Seeking Alpha
What is your profession? ×
Portfolio strategy, commodities, oil & gas, energy
Profile| Send Message|
( followers)

Source: The Energy Report 05/07/2009 (http://www.theenergyre...)

As Stansberry & Associates Investment Research founder Porter Stansberry sees it, cap-and-trade legislation is sure to drive up the price of coal. Coal-bed methane wells are producing so much natural gas that the economic incentive of shutoffs to sustain prices has vanished. The upshot, he tells The Energy Report, is continued weakening in natural gas prices and thus continued strengthening for companies that use natural gas for power generation.

The Energy Report: The last time we spoke with you was in late March at the Casey Research Crisis & Opportunity Summit in Las Vegas. At the time, you talked about equities being so cheap that everyone was afraid to invest, and as a result, equities seemed to be a better value than gold. Since then, though, we’ve seen a run-up in equities. So is that still true?

Porter Stansberry: It is still true, but unfortunately not as true as it was. A lot of categories of equities have become extremely overpriced since we last spoke. I would put all of the companies that are over-leveraged in that category. I was just looking at information from Bloomberg saying that companies with more than 100% of equity in debt and low return on assets were up 82% on an average in the last six weeks. In my estimation, that reflects a tremendous amount of short covering because those stocks had been a one-way bet for months and months and months. They were just falling, falling, falling.

Now, those over-leveraged companies have become very expensive. A lot of what I was buying that was very cheap—for example, the oil service companies—in some cases has doubled. So those things are not as attractive as they were only a few weeks ago. Six weeks ago, you couldn’t miss no matter where you were to aim your investment dollars in equities.

TER: So has the individual investor missed out? Or are there still some plays in the equities side?

PS: There are still lots of good buys on the equity side. For example, something I talked about when we last spoke that is still very attractive is Calpine Corp. (NYSE:CPN). Calpine owns a fleet of power generation plants. They’re the largest unregulated power generator in the United States, and they run on natural gas. I happen to be very bearish on natural gas, so I think we’ll see a long-term decline in the cost of Calpine’s fuel. I also think we’re going to see a long-term increase in the cost of electricity, thanks mostly to new cap-and-trade legislation that is going to be put through Congress.

We saw the first of that new kind of legislation in mid-April, when the EPA ruled for the first time ever that carbon emissions cause global warming and that global warming is a threat to the country. That is the first in a series of what I expect to be more and more restrictions and taxes on carbon emissions. Of course, that affects most directly the power industry. About half the country runs on coal.

These things are secularly bullish for Calpine, and meanwhile, you can still buy the stock. It was at $5 when I recommended it six weeks ago. It was at $8.98 May 5. It’s not quite as incredibly attractive as it was but it’s still very, very cheap relative to assets and relative to earnings. A stock like that is a better investment than just an ounce of gold.

I own a lot of gold personally and I’m a great believer in the role of gold in someone’s portfolio. But would I rather buy a share of Calpine stock today or buy an ounce of gold? In my opinion, Calpine’s equity is so attractively priced that it’s much more compelling today than buying another ounce of gold.

TER: Are other energy plays still attractive that go along with this leveraging the cap-and-trade that Congress has put through?

PS: That’s a great question. I am sure that there are, but the only one I’m particularly familiar with is Calpine. You’d want to look at energy companies with an eye toward assuming what happens if the cost of fuel—in terms of coal—were to double or triple. You’d want to see if they still make sense.

Obviously, nuclear energy doesn’t have any carbon emissions, so you could just buy Duke Energy Corp. (NYSE:DUK) and Exelon Corp. (NYSE:EXC), which are the two largest nuclear operators in the country. But those companies also own lots of coal-power plants, so even if they have advantages they’re not totally immune from the rise in price of coal relative to the regulation that is coming.

TER: You mentioned that one thing that interests you about Calpine is it runs on natural gas and you’re bearish on natural gas. We just saw a report that’s bullish on natural gas. It said the drill count is projected to go down to 700 drills, that they’re pulling nearly 50% of the drills out of the field. They’re expecting that to drive natural gas prices up. How do I, as an investor, reconcile your thoughts on natural gas to the declining drill count?

PS: Well, a couple of things…First of all, at Stansberry we’re big believers in studying the numbers and understanding the correlations. I mean no disrespect at all to any other publisher, but we have spent a large amount of money and have hired several PhDs to build databases for us and to run these studies so that we can really know what things mean.

For more than five years now, we’ve studied the correlation between rig count and prices extensively. It’s intuitive that you’d expect a fall in rig count eventually to lead to rising natural gas prices. I get that. But when you run all of the numbers and study all the correlations—even on 6-month, 12-month, 18-month delays—there isn’t any evidence of that whatsoever. In fact, all of our correlation studies say the exact opposite: that rig count tends to follow prices on a delay of about six to nine months.

