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Thursday
Aug192010

Saskatchewan: A Gold Mine for Uranium

Uranium Mines in Canada 20 August 2010.JPG

By Marin Katusa, Casey’s Energy Report


Mining is a risky business and accidents happen. But when your mine is the world’s largest uranium deposit, fourth largest copper deposit, and fifth largest gold deposit, an accident can cost a little bit more than the average. Something BHP Billiton found out after the shaft accident at its flagship Olympic Dam mine located 560 kilometers north of Adelaide, South Australia.

In October of last year, a breakdown of one of two haulage systems saw a loaded iron skip plummeting to the bottom of the 800-meter-deep main shaft. It caused enough damage to the inside of the shaft, and to the gears and the wheels that bring the ore to the surface, that it took nine months to repair.

So much does it actually cost when production is halted at a mine that’s clearly won the geological lottery?

BHP Billiton revealed on July 21 that annual copper production was down 11% in 2010, uranium production off by 43%, and gold production was 19% below the normal. The amount of material mined in fiscal 2010 was 5.3 million tonnes, down 9.8 million tonnes from last year.

The mine has, according to the company, returned to full production now. There is however, the small problem of contracts.
One of BHP’s largest clients is China, the country whose energy appetite just can’t get enough. The country that will be buying up to 5,000 metric tonnes of uranium this year.

The Olympic Dam mine produces 7% of the world’s uranium, production that was affected by the shutdown. While production is getting back on track today, the feeling in the BHP boardroom is one of unease.

The reason: the rise in the number of new nuclear power stations coming online in the next few years, along with all the contracts that need to be fulfilled. Expansion plans are in the works already. BHP is looking to massively increase the size of the mine and has handed in a 4,000-page environmental impact statement (EIS) draft to the Australian government.

The sticking point is, they’re going to have to go deeper, and it’s going to get a lot more expensive. The Australian government isn’t going to turn away from the opportunity to tax this goldmine either. And if the problems of additional cost aren’t enough, the rail system in Australia can’t handle moving that much ore at all times, so tack on some more delays.

Unsurprisingly, BHP is out scouting the market for some good deals on uranium. Top on their list is Saskatchewan, Canada.

Why Canada Is 45 Times Better Than the U.S.

The uranium deposits in Saskatchewan aren’t just significantly large; they’re also the highest-quality uranium known on the planet. The ore mined at MacArthur River has an average ore grade of 21% – average ore grades are given as a percentage of uranium oxide in the ore.

Just to compare, the uranium found in the U.S. is usually around 0.4 - 0.5%. That makes the Athabasca Basin uranium 45 times higher-grade.

The uranium deposit at MacArthur River can be visualized as a few school busses parked within a school football field. It might sound small, but in uranium-speak, that deposit’s big! It’s big because the grades are incredible in the Athabasca Basin. And that makes it huge financially.

Canada also ensures that the uranium it sells is used solely for electricity generation at nuclear power plants. The end use is very strictly enforced through an assortment of international non-proliferation treaties and Canadian export restrictions.
In fact, uranium on a per-tonne basis is worth more than gold if you’re in the Athabasca Basin. Given current uranium spot prices, it can fetch a staggering US$13,500 per tonne. That’s unheard of!

BHP Takes a Whole Building in Saskatoon

After meeting with many uranium executives, one can’t help but notice the large BHP building off 3rd Avenue while walking around Saskatoon. It’s not just the potash and diamonds that BHP cares about in Saskatchewan. The quantity of uranium underneath the Athabasca Basin is almost beyond reckoning. It can provide substantial wealth to the right company and the right investor.

If BHP decides to enter the uranium sector in Saskatchewan, which companies are on their short list?

That’s exactly what I was finding out while wandering the prairies.
----

If you want to know which juniors are the most likely to be taken over by uranium-hungry BHP, you’ll find out soon in Casey’s Energy Report. After Marin has done his due diligence, he’ll emerge with a few hand-picked small-cap companies that show the greatest potential to provide investors with handsome returns. Take your 3-month risk-free trial now and get in early when Marin gives the starter shot. Learn more here.







Stay on your toes volatility will be the order of the day and have a good one.

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

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.


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.



Thursday
Aug192010

Atticus Lowe: Scouting for Good Value

Source: Brian Sylvester of The Energy Report 8/19/10
http://www.theenergyreport.com/pub/na/7134

Atticus Lowe.JPG

Atticus Lowe, chief investment officer with West Coast Asset Management, is the kind of guy you would want making your investment decisions. He is coauthor of The Entrepreneurial Investor: The Art, Science and Business of Value Investing. In this exclusive interview with The Energy Report, Atticus discusses his value investing strategy. He also talks about the long-term potential of natural gas, questions shale gas production projections and offers a few names with oil exposure that he believes are not getting enough love from the markets.

The Energy Report: Atticus, on the institutional side, fund and pension managers are keeping their portfolios a little light on energy plays. What sort of event is needed to get the institutional side back to pre-2008 levels in terms of equity?

Atticus Lowe: Institutions are light on energy right now because nearly all of the independent oil and gas companies out there are leveraged to natural gas. The outlook for natural gas is pretty foggy, at least in the short term. The discovery of massive shale gas resources has been a blessing for the country and to some extent a curse for the exploration and production (E&P) industry. The implication of these shale gas discoveries is that natural gas prices are likely to remain quite elastic until demand increases.

There's so much shale gas out there that it's going to keep a cap on gas prices, albeit perhaps somewhat higher than where we are today. Credit Suisse recently averaged the cost structure of more than 40 independent producers and found the total unit cost to be $5.74 per Mcf of natural gas equivalent. Current prices are $4.25 and the 12-month strip is at $4.65, which creates a puzzling situation. Why would companies be drilling today if they can't make a return on capital, let alone break even? There are several reasons.

First off, oil prospects are scarce and most companies don't have much to drill other than natural gas prospects. Second, many companies are drilling to hold leases with the hope that natural gas prices will increase in the future and provide attractive economics for further drilling on these leases. In addition, many companies feel pressure from shareholders to spend money and increase production and cash flow. All of these issues are weighing on natural gas, and that has backed a lot of institutions away from energy.

TER: How about longer term?

AL: Long term, I fully expect domestic natural gas demand to increase, and I expect that to be a driver for gas prices and to be fantastic for the industry, our country and our economy. I don't know whether you have seen the "Pickens Plan" or if you've seen T. Boone Pickens talking on CNBC during the past couple years, but he points out that domestic natural gas is clean, it's cheap, and it's American. I expect demand for gas to increase as a result of compressed natural gas vehicles, primarily from the fleets of larger vehicles, and also from plug-in electric vehicles, which source their power through electricity, which is often generated from natural gas. Honda already makes a compressed natural gas vehicle and they are big in Europe. In that context, you're paying less than half the price for the same amount of energy from natural gas versus oil and emitting far less CO2, and you're supporting the economy while creating tax revenues and jobs.

I also expect more dirty coal-fired power plants to be replaced by natural gas-fired power plants over the long term.

TER: With institutions shying away from natural gas companies, does that create opportunities for the retail investor?

AL: I really think it does. Oil prices right now are tied closely to the economy; historically, it's been an uncorrelated asset, a hedge. But right now everyone is confident that supply and demand for oil is very tight, and long-term demand is going to significantly exceed supply. I don't know if supply and demand will converge in one year, two years or five years, but I definitely expect to see $150 oil again this decade, and I wouldn't be surprised to see oil touch $100 by next year.

The independents are being penalized for being really gas heavy right now. You're seeing the oil and gas companies scrambling to get domestic oil exposure, and that includes acquisitions. Buyers are often paying more than $100,000 per flowing barrel of oil right now and oil reserves are trading hands at more than $20 per barrel. SandRidge Energy, Inc. (NYSE:SD) recently bought one of the few publicly traded pure play oil companies out there, Arena Resources. They paid $182,000 per flowing barrel and $22 a barrel for proven reserves, two-thirds of which were undeveloped. As all that relates to retail investors, most of the big oil was had in America decades ago. There's still a lot of oil out there, but it's in small pockets that typically aren't enough to move the needle for the larger independents and the majors. But for the micro- or small-cap exploration and production (E&P) company, there is a lot of opportunity.

TER: How so?

AL: There's opportunity to create value through aggregating assets, and through discovering relatively small fields that may have been overlooked. And there is definitely opportunity to apply modern technology to established tight oil deposits that weren't commercially viable at lower historic prices. With modern technology, you can go back into a lot of known deposits and make them into economic plays. Some of these are big enough to attract the majors, such as the oil window of the Eagle Ford shale, but a lot of them are small company plays.

TER: That's certainly happening in the Permian Basin.

AL: Sure, it's happening in the Permian. It's also happening up in the Bakken Formation, and it's happening in the Niobrara Shale play. What you've seen the technology do with the shale gas plays, well, you can take that same basic technology and apply it to certain tight oil plays.

TER: Are you talking about radial drilling and that kind of thing?

AL: Primarily fracture stimulation, through either vertical or horizontal wellbores. A lot of the tight oil plays have responded well to fracture stimulations in vertical wells, and some of them are now responding well to horizontal wells. Long laterals with multi-stage fracture stimulations are having great early success in the Eagle Ford shale, the Bakken, and in the Niobrara Shale. Now, this kind of success is at the very front end of the production curve, and we don't have a lot of data yet. I don't know how the oil shale plays are going to ultimately work out, but there is already a lot of long-term evidence supporting the benefits of fracture stimulation in tight conventional reservoirs. With modern fracture stimulation technology, even conventional reservoirs that may not have great permeability can really be opened up and improve economic returns.

TER: What are some companies in those types of plays?

AL: One company that we follow— and we don't own it—is Evolution Petroleum Corporation (NYSE:EPM). Evolution has done an outstanding job leasing up older fields and bringing in development partners at fantastic terms to redevelop the assets utilizing carbon dioxide (CO2) floods. Venoco, Inc. (NYSE:VQ) had done a great job at this as well. Typically the prospect generator in this scenario can reap a large upfront cash payment while retaining an overriding royalty interest and a sizeable back-in after payout interest. Evolution and Venoco both partnered their CO2 plays with Denbury Resources Inc. (NYSE:DNR), which specializes in tertiary oil recovery using CO2. Evolution is a publicly traded micro-cap oil and gas company that appears very cheap, and insiders own a lot of the stock.

We own, through one of our own investment vehicles, a sizable stake in a small-cap company called EnerJex Resources Inc. (OTCBB:ENRJ). We own about 20% of the equity. The market cap is barely over a million dollars, but the company's got nearly 2 million barrels of oil reserves. Those reserves—based on the company's reserve report in its recently issued 10-K—have a present value of more than $20 million, which assumes a 10% discount rate back to present. The stock is trading at less than $1. Net of the company's debt, the proven reserve value based on that discounted valuation scenario exceeds $2 per share. If you apply a $100,000 per-flowing-barrel metric to the company's net production, you're in that same ballpark. Institutions aren't able to get this type of oil exposure because these companies are so small. They're not liquid enough, and they're not big enough to really move the needle for institutions. I think micro-cap oil stocks are an interesting place for retail investors to look.

EnerJex has debt, of which our firm represents a portion, and I think this must be holding the stock back, but it appears to us that the asset value exceeds the value of its debt. I know the company has been pursuing some strategic alternatives, and we're hopeful that EnerJex can bring in a few million dollars to help the company move forward and pursue its strategy, which I think is a really good one.

They're basically an aggregator of oil reserves from mom-and-pop operators out in Kansas, which as a state is a large producer of oil. Kansas produces around 30 million barrels of oil a year, and the top 15 producers in the state make up a very small percentage of the production, less than 30%. The remaining oil production from Kansas comes from around 2,000 different producers. There are just tons of tiny producers out there that probably aren't operating very efficiently and therefore aren't realizing the value of their assets.

TER: And some probably just want to sell.

AL: Oh, absolutely. Being a public company, EnerJex has the ability to use its stock as a currency, which makes great sense as long as they're making acquisitions that are accretive to shareholders.

These are some of the oil opportunities available to retail investors that I don't think most institutions even look at. There aren't many pure oil plays out there for the institutions to invest in other than the majors. There are some independents in the Gulf of Mexico that have pretty significant oil exposure, but the whole Gulf of Mexico situation is very cloudy because of the drilling moratorium and the uncertainties about future insurance costs. People are pretty leery of that and are not willing to pay what they would have paid before the BP Plc (NYSE:BP; LSE:BP) spill.

TER: Where do you think EnerJex's stock price could go?

AL: In the 10K that was just filed, the stock net of debt could increase exponentially from its current price. There's no reason they can't use the same strategy moving forward, continuing to make accretive acquisitions, and increasing shareholder value every step of the way. The only obstacle we see is the debt overhang, and we are hopeful this will be addressed in 2010. We have high hopes for EnerJex.

TER: You have a three-pronged approach to energy investing, and that involves ultimately knowing a few companies really well. As part of that approach, as you have stated in previous interviews, you put the strongest emphasis on management. But others might argue that good assets trump good management because you can always bring in good people to get the most out of existing assets, whereas even the best management can do little with poor assets. Why do you put such a strong emphasis on management over assets?

