Sven Del Pozzo, until recently a senior oil and gas analyst with C.K. Cooper and Co., is nothing if not honest. In this candid interview with The Energy Report, Del Pozzo discusses the importance of Gulf of Mexico oil exploration to the U.S. economy, the need for more reflective oil price markers, how shale gas is keeping investors awake at night and oil and gas companies that could be ripe for the picking. The Energy Report interviewed Del Pozzo in late May, prior to his leaving C.K. Cooper.
The Energy Report: The massive oil slick from the Macondo well in the Gulf of Mexico could result in a ban on offshore oil exploration. What's your take on the fallout from the spill?
Sven Del Pozzo: There's obviously been irresponsibility on behalf of more than one party, mostly BP (NYSE:BP). BP is a British company. These are U.S. waters. Typically we left the waters open to foreign operators, but in this case you'd like to see the bad operators get out of town and the good operators stay. Norwegian companies have an excellent track record of not having injuries and not having spills because they rely on fishing a lot in Norway and they drill where fishermen fish. They make sure there aren't any oil spills. It can be done. I say get rid of the companies that can't do the job. They don't deserve to drill over here.
TER: Do you think there will be a ban?
SDP: I think it's very difficult for the U.S. to ban offshore, exploratory drilling. That's a kind of death for us, because the Gulf of Mexico is the only place where we had production growth enough to cause our production to rise about 2% in 2009. Basically, the Gulf of Mexico allows us to be less dependent on foreign imports. To ban offshore drilling in the best place the U.S. has for oil exploration is really going to hurt our balance of payments and make us more and more dependent on foreign oil. That's going to be a very sour pill to swallow, and it makes me think the economic necessities of the United States are going to prevail over the environmental ones. Rather than saying, "No, you can't drill here anymore," you need to regulate better and make sure the companies that come here are fulfilling certain guidelines for safety and health.
TER: Are you seeing any investment opportunities as a result of the spill?
SDP: ATP Oil and Gas Corp. (NASDAQ:ATPG). It has been really banged up, and I think a lot of it is related to this debacle. It has a big offshore deepwater development called Telemark. Essentially, the future of the company depends on the performance of this one field, at least in the near term. They're in the development phase, so that means they're not exploring. If there's a ban on offshore exploratory drilling, then ATP shouldn't be affected too much because they're already in development and they've never really been known to have exploratory success anyway. If it achieves its production targets, I think it is going to come out from this debacle a winner.
TER: Are there other companies in the Gulf that you like?
SDP: If the U.S. continues to invite foreign capital, but only from companies that have a good record of not having spills and not killing their workers, that all points to Statoil ASA (NYSE:STO), Norway's oil company. Statoil is at the forefront of technology and subsea developments. All of its production is offshore in Norway; that's pretty much the only thing that they do. If there is a shift to appreciating companies that do a good job in offshore, it would be Statoil.
TER: Crude stockpiles are at near capacity at Cushing, Okla., the delivery point for U.S. West Texas Intermediate (WTI) crude. As a result, WTI is trading at a significant discount to international crude. What's your view on the glut of oil in the U.S. and how is this likely to affect the oil price in the near and medium-term?
SDP: The way I think about storage might be a little different. I tend to think that oil is not just in storage in Cushing, but it's also in storage under the ground. We need to produce it and develop it in order to make it useable. I think there tends to be a little too much focus on stockpile data, which is simply data at a given point in time and it doesn't really tell you how active drilling is or how much new supply is coming onto the market. Also, Cushing is a little bit dated in its usefulness as a marker because there isn't much of a local market for the crude, but crude still goes there.
TER: Are you saying we need a new system to determine oil prices?
SDP: WTI is used as a marker for international oil price contracts. It's being used less and less because other countries recognize that WTI is less useful. It's not representative of what the true oil price should be. That being said, it's still used kind of as a legacy marker, so movements in WTI might end up affecting sale prices of oil in a completely different country. Brent oil prices are more relevant, despite the fact that there's not that much Brent oil out there. So we've got a lot of markers that are reference prices for oil, mainly WTI and Brent, which are really dying markets, because that's not where the future growth in oil supplies is going come from. As time goes on and as countries recognize that these markers are less useful, they're going to start and try to use different markers for oil prices because you're going to get these local supply and demand fluctuations that are not necessarily reflective of the true global oil supply.
TER: What would act as those new markers?
SDP: There should be more focus on the countries that have the most reserves and the most production growth. Those would include Angola, Brazil and Russia. It's difficult to hand over the reins to countries like that. Ideally, you want an oil price marker that is reflective of true conditions for supply and demand. What will probably happen is that there will be a mix of markers that will be put into some kind of fictitious "basket" of oil. They'll take various markers and combine the price movements for oil prices from these regions and come up with kind of synthetic global marker.
