Porter Stansberry: Sea Change in U.S. Natural Gas Industry

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.

Comments

[blu:]

I can't help but wonder if Stansbury is referring to Barnett Shale production when speaking of "coal bed methane wells".

Coal bed methane wells produce a small percentage of this country's natural gas. The Barnett Shale play has been the hot play and many of the wells are minimal producers after the first two years.

It is probably an issue of nomenclature. Barnett Shale producers are famous for their rapid depletion rates.

Interesting interview, nevertheless.

May 08 12:31 PM

[frflyer:]

Subsidies are a lousy and misleading argument against renewable energy like solar. Coal gets $8 billion a year in subsidies, and I believe more with the recent bills since last fall. Oil and gas got $39 billion in 2006 and I would assume that to be about right for recent years. Oil has been subsidized since 1919 continuously. Nuclear has received subsidies for 50 years, or about $500 billion total.

The internet was subsidized with about $400 billion over the past 35 years or so.
The railroads were built with about 50% coming from subsidies.

May 08 12:51 PM

[john s. gordon:]

coalbed methane wells really exist (for mine-safety reasons) where bituminous coal is deep-mined, for example in northern west virginia.
before mining in a particular location can begin, wells are drilled to tap the methane trapped under pressure in the coal seam. gas comes out and is processed cryogenically using automated (unattended) equipment and stored as liquid in an insulated above-ground tank. once a week or so the men with the tank truck come around & collect the contents of the tank. truck goes to the central collection station, CH4 is allowed to vaporize & goes to processing for purification, eventually ends up in your kitchen range along with all the other CH4.
> jack

May 09 09:00 AM

[billp37:]

" a lousy and misleading argument against renewable energy like solar"

Fast Neutron may have a good argument against solar and wind for large scale electric generation?

fast neutron
Santa Fe, NM
January 12, 2009

From actual experience, wind farms produce 1.2 watts per square meter. Solar Thermal and Photovoltaic methods capture 5 to 6 watts per square meter. There is no economy of size in either technology. Dividing the watts you need by those values gives the land area in square meters needed to produce the juice. The numbers are astronomical

www.topix.net/forum/so...

The more we study solar, the more convinced we are becoming that there may be serious heat input problems.

Electricity can be used to produce heat.

1kWh = 3412.14163 BTU.

Heat, on the other hand, is used to produce electricity. HEAT RATE.

More heat must go in than comes out the laws of thermodynamics tell us.

If not, then one might have the thermodynamic equivalent of perpetual motion?

Again, energy and investing are not a areas of our expertise, or perhaps even ability, but are areas of interest.

Technical writing is area of our interest, expertise, and hopefully ability. And can be fun too for retired senior citizens

home.comcast.net/~bpayne37/pnmelectric...

who are more free to expresses their thoughts.

:-)

May 09 09:04 AM

[dan-d:]

Stansberrys' dissing of alt energy is humorous and his knowledge of subsidy utilization throughout the energy industry, bar none, is in serious deficit. The need for energy from what ever source is insatiable throughout the world. Coal, natural gas, oil, nuclear, wind, geothermal, and solar will all be utilized to meet this need. There is money to be made in investing in the right areas of all these sources of energy production. One important factor to remember is that fossils, and nuclear are expensive in lives to secure sources and pollution issues. Also they are nearing the end of their life cycles. Alt energy is just beginning and will experience serious major long term growth. I do agree with his assessment of First Solar as being tremendously over valued. Their only selling point is they are cheap. Unfortunately, they are also made with known carcinogens and are very inefficient relative to many of their more expensive silicon panel competitors. However, First Solar is so well capitalized that they will be able to survive into the future but not without serious competition and product revamping. He is right to short it at this time.

May 09 11:33 AM

[notsosmart:]

the nuclear plants here are nearing their life spans.nobody mentions this.also-what to do with the waste?

May 09 11:50 AM

[john s. gordon:]

high-level waste is to be kept in pools @ the generating site until the politicians figure out what to do with it. presumably when a plant is dismantled there will be certain highly radioactive metal parts which will also have to be stored (or buried with a sign saying don't dig here).
the citizens of nevada don't think yuck mountain is such a good idea.
reprocessing in u.s.a was halted by the carter administration because of missing nuclear material @ the kerr-mcgee plant & fear of terrorist diversion. sooner or later we will have to reconsider reprocessing, taking into account experience in other countries (japan, scotland, france).
> jack

May 09 12:08 PM

[frflyer:]

billp37
"There is no economy of size in either technology."