AL: It's funny you say that about good assets trumping good management. We've been guilty of making that assumption before, and some bad experiences have really led us to our emphasis on management. You can certainly bring in good people, but bad management won't necessarily bring in good people. They might not be "incentivized" to. And good assets can be ruined by bad management; bad management can take a good asset base and overleverage a company and kill it. They can allocate the cash flow poorly; bad management can do all kinds of things with good assets that destroy shareholder value. It doesn't mean that the underlying asset won't still be good, but it does mean that there is a lot more risk to making money as an investor because the company won't necessarily be creating per-share value. That's what we're intensely focused on: per-share value creation. We're not looking for a company to grow exponentially if its share count or debt grows at an even more rapid pace.

TER: But what can good management do with poor assets?

AL: We're not looking for good management with poor assets, but we would certainly consider it if the price were right. Good management can create opportunities that create future value. That is one of the first things that we look at: is the company a good steward of capital? Does management have their own skin in the game? How are they incentivized? What is their track record of allocating capital? What is their focus? We like to find people who are focused on creating per-share value and have a track record of doing so.

TER: Do you have a management ownership threshold that you think is ideal? For instance, if a manager owns 10% of a company, is that good? If they own 30%, is that too much?

AL: We like it if it's meaningful to them. If it's someone who has a giant net worth and they have hardly any skin in the game, then it's a turnoff. But if it's someone who isn't necessarily wealthy, but they've got a sizable amount of their net worth in the company, then that is more important to us than owning a specific percentage.

Another thing we pay close attention to is company culture. Our co-founder here at West Coast Asset Management is the founder of Kinko's. He really built that company into a success based on a positive company culture. We like to eat in the lunchroom when we visit a company, talk to the co-workers and get a feel for the people. Are they hungry for success or are they just there to collect a paycheck? That's an intangible that you can't quantify, but it's something that we pay attention to. Management has a lot to do with that.

TER: The other two prongs of that strategy are the assets and catalysts for growth. Please explain those.

AL: We like to find underpinning asset value that not only supports the price the stock is trading at, but also provides upside. We want to buy a stock at a discount to what we think its underlying proven reserve value is. We will look at the proven reserves, the expected cash flow from those reserves, and try to buy the company at a discount to those values.

And the third prong would be catalysts, whether that's something the company has on its plate or something that the company is able to pursue through its strategy. A catalyst might be a company sitting on a lot of undeveloped acreage that is highly prospective and not accounted for in its reserve value and share price. Or it might mean a strategy like the one EnerJex has, where the company can deploy capital opportunistically in a sweet spot: something that could provide a catalyst over the long term to increase shareholder value.

TER: In an interview you did with Oil & Gas Investor, you said: "I'm skeptical about a lot of these average type curves you see for the shale plays. We shouldn't be surprised to see the economic threshold of these plays really increase over the next five years." That seems a bit bearish.

AL: Bullish on prices, but bearish on the information that is being given to Wall Street.

TER: Are you saying these companies are lying to The Street?

AL: I personally looked into a number of these gas shale plays where management teams are holding out curves of what the production from a single well on average is expected to do over its life. If you look at the actual production of the wells they've drilled to date, the median is nowhere near the curve they're showing people. It's looking at the potential through rose-colored glasses in my opinion. The results from the wells that have been drilled often don't jive with the type of curves we're being shown. Even if they did, you're at only the very front end of the well's life in these shale plays. In some cases, we only have data for less than a year of production on some of these large horizontal shale plays. Yet projections for production are being made 20–30 years out about what the wells will be producing down the road. And those projections are being extrapolated back to present quantities of proven reserves and associated value. I think it's quite risky to assign value to reserves based on future production that is largely unknown.

TER: You coauthored a book on long-value investing titled The Entrepreneurial Investor: The Art, Science and Business of Value Investing. What are three solid value investments in the E&P space?

AL: We have a large position in Sonde Resources Corp. (NYSE:SOQ). That's a Calgary-based company that's got western Canada oil and gas production and some enormous assets offshore Trinidad. The company was recently recapitalized from the capital structure all the way up to the management team and the board of directors. The market cap right now is around $180 million. I think their western Canada assets are worth double that over the next two years, and the company has assets in Trinidad that are potentially worth multiples of the current share price. They're partners with BG Group Plc (OTCQX:BRGYY; LSE:BG) and have discovered somewhere in the neighborhood of 5 trillion cubic feet (TCFs), of which they own 25%. Trinidad is one of the largest liquefied natural gas (LNG) hubs in the world, and those are valuable gas reserves. As the company moves forward on the development plan with BG in the coming year or two, I think the company will start to realize value for those reserves. I also think that at the current share price, it's a likely acquisition target for any number of companies that have western Canada and international exposure.

Sonde is starting a very high-impact exploration project offshore Tunisia later this fall. From my understanding they will be drilling a stone's throw away from a Marathon Oil Corp. (NYSE:MRO) discovery made 10–20 years ago that tested at more than 5 thousand barrels of oil per day. Marathon abandoned this discovery for political or economic reasons when oil prices were much lower. In addition, I believe this prospect adjoins a very large structure that is defined on a 3D seismic survey where another operator, PA Resources AB (NASDAQ OMX Nordic:PAR), is already producing oil on a large scale. I think Sonde is teed up to make a very large oil discovery and prove up a very large oil reserve base in Tunisia. That's special because oil is so rare in the market right now, and the company is so small that it could have a major impact on the share price.

TER: What's your target price on Sonde?

AL: We don't have a target per se, but I think the stock will trade hands at multiples of its current price in the next three years. I don't see why the stock couldn't double within the next year if they execute as they have been.

TER: Are there others?

AL: We also have a large position in Contango Oil & Gas Co. (NYSE.A:MCF). It's primarily a shallow water, Gulf of Mexico exploration and production company. We consider the CEO, Ken Peak, to be the Warren Buffet of oil and gas. He's very shareholder friendly; he's created a $700 million company with negative equity capital into the business. He capitalized it with very little money, and he's repurchased more equity than he's raised. He also made a grand slam discovery—one of the biggest discoveries on the Gulf of Mexico shelf in the last few decades—and that really put the company on the map. He also made a few other unique investments that were quite opportunistic and turned out to be grand slams. He's not afraid to jump on an opportunity even if it isn't within the company's current business focus. He was one of the first to get into the Fayetteville Shale. He acquired a lot of acreage on the cheap, and sold it for hundreds of millions of dollars just a few years ago to Petrohawk Energy Corporation (NYSE:HK) and XTO Energy Inc., which was recently acquired by Exxon Mobil Corp. (NYSE:XOM). Also, he opportunistically purchased a limited partner (LP) interest in the Freeport LNG facility some years ago for only a couple of million dollars, and ended up selling that for $68 million just a few years later. Ken owns around 20% percent of Contango, so he's got a lot of skin in the game.

TER: What are Contango's catalysts for growth?

AL: From our perspective, the stock is trading at only about two-thirds of the value of its proven producing reserves. So, just with the existing reserves alone, you're buying at a pretty substantial discount, and you're getting the value that management can create in the future with the cash flow from Contango's underlying assets. I think that's a very valuable catalyst, although it's not something you can point to specifically. It's an intangible that we think is quite valuable.

TER: By buying Contango, you're sort of buying shares in Mr. Peak.

AL: Yes, and we're paying a discount, a substantial discount, in doing so. The company is actively repurchasing stock. It's got zero debt and more than $50 million in cash.

TER: What you're saying, too, is that they are focused on earnings per share. If they're buying back stock and they're making money, obviously their earnings per share will increase.

AL: Yes, that's true. And Peak has got two of the best prospect generators in the world on his team, and they're basically incentivized to find big prospects that have a good chance of success. The company is well capitalized to drill those prospects. This team is responsible for putting together the large discovery that the company made just a few years ago, which has really put them on the map.

TER: Do you have a target price on Contango?

AL: We think the stock is worth north of $60 per share, and I think Ken would like to sell at the right price. We're in such a depressed natural gas price market that he is being patient, and I don't think he's in any hurry to sell the company. But I think he would sell the company at the right price.

TER: With oil hovering around $80 per barrel, what are some E&P names with significant oil exposure?

AL: Well, a few that I mentioned—Evolution Petroleum, EnerJex. There are a few Gulf of Mexico companies that appear to be extremely cheap that are fairly levered to oil such as W&T Offshore Inc. (NYSE:WTI) and ATP Oil and Gas Corp. (NADAQ:ATPG).

There are some larger independents that have emerging shale-oriented plays that certainly have upside, but less certainty as to the quality of the assets. For instance, regarding this Eagle Ford shale, the oil window of the shale has become extremely active. A few companies have large exposure to that play, such as Pioneer Natural Resources Co. (NYSE:PXD) and Swift Energy Co. (NYSE:SFY). If these plays work out, as people are expecting, they could really perform well in the months ahead.

Atticus Lowe is the chief investment officer of West Coast Asset Management, Inc., a founder and principal of Montecito Venture Partners, LLC, and a director of Black Raven Energy, Inc. Atticus has been a featured speaker at the Value Investing Congress as well as the Value Investing Seminar in Molfetta, Italy. He is a CFA Charterholder and holds a Bachelor of Arts degree in Economics and Business from Westmont College in Montecito, California.

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

DISCLOSURE:
1) Brian Sylvester of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report or The Gold Report: EnerJex Resources.
3) Atticus Lowe: I personally and/or my family own shares of the following companies mentioned in this interview: EnerJex Resources and Sonde Resources. I personally and/or my family am paid by the following companies mentioned in this interview. None.
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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.
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Stay on your toes volatility will be the order of the day and have a good one.

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

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.




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
Aug172010

Yves Siegel: Management, Patience Keys to MLP Success

Source: Brian Sylvester of The Energy Report 8/17/10

Yves Siegel.JPG

Credit Suisse Analyst Yves Siegel believes master limited partnerships (MLPs) are strong investment vehicles, particularly in uncertain economic circumstances. "I don't think there are many other places where investors can put their dollars and get a nice return with very moderate risk," he explains. In this exclusive interview with The Energy Report, Yves talks about the "Big Kahuna" and a handful of other well-managed MLP names with impressive yields and sector-leading growth prospects.

The Energy Report: Yves, as of July 20, 2010, the Alerian MLP Index was up 13.7% for the year, whereas the S&P 500 was down 4.5%. What factors are allowing MLPs to vastly outperform the market right now?

Yves Siegel: I think it's pretty simple. Firstly, MLPs are viewed as good defensive investments in times of uncertainty. Secondly, MLPs provide investors with an attractive, partially tax-deferred yield. Right now, the average MLP yield is around 6.5%. Thirdly, with distributions there's the potential income growth that could average 3% –6%. The yield plus distribution growth still provides a pretty good investment value proposition. I don't think there are many other places where investors can put their dollars and get a nice return with very moderate risk.

TER: Is this an unprecedented time in terms of money pouring into MLPs?

YS: I'm not sure it's unprecedented. Back in 2007, you had a lot of inflow of capital. The difference is the money attracted to the MLP space back in 2007 was what I could call "fast money." It was more hedge fund–based than the more traditional retail investor. They were attracted to the unprecedented growth in MLP distributions. Those investors tended to have a much shorter time horizon. I think they correctly viewed MLPs as a good place to invest, but perhaps too much of a good thing is no longer a good thing.

TER: You mentioned the tax-deferred status of MLP distributions. Is Credit Suisse concerned that the combination of the U.S. federal cash crunch and the success of MLPs in this bear market could lead to further taxes?

YS: There's always a risk that someone in government will take a harder view of the MLPs. We don't see that on the near-term horizon. We would say that the MLPs are building a lot of the necessary energy infrastructure in the United States and that this is creating a lot of jobs. MLPs provide a really valuable service, and I don't think it makes a whole lot of sense to change the tax status.

TER: Kinder Morgan Energy Partners L.P. (NYSE:KMP) did a $75-million equity financing in June and Energy Transfer Partners L.P. (NYSE:ETP) raised about $437 million in a recent financing. In total, MLPs have raised $7.2 billion in equity financings so far this year. Is this normal, or is this amount of dilution cause for alarm?

YS: I'd be careful using the term "dilution." The MLP business model is such that nearly all of the cash flow—after maintenance capital—is distributed to the unit holders. In most conventional businesses, you retain a portion of your cash flow to reinvest in the business. MLPs generally do not do that because of the structure. That raises the question: How do you grow if you're distributing all your cash? The answer: You have to rely on external capital, both equity and debt. As I said earlier, MLPs are financing the infrastructure growth in the U.S. They're building the pipelines, storage assets and processing assets necessary to get the new energy supplies to market. The way they finance that growth is by issuing equity and issuing debt. It's really important to recognize that the MLP structure is very transparent. Just follow the cash. If MLPs were not able to invest that cash productively (i.e., have a return in excess of their cost of capital), they wouldn't be able to continue accessing external capital. That transparency is a plus. The mindset is: I have to be a good steward of capital from investors; otherwise I'm not going to be able to go back and ask them for more money. That rationale is incredibly important. As long as MLPs have good investment opportunities, you'll see relatively high financing requirements and a lot of equity and debt being raised.

TER: Is the $7.2 billion invested so far this year a lot higher than that over the same period last year?