TER: What role do you think OPEC would take in determining the oil price in that basket?
SDP: Fundamentally, OPEC's role will get bigger and bigger. The only countries that can really fight back against OPEC in terms of producing more oil are Russia, and to a smaller extent Brazil, which has a lot of reserves but not as much production. And the fact that OPEC countries made a lot of investments in refineries to process heavy crudes and turn them into higher end products; those investments made in the last five or six years are going to help heavy oil prices stay higher in the future. OPEC has quite a lot of heavy oil it can bring on and off; the swing volumes that Saudi Arabia will bring on are typically heavier oil. Saudi Arabia has more power now, because all of a sudden their heavy oil is worth a lot more than it used to be, because technologies are out there that can process it.
TER: What is the impact of China in all of this?
SDP: Demand in the U.S. is pretty much flat, and that's 25% of the picture. Then the Chinese data is showing really big growth—like in the 20% to 30% range—but you don't quote it because it's not worth quoting. Everybody is wowed by the Chinese data, but China is not anywhere close to being the consumer of oil that the United States is. Give it five to 10 years, and it starts to become a lot more significant. You really need the Asian countries to pick up the slack. They're doing it to a certain extent, but probably not enough to offset the U.S. flatness to mild decline.
TER: What are your near-term projections for the oil price?
SDP: I moved to $80 recently, but it's been between $70 and $80. When I moved to $80, the oil price was already at something like the high $80s. My move was a little tentative in the sense that I had not seen earlier demand response, although demand in Asian countries was apparently pretty high in the first three months of the year—but you know the data is bad from over there. In the U.S., where we have some better data, demand has been pretty flat for gasoline and transportation fuels. You ask yourself, 'why is the oil price going up?' I think it was based on an influx of money into oil because it is a commodity and it was one of the commodities that hadn't really run up a lot since the beginning of the year. You had iron prices running up a lot. You had steel prices going up a lot, but oil hadn't really had this huge run in percentage terms like those other commodities. I think there was some money coming into oil simply because we need it to build things and, if the world is going to grow, then oil prices have to go up, so I'm ok with $75–$80.
TER: What's your timeframe on that price?
SDP: I'd probably give it another six months to a year, because the U.S. consumes 25% of the world's oil and until we really start to pick up, that's a huge portion of the picture that needs to start consuming more oil before you have good, solid, fundamental reasons for the oil prices to go into the $90 range.
TER: What do you see as the single biggest factor in that higher push that you're projecting?
SDP: U.S. employment—U.S. families making enough money so that they can go on vacation and drive around a lot this summer.
TER: With the uncertainty in the Gulf, do you see a shift to onshore exploration?
SDP: Every oil company would like to have a steady production base, and if you can't get that offshore, because projects might not start on time or might not get developed or you're going to get a start/stop production profile, then investors really don't like that. What they like is steady production, and that comes from onshore, where you can actually manage drilling programs and deploy rigs on schedule. Onshore gives you the power to create your own destiny. I mean, the Bakken Shale has been really the number one spot to be. A lot of the merit of the Bakken Shale has already been priced into Bakken stocks, but there's even more value being placed on the onshore because it's one of the only places where companies can go in the U.S. and really envision growing oil production.
TER: Can the big players really expand their growth profile in the Bakken Shale?
SDP: I think it's for smaller companies, small to mid-cap companies. It's going to be difficult for the big boys to generate the kind of growth they need from oil. The Bakken isn't big enough for them unless they go and buy companies. Bakken companies might get acquired by majors or by larger independent oil and gas companies. I'd say the most logical thing would be to talk about an M&A-driven type of premium being placed on Bakken oil companies that already have acreage that's leased up, because it's difficult to buy new acreage.
TER: Another onshore play is Canada's oil sands. What are some opportunities you're excited about there?
SDP: One I'm covering is Gulfport Energy Corporation (NASDAQ:GPOR). It has about 125,000 net acres of oil sands leases. That's a lot of oil sands acreage for a relatively small company like Gulfport. Not many people know it has this huge oil sands exposure. It's getting some value for the oil sands, but at $70 oil, the oil sands are still worth a lot of money; at $60 oil the oil sands become less interesting. I have a buy rating on it with an $18 target. It's trading around $13 right now.
TER: Tell us about some others.
SDP: There's a company called Cenovus Energy Inc. (NYSE:CVE). It has some of the best oil sands leases in Canada. With oil sands, you can get predictable production. If the Gulf turns out to be a slower area for North American oil production because of regulations, there's more oil to be developed in Canada, as long as oil sticks around $70 a barrel.
