends and offer investors a means to leverage the ongoing economic recovery. But it's a complicated business; that's why we asked Morgan Stanley Analyst Greg Gordon to break it down in this exclusive interview with The Energy Report. In this second half of our two-part interview, Greg explains the difference between deregulated utilities and their regulated counterparts and shares some of his favorite names in the space. (Read Turn on to Big Utilities, Pt. 1.)

The Energy Report: As an investor in today's unpredictable economic environment, you don't really know what part of the economy might be taking off and what part might continue to be sluggish. Do non-regulated utilities represent a better general investment strategy than regulated utilities?

Greg Gordon: If you're looking to get more leverage to an economic recovery, you can own companies in the deregulated universe like Entergy Corporation (NYSE:ETR), a Gulf states utility that also happens to own a 5,000 MW fleet of deregulated nuclear power plants in New York and New England. Their earnings are exposed to the power price in that merchant portfolio and to a fairly significant degree.

The earnings profile of Entergy looks like it's going to decline over the next several years. They're going to earn about $7 a share this year. We think that declines to about $6.75 in 2012. But they're highly leveraged to a very small change in the power price. If I change my power pricing assumption by $5 per MW hour, it boosts their 2012 earnings nearly $0.45 a share. So if the economy is up in that region, their earnings stand to benefit; and right now, the stock is trading at just $74/share—not a very high multiple relative to what I consider cyclically depressed earnings.

TER: What is $5 per MW in terms of a percentage increase?

GG: In their region, that would be between 5% and 10%.

TER: What does that increase translate to in percentage of earnings?

GG: That would increase it $0.45 on $6.75; about a 7% increase. So they've got a lot of leverage to recovery and power markets; and the stock is certainly not expensive compared to where power prices are today, given that they could still earn $6.75 at current forward curves for power. And the stock is not at a very high PE multiple on that number—it's at 11x those earnings. It's also a very well-run company that's actually buying back stock right now; they've got extra cash flow, and they're buying back stock. It's now got a dividend yield of 4%.

TER: What are some other deregulated utilities you like?

GG: There are two that I really like. The first one is PPL Corporation (NYSE:PPL). The company's based in Pennsylvania, but they're actually quite diversified. They own utilities and power plants in Pennsylvania, some power plants in the Pacific Northwest and a distribution utility in the UK. PPL just announced the acquisition of regulated utilities in Kentucky— E.ON U.S. LLC (PKSHT:EONGY; Fkft:EOA), the parent company of Louisville Gas and Electric Company and Kentucky Utilities Company.

PPL stock has declined quite dramatically on the back of the acquisition announcement, because investors were initially unhappy with that decision. At around $25.50/share, the stock is overly discounting people's disappointment with the decision to buy those assets. In fact, the acquisition is reasonably strategic in that they're moving the business more toward being regulated and less diversified in order to mitigate earnings volatility. They're also buying assets in a region where a lot of capital spending is needed, and that means a lot of base rate opportunities.

The earnings power at PPL is declining much like Entergy's because commodity prices are low currently. So, the earnings power at PPL declines from about $3.40 in 2010 to about $2.50 in 2013; that sounds pretty bad, except the stock is trading at about $25; it's trading at 10x that number. The stock yields 5.5%; and, in this particular case, they also have exposure to recovery in the power price. So, a $5 change in power price, which would be around 10% in their market, would change the earnings power by $0.30 off of $2.55, or 12%. I think the overhang on the stock right now is that they have to finance these transactions, so they will be issuing equity between now and year-end. It looks very interesting to me, even if power prices don't go back up.

TER: You mentioned two that you like. What was the other?

GG: Sempra Energy (NYSE:SRE) is even less exposed to commodity prices. It is more of a de-risking story in that one of its biggest businesses is a joint venture (JV) European bank, the Royal Bank of Scotland (RBS). The company had a commodities trading JV wherein they traded gas and power domestically and oil internationally. How they wound up in those businesses is a long story, but the bottom line is government regulators forced RBS to divest of the trading businesses; Sempra had to divest as well, and is now in the process of selling them.

We think they're going to raise about $2 billion, buy back a $1 billion of stock and reinvest the remaining $1 billion into their core businesses, which are utilities in California and San Diego, pipeline systems, gas storage and liquid natural gas (LNG) terminals. So Sempra becomes this very complicated higher-risk sort of energy conglomerate, and it converts into a simpler infrastructure growth story.

We estimate earnings growth from around $3.50 per share to $5/share between 2010 and 2013; and the stock is trading at $46. Pipeline assets tend to trade at pretty good multiples, and their utilities earn very, very good returns and have a good earnings visibility. So, when the announcement of the asset sales comes out—and people believe that they've, fundamentally, got a window to de-risk the business—the stock will trade back up into the low $50 range. Right now, they're trading at this big discount because people are afraid they won't be able to find a buyer for those assets. I am confident that they will find a buyer. But, for the sake of argument, even if they couldn't find a buyer and had to wind down those businesses, the company could still get something close to $1.5 –$1.6 billion just winding them down. I like the risk-rewarded Sempra a lot. Again, it's more of a special situation that isn't that exposed to commodity prices but is more of a de-risking story.

TER: So, if you were a financial planner, it seems like you could effectively put investors into a utilities-only portfolio that would give them consistent earnings with limited risk—and still have fairly high growth potential. Would you agree with that?

GG: You can buy growth at a reasonable price in the utility space, and I think that's underappreciated. Utilities investors tend to gravitate towards big, liquid companies that simply pay high dividends but don't offer much growth.

Con Edison, Inc. (NYSE:ED), for instance, trades at a 5.6% dividend yield and pays out 75% of its earnings. It has been a predictable dividend payer but doesn't offer much growth. Yet, it trades at 12x PE multiple just because it offers a fat yield. You can buy American Electric Power Company, Inc. (NYSE:AEP), which offers a 5.2% yield, not much less, and you can buy that under 10x earnings and get almost the same total return at a much better price. You could get CMS Energy (NYSE:CMS), which gives you 8% growth with a 4% yield and at a 9x multiple. While that is a little bit lower income, it is more than offset by the above-average growth you get.

So, yes, within regulated utilities, I think you can get pretty consistent total return without a lot of risk, and I do think that is underappreciated. They also look very cheap vs. other market alternatives, such as bonds. They're trading as cheap in the bond market as I've seen since the mid-1980s. From an absolute and relative perspective, they look like good return investments.

In the diversified names, you are making more of a cyclical investment decision regarding where we are in the power cycle. Are the stocks poised to benefit from a recovery, or do they stand to be hurt in a downturn? The diversified utilities have suffered mightily in the last 18–24 months—they have all declined dramatically. Many of them look poised to rebound, especially if the economy continues to improve and power prices go back up.

TER: Many people out there who believe inflation is just around the corner, some even argue hyperinflation. If investors believe we're moving into an inflationary environment, would returns from these regulated utilities vs. non-regulated utilities be relevant?

GG: Regulated utilities are generally perceived as poor performers in an inflationary environment because it's very difficult to get the regulators to provide timely and effective recovery of costs when their costs are rising rapidly. In an inflationary environment, you'd want to be much more exposed to the diversified utilities (presuming that you were also getting inflation in commodity prices). That way, they would benefit from the rise in gas and power prices. If you were to make a bet on hyperinflation, you'd want to be overweight with diversified utilities and less exposed to regulated utilities.

That being said, I think that a lot of expectation for rising inflation is somewhat built into those regulated stocks. We use a macro model that compares the dividend yield on the utility stocks in the regulated universe to yields in the bond market to see where they're trading vs. bonds. And because they haven't traded this cheap to the bond market on a spread basis since the mid-1980s, investors are implicitly discounting them because they're afraid of rising rates and/or higher inflation. So, I think a lot of that fear is already discounted into the PE multiples.

TER: What is the impact of government incentives for alternative energy capital investment? How does that impact these big utilities or is it so small it's irrelevant?

GG: No, it's very relevant. You've got over 30 states that have their own independent renewable portfolio standards, which require utilities to procure a certain amount of power from non-fossil-based sources on deadline. A lot of capital investment is being made on the margin in these areas; so, utilities in many states are participating in that capital spend.

Obviously, the government has stimulated that by granting tax credits for wind and solar. They've also stimulated spending on what we call "smart grid investments" through Department of Energy (DOE) grants. They've granted money to defray the cost of installing smart meters in some states and other new technologies on the transmission grid, etc. There's absolutely been a benefit.

We talked about CMS. Well, part of their rate base growth is driven by the fact that they must comply with the mandate to build renewables in Michigan. And they're going to be constructing wind farms as part of their regulated assets—that's a growth opportunity for them.

A piece of Sempra's rate base growth in their core utilities is from infrastructure they're building to accommodate wind and solar investment. While they're not a direct owner of many of these projects, they have to build transmission that brings the power to their customers, which is a rate base growth opportunity.

A lot of capital spending is going directly into renewable energy—or infrastructure that supports renewable energy—which is part of that 5% rate base growth profile we talked about. The risk there is that these wind and solar resources are expensive. It costs a lot more money to make power from the sun and wind than it does currently with cheap natural gas. You worry that, somewhere down the line, investor appetite for such investments could wane if commodity prices stay low.