YS: The pace of equity offerings has quickened this year relative to 2008 and 2009 when $6.4 billion and $6.8 billion was raised respectively in each year. This is due in part to the deferral of offerings in those years due to difficult market conditions.

TER: So, this isn't abnormal?

YS: No, it's not.

TER: You have an outperform rating on Energy Transfer Partners. Why do you have an outperform rating on them, and what does ETP plan to do with that capital?

YS: Energy Transfer is one of the companies that we can point to as building out the U.S. infrastructure. Specifically, Energy Transfer is involved in two ongoing multibillion-dollar projects to take shale play gas to market. They're building a Fayetteville pipeline that services the Fayetteville Shale and they have the Tiger Pipeline to access the Haynesville Shale.

We at Credit Suisse embrace the notion that there will be many investment opportunities around developing the shale plays in the U.S. We like Energy Transfer because we see them being able to grow the company via building these pipelines and benefit from the incremental cash flow that the pipelines will generate. We also think the management team is very good and has a very good track record of building shareholder value. Lastly, the MLP has a very nice yield—just north of 7%.

TER: Which MLPs stand to benefit most from their shale-play investments?

YS: Well, you have Boardwalk Pipeline Partners, L.P. (NYSE:BWP). They've spent some $5 billion on long-haul interstate pipelines accessing some shale plays, such as the Fayetteville and Barnett Shales. They also have some exposure to Haynesville. Energy Transfer has a couple of pipeline projects. Enterprise Products Partners, L.P. (NYSE:EPD) has multibillion-dollar investments surrounding the Eagle Ford Shale, which is a new play folks like because not only does it have a lot of natural gas, it also has a lot of associated natural gas liquids (NGLs). EPD is very well poised to benefit from that play.

The "Big Kahuna," Kinder Morgan, also has exposure to various shale plays, including the Haynesville play via their KinderHawk joint venture in Louisiana. They also have large pipeline assets in Texas that give them exposure to the Barnett Shale, and they're a partner with Energy Transfer on the Fayetteville Express Pipeline. They've also teamed up with a small MLP called Copano Energy, L.L.C. (NASDAQ:CPNO) to access the Eagle Ford Shale. Those are just a few of the MLPs that have nice exposure to the shale plays.

TER: A lot of these MLPs are quite large. Is it more encouraging that the "Big Kahuna" is making investments in the shale plays?

YS: Just from the vantage point that Rich Kinder is one of the smartest guys around. Typically, they do an excellent job of trying to identify trends and investing in those trends. Kinder Morgan being there confirms that these shale plays are real, and I think are very viable for the long term. You can make the same case for Enterprise. I mean those guys are extraordinarily bright, as is Energy Transfer's management.

TER: You mentioned that one of the things making these shale plays viable is the NGLs, which require little processing. But, in your research, you also say that the NGL prices will be somewhat lower for the next while.

YS: You have to be careful because not all shale plays are alike. Some have more NGL content than others. I think it's sort of good news and bad news. The good news is that there's a lot of natural gas around. The bad news is that, from a pricing perspective, it's still supply and demand. If there's a lot of supply and not that much demand, it does put some pressure on prices.

As we come out of this recession, we're still building demand. Consequently, natural gas prices are somewhat depressed. We know that crude oil prices are fairly attractive in the $75–$80 range. When natural gas is produced, typically it comes out of the ground wet and has to be processed. The more NGLs produced as a byproduct, the more value that accrues to the producer.

TER: A premium.

YS: Yes. NGL prices tend to track crude because they compete with crude in the petrochemical market. In an environment where natural gas prices are depressed and crude oil prices are strong, NGLs add a really nice premium. Consequently, producers are going to drill in areas that have the liquids-rich natural gas. That's what we're seeing, and that's why the Eagle Ford is such an attractive proposition for producers today.

TER: Which MLPs have a fair amount of exposure to the NGLs?

YS: About a third of Enterprise Products Partners' business is exposed to the natural gas liquids. They just reported on their second quarter earlier this week. That business was very, very strong. In our universe, that's the one company that has the most exposure. There are other companies we don't follow that also have some exposure. ONEOK Partners, L.P. (NYSE:OKS) is similar to Enterprise in that they have an integrated value chain on the NGL side. There's a host of smaller MLPs that primarily do natural gas processing. Those would include companies like DCP Midstream Partners, L.P. (NYSE:DPM), MarkWest Energy Partners, L.P. (NYSE.A:MWE) and Targa Resources Partners, L.P. (NYSE:NGLS). I would classify those companies as more "pure-play" NGL companies.

TER: Going back to your Credit Suisse MLP market overview. It said: "stock market volatility can present better buying opportunities. However, we are not market timers. We continue to add Boardwalk Pipeline Partners, Enterprise Product Partners and Plains All American Pipeline, L.P. (NYSE:PAA)." You discussed the first two earlier. Tell us why you like Plains.

YS: What's so glamorous about Plains All American? They're focused on the movement of crude oil through pipelines, and they also have large storage operations. They recently did an IPO of their natural gas-storage business—PAA Natural Gas Storage, L.P. (NYSE:PNG). I'm not enamored necessarily with the crude logistics business, but I am enamored with really strong management teams that have consistently delivered year in and year out and have a track record of providing shareholder value. Plains All American is what I'd like to characterize as my "Rip Van Winkle stock." I feel I could put my money in Plains and sort of sleep for a while, then wake up to find my investment has grown nicely and feel pretty good about it. That's the Plains All American story—really exceptional managers, great stewards of capital and just a very, very nice track record.

TER: Can you talk about Boardwalk's and Enterprise's management teams?

YS: Boardwalk has very strong pipeline management. They know what they are doing. They benefit from the assistance of Loews Corp. (NYSE:L), a holding company run by the Tisch family that owns the general partnership (GP), and that has been successful guiding the partnership. Boardwalk also has a very capable natural gas pipeline management team that calibrates risk very well.

Then you have Enterprise Products Partners, which was started by Dan Duncan, an impressive visionary in the industry. EPD is a little more of a risk taker than perhaps Boardwalk. By risk taker, I mean a bit more entrepreneurial. Duncan's built the largest MLP that has favorable investment characteristics due to its very large footprint; they are well diversified in different businesses. They have the natural gas liquids business, wherein they are the premier NGL publicly traded company. Then they have natural gas pipelines, refined petroleum products pipelines and crude pipelines. And they are very conservatively financed. It's almost unprecedented to see an MLP that has a 1.2, 1.3 coverage ratio—especially being as large as Enterprise. This is one I'd strongly consider as a core holding among the MLPs.

TER: That's quite the endorsement. Spectra Energy Partners, L.P. (NYSE:SEP), Magellan Midstream Partners, L.P. (NYSE:MMP) and Duncan Energy Partners, L.P. (NYSE:DEP) are all at the bottom of your capital-cost table. Does this position these MLPs for growth? Or does cheap money often lead to bad decisions?

YS: I would agree that cheap money often leads to bad decisions. We've just beared witness to some really bad decisions because of cheap money. As it relates to MLPs (and what I tried to articulate before) is, if MLPs cannot deliver returns in excess of their capital cost, they're going to be in trouble. Some MLPs have made bad investment decisions, and they have had to face the consequences.

As it relates to the three companies just mentioned, Duncan Energy is basically an affiliate of Enterprise Products Partners. Consequently, Duncan has the same sort of financial discipline as Enterprise. Magellan Midstream? I don't mean this in a disparaging way but, when I think of Magellan, I usually think of a company that has been very conservatively managed. But they are also prudent stewards of capital. Lastly, Spectra has demonstrated that they, too, are very prudent when it comes to investing capital.

First and foremost, we take our view of management very seriously. If we don't have a strong conviction that the management team is extremely capable, it's hard for us to have a favorable view of that company. Needless to say, we feel pretty good that the management teams of the companies we've discussed understand risk and finance; and, just as importantly, they understand their businesses.

TER: Among the energy MLPs, you have outperform ratings on Niska Gas Storage Partners, L.L.C. (NYSE: NKA), Kinder Morgan Management, L.L.C. (NYSE:KMR) and Energy Transfer Partners. But you also have an outperform rating on ETP's general partner, Energy Transfer Equity, L.P. (NYSE:ETE). Tell us about Niska, Kinder Morgan Management and ETE.

YS: Energy Transfer Equity benefits disproportionately when Energy Transfer Partners raises the distribution or issues equity to finance their growth. The general partners own something called "incentive distribution rights." The incentive distribution rights reward the GP for hitting distribution targets. Consequently, the GP can grow twice as fast as the underlying MLP. Historically, most GPs have grown faster because of those incentive distribution rights. If one is positive on the underlying MLP, it's not unreasonable to think you may also be positive on the general partner.

TER: Are you saying we're about to see substantial growth in ETE's distributions?

YS: We think ETE is positioned for a compounded annual distribution growth rate of 8.6% over the next three years. ETE owns the general partner and limited partnership units in both Energy Transfer Partners and Regency Energy Partners, L.P. (NASDAQ:RGNC). As such, ETE stands to benefit from the growth of these two MLPs.

TER: And Kinder Morgan Management?

YS: Think about Kinder Morgan as two classes of securities. One is Kinder Morgan Energy Partners (KMP), which pays their distribution in cash. The other is Kinder Morgan Management (KMR), which pays their distribution in stock. That's the major difference between KMP and KMR. The other difference is that Kinder Morgan Management is structured such that investors receive a 1099 instead of a K1. That means you can buy KMR and put it in your IRA account, and institutional investors can buy KMR because it's not generating any unrelated business-taxable income.

TER: That's why it exists.

YS: It helps with financing, too. It's an attractive alternative for institutional investors that are sensitive to investing in MLPs. In addition, it helps finance Kinder Morgan's growth because, if you buy KMR, it's almost like an automatic dividend reinvestment plan. But for whatever reason, KMR trades at a 10%–13% discount to KMP. We think KMP may be fairly valued and thus we have a neutral rating on it, whereas we think KMR is attractively valued because we see no rational reason for it to trade at such a large discount to KMP. The only real difference between KMR and KMP is that KMR pays their distribution in stock rather than cash.

TER: And Niska?

YS: Niska just did their IPO in May, and Credit Suisse participated in that offering. Niska quite simply is a play on the need for natural-gas storage both in Canada and the U.S. We like Niska because they have plans to expand storage in Canada and California and a very clean balance sheet. In essence, they have pre-financed that growth via their equity offering. We also think that other storage assets owned by private equity may very well be for sale. Niska is likely to participate in those acquisitions, and that should help them grow above and beyond the organic growth already on their drawing board. Finally, we think the management team there is very astute. They have years of experience developing and operating storage. For folks looking to participate in growing natural-gas production and the need for natural-gas storage, Niska's very capable management makes the company an interesting way to play that.

TER: Do you have any thoughts you would like to leave us with?

YS: You read that quote from our research that said: "Stock market volatility can present better buying opportunities; however, we are not market timers and will continue to add to positions." I purposely said that because I think readers should differentiate between investing and trading. I view investing in MLPs as a multiyear commitment. The underlying rationale for investing in MLPs is that you're investing in a cash-flow stream that you think is secure, stable and predictable, which may very well grow. If that's the case, one shouldn't be overly concerned about market volatility. Just stay focused on that cash-flow stream and don't obsess over the day-to-day swings in the stock price. Too many investors do that. My message is to invest in strong companies with good cash flow and visible growth.

I'm also very cognizant of the fact that MLPs have had a really strong run in 2010. They may be due for a pullback, especially if capital markets freeze up. Conversely, if the stock market takes off, then you could see folks pulling out of MLPs to invest in the next herd mentality scheme.

Yves Siegel joined the Credit Suisse Energy Research Team in June 2009 to cover the Master Limited Partnership (MLP) and Natural Gas Pipeline sectors. Immediately prior to joining Credit Suisse, Yves was a senior portfolio manager at a New York hedge fund focused on MLPs. Prior to his buy-side experience, Yves had established a leading sell-side MLP franchise, having spent over 10 years at Wachovia Securities after prior sell-side engagements at Smith Barney and Lehman Brothers. Yves has received both a BA and MBA from New York University and is a CFA charter holder.

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

DISCLOSURE:
1) Brian Sylvester of The Energy Report conducted this interview. He personally and/or his family own the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report or The Energy Report: Energy Transfer Partners L.P.
3) Yves Siegel: I personally and/or my family own the following companies mentioned in this interview: Kinder Morgan Energy Partners. I personally and/or my family am paid by the following companies mentioned in this interview: None.
CREDIT SUISSE SECURITIES (USA) LLC: NSH NKA DEP EPE SEP KMP KMR ETE EPD WES SXL ETP NS BWP
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Aug172010

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Thursday
Aug122010

Stan Bharti: A Few of His Favorites



Source: Karen Roche of The Energy Report 8/12/10
http://www.theenergyreport.com/pub/na/7059

Forbes & Manhattan Founder and CEO Stan Bharti, whose genius has guided dozens of junior resource companies to the pinnacle, discusses his approach in this exclusive interview with The Energy Report—and a few of his favorites. Among them is a company using a molecular-tagging technology to foil a practice that fuels terrorist activities and deprives governments of more than $100 billion in tax revenues annually.