That is exactly opposite from what the NREL says about solar thermal (CSP).

""Trough and tower plants, with their large central turbine generators and balance of plant equipment, can take advantage of economies of scale for cost reduction, as cost per kW goes down with increased size."

That's because once the large central turbine generators and balance of plant equipment, like heat storage, is installed, the cost of adding more solar collectors is a dimininishing cost per generating capacity.

The heat that goes into a solar thermal plant is FREE. It comes from the sun. And storing that heat for later use, is far cheaper than storing electricity. At least 20 times cheaper! And the resulting power from CSP with heat storage is dispatchable power day and night. This is highly valued power.

And it's rediculous to assume that economies of scale of manufacturing won't help both solar and wind in general.


john gordon
"sooner or later we will have to reconsider reprocessing, taking into account experience in other countries (japan, scotland, france)."

France is not a convincing argument for nuclear energy.

"France's decision to reprocess reactor fuel has contaminated the seas as far as the Artic Circle and may have led to leukemia clusters near the reprocessing plant. Its decision to try breeder reactors was an expensive failure. Its plutonium fuel program has not reduced its surplus stockpile of plutonium which is calculated at greater than 80 metric tons sitting in tens of thousands of vulnerable containers and with no disposal option. France has no radioactive waste repository."

"In the summer of 2008, France experienced a cascade of accidents at its nuclear facilities. While leaks and spills, including uranium that contaminated groundwater, caused a ban on drinking and bathing and local vintners to change the labels on their bottles, Areva downplayed the gravity of the releases. But the black summer of radioactive leaks and spills shed doubt on the nuclear industry's - and in particular Areva's - ability to uphold fundamental safety standards according to an article in the International Herald Tribune."

"A new video - Everything you always wanted to know about nuclear power...but were afraid to ask - found on the Alliance for Nuclear Responsibility Web site, debunks various nuclear myths including the notion that France 'recycles' its radioactive waste. "
view here:
www.everythingnuclear....

The cost of dismantling an aged nuclear reactor could be as high as $500 million.

May 09 12:50 PM

[frflyer:]

In order to get heat from fossil fuels, first you have to prospect for them, then mine them, then refine them, then transport them, then store them, then burn them, then clean up the mess from them, then fight wars over them, then put up with their wild price fluctuations.

May 09 12:54 PM

[Tom in Midl...:]

Maybe because I listened back in March & invested in CPN, I have
a big thumbs up for Porters' parsing of the subject. I do have a much
better understanding of my investment, other than the carbon-tax footprint & what to do about it. The info about geothermal was very
interesting and just adds to the depth of the pick. Thanks "Stansbery
Research"!

May 09 04:45 PM

[Turnipseed:]

Much of the new "discoveries" of natural gas are in shales. These have been known for years but were uneconomic until improvements in horizontal drilling. Horizontal shale wells are short lived, with production falling as much as 50% in the first year, so to maintain production levels, new wells have to be brought in all the time. And since horizontal wells are much more expensive than conventional wells, they are probably uneconomic at todays low NG prices. Stansberry is correct when he asserts not many wells will be shut in - the major expense is upfront. But as drilling falls off in the shale basins, production will fall more rapidly than in other types of gas fields, and because more of our NG supply comes from shale basins than in the past, a balance between supply and demand might be achieved more quickly than Stansberry suggests.

By the way, I think Stansberry is confusing shale NG and coal bed NG. Not good for his credibility.

Before investing in CPN, investigate its bankruptcy and present debt obligations. A great company may not be a great investment.

May 09 08:42 PM

[john s. gordon:]

frflyer -

your discussion of the french experience is exactly the point i was trying to make. u.s.a can't consider reprocessing until after thoroughly evaluating all the mishaps others have experienced. remember the utility company in france is the govt, they can do anything they want, there is no professional intervenor class like we have here.
> jack

May 10 08:05 AM