TER: Do you see any one type of renewable energy as being out in front of the others—geothermal, solar, wind?

GG: Wind and solar are growing resource bases in the U.S., but they still represent small fractions of the supply. Geothermal is also a minuscule fraction because, obviously, you can only harness it where there is volcanic activity. The problem is a lot of these resources are where people aren't. The big challenge is not just harvesting them but delivering that power to the population.

Greg Gordon joined Morgan Stanley as a Managing Director in July 2009. He has over 17 years' experience analyzing the power and utility industries. Before joining Morgan Stanley, he spent over six years at Citigroup covering the power and utility industries. Prior to that, he spent over three years at Goldman Sachs covering Electric Utilities and Independent Energy. Institutional Investor recognized Greg as one of the top research analysts in his field for the past four years, and he was ranked as the top research analyst in his field by Greenwich Associates for the past three years.

Before joining Goldman Sachs, Greg was managing director at CIBC World Markets in the power and utilities group. Prior to joining CIBC in 1993, Greg was an analyst at Regulatory Research Associates for the electric, gas, and telecommunications industries. He graduated magna cum laude from Drew University with a major in economics and holds the CFA designation.

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 and Karen Roche of The Energy Report conducted this interview. They personally and/or their families own shares of the companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: None.
3) Greg Gordon: See Morgan Stanley disclosure that follows.*

*The information and opinions in Morgan Stanley Research were prepared by Morgan Stanley & Co. Incorporated, and/or Morgan Stanley C.T.V.M. S.A. As used in this disclosure section, "Morgan Stanley" includes Morgan Stanley & Co. Incorporated, Morgan Stanley C.T.V.M. S.A. and their affiliates as necessary.

For important disclosures, stock price charts and equity rating histories regarding companies that are the subject of this report, please see the Morgan Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures, or contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Research Management), New York, NY, 10036 USA.

Analyst Certification

The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Greg Gordon.

Unless otherwise stated, the individuals listed on the cover page of this report are research analysts.

Important U.S. Regulatory Disclosures on Subject Companies

As of April 30, 2010, Morgan Stanley beneficially owned 1% or more of a class of common equity securities of the following companies covered in Morgan Stanley Research: American Electric Power Company, Inc, CMS Energy Corporation, Entergy Corp, PG&E Corporation, Sempra Energy, Wisconsin Energy Corporation.

As of April 30, 2010, Morgan Stanley held a net long or short position of US$1 million or more of the debt securities of the following issuers covered in Morgan Stanley Research (including where guarantor of the securities): American Electric Power Company, Inc, CMS Energy Corporation, Entergy Corp, NV Energy, Inc., PG&E Corporation, PPL Corporation, Progress Energy Inc., Sempra Energy, Wisconsin Energy Corporation.

Within the last 12 months, Morgan Stanley managed or co-managed a public offering (or 144A offering) of securities of PG&E Corporation.

Within the last 12 months, Morgan Stanley has received compensation for investment banking services from American Electric Power Company, Inc, CMS Energy Corporation, Entergy Corp, PG&E Corporation, PPL Corporation, Progress Energy Inc., Sempra Energy, Wisconsin Energy Corporation.

In the next 3 months, Morgan Stanley expects to receive or intends to seek compensation for investment banking services from American Electric Power Company, Inc, CMS Energy Corporation, Entergy Corp, NV Energy, Inc., PG&E Corporation, PPL Corporation, Progress Energy Inc., Sempra Energy, Wisconsin Energy Corporation.

Within the last 12 months, Morgan Stanley has received compensation for products and services other than investment banking services from American Electric Power Company, Inc, CMS Energy Corporation, Entergy Corp, NV Energy, Inc., PG&E Corporation, PPL Corporation, Progress Energy Inc., Sempra Energy.

Within the last 12 months, Morgan Stanley has provided or is providing investment banking services to, or has an investment banking client relationship with, the following company: American Electric Power Company, Inc, CMS Energy Corporation, Entergy Corp, NV Energy, Inc., PG&E Corporation, PPL Corporation, Progress Energy Inc., Sempra Energy, Wisconsin Energy Corporation.

Within the last 12 months, Morgan Stanley has either provided or is providing non-investment banking, securities-related services to and/or in the past has entered into an agreement to provide services or has a client relationship with the following company: American Electric Power Company, Inc, CMS Energy Corporation, Entergy Corp, NV Energy, Inc., PG&E Corporation, PPL Corporation, Progress Energy Inc., Sempra Energy, Wisconsin Energy Corporation.

Morgan Stanley & Co. Incorporated makes a market in the securities of American Electric Power Company, Inc, CMS Energy Corporation, Entergy Corp, NV Energy, Inc., PG&E Corporation, PPL Corporation, Progress Energy Inc., Sempra Energy, Wisconsin Energy Corporation.

The equity research analysts or strategists principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues.

Morgan Stanley and its affiliates do business that relates to companies/instruments covered in Morgan Stanley Research, including market making, providing liquidity and specialized trading, risk arbitrage and other proprietary trading, fund management, commercial banking, extension of credit, investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered in Morgan Stanley Research on a principal basis. Morgan Stanley may have a position in the debt of the Company or instruments discussed in this report. Certain disclosures listed above are also for compliance with applicable regulations in non-U.S. jurisdictions.

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


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.

The latest trade from our options team was slightly more sophisticated in that we shorted a PUT as follows:

On Friday 7th May our premium options trading service OPTIONTRADER opened a speculative short term trade on GLD Puts, signalling to short sell the $105 May-10 Puts series at $0.09.

On Tuesday the 11th May we bought back the puts for just $0.05, making a 44.44% profit in just 4 days.



Accumulated Profits from Investing $1000 in each OPTIONTRADE signal 14 May 2010.jpg

Recently our premium options trading service OPTIONTRADER has been putting in a great performance, the last 16 trades with an average gain of 42.73% per trade, in an average of just under 38 days per trade. Click here to sign up or find out more.


Silver-prices.net have been rather fortunate to close both the $15.00 and the $16.00 options trade on Silver Wheaton Corporation, with both returning a little over 100% profit.

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.

Saturday
Jun262010

The Doctor and the Dealman: An Energy Update





By David Galland, Managing Director, Casey’s Energy Report

At first glance, no two individuals could seem more different.

The Doctor, middle-aged and balding, could be the very archetype of the college professor. The Dealman is young with a full head of well-styled hair: more than a few people have compared his looks to Elvis in his prime.

The Doctor is quiet and soft-spoken. The Dealman is outspoken and, under the right circumstances, even outrageous.

On further examination, however, you begin to uncover the similarities that make them one of the energy sector’s most potent teams, starting with the fact that they each possess an intimidating intelligence.

Case in point, while only 23 years old, the Dealman taught advanced mathematics at the university level.

The Doctor, an elected fellow of the Royal Society of Canada, is a PhD professor of petroleum and coal geology at the University of British Columbia and the winner of the coveted Thiessen Award, the highest award presented by the International Committee for Coal and Organic Petrology.

They also both share a passion for the energy sector, though as is typical with this atypical team, they approach the sector from two different perspectives.

The Doctor, one of North America’s leading experts in “unconventional” oil and gas, loves to analyze every aspect of modern-day hydrocarbon exploration and production.

While fully conversant in the technological and geological facets of the global hunt for energy, in his work as the chief investment officer for Casey Research’s Energy division, the Dealman lives to find the next big money-making energy play. Even if it requires working almost around the clock, he is passionate to uncover companies with the magical combination of the right management, the right commodity in the right place and with the right geology. And, most important, the right financial structure at the right price that allows investors to lock in serious upside potential but with very little downside risk.

Individually, the Doctor, Dr. Marc Bustin, and the Dealman, Marin Katusa, are powerful resources when it comes to separating facts from fiction about today’s energy scene and where the real opportunities for investors are to be found. But working as a team, they become a force of nature.

With oil gushing into the Gulf, the global economy under pressure as well as the prices of energy and energy stocks, and with the new American Power Act lurking in the background, John Mauldin called to ask if we could provide an update for readers on the always-important energy sector.

And so, with that goal in mind, I arranged to sit the Doctor and the Dealman down for a chat. The highlights of that chat follow.

Q: Let's start by asking your opinion, Dr. Bustin, on the sinking of the Deepwater Horizon rig off the coast of Louisiana and the impact that could have on oil exploration in the U.S.

Bustin: It’s an environmental ecological disaster, and everything else pales besides that fact. That said, I think what we're looking at is a major shutdown in offshore exploration off North America.

In addition to the Obama administration, the Canadian government has also come out and said that there will be no further offshore exploration until we understand what went wrong and there is something in place to better control a similar incident should it happen.

The impact of the disaster is already being felt in that Obama had only recently announced an expansion of offshore drilling, but that's now dead. Likewise, probably for the rest of my life, offshore Western Canada won't go ahead, so it's a huge impact, and of course this is going to affect the mid-term oil price.