The Energy Report: What led you to start Forbes & Manhattan, Stan? Where did you begin?

Stan Bharti: I graduated in engineering and had my Master's in Engineering from the University of London. I started my career in Africa, working in Zambia for two years as a young engineer. I came to Canada and worked for Falconbridge for about 15 years. After that I went on my own, setting up an engineering and contracting firm—BLM Inc.—that grew into a sizeable business with offices around the world, providing services primarily to the mining industry.

Then in '95 I got into public markets, starting with some of the assets BLM had acquired. I was in the public markets in the resource sector until it got into a real decline in about 2000, when we got into the tech sector—which was in an uptick—with Forbes & Manhattan. We came back to the resource sector in about 2002, when I saw that a huge bull market in resources was shaping up. Since that time we've been pretty much exclusively in resources.

TER: How does F&M define resources? Your portfolio of companies includes some in the financial sector, some agricultural, some that are traditional metals and mining.

SB: It's a broad definition. As a group, Forbes & Manhattan really operates in five broad divisions. The agricultural division really is mining resources for the agricultural industry, primarily potash and phosphate. Our oil and gas group, which is based in Calgary, has several high-impact exploration projects around the world. Third is the bulk commodities, where we've focused on coal and iron ore. The mining group includes gold and base metals. Then finally, the special metals—rare earth elements, vanadium, lithium—that really drive a unique part of the metal sector.

TER: Do you see all five of these in a bull market now?

SB: They go up and down, but they're all in a long-term bull market right now. I'm talking two, three, five years. We see potash prices, for example, going much higher. We're almost at $1,000 or $1,100 a ton. And a couple of years ago they were $600 or $700, still a good price compared to $100 or $200 a ton where they were for a long time. Same thing with iron ore. Iron ore prices are at an all-time high. But we see these bull markets as long-term trends, driven obviously by China and so forth, but more importantly just a secular trend in the evolution of mankind.

TER: What triggered this secular trend in the evolution of mankind?

SB: If you look at the last 30, 40, 50, 60 years, the economy goes between the hard assets and the financial assets. Those two sectors oscillate back and forth. The last hard assets growth period went from about the mid-'60s to 1980. We had a 15-year bull cycle and we saw the commodities all take off, all tied to inflation. The same thing's happening again. We see inflation. We believe it's going to come back because of the need to ingest dollars into the economies in the U.S. and western European countries.

Then we saw huge growth in the financial sector all the way until to 2001. That trend has now changed again, and we're back to hard assets. Whenever inflation comes back and governments spend in excess, people go to hard assets. I believe the best hard assets you can buy are commodities. They're real. They're fundamental. They're something you can touch and feel.

TER: When would you say this hard assets boom got started?

SB: I think it started in 2002. The first peak was 2007, early 2008, and then we got into a bit of a trough but I think we're in a 5- to 10-year bull cycle in hard assets.

TER: So Forbes & Manhattan is in synch with that cycle as a privately held merchant bank that essentially incubates, finances and then manages companies in the junior resource sector. But how does the F&M model differ from Pinetree Capital Ltd. (TSX:PNP) or 49 North Resources Inc. (TSX.V:FNR)?

SB: It's different in the sense that we actively manage our assets. There's a lot of leverage in junior companies. If you can get in early on, with what we call the seed stock—$0.10, $0.20, $0.30 cents—you see these seed stocks grow. Five key elements drive junior companies. One is a good asset. Second is management. Third is the ability to raise capital. Fourth is telling the story, promoting the stock. Fifth is good capital structure.

The difficulty with a lot of the junior companies is that they just don't have the management depth, the ability to raise capital to take these stocks to a level where they belong. We believe that by taking a junior company with a good asset—a good asset is key—and surrounding it with a lot of depth in terms of management, access to brainpower and capital, and working the asset over four to five years, the rewards can be phenomenal for our shareholders.

TER: You say you actively manage these assets to drive these returns. How so?

SB: We bring all the companies that we invest in into our shop. We surround them with our own lawyers, accountants, IR people, investment bankers, analysts. We have all of them in-house so that a junior company can operate like a major without the overhead of a major. We have more than 100 people in the Toronto office alone, for example—more than 25 geologists, 20 engineers, several securities lawyers, four or five investment bankers, two or three full-time analysts and accountants.

So a CEO of a junior company can access that expertise without having to really pay much for it because that expertise is available to 20 or 25 companies. So this is almost like an incubator or a venture-capital (VC) model but in the public marketplace.

Forbes & Manhattan is also different in that I am on the boards of all these companies, typically the chairman, because I want to make sure I influence their strategy and vision. I'm also typically the first investor at the seed level in these companies.

TER: It does sound a bit more like an incubator VC type of model, except that with a VC model, if you invest in 10 companies, you might expect five to be so-so, three to do pretty well and two to explode into 10-baggers.

SB: This isn't so much the case with us. It's not the VC model like on the West Coast , where of 20 companies you invest in, 10 will work—but there's always a risk. Every F&M company has the potential to be a multi-billion dollar company, but some things have to kick in. Some of the assets we have are exploration assets, for example. With an exploration asset, sometimes you drill and don't hit. We have two fabulous oil and gas assets in the Kurdistan Region in northern Iraq, with proven successful partners such as Niko Resources (TSX:NKO). The seismic acquisition and geological work look very attractive, but until we drill the assets we don't know how big the oil discoveries could be. When exploration isn't successful, there's a problem. In Kurdistan , one of our companies, Vast Exploration Inc. (TSX.V:VST), is drilling its first well and we should know results over the next several weeks.

TER: Barring dead ends in exploration, what other factors help determine an asset's success?

SB: Obviously commodity prices have to stay strong. In 2008 and 2009, commodity prices essentially collapsed. The financial markets have to be good to be able to raise capital, and again, in 2008 and 2009 a lot of the companies that were in the process of raising capital couldn't do it. And you have to be able to deliver results. So you have to go through these gyrations, but fundamentally, all the companies in our group have a good asset and in a bull market with the right environment should give good returns to shareholders.

TER: Because you cannot guarantee success, how do you suggest investors play the Forbes & Manhattan game? Should they buy a little bit of all of your companies? Are you planning on creating a fund that represents a bit of each company that they can invest in?

SB: I think individual investors should look at all the companies but pick the sector they like. If they like agricultural sector, if they like the gold sector, if they like the base metal sector or the bulk commodities and then within that sector decide what stocks they like. They can be certain that within the group, a lot of support is available to these companies financially, technically, strategically. That should give investors more comfort than buying another junior on the Toronto Venture Exchange where that support may not be available.

TER: It's curious to see that F&M, a merchant bank, has another merchant bank in its portfolio.

SB: Many people on the street, so to speak, and many funds in the financial sector find a lot of the juniors that Forbes invests in—or that I invest in personally—too small. Raising $5 million to $10 million isn't enough for big funds to come in. So we created Aberdeen International Inc. (TSX.V:AAB), and raised $100 million or so in Aberdeen. The model for Aberdeen is that any time I invest in a junior company at the seed level, Aberdeen co-invests with me. This gives investors indirect exposure to all of Forbes companies.

Aberdeen typically invests only when I'm involved with deals. It's like having a pool of capital that invests and gives a shareholder an upside on all of Forbes' companies. Interestingly about 60% of Aberdeen's portfolio right now is gold. So not only do you get exposure to gold, you get exposure to the Forbes' group of gold companies. If you're not sure you want to play Avion Gold Corp. (TSX.V:AVR; OTCQX:AVGCF) or Sulliden Gold Corp. (TSX:SUE; OTCQX:SDDDF), for instance, you're better to buy Aberdeen.

So Aberdeen is there any time I invest at the seed level. That should give the investor comfort that he's in there at the seed level, too. We just put some money into one of our coal deals through Aberdeen, too.

TER: So this is a way that I was referring to earlier that someone can play the Forbes & Manhattan. . .

SB: Yes, they could. They could, absolutely. Aberdeen is also trading at half net asset value. Its NAV—and we publish it every quarter—has been between $0.80 to $1. It's trading at about $0.40 now, so there's a lot of leverage in Aberdeen.

TER: Does Aberdeen invest in companies that are not part of the F&M group?

SB: Generally no. Sometimes a company is in trouble or needs money, but we typically only put in capital when we want the company to come into our group. So it can happen but it's rare. Generally that's not the Aberdeen model.

TER: Another company in your portfolio doesn't deal with a commodity per se, but rather security systems. Can you tell us a bit about that?

SB: You're talking about Eurocontrol Technics Inc. (TSX.V:EUO). It is a commodity company but it has a different twist, because it has a unique patent on fuel-tagging technology. The single largest source of terrorist funding in the world is through oil. About $100 billion worth of oil, perhaps more, is illegally sold or shipped or transported. This $100 billion loss is primarily to governments because governments collect taxes on oil. Whether it's terrorists or the mafia, they find ways to take oil illegally and avoid paying taxes. So through a wholly owned subsidiary called GFI (Global Fluids International), Eurocontrol has a product that was developed in Israel that molecularly tags fuel. This innovative molecular marking system detects any change in the fuel content along the pipeline from the refinery with 99% accuracy.

Imagine, for example, a gas station. The refinery can add our product, and anywhere along the supply chain, all the way to the gas stations, they can measure and sample the fuel, and they can tell whether what's being pumped at the gas station is legal or illegal fuel. This may not be a big problem in the Western countries, but it's a huge problem in Third World countries. For example, India alone estimates $10 billion to $20 billion in illegal fuel sales; gasoline sold at service stations where the government is not recovering its taxes. We know that a lot of the funding for terrorist in Iraq comes through illegal shipments of oil.

Eurocontrol is a very interesting company. Typically a government or a large private oil company will take out on a contract. Eurocontrol supplies this product and charges $0.01 for every liter of fuel tagged. We haven't been able to get the market to understand the Eurocontrol story properly, but that's beginning to change. The company is slowly expanding, with contracts now in Uganda, Tanzania, Nigeria and Romania. I think in the next two to three years, the prospects for Eurocontrol are very good.

TER: If I'm a refinery, what's in it for me to tag the fuel?

SB: Suppose one of your managers decides to do a side deal and starts selling fuel to some gas station or somebody else and as a result avoids taxes. Then the refinery could be liable for selling fuel illegally. Or if you happen to be shipping fuel on a truck and the driver stops somewhere along the way, sells half of the fuel and fills the tank with water, you supply poor fuel to a gas station. The refinery would also be liable for that. It's an attractive proposition for a refinery, for a small amount, to ensure the product that goes to the end customer is what is coming out of the refinery.

TER: Excellent. Are there other gems in this portfolio that have real compelling stories?

SB: They all do. We go through some struggles, ups and downs. But they generally all have a good asset base, good leverage. In the agricultural sector we have a private company, Brazil Potash. We raised $25 million privately. We're drilling it now. Once the drilling is completed we're going to IPO this—we hope this year or early next year. We think it'll be a huge IPO.

This is in one of the largest potash basins in the world—we estimate more than10 billion tons in this 400-kilometer-ong Amazon potash basin—and Brazil Potash owns 90% of the basin directly. This basin could rival the Saskatchewan Basin, and geological, seismic and borehole surveys all indicate scale, geological properties and age similar to the Saskatchewan basin. So it's a big, big play.

TER: Any other potash plays in the F&M portfolio?

SB: We have one public company in potash—Allana Potash Corp. (TSX.V:AAA) in Ethiopia. It's a great company. It's in the Danakil Depression, where the geology is also similar to Saskatchewan's. It's surrounded by BHP Billiton Ltd. (NYSE:BHP; OTCPK:BHPLF) and an Indian company, Sainik Coal Mining, and has 43-101-compliant resources of more than 100 million tons. We expect to put that into production shortly and think that Allana also will be a great takeover candidate in the next 12 to 24 months.

TER: Stan, do you have any other thoughts you'd like to leave with our readers?

SB: The only other thing I want to mention is that sometimes people who don't understand Forbes and our model say we're charging our companies too much, Stan's too involved in a lot of companies, he's spread himself too thin, he issues too many shares. We don't take any more fees than anybody else. We believe very much in a model where you have a small base fee for all the management and very big bonuses based on results. Results may be the share price going higher, making a big discovery, arranging a big financing. We believe in that model, which is really the model on which the whole financial sector works. Really, our intention is the same as everybody else's—to add shareholder value. Sometimes the market gets confused. Any time people have any questions, just call us we'll be happy to answer them.

Stan Bharti, business consultant, professional mining engineer and international financier, has amassed more than 30 years' experience in business, management, operations, public markets, finance, mergers and acquisitions—the whole nine yards. He also has amassed more than $3 billion in investment capital to help propel junior resource companies to wealth-creating heights for their stockholders. He has been instrumental in acquiring, restructuring and financing scores of promising startups as well as struggling producers, from Europe to the Americas to Australia. As Financial Commentator and Market Analyst Peter Grandich puts it, "In a business where failure is the norm, people like Stan Bharti. . .have separated themselves from the also-rans." Serving on the boards of numerous companies, both public and private and often as chairman, Stan devotes the lion's share of his time to the premier merchant bank he founded, Forbes & Manhattan, Inc., where he is president and CEO.