That makes sense, because when prices go up, people rent more rigs and put them to work. When prices go down, they take rigs offline. So I don’t see a fall in rig count as anything other than an indication that natural gas prices are weak and likely to continue to weaken.

TER: How do you predict the bottom then? At some point production will go so low that the price of natural gas will have to go up.

PS: You see the bottom coming when you see peaks in storage. I don’t know that we’re there yet. There’s been a lot said and written about this, that storage is way up and rigs are coming offline and these are signs of a bottom. But one thing to remember about natural gas is the size of the discoveries that have been made in the last five or six years and the amount of new production that’s come on line.

Old hands in the industry will tell you that $3.50 is the shut-in price. Once you go below $3.50, people will stop producing because it costs them more to produce than the price. The big problem with that argument is that a lot of these wells are now coal-bed methane wells, and you can’t shut them in. They get connected to pipelines and they just run. They run because each well has a very small amount of production. It doesn’t do any good to turn all these wells off. It would cost more to turn them off than to keep them running.

TER: You have built-in supply almost.

PS: People who believe that natural gas has bottomed or will see a bottom soon don’t understand the size of the pipeline that’s been built, and the amount of production that will not be shut-in, no matter how low the price goes.

I think there has been a sea change in natural gas in the United States. The best figure I can give to help people understand all of this is that in 2008 we produced an all-time high amount of natural gas in the U.S. If you’re familiar with peak oil and the idea of a fundamental scarcity of carbon-based fuel sources, that shouldn’t have happened.

It’s hard to exaggerate not only how much natural gas has been found in the last 10 years but also how much of it has been brought on line. I just don’t think the price fully reflects that yet.

TER: We have the big push to go to “green,” non-carbon-based fuel alternatives. But with this abundance of natural gas, why would we expect any alternatives—solar, biofuels and so on—to take off?

PS: I agree completely. I’ve been shorting solar stocks regularly. For instance, First Solar Inc. (Nasdaq:FSLR) is a fantastic short for several reasons. The dead giveaway is that First Solar makes solar panels only because it gets huge government subsidies to do so. And it sells solar panels only because the people who buy them get huge government subsidies for doing so. Solar energy is not economically practical. First Solar’s technology, in particular, is much less efficient than the newer versions of solar technology, but First Solar is the largest of the solar stocks by far in terms of market cap. It’s worth $16 billion right now—which, in my opinion, is completely insane.

So if you want to talk about alternative energy, why would you make the investment in a large amount of solar panels when you can simply tap into natural gas at very, very low cost in most places in the U.S.?

TER: Given the way the government does subsidies, might there still be a place for solar or other non-economic alternatives?

PS: Sure. I guess it’s a matter of relative valuation. I certainly would rather own the largest fleet of unregulated natural gas power generator equipment in the U.S. for $4 billion than I would own the largest producer of solar panels for $16 billion. One of them doesn’t make any money and probably has no intrinsic value. One of them makes about $500 million a year in free cash flow and has assets worth about $20 billion.

TER: Do any other green sources of energy look appealing?

PS: According to a lot of people, wind is attractive; but I haven’t studied it enough to know—in part because there’s no large standalone wind operator I can analyze.

TER: What about geothermal?

PS: In addition to owning all the natural gas plants, I think Calpine also may be the largest geothermal operator in the U.S. I don’t know if it’s the absolute largest but that’s only because I’m not familiar enough with the industry. I do know that it’s a very large geothermal operator.

There are a lot of geothermal standalone stocks and I haven’t spent enough time analyzing the geothermal penny stocks, but I think you have to be very careful because, generally speaking, the capital requirements for such installations are always much bigger than they tell you the first time they raise money. I’d be uncomfortable with that unless I knew the money was in place.

TER: At some point, you said there’s always a sector that is moving in any environment. What sector should investors be looking at for the next six months or year?

PS: I’m afraid I don’t have an answer right now. One of the things we spend a lot of time studying is the extremes in valuation and sentiment. I spoke about the drilling stocks being at an incredible extreme two months ago. And there are times when you can buy entire sectors because they are so out of favor and so incredibly cheap or vice versa. You can short them with impunity because they are so incredibly popular and so wildly, outlandishly valued.

Right now, I just don’t see a lot of that. The market was really screwballed about two months ago and, unfortunately, since then it’s really come into more normal ranges. So I just don’t see any sector-wide, no-brainer trades right now.

TER: Any other insights you can give to our investors to wrap this up?

PS: The biggest thing I would tell people is that you’re only going to make money consistently as an investor if you’re willing to buy what nobody else wants and if you’re able to understand enough about valuations to know when it’s time to buy. Most individual investors have no emotional capability to be contrarian because they can’t handle buying what other people are selling. Unfortunately, most individual investors have no capability at all to analyze valuations. They just don’t understand what they’re buying when they buy a security.

So, those are the two things I tell everybody all the time: Number one, don’t buy if other people are buying it; and number two, make sure you understand what you’ve bought.