Katusa: It is really important to understand that, for companies with existing drilling permits, the costs are going to be significantly higher… in terms of construction and maintenance costs, labor, permits, battling lawsuits filed by environmental groups and others with an interest in the water – the fishing industry, for example. Then there is a big increase in insurance costs, more taxes, and special clean-up funds.

As a result, when you start looking at the bottom line impact on companies you might want to invest in, when it comes to offshore projects, the netbacks are going to decrease significantly, so your profits are going to decrease significantly. Then there’s the overhang of the potential for another actual disaster and the clean-up costs.

Q: So this is clearly going to be a setback to offshore drilling. What are the implications from a supply perspective? Are you guys believers in the whole Peak Oil thing?

Bustin: Fundamentally, I'm a believer in the concept of Peak Oil. Yet, with the new accessibility to reservoirs made possible by technologies that allow us to drill horizontally and release petrocarbons unconventionally through fracking, I am not sure we have actually seen Peak Oil. Ultimately, however, we are burning through an awful lot of what is undeniably a finite resource.

Katusa: David, the problem with the Peak Oil theory is, it doesn’t take into account the increase of production and supply and the economic value of the reserve using unconventional technologies, which are always improving. Moving forward, we are long-term bulls on the oil price, but we've been consistent in telling our subscribers to stick to the fundamentals – that the companies they should be investing in are those that are able to produce at the lowest costs. Viewed from another angle, if a company in your portfolio needs $150 oil to make a profit, you should be a seller.

Q: What cutoff price do you think investors should be looking at for a company they want to own?  

Katusa: In our in-house calculations, we use US$45 per barrel. If a company cannot produce economically and with a solid netback at $45 oil, they are not a low-cost producer and should be avoided. 

Q: For the readers who are not familiar with the term, can you define "netback"?

Katusa: Netback is basically the difference between your production costs and what you sell your oil for at the well head. Let's say the spot oil price you are receiving is $75 and your all-in costs are $40, your netback would be $75 minus $40, for a netback of $35.

Q: On the topic of unconventional production, there's clearly a trend towards viewing the oil sands from an environmental standpoint as being a bad thing. Do you anticipate there being additional taxes levied or even a complete ban on the sale of oil from oil sands?

Katusa: The oil sands have too big of a production profile for them to be banned as a source. Already, one out of every six barrels of oil consumed by a U.S. citizen comes from the Canadian oil sands. We’ll almost certainly see increased taxes, however, that assure that oil sands are not going to be our cheap source of oil, though it will continue to be a sure source of oil. 

Q: Won't that ratchet overall prices higher?

Bustin: The overarching problem is that the oil sands projects are so capital intensive – we're talking about 60-80 billion dollars already invested, with potentially another 300 billion dollars yet to be invested to maximize the resource. You can't put together projects with a capex of that magnitude unless you have a predictable price of oil.

Katusa: It’s worth noting here that the existing production is profitable at a cost of around $40-$45 per barrel. But of course, that doesn’t take into account any new taxes. 
For the time being, taking into account the netbacks being earned by both conventional and unconventional producers – with even the oil sands operators currently operating at margins of close to 100% -- we see the potential for some downward pressure in the price of oil in the short term. Remember, for years and years, the big oil companies were running at 10-15% margins.

Q: Do you think we’ll see a carbon tax – cap-and-trade and all that?

Bustin: Absolutely.

Katusa: Whether you like it or not, it’s coming. While we all know it’s complete nonsense, if there is one certainty in today’s world, it is that the governments are going to tax whatever they can, and most of the people who support the current government in the U.S. believe that a carbon tax is good because they’re taxing the bad polluting companies that have billions of dollars in their banks. So it's coming.

Right now the voluntary market for CO2 is trading around $8-10 per ton, but in Europe, which has a mandatory market, the cost is double that. That's a big cost. 

Q: Let's talk a bit about natural gas. From the geological perspective and also as an energy investor. Dr. Bustin, what’s your outlook for natural gas?

Bustin: In North America, we see natural gas lingering around the $5-or $6 range probably for the rest of the year. There really is a lot of natural gas available. Also keeping a lid on prices is that there are a lot of projects on line that aren’t quite economic at current prices. However, as soon as prices start moving up a little, a large amount of gas will become economic and therefore hit the market.  

Prices in Europe are starting to decline significantly from a year ago as well, thanks also to increased supplies, so we're pretty soft on natural gas. That doesn’t mean you can't make money in natural gas or by investing in natural gas-producing companies – you can, but you have to be very selective and focus on low-cost producers.

Katusa: Moving forward, there are two things that will be very important to the sector. The first is that, thanks to unconventional technology becoming increasingly streamlined and effective, there are thousands of wells that have been drilled, fracked, but not completed. Those wells can come on stream with between 2-10 BCFs per day and are just sitting there. Think of it as a shadow supply of natural gas in the U.S. 

The second thing to keep in mind is that the success that companies have had in exploiting the shales has resulted in massive new deposits. 

Finally, it’s important to understand some of what’s going on with the oil-to-gas-equivalent ratio, which has traditionally been around 6:1. Consequently, at current spot prices, many analysts and promoters are saying, "Well, natural gas is cheap relative to the price of oil." Be careful when you hear that. 

For instance, a lot of oil companies are purchasing gas companies because lower gas prices have made the companies cheap. The oil companies then look to boost the reserves on their balance sheets by reflecting the gas they acquire as BOEs, or barrels of oil equivalence. They will then actually book it as a barrel of oil to analysts at a ratio that is something like 22:1 today.

Q: What are the implications to us as investors?

Katusa: It all comes down to what a company is actually worth, which will guide you in what you pay for it. If a company says it has a billion barrels of oil equivalent in the ground, it will command a much higher price than if it showed its actual oil reserves and that it also had, say, three TCFs (trillion cubic feet) of gas. A surprising number of companies are doing this, including mid-tiers and majors. Imagine the implication to shareholders if this con is exposed for what it is?

Q: Can these companies actually convert their gas into usable oil?

Katusa: No.

Q: With the oil/gas ratio skewed in favor of gas, what about the market for substituting oil with gas?

Katusa: You have to ask, can we create a market for the natural gas that actually substitutes for oil? Of course, the big one would be having more compressed natural gas stations to encourage car manufacturers to make the switch, and there are a number of companies in North America looking to do just that. The big movers in that initiative are Canadians, but the idea has a lot of potential given the general theme of trying to reduce reliance on oil from foreign sources. 

Q: Isn’t an increasing amount of base power generation switchable from oil to gas?

Bustin: With a lot of effort. Of course, the big one is the switch from coal to natural gas. Natural gas is much cleaner burning. In Canada, just a couple of weeks ago, legislation was passed calling for no new coal-fired plants. I think after a period of 15 years, they won't allow the existing coal-fired plants to be refurbished and continue to burn coal. So there's going to be a huge shift towards natural gas-fired electrical generation in North America, because of the carbon issues. 

Q: I know you guys like coal, which is kind of counterintuitive, seeing how most people view it as dirty and dangerous. What's driving your outlook on coal – again from a fundamental standpoint and also in terms of finding investment opportunities?

Katusa: Start with the big picture. As much as 75% of China’s electricity generation currently comes from burning coal. That’s not going to change anytime soon. In fact, 2009 was the first year ever that China actually imported coal. Not so long ago, it had been a big exporter. But already half of the coal in the world that is produced is used by China. 

On top of that, and this is pretty ironic given the popular view of coal, is that the U.S. is the second largest consumer of coal in the world, after China – with India being a distant third. Everyone is saying coal is dirty, coal is ugly, coal is smelly. It's done. We're going green. Even Obama said so. Yet if you’re careful, it’s where the profit is to be made. In fact, coal has been the biggest winner of all the energy subsectors over the last 12 months. 

Q: How do we invest?

Katusa: In terms of investments, we like those related to met coal, versus thermal. As a reference point, there have been contracts signed in China at $105 per ton of thermal coal, but and as high as $500 per ton of met coal. 

That’s because on the order of 90% of all steel production is dependent on met coal because of the temperature it produces. In North America, there are serious difficulties bringing on a thermal coal project, starting with environmentalists and government regulators, but also because transportation of the coal is the largest cost of a coal project – and therefore the deciding factor in the economics. Simply, at today’s prices, if you don’t already have a train running almost right up to your new thermal coal mine, it’s almost certainly not going to get off the ground.

So we have decided to stick with met coal for North America. On our North American met coal plays, we have recently recommended two in our alert service. They are doing well, and we expect them to go a lot higher. 

Q: You like companies with significant upside as opposed to run-of-the-mill returns. That typically means small-cap companies. Are there smaller coal companies investors can get into, or are these all large companies?

Katusa: The coal companies have huge amounts of cash right now, because they’re kind of like the base metal of the energy sector. They’re boring, but they make a lot of money.

There are ETFs you can use to play the coal sector, but the reason why I like the juniors is the share price can go up ten times, as was the case recently with Western Canadian Coal. Of course, there are big companies with good coal exposure, like Peabody or Nobel or Teck Cominco. They have great assets, but the bang for your buck is not going to be as high as with a small-cap play.