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) The Energy Report Publisher Karen Roche conducted this interview. She personally and/or her family owns the following companies mentioned in this interview: Dacha, Pinetree and Aberdeen.
2) The following companies mentioned in the interview are sponsors of The Gold Report or The Energy Report: Vast, Allana Potash, Sulliden, 49 North Resources, Eurocontrol Technics, Aberdeen and Avion.
3) Stan Bharti: I personally and/or my family own shares of all the companies mentioned in this interview. I personally and/or my family am paid by all the companies mentioned in this interview.
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.
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Stay on your toes these are treacherous waters and have a good one.

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

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.



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
Aug112010

Expatriate Your Wallet

By Terry Coxon, contributing author of Casey Research’s ‘Going Global’ Special Report



If everything you own is held in your own name in your own country, then you are not merely exposed, you are vulnerable absolutely, to whatever decisions the government might make about how you should behave and who gets the wealth you’ve earned. Tomorrow's new government measure, which might land out of the blue, could be a law that affects everyone, or it could be a rule devised to deal with people like you. Or, it could be an administrative action aimed at you alone. In any case, with all your assets at home, you'd find out how the lobster feels when his trap is being hauled out of the water. Nothing he can do about it.

The only way to protect yourself against the risk of being boiled in a government pot is to keep some of your assets in another country. Depending on how you go about it, the specific benefits you might achieve are:
 
Protection from currency exchange controls
Protection from the confiscation of precious metals
A lower profile as a lawsuit target
Income tax planning advantages
Estate planning advantages
Easier access to investments in other countries
A measure of financial privacy
Practical readiness to move additional assets quickly
Psychological readiness to think and act internationally when you need to

There are many ways to go about getting those benefits. None is right for everyone, and they all come with some element of cost or inconvenience. Here’s the main menu.

Small bank account. A small account at a foreign bank gives you a ready and private landing spot if you ever decide you want to move a large amount of money in a hurry. If you're a U.S. person, the account is non-reportable, so long as the balance (together with any other foreign financial accounts you own) never reaches $10,000.

Large bank account. A large account at a foreign bank also provides a landing spot for anything you want to send later. If foreign exchange controls are ever imposed, the new rules may require you to repatriate the money – or they may not. Depending on the specifics of the new rules, your account may be grandfathered. In that case, the overseas funds would enable you to travel outside your own country while others are forced to stay at home.

A foreign bank account also slows things down if you’re ever under attack. It’s safe from an instant seizure by functionaries of your own government or by the unassisted order of a court in your own country.

The disadvantage of a large bank account vs. a small bank account is the loss of privacy. If you’re a U.S. person, you are required to report your foreign financial accounts if their aggregate value reaches $10,000.

Physical gold. Gold stored in a safe deposit box in a foreign bank is not a foreign financial account, nor is physical gold in segregated storage with a non-bank safe-keeping facility. So a U.S. person can store an unlimited amount of metal that way without triggering any reporting requirements. Avoiding a need for annual reporting is a plus, but don’t rely too heavily on the privacy you get with a safe deposit box, since the steps the gold takes to get there may create records of their own.

Foreign variable deferred annuity. As with an annuity issued by a U.S. insurance company, a variable annuity issued by a foreign company is tax-deferred for a U.S. investor until he withdraws the earnings. The annuity can be invested in major currencies or in portfolios of international stocks and bonds. If the annuity is big enough (a minimum of $1 million or more, depending on the insurance company), it can be invested in real estate, a private business, or just about anything else.

It’s only conjecture, but if foreign exchange controls are imposed, they are unlikely to disturb any foreign annuity that’s already in place, which is a big plus for an annuity vs. a foreign bank account.

A foreign variable deferred annuity isn’t private for a U.S. investor. When you buy one, you generally must file an excise tax return and pay a 1% tax, and you must report the annuity as a foreign financial account.

Swiss immediate lifetime annuity. A Swiss annuity that begins paying you an annual income when you buy it isn’t a foreign financial account, which may save you a reporting burden. And under a tax treaty with the U.S., Swiss annuities are exempt from the 1% excise tax. There’s nothing private about it, however, since part of each annual payment you receive will be taxable income.

You can make it difficult for a creditor (such as someone who won a lawsuit against you) to get his hands on a Swiss immediate lifetime annuity by electing not to have the option to cash it in. A forced assignment to a creditor generally would not be valid under Swiss law.

Offshore mutual funds. The array of mutual funds available internationally is even broader and more varied than what’s available in the U.S. And, like a foreign bank account, your share account with an offshore fund is safe from a lightning seizure by your own government. But for a U.S. investor, an investment in a foreign mutual fund comes with certain tax disadvantages. They are tolerable if you handle the investment properly or truly ugly if you don’t. And your shareholder account would be a foreign financial account and so would be reportable.

Offshore LLC. You can use a limited liability company formed outside your home country as an international holding company. It, not you personally, would buy and hold the overseas investments you want.

An offshore LLC can be designed to be very unfriendly to your potential future lawsuit creditors, even more so than an LLC formed in the U.S. An additional plus is that while many banks, mutual funds, insurance companies, and other financial institutions shun business from individual Americans, many of the shunners will welcome business from a non-U.S. LLC even if it is American-owned.

An offshore LLC owned by a single U.S. person (or by husband and wife) can elect to be treated as a disregarded entity for U.S. income tax purposes, which makes it absolutely income-tax neutral. Or it can elect to be treated as a partnership, which makes it almost income-tax neutral. The LLC also can be used for estate-planning in the same way as a U.S. LLC.

By the ratio of benefits to cost and complexity, an offshore LLC rates especially high. But it does not eliminate your reporting burden. If the LLC owns a large foreign bank account, you will be required to report it. And there will be annual reports for you to file about the LLC itself.

Foreign real estate. A direct investment in foreign real estate is free of any special U.S. tax or reporting rules. It’s just like buying a farm in Kansas. It would also present added difficulties for a lawsuit creditor looking for ways to collect. And it is unlikely that any regime of foreign exchange controls would touch existing foreign real estate investments.

Foreign real estate can also pay you a psychological dividend. Knowing you have a place to go to, should you ever want or need to go, provides a sense of security. That apartment in Buenos Aires or the acreage in New Zealand means you’ll never be a lobster.

Foreign real estate partnership. By investing in a private foreign partnership or LLC that owns foreign real estate, you can achieve all the advantages of a direct investment. In addition, you increase your protection against foreign exchange controls and lawsuit creditors because there is no ready resale market for your partnership interest.

International IRA. An IRA or a solo 401(k) is permitted to own anything other than life insurance and so-called “collectibles.” Anything.

Some IRAs and solo 401(k) plans own a domestic limited liability company and use it as a vehicle to buy and hold other investments. Such an LLC can own an offshore LLC that does the real investing. As with your direct ownership of an offshore LLC, this does nothing to reduce your reporting duties; in fact, it adds to them.

The advantage of such an arrangement is that it allows you to internationalize your retirement plan. Anything international you might do with your personal investments, you can do with your IRA’s investments. And it’s the ideal structure if you want to invest in offshore mutual funds. The IRA short-circuits the special tax rules that apply to investments in offshore funds, and the offshore LLC’s shareholder account application is likely to get a warmer reception from the fund than would your own American hand knocking on the door.

Private international investment contract. Depending on your circumstances, it may be possible to structure an investment contract between you and an international financial institution that is tax-deferred, non-reportable, and protected from future exchange controls or prohibitions on owning gold. This is custom work, so, of course, it’s only practical for large chunks of capital.

International asset protection trust. A properly structured international asset protection trust provides the maximum level of protection from anything that happens in your own country. It does so by leaving you with a measure of influence, but not control, over the trustee. The trustee is outside of your home country and thus is not subject to its laws. And you don't possess the authority to compel the trustee to invest or distribute the trust fund in any particular way. Thus there is no direct means for your own government to impose any regime of exchange controls or investment restrictions on the trust fund.

An international asset protection trust is far and away the most powerful of all financial planning devices. Handled properly, it is virtually impenetrable to future creditors and is especially helpful in estate planning. It is also the most complex device and hence the one most likely to be handled ineptly. And of all the tools mentioned in this article, it comes with the heaviest reporting burden if it is funded by a U.S. person.

Of course, this is the briefest of overviews of a complex topic. For specific guidance on each of the menu items listed, and pros and cons related to your own circumstances, you’ll need to seek qualified counsel.
----

With an ever-growing number of regulations and financial restrictions that gradually choke your ability to build and maintain wealth, protecting your assets by getting them out of the country should be a critical part of every investor’s strategy. We recommend you get started before it’s too late. Read more about the 5 best ways to internationalize your assets.




Stay on your toes and have a good one.

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

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.





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.



Thursday
Aug052010

China Is Winning the Energy Race

US 06 August 2010.jpg

By Marin Katusa, Casey’s Energy Opportunities



Stop the presses. The United States is no longer the world’s biggest consumer of energy.

After topping the energy consumption charts for more than a century, the U.S. has been left behind as China leapfrogged past. According to the International Energy Association’s (IEA) latest report, China burned its way through 2,252 million tonnes of oil equivalent last year – about 4% more than the U.S.

(The oil-equivalent measure is a bundle of all forms of energy consumed, including crude, coal, nuclear, natural gas, and renewable resources.)

That’s an astonishing turnaround, according to IEA chief economist Fatih Birol, who noted that as recently as 2000, the U.S. consumed twice as much energy as China.
 
Energy Consumption Trends of China and the United States 1965 – 2009
 
Source BP Statistical Review of World Energy, 2010.JPG


Source: BP Statistical Review of World Energy, 2010
It’s no longer 1973, when President Nixon could declare that our status as top energy consumer was “good. That means we are the richest, strongest people in the world.” Today, bragging about winning the energy-eating competition doesn’t gain you any brownie points. Which is probably why Chinese authorities were quick to reject the IEA data as “unreliable,” choosing instead to focus on their intention to sink about 5 trillion RMB (about US$750 billion) into renewable energy projects.

Despite the denials, a new age in the history of energy has begun, and the implications are enormous. China may not want to accept the honors, but the reality is that it’s now the most important player on energy’s demand side.

According to the IEA report, China will be investing more than $4 trillion over the next 20 years to ensure there are no power or fuel shortages, and that there is enough energy to keep feeding its economy. Thus the ever-increasing number of ships steaming out from Canadian and Australian ports: all are bound for Beijing, all loaded with precious energy supplies.

Whether it’s coal, gas, uranium, or oil, China’s import numbers are only heading one way – up. Here’s a brief overview.

Coal:

The wealth of Western nations was built on the back of coal, and China plans to be no different.

King Coal, cheap and plentiful in China, accounts for 70% of all energy consumed. Most of that goes to meet the burgeoning demand for power, and with US$30 billion just invested into improving the national electrical grid, we’re not going to see coal taking a backseat anytime soon.

China also needs metallurgical (coking) coal for producing steel – the backbone of an economy. As the construction boom continues, corporations will be crying out for it. But with no higher-grade reserves of its own, China is buying up whatever is in the market, sending coal prices skywards.

Oil 06 August 2010.jpg

Oil:

Beijing continues its relentless courting of oil-rich countries across the globe. Its national oil companies (NOCs) offer debt forgiveness, development packages, infrastructure improvements, and, yes, bribes, in exchange for secure oil contracts, especially in Africa. The net overseas production from the three Chinese NOCs for 2010 will be a record-breaking 1 million barrels a day... that’s enough to fuel all of Australia!

Not content with just acquiring oil assets outright, Chinese NOCs are also tying up partnerships with other oil companies. In fact, the three Chinese NOCs accounted for nearly 20% of all global deal values in the first quarter of 2010.

Nor has China ignored North America. It’s heavily invested in the oil sands of northern Canada. This huge reserve is likely to become the most important source of U.S. oil, and China is making sure its finger is very firmly in the pie.

The U.S. still remains the number one consumer of crude. But over the past three years, China has accounted for at least a third of world demand growth in crude. And with a projected 45% increase in demand in the next five years, Chinese NOCs won’t be hitting the brakes anytime soon.

Gas:

China is throwing itself onto the clean and green bandwagon as well. And the cleaner-burning alternative to oil is its cousin, liquefied natural gas (LNG).

Expectations are for a hike of almost 50% in Chinese demand for LNG by 2020. This year alone, China is expected to boost its LNG imports by about 65%, from 5.5 million tonnes in 2009.

No surprise that China is wedging its foot very firmly into the vast gas reserves of Kazakhstan, Uzbekistan, and Tajikistan. A 1,100-mile-long pipeline has just been completed to link Chinese factories and power plants to Central Asia.
Unconventional gas deposits – like shale gas – will also have a role to play. The country’s shale gas reserves are estimated to be about 26 trillion cubic meters.

As China wakes up to the potential of this energy source, it’s also waking up to the fact that the technology to unlock it is in North America. So planes full of well-heeled Chinese investors are heading on over to woo North American producers.
If you’re a small-capitalization firm, with the potential to lower costs and risks, improve project returns and tap opportunities that are otherwise beyond reach, you’re in demand.

Uranium:

Nuclear power is coming to China in a big way. The country is set to purchase up to 5,000 metric tonnes of uranium this year – more than twice what it needs.

But consider that by the year 2020, China will have at least 60 nuclear reactors up and humming across the country, throwing off 85 gigawatts of output and demanding 20,000 tonnes of fuel per year. That’s nearly 40% of the 50,572 tonnes mined globally in 2009.
Now the hoarding makes more sense.

The result: After a three-year lull, uranium prices are spiking up. Analysts at RBC Capital Markets have predicted a 32% spike in prices for next year – for a uranium company, this is Christmas come early. And while the bull market of 2006 saw at least 27 new uranium mines opening up across the world, it’s not going to be enough. Yellowcake is back, and it’ll be glowing red this time around.

China might not wish to be called the world’s biggest energy consumer, but it’s a fact, and its edge will continue to grow. The process of explosive economic development is like feeding teenagers – they’re never full. And while China continues on this tear to eat up the world’s coal, oil, uranium, and gas, there are some great opportunities unfolding.

Which producers are favorites to supply China?

Which companies are most attractive to Chinese investors, and to the NOCs?

When will uranium prices jump by 200% again?

----

We’ve put a lot of effort into charting China’s moves on the energy game board, and things are getting exciting. If you’re an investor, this is the perfect time to boost your portfolio with some carefully chosen stocks that will make the trend your friend. Try Casey’s Energy Opportunities for only $39 a year – and with our 3-month money-back guarantee. Read more here.




Stay on your toes and have a good one.

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

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
Aug032010

Keith Schaefer: Stick with Wet Gas, Heavy Oil Plays

Source: Brian Sylvester of The Energy Report  08/03/2010
http://www.theenergyreport.com/cs/user/print/na/6974

Keith Schaefer.JPG

Oil and Gas Investments Bulletin Editor and Publisher Keith Schaefer specializes in Canadian oil and gas plays. Despite the languishing gas price, he sees opportunities in some hedged Canadian gas companies and unhedged "wet-gas" producers. If you're not into gas, Keith is big on oil. In this exclusive interview with The Energy Report, Keith will tell you how radial drilling is creating opportunities in heavy oil, too.

The Energy Report: Keith, when The Energy Report talked with you in December, you said that a gas price below $5 would be "hell." Well, welcome to hell. Gas is hovering around $4.50 right now. Where's the bottom?

Keith Schaefer: It has been a very tough year for gas producers. Since January, the gas price has been on a straight downhill slide, with very few bumps up along the way. It has been hell, particularly for the juniors that are unhedged. These companies are creating no value for their shareholders. Their cash flow is anemic.

Where is the bottom? I think there's a good chance we're going to find that out in the next month or so, because gas traditionally bottoms in August. Last year, it bottomed around $2.50, $2.75 per MCF. Then in September, it started to take a big jump back up to $5. These stocks had a huge run along with that. It's almost funny, because none of these companies were really making money at $5, but the fact that they were losing a little bit less made the market very happy, and that took the stocks for a big run.

TER: At the same time, a lot of producers are hedged. Most of them are right around the $6 mark.

KS: Many of the seniors are hedged at $6. The forward curve has allowed them to do that. Good for them and their shareholders, because it looks like we could be in for a multi-year low gas price if these U.S. shale plays hold up.

TER: What's your view on the gas price through the end of this year and the end of 2011?

KS: I think this year we're going to get a little bit higher, but not much. Right now gas in the States is running around $4.50. In Canada, it's running at about a dollar less. These shale gas plays in the U.S. are doing a superb job at increasing production. Unless there's a dramatic increase in demand or a significant falloff from production, we're going to be staying right around here; maybe a little bit higher, but not much.

TER: And that's through the end of 2011 as well?

KS: The end of 2011 could be very interesting, just because many of these shale gas plays are relatively new. Right now companies stake a bunch of land and they have to drill the land to hold it. Once they've drilled a certain amount of holes, that land is theirs. When that happens, I expect these companies to stop drilling. That should actually be quite positive for the gas price. Companies are being forced to drill to keep their land when the market says they shouldn't.

TER: Are there companies that, despite the low gas prices, continue to perform?

KS: Oh, yes. You're seeing several companies do better than expected, for a couple of reasons. Some have been smart enough to hedge, which has benefited their balance sheet and their cash flow. Bellatrix Exploration Ltd. (TSX:BXE) is at the top of that list, and it's in our Oil and Gas Investment Bulletin Portfolio. They've hedged 50% of their gas at close to $7, so their cash flow has been fantastic this year. A second reason Bellatrix is doing better than expected is that they have a large land position in a burgeoning oil play in Alberta known as the Cardium. That stock has outperformed its peers this year, and in my mind, it will continue to. Another company that's done really well is Angle Energy Inc. (TSX:NGL), a wet-gas producer. Wet gas gets about twice the amount of money as dry gas.

TER: Is this what's known as natural gas liquids in the U.S.?

KS: Yes, liquid-rich gas. Angle has a huge growth curve in front of them. They're not hedged. If you're looking to play gas, that's a good one, because from their wet gas, they have downside protection with good cash flow, at current gas prices. They also have huge exposure to the upside if gas moves.

TER: Are we seeing companies with assets that have a high percentage of natural gas liquids getting higher valuations?

KS: Absolutely. Companies are getting higher valuations because of their higher wet gas percentages. Not across the board, but most of them are, companies like Angle and some of the other high wet-gas producers, which are mostly in the Deep Basin area of Alberta, right outside the foothills. And up in the Montney shale play, as well, they're getting higher liquids contents. They're getting 10, 20, 30, 40 barrels of wet gas per million cubic feet of dry gas, which could basically double the economics.

TER: Wow. Do you have some specific names with exposure to those plays besides Angle?

KS: Orleans Energy Ltd. (TSX:OEX) has a good wet gas count. Cinch Energy Corp. (TSX:CNH) has a wet gas count. Vero Energy Inc. (TSX:VRO). . .

TER: All right, what about Vero?

KS: I love Vero. I think it's a great company. The stock trades very, very well for how few shares—only 30 million—are out. Vero has one of the top management teams in the business, Doug Bartole and his vice president of exploration, Kevin Yakiwchuk. They have a great property in the Edson area of Alberta. They've shown great discipline in producing when the gas price is good and shutting down production when it's not. They've managed their finances very well. Vero keeps a high debt ratio, which means they don't have to issue many shares because they're generating most of their growth by using debt. They've got this new Cardium oil play, which has over 90 net sections. That's a lot of oil that they can bring onstream, very profitable oil.

TER: Are they in production right now?

KS: They're producing 8,000–8,500 barrels a day.

TER: Are there any other gas companies that you're excited about? You cover Peyto Energy Trust (TSX:PEY-U; OTC:PEYUF). Tell us about that one.

KS: Peyto is the lowest-cost producer in Canada. Their suite of properties is best of breed. Management has done a fantastic job. Over the last 10 years, that stock went from $1 to $45. I actually owned that stock when it was $1 a share, back in 1998. Now, of course, after the crash, everything's changed; but they continue to have the lowest- cost production, and a great growth profile. If you were only going to buy one gas company to get some exposure to a potentially rising gas price, Peyto—being the lowest-cost producer—would be it.

TER: A recent report on the U.S. shale plays by Credit Suisse talked about some of the gas shale plays with the best internal rates of return (IRR). The Marcellus was ranked second, with a 42% IRR. What are some companies with significant exposure to the Marcellus?

KS: One of the best companies that I like for exposure to the Marcellus shale play is actually an energy services company that does a lot of the drilling work and mud work for the producers in that area. It's called Canadian Energy Services and Technology Corp. (TSX:CEU). They've been able to make huge inroads into the Marcellus by selling their products to the drillers and producers there. Their mud allows drillers to complete a well in the Marcellus about 10 days sooner than normal. That dramatically reduces costs, which is one of the reasons the Marcellus is turning into a much more profitable play. On the producer's side, I think one of the safest plays in the Marcellus is a company called Epsilon Energy Ltd. (TSX:EPS). They have a deal with Chesapeake Energy Corp. (NYSE:CHK), the second largest gas producer in the United States. Between cash payments and work commitments, they've paid Epsilon about $200 million to get access to Epsilon's Marcellus ground in Pennsylvania. Epsilon basically has a free ride. In one sense it doesn't really matter what gas prices do, because Chesapeake is paying the freight. I love companies like that.

TER: I think we'll switch over to oil. Oil remains just below $80 a barrel. Do you think that's a psychological barrier? Does oil need to get past $80 to have a run?

KS: No, not at all. Oil doesn't need to run. I'm happy to see oil trade here for the next five years, because there are lots of companies that make fantastic profits at $75 oil. Technology is lowering costs in the oil patch. With the new horizontal drilling technology and multi-stage fracking, all kinds of new plays are opening up. Literally. Just yesterday, a new play opened up in Canada that no one had really paid much attention to. One of the independent consultants estimated that there are over 6 billion barrels of oil just in that one formation in Alberta in B.C. So all over the place you're seeing new basins, new formations being opened up with all this new technology, and it's relatively low-cost oil, not compared to the Saudis per se, but by the standards everywhere else in the world, it's very profitable oil at these prices. The oil price does not need to go any higher.

TER: Do you see it staying in that range for the next couple of years?

KS: That's a question that only history is going to be able to tell us. But I would suggest that, with the decline in demand in the U.S. and Western Europe being offset by the rise of China and India, we're going to see a fairly stable oil price for a while.

TER: You were talking just a few seconds ago about technology opening up some new plays. At the same time, fracking is not all that new. Multi-stage fracking has been around for a while. and horizontal drilling has been around for a while. What are new technologies in oil and gas exploration that we haven't heard about?

KS: There are new ones coming up all the time. But let's just go back to fracking and horizontal drilling for a second. Although those technologies have been around for 40, almost 50, years, it was just 10 or 12 years ago that the technologies got perfected enough so that they could start producing oil and gas out of rock. That was the Barnett shale.

What you've seen here now is that many new plays around Canada and the U.S., where the technology was developed, have become newly commercial. Even though they're old technologies, they're still opening up many, many new plays all around the world—the European shale gas plays, the African shale gas, and that's just scratching the surface. We're going to see huge growth in Europe and Africa shale gas over the next 20 years. You're right, they are old technologies, but they're being used in new basins for the first time and that's creating big value for shareholders.

One of the new technologies that I'm really intrigued by is radial drilling, which is used in heavy oil basins. I believe this is a technology developed by Halliburton Co. (NYSE:HAL). Little jets are sent into the very porous heavy oil formations and are able to create wormholes 100 meters out into the formation, to get oil to flow back to the well. Before this technology was being used, you could only get about 3 to 5 meters outside of the wellbore. It's a huge increase in potential production and reserve creation.

TER: And that's making some of these old basins profitable again?

KS: Yes. What's happening is that the old basins that have been worked over now have a new lease on life. I would say that heavy oil formations haven't really been used or exploited that much. The world's been very focused on getting the light oil out. But over the last dozen years, much more time has been spent focusing on the heavy oil. They're continually finding ways to improve the technology and lower the cost.

TER: What are the big differences between heavy oil and light oil?

KS: Light oil is easy to process, and doesn't need much work to get into the form that would go into your car. Heavy oil has heavy products in it like metals; it's the basic component of asphalt. We have to spend a lot of money to remove the asphalt, rocks, and bits of metal to make heavy oil into various types of fuel. Heavy oil doesn't go into your car; it will go into heating products or diesel, or products where it doesn't need to be refined quite as much.

TER: It's more expensive to process, but are there still some companies that you like that are big into heavy oil and are profitable. Could you tell us about some of those?

KS: Yes. That's a great point. What's happening here is that many of the U.S. refineries, particularly those down in the Gulf of Mexico, are geared toward heavy oil. You just can't change your refinery at the flick of a switch and say, "Alright, today we're going to do light oil. Tomorrow we're going to do heavy oil." When you're a heavy oil refinery, that's the type of feedstock you need.

The two biggest sources of heavy oil, Mexico and Venezuela, are in steep decline—Mexico for geological reasons, Venezuela for political reasons. That means that the heavy oil from Canada is in hot demand in U.S. refineries. There's a new pipeline being proposed to take oil from Canada down to the U.S. refineries. Many heavy oil producers that are used to getting only 50%–60% of the regular oil price for their products, because it costs so much more to process them, are now getting 85%–90% of the regular oil price. Over the last two or three years, there has been a huge increase in the heavy oil price. What they called a "heavy oil discount" has gotten much smaller. And the heavy oil in Canada is very shallow, so it does not cost much to produce. Wells only cost $300,000–$700,000, versus $3 million–$5 million for a deep light oil well. So when your costs are low and the price of your product has gone up a great deal, that's a recipe for profits.

TER: Tell us about some of those companies that are profiting from this trend in heavy oil.

KS: Well, one of my favorites is a company called Emerge Oil and Gas Inc. (TSX:EME), which has lots of heavy oil in Alberta and in Saskatchewan. They have done a great job securing large land packages that have highly prospective oil leases. Emerge has been able to deliver good production growth and will continue to do so over at least the next two years.

TER: Any others?

KS: Another one that I like is a company called Rock Energy Inc. (TSX:RE). CEO Al Bey knows how to secure land positions, and he has a very good cost-control system in place. Some of their properties are able to deliver profits of three to seven times the money that Rock puts into them. For every dollar that they put into the search for the oil, they're able to return $3–$7 to the shareholders. That's a fantastic "recycle ratio."