Q: Let’s talk nuclear. There has been a lot of talk about pebble-bed reactors dotting the Chinese landscape, yet here they are scrambling for coal. Whatever happened to the dozens of new nuclear plants that were supposed to be headed for China?

Katusa: Despite popular conceptions, the pebble-bed reactors are actually an old technology, initially developed by the Nazis. The Chinese bought the technology off the Germans.

Pebble-bed reactors were supposed to be the Henry Ford Model T of nuclear reactors. They would actually be built in an assembly line. Imagine it like a LEGO set. As a town grows, you add a module. As the city grows and the energy requirements grow, so does the number of nuclear reactors. 

However, the technology is still not ready for prime time. In fact, it's years away. That said, in the not-too-distant future, the demand for power and the need for governments to launch make-work projects will almost certainly kick off a rush to get a piece of the action. Especially in China.

Q: How would you play it as an investor?

Katusa: The best way is through a small-cap uranium company with a substantial economic resource, because these reactors are going to need a lot of feed. The time will come when the spot price of uranium is going to return north of $100 per pound. The last time that happened, a lot of the early investors in the better uranium juniors – most of which are Canadian – made a lot of money.

Q: What's your time line for uranium to push back over $100 per pound?

Katusa: I'd say 3-5 years.

Q: What are the fundamental reasons for this?

Katusa: The HEU Agreement, which involved nuclear warheads being dismantled and the uranium blended down to nuclear fuel has now come to an end and it will be three years before it is renegotiated. The last time it was negotiated, Boris Yeltsin was in power and Russia was on its knees. That's not the situation today. Russia is very powerful and Putin is still running the country behind the scenes. This time around, they’re going to negotiate a much different agreement. And don’t forget that today, unlike back when the last treaty was negotiated, the China factor is huge. 

We would expect the Russians to go to the Chinese first before they renegotiate with the Americans. So the Americans are a victim of their own success by depending on the cheap Russian nuclear fuel. That time is coming to an end in three years, and within five to six years you'll see spot prices very high.

With the world increasingly looking to ramp up nuclear energy production – as it very much is – any of the companies with large reserves and the potential for low-cost production are going to be trading at a nice premium to where they are today.

Q: As an investor, where in the energy sector is your biggest focus right now? Where are the big opportunities in the relative near term?

Katusa: Before you can talk about specific opportunities, it’s important to be sure you have the right strategy to bringing those opportunities into your portfolio. These are very fragile markets, and so our strategy has been very conservative for some time now.

For instance, we spend a lot of time identifying great management teams that are personally heavily invested in their own companies – and then wait for them to raise cash through private placements that allow investors to pick up both a share and a warrant on favorable terms. Once the holding period is over, which can be as little as a few months, selling the shares and riding the warrants can be a good move as it gives you most of the upside with none of the downside if the markets tumble.

Likewise, we don’t chase stocks but instead decide what we’re willing to pay for a stock – which in these volatile times might be 20% below where it currently trades – and then wait patiently for it to come to us. That approach doesn’t always work, as sometimes we don’t get filled, but we’re okay with having a greater-than-normal allocation to cash at this point.

Another technique we use is what we call the Casey Cash Box – which involves running regular screens of a universe of small to mid-sized energy companies, looking for prospective companies selling at discounts to cash and other liquid assets. You might say we look to buy dollars for quarters.

Finally, when we get the desired result from our analysis – i.e., we buy good companies cheap and watch them move higher, we don’t hesitate to cash out our initial investments and take a free ride on the balance.

These are dangerous markets, and being cautious while building a diversified portfolio of energy plays makes a lot of sense. At least to us.

Okay, with that foundation, where would I invest today?

For starters, I might try to get ahead of the large sovereign wealth funds. And they are being pressured to invest in green energy. That’s one reason we’re more bullish than ever on green energy plays with the real potential to be economic.

Q: So which of the green energies are potentially economic?

Katusa: Geothermal and run-of-river are two we particularly like just now. 

Q: Geothermal is not a new technology. It’s been used in energy production for something like 100 years, right?

Katusa: That’s correct. 

Q: So why isn't it in wider use? What percentage of the base load in electricity in the U.S. comes from geothermal?

Katusa: Less than 1%. 

Bustin: Economic geothermal projects are found in areas where you have very high heat flow or fluids near the surface. Of all the deep dry rock geothermal projects, where the real energy potential exists, none are actually economic. Currently they’re still in the experimental stage. At some of the more prospective sites in Australia, they ran into some significant problems, so it's still in the science box.

As a consequence, most of the geothermal projects you see are not where the real future is, which is in the deep dry rock geothermal projects, and those are going to take more time and a lot of money to get right.

Q: Aren’t government subsidies that can help the geothermal companies try to reach economic sustainability a big part of the attraction just now? Isn’t that also the case with run-of-river?

Katusa: No question, depending on the jurisdiction a company operates in, the subsidies for green energy projects can be very substantial. So much so that it makes it almost impossible for a company to lose money. Which, of course, all but eliminates the risk to shareholders as the company tries to build something that can last.

As for run-of-river, which involves diverting flow from a strongly running river, using it to turn a turbine, then returning it to the main river, there are actually quite a few opportunities. In fact, our latest look at the sector found over 45 small-cap companies. We recommended two, and one of them gave us a double that allowed us to cash out all of our initial investment, giving subscribers a free ride on the rest. 

Overall, the prices on these companies have reached the point where we are holding off on any new recommendations in the sector, but we expect the prices will come back to an attractive level in the not-too-distant future. We’ll be ready when they do.

Q: Dr. Bustin, we’ve heard from the Dealman. Now, speaking from the technical perspective, are there any particular energy sectors now attracting your attention?

Bustin: Well, I'm really concerned about the coal sector. We're so dependent globally on coal. If we start slapping some major carbon taxes on coal, it's going to be catastrophic. I'm not quite sure how it's going to work out, because there is no way China and India and a lot of the developing nations, particularly in Southern Africa, which are so dependent on coal, are going to be able to manage. If they have to face these carbon taxes, I'm not sure where the world economy is going to head, because there's no way we can free ourselves from coal.

Q: I've heard the idea to use taxes to level the playing field between the dirty and the clean sources of base power. So coal would be weighed down, if you will, by added taxes to the point where there is no cost advantage to using it over natural gas. Have you heard the same thing?

Katusa: The beauty of coal is, it's base load. It's cheap and it's easy. The problem with solar is nighttime, and the problem with wind is no wind. And even run-of-river, which we like, fluctuates according to the climate, which is why geothermal is our favorite green energy because of its base load potential. 

Taken together, these alternative energy sources are okay as secondary sources to meet excess demand, but they’re not your go-to sources. What most people don’t realize is that much of the power used isn't from people charging their Blackberry or running their computers, or any of that. It’s used by big commercial industries, such as manufacturing and mining, for example.

Q: In the past, Dr. Bustin, you’ve said that is the question is not so much about which energy sources to use, but rather that, in order for the world to maintain even the status quo, the answer will be “All of the above.” In order to avoid the economic devastation of runaway energy costs, we're going to need every single source we can get over the next ten years. Fair statement?

Bustin: Yes, it is. Unfortunately, when we look at our gross national product per capita, it's directly proportional to our energy consumption. And, of course, if you look at multiple billions of people who have very low standards of living and if you want to give them a gross national product per capita comparable to that we enjoy in the developed world, you have to expect global energy consumption is going to continue to skyrocket.

As I’ve tried to indicate, the only way to even come close to meeting that energy demand is with coal. There is just no alternative for the foreseeable future, until we get into bigger reactors or some other interesting usage of nuclear power. Bottom line, we're stuck with fossil fuels, and the fossil fuel that is readily available and most economic is coal.

Q: Are you looking from an investment standpoint at any offshore opportunities to tap into some of that demand for coal coming out of China?

Katusa: We've got one on our radar screen now, but it’s premature to mention it here. I've actually visited the site twice and like the story. It's a great project, the management is heavily invested in it themselves, but we haven’t recommended it yet because we are waiting for a couple of financings to come free trading, which will result in more stock available – and that will create downward pressure. By being patient, investors should be able to get it at a cheaper price. That theme, of being patient, can’t be stressed enough. Especially in markets as volatile as these.

Q. Good advice, and a good place to leave off. Thanks for your time.

----
David Galland is a partner in Casey Research, LLC., an international firm providing research and investment recommendations to individuals in over 150 countries. Prior to joining Casey Research, he was a founding partner and director of a successful mutual fund group (Blanchard Group of Mutual Funds), and well as a founding partner and executive vice-president for EverBank, one of the biggest recent successes in online financial services. 

If you’re interested in the staying closely in touch with the ever changing investment opportunities in the energy sector, you’ll find no better team than Marin Katusa and Dr. Marc Bustin as your guides. Just recently they tapped into one of the best-kept secrets in European energy policy – a sure-fire winner. Read more here.






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.