TER: What other things has management done?

KS: They just brought on John Van De Pol as President and CFO. John's been involved in a couple of winners in the past, has a lot of experience and does it right. He's very methodical. For a shareholder, he's exactly the type of guy who gives you a lot of confidence.

TER: What are Rock's prospects for growth?

KS: They still have a large undeveloped land package, with a drilling inventory of at least two to three years ahead of them. They'll be able to continue to grow production quite strongly. Rock is also one of the pioneers in using this new radial drilling technology. They're finding that the amount of oil they can get out of each of their land sections is increasing quite dramatically, and that's been a big, big bonus.

TER: Are there any other companies you like in the heavy oil space?

KS: Not too many. Rock and Emerge are two of the best. Another one is BlackPearl Resources Inc. (TSX:PXX), which has a strong growth profile. Their growth is actually going to come in chunks. Unlike Emerge and Rock, which are able to drill a lot of small wells, BlackPearl has slightly larger assets that take more time and more capital to develop. Their growth is going to come more in steps and stages, as opposed to the steady growth that Rock and Emerge will have. But it's a well-respected team, and the market loves BlackPearl.

TER: How so?

KS: They trade at a much higher valuation, for example, than Emerge does. Its market cap relative to its production is very high. With almost 300 million shares issued, the company is worth almost $1 billion. For the level of production that it has right now, BlackPearl is a relatively expensive stock.

TER: Yesterday, BP (NYSE:BP; LSE:BP) sold most of its Canadian assets to Apache Corp. (NYSE:APA). Will that create any opportunities in Canada?

KS: I think it's too early to say. But let's consider Apache the general contractor in a construction job. They are going to cherry-pick the assets that they really want and sell off the smaller assets that they don't want. You're going to see a filtering-down of these assets to smaller companies over the next year. That should create a pretty big opportunity for the right team that's able to get a good land position.

TER: What could it do for Apache?

KS: Apache has been spending a lot of money up here, which is interesting. They're one of the largest gas producers in Canada. They bought the controlling interest in the LNG (Liquefied Natural Gas) terminal being built at Kitimat, British Columbia. That gas will go to Asia, where the price is much better. This is one of the strategic things Apache has been able to do: basically, set themselves up as huge land and major infrastructure owners to send gas overseas, where it gets a much better price.

If Apache had to send this gas down to the U.S., it would not be very profitable, because it's way up near the Yukon border. And with Marcellus production coming on-stream, that's really cutting out a lot of Canadian gas into the States. But if they can keep that gas producing and send it over to Asia, via the LNG terminal on Canada's west coast, that could be a huge profit center for Apache.

TER: Are there parting thoughts you want to leave us with?

KS: Many natural gas companies are trying to rebrand themselves now as wet-gas companies, to try to get higher valuations. We're going to see a lot of that type of talk over the next six months. But I don't see any sustained pick-up in the gas price for a year. Having said that, as soon as we get a sign that some of these U.S. shale plays are going to fizzle quicker than expected, that situation could change very, very quickly.

Also, we have a special offer exclusively for Energy Report readers—we're offering a free Oil & Gas Investments Bulletin report, which includes an exclusive stock pick, one which I believe has lots of room for growth—despite it having already doubled for my subscribers. As well, we're offering your readers a 30% discount on current subscription rates for a limited time only. For more information on this special offer, please visit our website at: www.oilandgas-investments.com/special-offer/. Our returns have done very, very well this year and with the annual subscription there is a 60-day money back guarantee.

Keith Schaefer of the Oil & Gas Investments Bulletin writes on oil and natural gas markets. His newsletter outlines which TSX-listed energy companies have the ability to grow, and bring shareholders prosperity. He has a degree in journalism and has worked for several dailies in Canada, but has spent the last 15 years assisting public resource companies in raising exploration and expansion capital.

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

DISCLOSURE:
1) Brian Sylvester, of The Energy Report, conducted this interview. He personally and/or his family own none of the companies mentioned in this interview.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Rock Energy.
3) Keith Schaefer—I personally and/or my family own the following companies mentioned in this interview: Rock Energy, Angle Energy, Bellatrix Energy, Vero Energy, Orleans Energy, Cinch Energy, Canadian Energy Services, Emerge Energy, BlackPearl Resources. I personally and/or my family am paid by the following companies mentioned in this interview: None.
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Stay on your toes and have a good one.

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

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Thursday
Jul292010

Gabriel Hammond: New MLP Options

Source: Brian Sylvester for The Energy Report  07/29/2010
http://www.theenergyreport.com/cs/user/print/na/6942

Gabriel Hammond.jpg

SteelPath Fund Advisors Founder Gabriel Hammond recently launched three Master Limited Partnership (MLP) mutual funds. They are the first open-ended funds in the MLP space, but will certainly not be the last. Gabriel explains the appeal of the new funds and gives us some of his firm's favorite MLP names in this exclusive interview with The Energy Report.

The Energy Report: You recently launched three MLP mutual funds. When an investor places money in these funds, he or she is basically investing in energy infrastructure. Your firm is the only one to offer open-ended funds such as these. Tell us why you decided to launch them.

Gabriel Hammond: For years, investors have been searching for a liquid, transparent investment product that allows them to gain exposure to energy infrastructure through the MLP asset class. Particularly throughout the volatility in 2008–2009, whether you were a registered investment advisor or an institutional investor such as a pension fund, you probably spent a significant amount of research time working on this asset class in order to better understand it. Out of that effort has come a significant understanding that MLPs should really be part of any diversified asset allocation strategy. In other words, they're a permanent part of someone's portfolio and have tremendous diversification benefits, not to mention their 7% plus yield and their annualized 18% total returns over the last decade.

People want to invest in the MLP asset class, but they haven't been able to find the right product to access them. Investing directly in MLPs demands dealing with K-1 tax forms, and while many investors and institutions do have the systems in place or the accounting help to be able to do that, for most, receiving 20 to 40 K-1s from a diversified portfolio, as well as possibly having to file taxes in 30 to 40 states, is not something that they are prepared to do. Also for tax-exempt accounts, whether they are personal IRAs or multi-billion pensions, unrelated business taxable income (UBTI) considerations are a concern for direct holders.

TER: But you can get exposure through closed-end funds and MLP exchange-traded notes (ETNs).

GH: There are a variety of closed-end MLPs funds and ETNs, but each has drawbacks.

On the closed-end fund side, you have very high ongoing management and administrative fees and substantial underwriting discounts. Throughout their history, those products have consistently failed to outperform the benchmark—investors would have done far better investing on their own in an index.

ETNs require the investor to take on credit exposure to the issuing firm. Many institutional investors are limited as to the amount of credit risk they can take on from any one firm—maybe 2% of any one institution's credit. Let's use JP Morgan credit exposure as an example. An institutional investor may very well want a 5% or 10% allocation to MLPs, but they can't do that completely through J.P. Morgan's exchange-traded note, because they can't take such a significant single credit exposure as part of their mandate. They are a terrific product in many ways, but can't fit all of an institution's needs.

We've been looking to develop a product that allows these different types of investors to access MLPs with liquidity and transparency, using a single 1099 tax form. Another significant benefit of an open-ended fund is that the underlying MLPs trade upwards of $600 million a day. If you're looking at the liquidity of a closed-end fund that trades 150,000 shares a day (only $3 million a day for a $20 stock), it could take an institutional investor three months to exit. Or, they'd have to pay a significant discount if they want to trade a block, say, 5%–7%. In many ways, it's not a true institutional choice.

TER: Is that key for an institutional investor?

GH: Absolutely. Mutual funds are traditionally thought of as a retail product. But this open-ended fund structure allows those investors to take part in a much greater pool of liquidity to access the space. Mutual funds always trade at net asset value. Investors always know that they can enter and exit an mutual fund, which I think is very important to the institutional investor.

TER: Why haven't we seen open-ended MLP funds before?

GH: I think there's been confusion about the structure of a registered investment company versus an entity making a tax election as a regulated investment company (RIC). With the Securities and Exchange Commission, being an open-ended fund means you're an N-1A filer; that is how you register under the 1940 Act, and that is your structure. On the other hand, choosing to be taxed as a RIC is a tax selection made with the IRS. In other words, when your administrative assistant goes to irs.gov to create your Tax ID Number (TIN), there are a number of choices: partnership, limited liability company, corporation and RIC. Most mutual funds, for obvious reasons, have chosen RIC, which unfortunately, along with tax-free benefits, has a 25% limit on investments in MLPs. Obviously, we want to be able to provide pure play exposure, so we have elected to check the corporate box.

People have typically thought of a RIC as a structure. Whether you're an attorney or the CEO of an investment management company, most people seem to have confused the two; they hadn't really thought of a RIC as simply a tax selection, as opposed to a structure. Our fund is a registered investment company under the 1940 Act; we make all the usual filings. There's no difference between us and any other plain vanilla mutual fund.

TER: And your company, SteelPath, has a lengthy history in MLPs.

GH: Our affiliate, which exclusively advises MLP separately managed accounts, has a six-year performance history that substantially outperforms the benchmark index, and whose reporting has been Global Investment Performance Standards (GIPS) verified. In March 2010, our firm, SteelPath, spun out from a company called Alerian MLP Index (NYSE:AMZ). That's the company that created the very first MLP index, the Alerian MLP Index (NYSE:AMZ) and the very first MLP exchange-traded product based on an MLP Index. There's a history of innovation. We spent a lot of time with our attorneys developing this structure. If you called one of our direct MLP competitors before we announced this product and asked, "Why didn't you offer an MLP mutual fund?" they would have said, "Oh, you can't do an MLP mutual fund. Everybody knows that you can't roll more than 25% of MLPs into a RIC." But we were able to put a tremendous amount of time and money into effective research to understand the structure.

TER: Do you think your model will be copied?

GH: Absolutely. We've already had a competitor copy our structure and re-file an N-1A with the SEC. We're less focused on that sort of direct MLP manager competition, however. If these funds are as successful as we think they can be, we fully expect much larger competition—your Fidelities, American Centuries, Putnams. This will probably mark the beginning of a sea change in terms of the institutional ownership of the asset class over the next five years.

TER: What are the key differences between open-ended and closed-ended funds?

GH: The closed-end funds are affectionately known as "roach motels," because you check in, but you never check out. The reason that's such a well-known joke in the wealth management space is that these companies, once they do their offerings, hold on to that capital. You can't say, "Listen, I'd either like my money back or the underlying securities." It's permanent capital. Whether or not you like that investment, or whether or not the management is doing well, your only option is to trade your shares on the secondary market. That could mean trading at very steep discounts to their net asset value.

TER: So why would anybody be in a closed-end fund?

GH: The reasons that closed-end funds exist is that they purportedly offer access to an asset class you can't traditionally have access to. For example, Nuveen Investments Inc. might say, we're going to buy 2,000 different municipal bond issues. That's something that an ordinary investor couldn't do because he just doesn't have the access. Typically, because of the liquidity of what they're investing in, maybe it's a 30-year municipal bond portfolio, the closed-end fund says, "Listen, we really need your capital for the next 30 years."

With the addition of exchange-traded notes, mutual funds—and there's also an ETF filing out there—we think that that logic is going to disappear in the MLP equities space. If SteelPath were to consider launching a closed-end fund in the energy infrastructure sector, it would be very different from the model that our competitors have, both structurally and in terms of its portfolio holdings. We would only do something in the closed-end-fund space if we truly believed the permanence of the capital was warranted by the investment strategy, and we could provide value or access to a segment of the market that investors cannot reach today.

TER: Please tell us about the three different funds and briefly describe each.

GH: The Select 40 Fund provides broad-based exposure to the MLP asset class. No company will be more than a 5% position in that fund. This really is, again, an access product, with an 85 basis point expense ratio.

The Income Fund is unique. It has a monthly dividend, with a 100-plus basis point yield premium to the other two funds. For instance, if the other two funds yield 6.8%, the Income Fund yields 7.8%, paid on a monthly basis. Whether you're an individual who wants to receive the monthly checks, or a pension fund looking to offset its liabilities, we think that's a unique feature of this particular fund. It's really focused on the income side, as opposed to growth.

The third fund is the Alpha Fund, which allows us to take advantage of the inefficiencies of the MLP asset class. This fund has a long-term investment horizon, in terms of seeking those MLP names we believe will have the greatest capital appreciation—whether through revaluation or superior distribution growth. Typically we're going to have less than 20% turnover, but it will be closer to 10% on an annual basis. We're very much private equity investors in terms of how we think about investing in the space.

TER: What are the advantages of being in MLP mutual funds like the ones you're offering, versus being directly vested in MLPs and getting the distributions?

GH: The big difference is the tax form that you will receive. By investing in MLPs directly, as I mentioned, you end up with a K-1 and you will owe state taxes in every state where that company operates. If the MLP owns a pipeline that operates in 20-plus states, you will need to file 20-plus state tax forms. With the mutual fund, you're going to receive a single 1099 for your entire portfolio.

Also, if you're a tax-exempt institution, direct ownership creates UBTI. If you hold MLPs through our funds, you're not subject to UBTI, so that's one reason we think tax-exempts will likely gravitate toward the structure.

TER: And exposure to the rapid growth of GPs?

GH: Our funds can, and do, hold MLP GPs. You can receive that exposure through ownership in the fund.

TER: So you have basically simplified investing in MLPs.

GH: Yes. The result is simplified tax reporting. Essentially, the elimination of any UBTI means you can hold MLPs in an IRA or 401(k) account, pension fund, endowment, or other tax-deferred account. It allows you to replace 20 K-1s with a single form 1099.

TER: And the minimum investment is $3,000?

GH: Yes. We believe that MLPs should be an allocation in every diversified portfolio, and want to ensure that investors of all sizes can allocate to this asset class.

TER: As you mentioned earlier, investment-grade MLPs have had 10 straight years of 18% annualized growth. Do you think the MLP bull run is close to ending, or is there a lot left in the tank?

GH: It's not just the investment grade. It's actually the broader market index, the Alerian MLP Index. The AMZ is similar to the S&P 500; it's market cap weighted, float adjusted. That index has risen 18%, throwing in the kitchen sink of any company that's ever had an initial public offering as an MLP.

Where are we in the return cycle? We're in the bottom of the third inning right now, in terms of where this investment thesis is. You've had very strong returns over the past decade, but you have to look at the factors that have driven those returns and think about the sustainability. The big differentiator there is that MLPs have grown their distributions at nearly 9% a year for the past 10 years, whereas other asset classes like big utilities are under 2%. That is a significant disparity.

The three pieces that have led to that strong performance make up the organic growth profile. First, increasing energy demand means more throughput in these pipelines. Second, you've got investment growth in these companies and regional franchise monopolies. As they continue to grow, so does your return on those investments. Third, there's a tremendous acquisition story here; you're seeing the potential for $10 billion in acquisitions a year.

To give it perspective, more than $200 billion worth of new energy infrastructure needs to be built in the next decade. There's nearly $300 billion worth of existing energy infrastructure in corporate form that can be sold into the MLP structure. When you look at the past decade and the factors that have contributed to that growth, all three legs of the stool are still in place.

TER: But can you realistically expect those kinds of returns to continue?

GH: Do we expect 18% returns over the next decade? No. I think growth is going to be more modest. We've got a variety of perspectives on broader economic growth at our firm. I'm personally more pessimistic in terms of the trajectory of the U.S. economy and overall I would say we're probably significantly more cautious than the rest of the market. That being said, we feel extremely confident in MLPs relative to the market. That's not to say MLPs can't go down, but we believe that if the broader market falls, MLPs will experience less of that downward volatility. We would be looking at 4%–5 % distribution growth, relative to the 8.0%–8.5% that we've experienced. But coupled with the current 7% yield, you're looking at total returns in the low teens. We think the market will do 6%–7%, at best. Bonds and utilities will probably have similar performance.

TER: But MLPs are particularly sensitive to global credit markets. That subject seems to be coming to the fore in Europe, and probably in the United States, too. Could that inhibit the growth prospects that you're talking about?

GH: There's no question that access to capital is critical to these companies. Although they're not required to in the same way REITS are, MLPs do pay out the majority of their cash flows. And whereas REIT dividends go up and down with the state of the economy and lease rates, MLPs are very conservative about their dividend policies. Boards of directors are only going to increase distributions if they can perpetually sustain them. If you look at the past 10 years, infrastructure MLPs have, on the whole, increased their distributions each and every year. That's extremely important.

TER: And that includes 2008?

GH: Yes, but there's no question that access to capital is extremely critical. To finance these large, organic-growth opportunities MLPs need to access capital markets. Typically, new acquisitions are financed on a 50/50 debt-to-equity basis. So every $1 billion worth of additional projects is going to require $500 million in debt capital and $500 million in equity capital.

But I want to take you back to November 2002. There was a significant credit spread blowout. Enron, Williams (NYSE:WMB), and El Paso Corporation (NYSE:EP) were all suffering, but it was a terrific time for MLPs to be buying assets. Their share prices did suffer in the short term when they purchased those assets; however, the MLPs made such critical purchases on such a cheap basis, it spurred an unprecedented period of growth from 2003 to 2005.

You saw something similar in 2008, but more in terms of organic investment opportunities. Did that hurt MLPs' current share prices, and short-term issuance costs? Sure. But the spreads that they're earning on these investments has significantly exceeded their cost of capital.

TER: Now we're going to go talk about actual MLPs. What are your top three holdings?

GH: They're different in all the funds, but I can tell you two of our long-standing holdings are Inergy L.P. (NYSE:NRGY) and Holly Energy Partners, L.P. (NYSE:HEP).

TER: Tell us about Holly.

GH: Holly is an interstate refined petroleum products transportation company. Holly owns and operates interstate refined petroleum products pipelines—gasoline, jet fuel, heating oil and diesel. The parent company, Holly Corporation (NYSE:HOC), is also publicly traded. It's a terrific refining company, and has some of the highest Nelson complexity refineries in the United States. Their refiners can process a very wide batch of crudes, everything from sweet crude to sour West Texas crude to the heavy crudes from Canada.

Before the heavy sour to light differentials got big in 2006 and 2007, and people started talking about heavying up their refineries, HOC showed tremendous foresight and soured up way ahead of that trend. So they have a very strong parent company with tremendous demographic territories: Arizona, West Texas, New Mexico. We think there's a very significant growth profile there, and they'll continue doing their best organically to support the growth of their parent. Certainly we're very excited about that name. We think the market tends to undervalue Holly simply because it's not one of the larger companies in the space. But it's got one of the lower business-risk profiles, and we're very confident in the management team.

TER: What about Inergy?

GH: Inergy is in a unique position in natural gas storage in the Northeast. They're just outside New York City, and have a tremendous position, in that storage is in very short supply around New York City. As you know, gas prices can be very volatile in the winter. You've got the head-and-shoulders pattern, and those prices increase in the winter. Creating that storage is what allows utilities and the end consumer to mitigate price volatility in the winter.

Inergy's customers enter into long-term contracts with the company, and then fills its storage facilities during the summer so that utilities can draw down on that during the winter months. This is very much a critical piece of the energy value chain. Inergy has these terrific storage opportunities, plus the land and the structure that allow them to continue to grow. We think Inergy is one of the more exciting opportunities to put capital in the ground.

TER: The Energy Report has talked with a few MLP experts in recent weeks, and the same names keep coming up. What are some growth stories that people probably haven't heard about?

GH: Global Partners, L.P. (NYSE:GLP) is probably a company that people are less familiar with. It was a family-owned business for decades, and went public in 2005. It's still very closely held by the family, which also owns the general partner. Global Partners owns heating oil, diesel and gasoline terminals in the Northeast. At Boston Harbor, where there isn't any more physical land available, they're terrifically positioned with their terminals, plus they've got tremendous expertise.

I think one of the reasons the company has been ignored is that it has a modestly different business model than some of the other MLPs. It earns margin by taking title to the commodities that go through its terminals, and that has a little more volatility. As a result, it has been more difficult for analysts to model and really get their arms around this. Global Partners trades very cheaply relative to the asset class. They've just announced a $200 million acquisition of some of Exxon Mobil Corporation's (NYSE:XOM) terminals and gas stations. We think that's a potentially significant catalyst for additional growth. Global Partners is certainly a name that, in our view, has been ignored.

TER: Are there other MLPs that are taking advantage of the selloff from companies like ConocoPhillips (NYSE:COP) and Exxon?

GH: Just two days ago, Magellan Midstream Partners, L.P. (NYSE:MMP) announced a $289 million acquisition from BP (NYSE:BP; LSE:BP). I would also put MMP up there among our favorite names.

The majors don't get any credit on their valuation for these types of assets. The oil majors' shareholders simply don't reward them for what is viewed as a cost center, if not totally ignored. A major can sell the assets to an MLP that specializes in operating a specific type of asset, with a specific customer base, in a certain area. In turn, the MLP can deliver more value from that asset more efficiently than BP. Meanwhile, BP, Conoco or Exxon can redeploy that cash into projects that the shareholders will truly reward them for. It's really a win-win situation for all parties.

TER: Maybe just one other off-the-radar name before we go.

GH: I would say one of the more recent initial public offerings, Niska Gas Storage Partners LLC (NYSE:NKA). It's a natural gas storage operation that just went public in the last month and has a terrific private equity sponsor, Carlyle Riverstone. NKA has a very strong management team and a lot of organic growth opportunities.

The name slipped, though, after the IPO. Quite frankly, the sponsors pushed the investment banks too hard. A lot of times when you've got a big client like that, they'll push really hard on pricing. They got a little aggressive, and that created a buying opportunity for us. In fact, we knew that was going to happen because we'd seen it happen before in the space with that type of asset. So we did not participate on the offering itself, and actually waited for the fall and then took a position in NKA. The company essentially has salt dome storage caverns on the natural gas side. Here's how those work: you drill into a depleted natural gas reservoir and pump the gas back in for storage. By drilling deeper, they've actually got the ability to create significant additional storage at minimal cost. A lot of organic growth will occur in that name.

TER: This has been great, Gabriel. Thanks for your time.

Gabriel Hammond is a portfolio manager at SteelPath Fund Advisors and has been a portfolio manager and member of the Investment Committee of its affiliate, SteelPath Capital Management, since 2004. Prior to this, Gabriel covered the broader energy and power sector at Goldman, Sachs & Co., in the firm's Equity Research Division. Specializing in the Master Limited Partnership midstream energy space, Gabriel advised Goldman Sachs, & Co. Asset Management with portfolio allocation, short-term trading, and tax-advantaged specialty applications. In addition, he marketed nearly 30 public MLP offerings while at Goldman Sachs.

Hammond also sits on the Board of Directors of the National Association of Publicly Traded Partnerships (NAPTP). He graduated from Johns Hopkins University, with Honors in Economics.

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

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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 or The Gold Report: None.
3) Gabriel Hammond: I personally and/or my family own shares of the following companies mentioned in this interview: None. I do own shares of the SteelPath mutual funds mentioned in the interview. I personally and/or my family am paid by the following companies mentioned in this interview: None.
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Stay on your toes and have a good one.

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

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
Jul282010

Is the Future of U.S. Oil Really Secure?

Kazakh flag.jpg

By Marin Katusa, Chief Energy Strategist, Casey Energy Report



Two words that any oil company dreads to hear are “export duty.” Especially if the word “increases” or “introduced” is floating around there too.

So when Kazakhstan introduced an oil export duty to meet shortfalls in the national budget, the mood wasn’t exactly jovial.

On July 13, the Kazakh government brought back the tax that had been abolished during the financial crisis. A US$20 tariff will be levied on every ton of crude oil exported from the Central Asian nation. The hope: collect some US$406 million in additional revenue by the end of the year.

The energy-rich, former Soviet republic has some of the largest oil and gas reserves in the Caspian Sea basin, producing 1.43 million barrels per day (bbl/day) in 2008. And as the giant Tengiz and Karachaganak fields are developed further, an additional 1.5 million bbl/day will be coming off the production line.

With the country holding 3% of the world’s proven oil reserves and the majority of its Caspian Sea holdings still unexploited, it’s no wonder oil companies – both major and minor – are flocking to it like moths to a flame.

Of course, this new tax has everyone from Chevron and ENI, whose long-standing agreements have been unilaterally revised in effect, to the small-scale producers in an uproar. The move has been dubbed as the latest example of resource nationalism in Kazakhstan, analysts say, and the feeling is that the country seems to be taking its cue from Mother Russia.

There’s worry, too, that this is only the beginning of the end. There’s no guarantee to say that the tax will not rise as more and more oil begins to flow out of the country. And the thriving uranium industry might be next to get heavy taxes slapped onto it.

Bringing it back to an American context, the question of energy security rears its head yet again. Oil from Kazakhstan flows through two pipelines: one winds through Russia, the other through China. Not exactly the two countries you’d want controlling the taps of your oil supply.

Today’s realities – be they economic or security-related – mean that the natural shopping ground for U.S. oil are the Canadian oil sands in Alberta. According to the EIA (U.S Energy Information Administration), Canada remained the largest exporter of oil in April, exporting 2.486 million barrels per day to the U.S. The majority of these barrels come from the Canadian oil sands.

While protestors may get up their flags and launch advertising campaigns, technological breakthroughs mean the environmental impact from oil sands is far less than before. Canadian laws also protect the environment, ensuring that all disturbed land is returned to a productive state. Carbon revenue, too, is reinvested into clean energy research, paving the way to the future.

As we wait on alternative energy sources to take center stage in world energy plays, the truth remains that oil and gas must power our lives. And for the United States, Canadian oil sands mean a secure and most of all, reliable, source of energy.

With Canada looking ready to pick up the slack from the Gulf, it’s worth knowing which companies operating in the Great White North are worth adding to your portfolio. These are the ones that combine the latest technology with good site locations and excellent cash flow. Their inclusion will benefit any portfolio and rake in some promising returns.
----
Whether it’s Canadian oil sands, uranium, or viable green energies, Marin Katusa and his team make it their mission to find the best of the best junior energy companies for maximum profit potential. Read more about Marin and the new European “Cold War” that promises investors enormous opportunity.

Stay on your toes and have a good one.

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

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.