The latest trade from our options team was slightly more sophisticated in that we shorted a PUT as follows:

On Friday 7th May our premium options trading service OPTIONTRADER opened a speculative short term trade on GLD Puts, signalling to short sell the $105 May-10 Puts series at $0.09.

On Tuesday the 11th May we bought back the puts for just $0.05, making a 44.44% profit in just 4 days.



Accumulated Profits from Investing $1000 in each OPTIONTRADE signal 14 May 2010.jpg

Recently our premium options trading service OPTIONTRADER has been putting in a great performance, the last 16 trades with an average gain of 42.73% per trade, in an average of just under 38 days per trade. Click here to sign up or find out more.


Silver-prices.net have been rather fortunate to close both the $15.00 and the $16.00 options trade on Silver Wheaton Corporation, with both returning a little over 100% profit.

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
Jun232010

Mining Tax could cost Australian Prime Minister, Kevin Rudd, his Job

Kevin Rudd and Julia Gillard 24 June 2010.jpg
Kevin Rudd and Julia Gillard


On the air waves this morning we have the possibility of a change of leadership in Australia as the Prime Minister Kevin Rudd is well down in the popularity polls as the proposed mining tax becomes his Achilles heel.




June 24 (Bloomberg) -- Australian Prime Minister Kevin Rudd, whose support slumped after he abandoned a carbon-trading plan and proposed taxing the mining industry, faces a leadership challenge today from deputy Julia Gillard that may cost him his job.

Rudd needs a majority of Labor lawmakers when the party meets at 9 a.m. in Canberra. Gillard, who requested the ballot yesterday after Rudd began losing support, confirmed she would seek to oust Rudd, without further comment.

While Rudd said he was “quite capable” of beating back Gillard’s challenge, one analyst, Andrew Hughes, said the prime minister was likely to lose.

“He is a goner,” said Hughes, a political analyst at Canberra-based Australian National University, in a phone interview. “It’s the most significant political downfall in Australian political history.”
Three Labor Party lawmakers, including one minister and another who heads the party’s largest faction, also predicted Rudd’s defeat. They declined to be identified because of their party affiliation.

The Australian Workers Union, which represents over 135,000 people in such industries as agriculture, construction and hospitality and favors the mining tax, endorsed Gillard yesterday.
Rudd began to slide in polls in April after he shelved his carbon-trading proposal, a key campaign pledge when he won office in November 2007. Then he proposed a 40 percent tax on the “super profits” of resource projects in Australia, the world’s biggest shipper of coal and iron ore, and refused to back down even after members of his own party objected.




UPDATE 6.25am: JULIA Gillard is the red-hot favourite to lead Labor into the next election as Kevin Rudd faces a 9am challenge to his leadership.

Mr Rudd will put his leadership to the test at 9am today in a ballot of Labor MPs that could deliver Australia its first female Prime Minister.

Opening at $1.40 when betting commenced on sportsbet.com.au last night, Ms Gillard is now $1.20 to be in charge when voters next go to the polls, while Mr Rudd’s odds have blown out from $2.70 to $4.

Well it doesnt look good at the moment for Kevin Rudd and we will know the outcome shortly. We will publish the result in the comments section as soon as we the results of this leadership challenge is over.

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.

The latest trade from our options team was slightly more sophisticated in that we shorted a PUT as follows:

On Friday 7th May our premium options trading service OPTIONTRADER opened a speculative short term trade on GLD Puts, signalling to short sell the $105 May-10 Puts series at $0.09.

On Tuesday the 11th May we bought back the puts for just $0.05, making a 44.44% profit in just 4 days.



Accumulated Profits from Investing $1000 in each OPTIONTRADE signal 14 May 2010.jpg

Recently our premium options trading service OPTIONTRADER has been putting in a great performance, the last 16 trades with an average gain of 42.73% per trade, in an average of just under 38 days per trade. Click here to sign up or find out more.


Silver-prices.net have been rather fortunate to close both the $15.00 and the $16.00 options trade on Silver Wheaton Corporation, with both returning a little over 100% profit.

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
Jun222010

Greg Gordon: Turn on to Big Utilities, Pt. I

Greg Gordon 23 June 2010.jpg


Source: Brian Sylvester and Karen Roche of The Energy Report  06/22/2010
http://www.theenergyreport.com/pub/na/6598

Big American utilities pay big dividends, some as high as 8% among regulated utilities, and right now they're as cheap, relative to the bond market, as they've been in about a quarter century. If you like investments as income, few people who know the utilities equities better than Morgan Stanley Analyst Greg Gordon. In this exclusive two-part interview with The Energy Report, Greg eloquently and frankly explains the utilities market and offers some picks in the regulated utilities space. Part II will focus on Greg's picks among the deregulated utilities.

The Energy Report: Greg, please give our readers an overview of the market for big utilities in the U.S.

Greg Gordon: First of all, in looking at utilities in the U.S., they're a little bit complicated because they're not all homogeneous in terms of business models. In certain regions of the country, state regulators have liberalized the power markets; in other regions they have not. So when you look at the market capitalization of the utility sector, about 45% of the market cap is traditionally regulated utilities that operate regulated businesses where the state government regulator mandates the prices they can charge and gives them a fixed return on their equity investment in the company. Southern Company (NYSE:SO) is like that in the southeast, and so is PG&E Corporation (NYSE:PCG) in California and Consolidated Edison Holding Co. (NYSE:ED), or ConEd, in New York for example.

Now, Southern Co. owns power plants, burns a lot of coal, but their assets are regulated; so, they charge a regulated rate. They buy the coal; they pass the cost on to their consumers. The regulatory model is called "Cost Plus." You recover the costs plus a reasonable return on your assets. ConEd is regulated exactly the same way, but ConEd doesn't own many power plants. They sold most of their power plants by regulatory mandate back in the early part of the decade, but like Southern Co., they're still "Cost Plus" on the wires and the pipes they own. They buy the power on the open market that they need to provide their customers and then they pass it on to their customers at no margin.

And PG&E sold some of its power plants, still owns hydro and nuclear plants and also has a mixture of power purchases and fuel purchases that it uses to generate the power it needs. But it's not earning a margin on the power. It's earning a fixed return on the assets it's got.

That's very different from an Exelon Corp. (NYSE:EXC); that's very different from an Entergy Corp. (NYSE:ETR), which has regulated utility businesses, but also owns merchant power plants in liberalized markets. They earn a deregulated price, and they have to manage their costs. They become basically big cyclical energy companies where their margins rise and fall based on their ability to profit from power market dynamics. Generally speaking, power prices go up when natural gas is rising because natural gas is the marginal fuel for power in the U.S. in most markets. Power prices go up when demand is rising because as demand rises, less-efficient plants have to serve the load and that drives up power.

So the profit margins of the diversified utilities cycle, whereas the profit margins on the regulated side tend to be much more stable and predictable and are set by regulators, not by markets.

TER: What about dividends?

GG: The regulated utilities also tend, because they have more predictable earnings and cash flow, to be higher paying dividend entities. The average regulated utility in the U.S. dividends about 65% of its income to its shareholders. The average diversified utility only dividends about 45% of its net income to shareholders, and that makes sense because the diversified utilities in our coverage universe have a riskier cash flow stream. The dividend has to be lower to reflect the fact that the cash flow fluctuates more.

TER: So regulated utilities tend to be better long-term investments whereas diversified utilities have more upside and more risk?

GG: Let's talk about the regulated investment profile and diversified needs separately because really you would own them for separate reasons. Regulated utilities are perceived sort of as income first, growth second, investment vehicles and they're perceived really to be an alternative to other income-bearing instruments like bonds by most equity investors. They tend to behave in a defensive fashion relative to market dynamics; they tend to be less correlated to what's going on in the market in terms of the S&P. And they tend to be much more positively correlated to what's going on in the bond market.

Right now, the average regulated utility in the U.S. is investing capital in things like transmission lines and distribution grid enhancements like smart meters and putting environmental equipment on their power plants and building renewable energy facilities—more than 30 states in the U.S. have renewables mandates. Through these investments, they're growing their rate base, which is the capital investment on which they're allowed to earn by about 5% per year. When you grow your rate base, you have an opportunity to grow your earnings because you earn on the capital you invest. You actually have to spend money to make money. The risk is that they're periodically going into the regulator to ask for the revenues they need to pay for the investments that they're making.

TER: These are the base rate case rulings?

GG: Yes, you're constantly seeing this kind of activity and it pertains to their ability to earn a return on the capital that they're spending. The two drivers that really differentiate a good utility investment story are demographics and regulation. How much capital are you being asked to invest to keep up with trends in your local service region? And, is the regulator giving you a healthy return over your cost of equity or a skinny return on your cost of equity? I said the average rate-based growth was around 5%, but it varies. In California, the utilities are spending well in excess of that; and, in places like the Midwest, they're spending less because there's less demand growth.

The return on equity that these companies actually earn is mandated by the regulator, and the last 12 months the authorized return on equity was 10.5%–11%, but the authorized returns have been as high as 12% and as low as 9%. Again, if you go from state to state, some regulators are more magnanimous than others. As a utility analyst and a utility investor, you try to identify the companies that have the best opportunity for rate-based growth; with the best opportunity to earn healthy returns over their cost of equity. The best opportunities to make investments are in places where there's change taking place, where a state regulator has been historically maybe a little bit tight on the returns that they authorize and we think they're going to start to be a little bit more magnanimous or where a company had not been spending a lot of capital and we think it's capital spending is going to increase, and they'll get an opportunity to earn a decent return on that.

TER: What about regulated utilities?

GG: Again, we think the most money is made in regulated utilities when you invest in positive change; and frankly, the most money is lost when investors fail to perceive the change in dynamics the other way. I'll give you three examples of stocks that I like in that space or that fit that profile: American Electric Power Company, Inc. (NYSE:AEP), CMS Energy (NYSE:CMS), and NV Energy Inc. (NYSE:NVE).

AEP is a big regulated utility that operates in multiple states all the way from Ohio down to Texas. They have a management team that has historically been not tremendously disciplined in allocation of capital. They have spent aggressively to grow the rate base, but they have spent more aggressively than regulatory outcomes have allowed them to earn. So their returns on equity have been low relative to the industry average. What happened is AEP spent so much money on their capital base going into this last recession that they got over-leveraged, and they were forced to issue a lot of equity at very low prices at the bottom of the market. That was very dilutive.

They've since put a new CFO in place and reined in their capital spending. Now that the economy is recovering, the returns on what they have invested should begin to improve as the economy improves. I think they've got some newfound discipline in terms of managing their capital spending and operating costs. I believe that the regulatory outcomes in the states in which they operate will be incrementally constructive.

If you believe that, you've got a company that can earn $3 per share this year and grow earnings at probably 4% a year for the next several years, and it's trading at under 10 times my 2012 earnings estimate of $3.25; the yield is 5.2%. By the way, at around 10 times earnings that's almost a two multiple point discount to other larger cap regulated utilities that, like a Progress Energy Resources Corp. (TSX:PRQ), for instance, are perceived to be more stable. The stock price is basically discounting earnings never going up. There is just skepticism that AEP have their act together. I believe over the next 12 months, as they prove that they've got their act together financially and the economy continues to recover in the Midwest and the regulatory decisions that they get from the multiple states they're in continue to be constructive, that that stock will appreciate because investors will embrace the change that is happening in the company.

TER: Tell us about the other two utilities you mentioned in the regulated space.

GG: CMS is a little utility in Michigan, and when the economy was really contracting, Michigan utilities were really hard hit for what appeared to be fairly obvious reasons. The auto industry went into a tailspin, so there was a perception of "Gosh, you know utilities in Michigan serve the auto industry and if the auto industry is in trouble, then their sales must be in trouble." For CMS that was less true because they don't have direct exposure to the auto industry as much as some of the other state utilities.

The other thing that happened is the utility regulators in Michigan really put a regulatory framework in place to protect the utilities' financial performance from suffering as the economy continued to contract. They instituted a rate-making model called "Revenue Decoupling." That means is there is a much larger fixed component and much lower variable component, if a customer consumes less, so that fluctuations in demand don't have a huge impact on revenues. They can have a much more predictable earnings stream.

The reason regulators have done so, I believe, is because they see the regulated utilities in the state as partners in economic development. They want healthy utilities to spend on state of the art infrastructure in Michigan so they can attract business. I think that is not fully appreciated by investors. CMS Energy stock trades even cheaper than AEP on our earnings estimates. We think that CMS is going to earn $1.35 per share and will grow its earnings at around 8% a year for the next couple of years.

Again, we don't think that investors believe they will be able to do that, given that the stock is trading at almost nine times earnings. Now, they've got a little bit more debt than the average utility, and their divided yield is a little bit lower; CMS Energy yields 4%. But even taking those two things into account, we see no reason why that stock can't trade demonstrably higher as they execute on their growth strategy and investors begrudgingly come to accept that the regulatory model actually indemnifies them for a lot of exposure to industries about which people are concerned. We believe the regulators will continue to be constructive.

TER: And NV Energy?

GG: NV Energy serves Las Vegas and Reno, Nevada. That stock went down during the economic crisis because they weren't exposed to manufacturing like CMS, but they were exposed to housing and tourism through the casinos and hotels in Las Vegas. The economy did contract quite dramatically in Las Vegas. We think their earnings over the next 18 months will recover for two reasons: one, the economy in Nevada hopefully will start to show some improvement as we get into the first or second quarter of 2011. Analysts here at Morgan Stanley that cover the dominant industries in Nevada think that they will recover a little bit later in the cycle than other areas of the economy.

And the company will file a base rate case for the Las Vegas jurisdiction next year. One of the things that is happening in that rate case is not only will they ask for revenues to compensate for the decelerated economy, but they also have a big power plant investment that will be completed early next year. That's going to add assets to their rate base. When that happens, we think the earnings power of the company rises from around $1 per share this year (and it will probably earn a $1 per share next year, which is kind of a 7% return on equity), to about a $1.35 per share in 2012, which is closer to 9%. The stock is trading on that $1.35 estimate at under nine times earnings; so, there's clearly a complete lack of belief that they will be able to drive their earnings back to a more reasonable return on equity. Remember, I said before that the average utility has been authorized closer to a 10.5% return on equity in the past year.

TER: A lot of the profitability of these companies seems to hinge on positive outcomes in base rate case rulings. It seems like shareholder success at least in terms of NV Energy is directly tied to the regulator, no?

GG: Well, you can never say with certainty that a regulator is going to act in any particular way, but you can look at the history of their decision making and look at the mosaic of activity in any particular state to gauge the level of risk. The regulators asked NV Energy to build this power plant; so when they put it into rates, we believe the regulator will do its best to allow NV to earn a reasonable return on that investment.

The last several rate reviews that the company went through they were actually treated reasonably by the commission in Nevada; they were given decent rate decisions. They've just filed a small rate increase for their Reno-based utility, which is the smaller of their two utilities; it only represents about one-third of the company's earnings. That rate decision will be resolved before they file the next one, so it will be sort of an indicator of the level of constructiveness or lack there of between the company and its regulator.

TER: So sometimes you get an early indicator as to the outcome of the crucial base rate case rulings?

GG: Yes, the other thing that's interesting about NVE is that it's the only utility that I cover that is trading at a discount to its tangible book value. I said earlier that utilities earn a return on their capital investments (i.e., their book value). That means that if you believe that it's got the ability to earn a return in excess of its cost of equity on its capital investments, by definition it should trade at a premium to book. So, the fact that this one trades at a discount to book means either that investors believe that they're going to never achieve a return in excess of their cost of equity or that their cash flows are insufficient to fund their growth, so they're going to have issue shares of common equity and dilute their current shareholders. I think both those fears are unfounded.

TER: Alright, NV Energy is building a new plant in Nevada. They clearly have some fixed costs of just running facilities and power lines and such, and, in an environment like Nevada, the revenues must have dropped dramatically with the economy. How do they have any return in the years before a rate increase?

GG: The answer is yes; by our measure, they earned a 5% return at their Las Vegas utility. In 2009, the company earned $0.78 per share on a consolidated basis. We think they're going to earn around a $1.05 this year, which is an improvement to around 7.5% return in Las Vegas. Then, we think they can get to sort of an 8.5%–9% return by 2012, after they receive the rate decision we're expecting next year and, hopefully, go from there.

We think it's an interesting investment because we think the stock can go up even if they continue to have a sub-par return; it just has to improve from where it is today.

TER: It seems like the regulator is all-powerful in some cases. What are some jurisdictions, as some of the top jurisdictions as far as regulators go in the U.S.?

GG: That's a good question. Many of the utilities that are perceived to be very stable and well-regulated companies don't look like interesting investment opportunities to me because that's appreciated already. As a value investor by training, I am always looking to invest in something that's underappreciated or misperceived. Those were three examples of regulatory jurisdictions that may be perceived as being more difficult than they really are. If you look at a jurisdiction like California, I think some of the utilities in California are trading a bit cheap to where their fair value is. But that is a jurisdiction that since the California Power Crisis in the early part of the decade has demonstrated itself to be highly constructive in the way it regulates its utilities. Those stocks are trading almost like there is this sovereign risk discount being applied to some of those companies. PG&E's got a great history of getting constructive regulation after coming out of bankruptcy in 2004, but what happens if the California government defaults on its debt? Are they going to be somehow indirectly exposed to that?

I think the regulatory environment in the U.S. is actually pretty good. If you look at the regulatory activity over the past 18 months and you think about what's happened as we've gone through the depths of this recession, the vast majority of utilities that asked their regulators for revenue increases got some meaningful amount of the money that they asked for despite how difficult the economy was.

I am a little bit concerned that it's going to be more difficult as we start getting into an inflationary cycle because when interest rates start to go up, cost of capital starts to rise, the operating costs start to go up, and the physical cost of capital expenditures start to go up. Then the rate increases that become needed start to stress the ability of the regulator to be dispassionate. Then they start to cap the amount they raise rates and that can cause problems.

TER: Thanks so much for your time today, Greg.

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As of April 30, 2010, Morgan Stanley beneficially owned 1% or more of a class of common equity securities of the following companies covered in Morgan Stanley Research: American Electric Power Company, Inc, CMS Energy Corporation, Entergy Corp, PG&E Corporation, Sempra Energy, Wisconsin Energy Corporation.

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Have a good one.
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Thursday
Jun172010

Kevin Shaw: Carpe Cardium, Kurdistan & the North Sea

Source: Brian Sylvester of The Energy Report  06/17/2010
http://www.theenergyreport.com/cs/user/print/na/6563

Wellington West Analyst Kevin Shaw lives in Alberta and believes there are few better places to invest than Canada's oil- and gas-rich provinces. But he also sees attractive international opportunities in such places as Kurdistan, the North Sea and Albania. "When you're putting a drill bit into the ground in Kurdistan," he says, "you're. . .'deep-sea fishing.'" In this exclusive interview with The Energy Report, Kevin explains why he's also big on the Cardium, Notikewin, Bakken/Three Forks and the Montney shale plays.

The Energy Report: Last week, the government of Alberta announced that it will reduce oil and gas royalty rates in the province to make them more competitive. You're based in Calgary. What impact will this have on the industry and the oil sands in particular?

Kevin Shaw: For Alberta's oil and gas industry, it's an overall positive move. For the last couple of years, we've been competing in the oil patch against some of our neighbors like Saskatchewan and BC. In Alberta, the regulations were changing every 6–12 months; Alberta didn't have a long-term vision. As a result, small to major companies in the oil patch were pushing their dollars into places that had more attractive fiscal regimes like Saskatchewan and northern BC. Now the government of Alberta has a long-term vision; it has reduced royalty rates and put incentives into some really, attractive technologies on which the industry is focused.

TER: What sort of technologies?

KS: Areas of application like horizontal drilling techniques into more mature oil and gas basins where it's really a recovery-type game to exploit more oil and gas. The government has hit the right spots; it's also stated that nothing will change for three years, so we've got a longer-term vision for our royalty structure, which is what investors, the markets. . .everyone wants to see.

TER: What's the new royalty rate?

KS: There is now a competitive 5% royalty incentive rate in the first 12 months that could extend up to 40+ months, depending on what types of targets are being drilled for oil or gas. Out of the gate, the 5% royalty rate will benefit all Alberta producers. There are a lot of drilling and horizontal resource-play incentives that, in some of the deep shale plays or even the shallower horizontal plays, can be upwards of $1 million per well. That's an incentive for the industry to increase activity in horizontal developments or go after some of the deeper targets—especially targets greater than 2,000 meters below surface. I believe this will bring more focus onto some of the well-known Alberta plays.

TER: What are some of those plays?

KS: The Cardium. It's is a major emerging oil-resource play in Canada. It has companies like PetroBakken Energy Ltd. (TSX:PBN), Daylight Energy Ltd. (TSX:DAY) and ARC Resources Ltd. (TSX:ARX; UN:AET), which are really ramping up and spending significant amounts of cash in the play this year and next. Other emerging mid-caps like Bellatrix Exploration Ltd. (TSX:BXE) and Equal Energy Ltd. (TSX:EQU; NYSE:EQU), two companies that I cover, and even smaller exploration and production (E&P) companies like Midway Energy Ltd. (TSX:MEL) and WestFire Energy Ltd. (TSX:WFE), which I also cover. These companies are going to benefit from the revised royalty regime, especially as horizontal wells extend out deeper into the plays.

Operators big and small are drilling longer, horizontal lateral legs and putting a higher density of fracks into plays like the Cardium or Viking Oil resource plays. Other key ones currently include the Montney and Notikewin gas resource plays, which are big in Alberta and in northeastern BC.

One of the companies I cover that has a huge acreage position in the Montney gas play is Painted Pony Petroleum Ltd. (TSX.V:PPY.A). They're surrounded by Progress Energy Resources Corp. (TSX:PRQ), Husky Energy Inc. (TSX:HSE), Talisman Energy Inc. (TSX:TLM; NYSE:TLM) and Royal Dutch Shell plc (NYSE:RDS-B). Those companies are developing huge reserves in the Montney right in the same neighborhood as Painted Pony, which currently holds ~126 net sections in the heart of the fairway.

To gain exposure to the liquids-rich Notikewin, we believe one of the best companies to own is Bellatrix, which is drilling horizontals that test 10+ mmcf/d with 40 bbl/mmcf liquids (mostly condensate) and receive up to ~$1 million per horizontal in Alberta royalty incentives.

TER: You mentioned companies like Midway and Bellatrix. Has the new royalty legislation caused you to re-evaluate some the companies you follow?

KS: You definitely look at who can benefit from it. Without getting into a lot of details, these types of royalty incentives in Alberta allow you to drill two or three wells and get almost a third or fourth for free. On a deeper well, you can now get over $1 million in incentives. If you drill three wells, you get $3 million. In a lot of these plays, you can drill a well for $3 million or less. The point is oil and gas companies in Alberta will be able to ramp up their drilling programs with the same capital budget as before but drill incrementally more wells.

TER: If there's more drilling, it stands to reason that some of the drilling companies are good investments.

KS: No question about it. Drillers are definitely going to get busier as activity levels increase. Because of heightened activity levels for horizontal drilling and multi-stage fracks, there's a long wait time to get wells fracture-stimulated because frack equipment is becoming very scarce. It's running around the clock. There's not enough equipment on either side of the border on some of the horizontal plays, which can delay operations in some cases. Frack equipment is becoming a hot commodity. If commodity prices, especially oil, continue to move further or stay in the current range—call it $60–$85—we're going to be very busy as an industry in a lot of these multi-stage frack, horizontal-resource plays. As that happens, we expect that the frack companies are going to be very good investments going forward.

TER: Any specific names?

KS: Trican Well Service Ltd. (TSX:TCW), Calfrac Well Services Ltd. (TSX:CFW) is another one. I don't cover the services as an analyst but those are two. There are lots of other companies, like Schlumberger Ltd. (NYSE:SLB) and Canyon Services Group Inc. (TSX:FRC)—another player that's evolving in the energy services space. It would be one to watch as a smaller entity in the frack business.

TER: In the U.S., the Obama administration ordered a moratorium on offshore oil and gas drilling as a result of the Gulf of Mexico (GOM) oil spill. What's Wellington's take of what's happening in the Gulf?

KS: Overall, it's a tragedy. For the next six months, obviously, the drilling permits have been stopped for the deeper drilling. Approximately 33 deepwater drilling permits were suspended for the next six months, and no further licenses will be issued until the cause of the explosion is known in more detail. My numbers say approximately 9% of U.S. oil production and about 3% of U.S. gas production comes from the deepwater drilling in the GOM. If you look at shallow drilling, the numbers are closer to 30% U.S. oil and 11% gas. Obviously, stopping deepwater drilling for six months will have an impact.

TER: Do you see an outright ban?

KS: No, I don't. Let's face it, offshore development for the energy industry is very important to the global supply and demand picture. Thousands and thousands of offshore well operations have been executed safely and efficiently. Quite honestly, the industry does a very good job of putting the right procedures in place and operates many safely run operations.

TER: What do you recommend investors do with offshore plays in the GOM?

KS: If people, who are currently invest only in GOM-based companies, want to have a portion of their portfolio in the offshore space, there are other places they can direct their money over the next 6–12 months while the GOM gets sorted out and back up and running.

TER: Where are those places?

KS: There's an awful lot of activity going on in UK's North Sea. Companies like Talisman and Nexen Inc. (TSX:NXY; NYSE:NXY), which are starting to ramp up activity there; and even smaller caps I cover that are growing steadily into the mid-cap space, in terms of overall asset base, like Ithaca Energy Inc. (TSX:IAE) and Sterling Resources Ltd. (TSX.V:SLG).

Ithaca is manufacturing oil in the North Sea and has steadily delivered results over the past 12 months, increasing oil production and boosting 2P reserves. And Sterling just started a six-well offshore drilling program with five of those in the North Sea targeting shallow depths (i.e., relatively simplistic operations, yet high impact oil and gas prospects).

There's offshore in Brazil and lots of other places around the world where you can direct money to the offshore side of the business. Many people in the investment world like the offshore space, given it provides exposure to big reserve targets per well and material changes in a stock's market performance overnight.

TER: A recent Wellington West investment presentation deemed Kurdistan "the world's hottest exploration region." Please explain.

KS: Kurdistan has what we would call "mega play" potential. There aren't too many multi-billion barrel areas that have been under-exploited or under-explored. Kurdistan is one of those regions because it hasn't been open for business to oil and gas nations or entities under the different government regimes of the last 20 years. There's huge hydrocarbon potential there, contained within huge seismic structures. That's the attraction to Kurdistan. You've seen companies like Heritage Oil Corp. (TSX:HOC) and Gulf Keystone Petroleum Ltd. (LSE:GKP), the United States Short Oil Fund (NYSE:DNO) and others positioning in Kurdistan, as well as the smaller companies like Vast Exploration Inc. (TSX.V:VST), Longford Energy (TSX.V:LFD), Range Energy Resources Inc. (TSX.V:RGO) and others that are trying to tie up land positions as more and more management teams see the big rewards if you drill into one of these mega, multi-billion barrel discoveries. The discoveries are so big—it is one of the only places in the world you can still get truly "BIG" oil in place.

TER: What's the risk?

KS: The risk with Kurdistan continues to be the geopolitical environment between Baghdad and the Kurdistan regional government. At the end of the day, you've got over 35 international oil and gas companies in the area. Many governments around the world are trying to work with Baghdad and the Kurdistan regional government to figure out a proper business "law" to move the oil and gas industry forward. Kurdistan is definitely at a real primitive stage, in terms of having a business system and set of regulations for investment into the area by oil and gas companies. That's the risk right now, but there's a huge prize for the government to resolve this situation. I believe it will get resolved, but it may take some time.

TER: What are some junior E&P companies that you're following in Kurdistan?

KS: I cover Vast and Longford. Vast just spud a well a few weeks ago with Niko Resources Ltd. (TSX: NKO), a large international operator in the area. It's pretty exciting times for Vast right now. Vast has several large structures on their block in Kurdistan. Most of the blocks there are on trend with some of the major producing fields, whether it's Kirkuk or Taq Taq. When you're putting a drill bit into the ground in Kurdistan, you're—what I call—going "deep sea fishing." You're not sure what you're going to hit! Oil and gas has been hit over the last 12–14 months across four different horizons of interest. Whether it's in the Tertiary, Cretaceous, Jurassic or Triassic, there's a lot of hydrocarbon potential to change a company's stock price materially overnight.

Vast is currently drilling three large structures, all of which could easily be 100–350 million barrels. You could hit a 1 billion+ barrels-a-day find like that which Heritage hit not long ago. Other big players in the area that have drilled successful wells like Addax Petroleum Ltd. (TSX.V:SLG), which has now sold; and Gulf Keystone, farther to the north in the Kurdistan region, has hit some big finds. Both Vast and Longford are run by the same management team. The Longford block is a shallow development play that already has a number of vertical wells that were put into the block that did produce or show oil. We believe, Range Energy Resources is the cheapest trading stock in the Kurdistan space, currently, and could have one of the most attractive blocks in all of the Kurdistan region, nestled between the Heritage discovery and the existing multi-billion barrel Taq Taq field.

TER: Congratulations on the success you've had with Bankers Petroleum Ltd. (TSX:BNK), Painted Pony and Arsenal Energy Inc. (TSX:AEI). Of all those companies, what are some common elements that allowed such dramatic appreciation of their respective share prices?

KS: I'm a technical guy—oil and gas engineer/operations—by background. I look for what I call a "manufacturing approach" to a lot of the plays. I like to see legs to the story, in terms of growth in proven and probable reserves (2P). A lot of companies in the oil and gas industry can go out and drill a few wells and press release some pretty big production numbers. At the end of the day, you have to build 2P reserves to build a successful oil and gas company—small or big. Companies like Painted Pony, Arsenal, Bellatrix, Midway, Ithaca and Sterling are all steadily building 2P reserves and increasing shareholder value. Many of these companies are involved in very repeatable-type plays in the oil and gas space. There is minimal geological risk in these plays, as the oil or gas resource is there. It really comes down to recovery and the application of technology for exploitation. They tie up the land, and then use technology—horizontal drilling, multi-stage fracks, etc.—to boost the recovery factor per well. They boost the production rates and focus on depleting the resource per section across their acreage in a very methodical "assembly-line" manufacturing approach. If companies are doing that and you can see that they've got low-risk acreage in front of them, reserve estimators will give them credit for the reserves.

TER: Where does the "manufacturing" come in?

KS: If companies boost recoveries on their assets, they'll continue to what I call "manufacture" oil or gas in the space. The Cardium companies like Bellatrix are doing that very effectively right now. Bakken players like Painted Pony in southeast Saskatchewan continue to do this very effectively and have made a lot of money for shareholders in the last few years with significant growth we believe still ahead of them in very repeatable plays both in the Bakken and in the Montney resource play in northeastern BC.

On our valuation, Arsenal Energy is a very undervalued company—one of the cheapest oil stocks in the entire domestic space. Arsenal has just recently released two very successful North Dakota Bakken horizontal results, with these wells coming in at over 1,000 barrels per day (bpd) gross for initial production rates. You get big reserves from both of those wells, anywhere from 400,000–800,000 barrels in 2P reserve bookings. Arsenal's acreage in North Dakota is very low risk, as it has a number of wells on its property that have been drilled successfully in both the Bakken and emerging Three Forks oil resource plays. Companies like Continental Resources Inc. (NYSE:CLR) and EOG Resources (NYSE:EOG) have been drilling up all around them and de-risked their acreage. NuLoch Resources (TSX.V:NLR-A) is another North Dakota Bakken and Three Forks player to watch, with a huge acreage position (over 100 net sections) in these plays and partnered with larger companies like Baytex Energy Trust (TSX:BTE). When you have companies that have acreage in the right spot and very definable and visible production ramps in a well-known play wherein they have a large inventory of drill-ready locations, the value growth going forward is present. That's why I believe a lot of these companies have, obviously, appreciated over the last year or so.

TER: What are some of your strong buys among the domestics?

KS: We've talked about a few of them already. Bellatrix is definitely a strong buy recommendation. It has one of the premier acreage positions in the Cardium play with 81 net sections. It is right alongside the PetroBakkens and Daylights of the world. Bellatrix is one of the most attractive valuations in the Cardium space compared with its peer group. If you reverse engineer the buyout matrix of some of the companies PetroBakken and Daylight have purchased in the Cardium space over the last six months, you get Bellatrix anywhere between $8 and $10 a share. It's trading just over $3 right now.

Bellatrix has a great management team. It's a sizeable entity—over 8,000 bpd right now—and planning to exit the year at around the 10,000-bpd mark. There are hundreds and hundreds of locations in two great repeatable resource plays (i.e., the Cardium), and then the very liquids-rich Notikewin play in Alberta. These wells are drilled for about $3 million each. They test at 10+ mmcf/d and make anywhere from 30–70 barrels per million of liquids, which is mostly all condensate. Even in a low gas price environment, the economics in those plays are hugely supportive at current gas prices due to the couple hundred barrels of condensate/liquids they get with these wells.

TER: Let's continue with the strong buys.

KS: Arsenal is a smaller company than Bellatrix; it is producing about 2,600 bpd now, but it is very heavily weighted toward oil—more than 75% oil. The company really has three different core areas of operation and drilling. Right now, they trade at about half of their net asset value (NAV). I think they are around $0.90 on the recent broader market pullback, and it's trading at about 0.3x its price to cash flow at the end of this year. Arsenal is one of the best buys, valuation-wise; its stock should be well over a dollar.

Painted Pony's current trading price is more than backed up by what I call its Bakken oil "manufacturing" in southeastern Saskatchewan. It's in and around $6 and has over 100 net sections of Bakken acreage, which is over 95% undeveloped. We also believe the company's getting next to no value in its stock price for having one of the best acreage positions in the Montney shale play in northeastern BC. Painted Pony is surrounded by Talisman, Progress, Husky, Shell and others, with 126 net sections in the Montney. Over the last few weeks, it issued a press release on a couple of very successful Montney drill tests on its 100%-owned land; and the company's strategically partnered with Talisman and Progress on some bigger scale developments in the area. Painted Pony is one to watch, especially if gas price appreciates.

Another company in the domestic space and one to watch that just converted from a trust to a corporation is called Equal Energy. The company generates about 9,500 barrels of oil equivalent (boepd) and has several different resource plays in its asset portfolio. Equal has 21+ different oil pools here in Canada; and several of the favorites like the 'Cardium, Viking, Pemiscot and Dina light oil plays." It's just starting to drill some of growth areas and has already had some solid initial successes. The company, which rebranded officially as of June, is under new management; and management has done a great job of paying down over $150 million of debt so far to reposition this sizeable producer as a newly focused, emerging "mid cap." It's just coming out of the gate to start drilling its first series of horizontal wells; so that's one to watch.

TER: Any thoughts you'd like to leave us with?

KS: I see lots of room for growth in the energy side of the business. At some point, I see gas prices coming back to more of our cost basis on the North American side, call it $6–$7. As the gas price appreciates, you're going to see that a lot of stocks—both in the small- and mid-cap space—have a lot of torque to them. As the industries continue to put horizontal technology to bear, there's going to be significant growth in the oil plays domestically and internationally. It's a good place to be for investors—there's a lot of money to be made both domestically and internationally with oil prices over $60 a barrel.

TER: Thanks so much for speaking with us today, Kevin.

Kevin Shaw has extensive industry experience, including engineering, operations and management positions with Imperial Oil Resources, Trimox Energy Inc. and Colt Worley Parsons. Mr. Shaw has a B.Sc. in Mechanical Engineering with a minor in Petroleum; and an MBA from the Haskayne School of Business at the University of Calgary.

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Have a good one.