TER: On the natural gas side, there's a lot of debate about whether the long-term gas supply from shale plays will be as abundant as it was once thought to be. There's certainly an oversupply of natural gas right now. What does that mean for investment opportunities in the North American natural gas market?
SDP: There's not much demand growth in the North American natural gas market. You've got the petrochemical sector that uses natural gas and the petrochemical industry is firing on all cylinders. The Asian economy is doing well and they export petrochemicals to Asia. That creates an underpinning in demand, but I don't see much in terms of demand growth. That leads you to think about supply; it's more of a supply-driven problem. With the shale plays that have popped up, there's no reason why we shouldn't find more of them. It's a question of how much can you drill. I think service companies are probably charging too much to drill wells right now. Once service prices come down for things like fracking and completion services, then you might see it make more sense to develop these shale plays more aggressively. There are wells being drilled that probably shouldn't be drilled in this price environment.
TER: What about ways to play the market?
SDP: In terms of investment opportunities I like Comstock Resources Inc. (NYSE:CRK). It is buying up gas assets that are close to market in Louisiana's Haynesville Shale. For example, you know New York City is going to get cold and Buffalo, too. The whole Northeast will get cold, so investors are snapping up companies that have acreage that's close to the Northeast. You have growth in Marcellus gas, but why would you import gas all the way from the Rockies if you've got gas right next door in the Northeast? It doesn't make sense. If you figure that natural gas demand is not going to grow that much, you want to just have the supply that's close to the end user.
TER: Comstock is in Louisiana, but you're talking about trying to get plays in the Northeast. Why is Comstock your one investment opportunity then?
SDP: It's the one that I cover, and that I have a buy rating on. They've got really big wells. I also think the management is really good. They still have a sturdy balance sheet. Based on financial modeling, it's the production growth that is attractive. There are quite a few pipelines going from Louisiana to connect to the major Appalachian interconnects. I think it's kind of an opportunity. If you like natural gas in general because you think it's been oversold, why would you buy the companies that have already experienced the share price run up when you can find one that has been really banged up and is essentially a high quality company?
TER: What about playing the Euro market via something like FX Energy (NASDAQ:FXEN)? You have a buy rating on it.
SDP: Gas in Europe is different, because gas contracts in Europe are linked to refined product prices and if oil prices go up then at a lag you tend to get a response in natural gas prices through the increase in price reflected in refined product prices. So there's a tighter link between oil and gas prices in Europe. The reason FX has a buy rating on it isn't really price based. It's based on reserve growth, future reserve growth and exploratory track record of success.
TER: You said Harvest Natural Resources (NYSE:HNR) would get to $8, and it did. You're bullish on Gulfport but you also like Concho Resources Inc. (NYSE:CXO) and Pioneer Natural Resources Co. (NYSE:PXD). What do these companies have in common?
SDP: It's mainly exposure to oil. That's the only thing that these companies have in common. Each of them is quite different. I mean Harvest has all this exposure in Venezuela that the market doesn't care about. Then it has a couple of discoveries in Utah, which might be new oil plays for them. Concho is like 75% oil. They have a really good growth rate and really good returns on capital. Gulfport? It is almost 100% oil and it has all this oil sands acreage, although it's not proven. The oil sands acreage isn't a proven reserve because it hasn't been developed yet.
TER: You're projecting that maybe oil would get to $75, but in essence the global market is somewhat flat. Given that, why do these oil exposure companies like Harvest and Concho appeal to you now?
SDP: Harvest is actually below my target price now. It had a run and I made the correct call. Now you can kind of say that the target price is pending review. As for Concho, I started liking oil about two years ago. I still think that oil makes a lot of sense because it's a transportation fuel and its usefulness is more tangible than natural gas. The main investment thesis here is that you aren't discovering a lot of new oil shale plays. You're discovering a lot of new gas shale plays. You can go to sleep knowing there probably won't be many oil shale discoveries. Frankly, it's the gas shale plays that you have to be worried about, because they will discover another one tomorrow or the day after. If it's oil, you might find one or two more but it's not going to be something that can really change the dynamics of the market.
It's in the Gulf of Mexico where you can find oil supplies that will change supply and demand for the U.S. It has the power to change it. Yes, we're going to get more people coming to the U.S. to look for oil onshore, but you know there's not that many places you can go. You have to explore for it because it's not well established where you have to go to get your oil growth. The growth that you will get is going to be with smaller companies. You're not going to find something big that's going to make an individual big company stock price go up, because there's oil resource scarcity. Period. As an investor, you kind of have that on your side; it's a safer investment if you lean on oil. Now for gas, which has been really banged up, you might have a chance to make a bigger return, but in the near-term we don't know exactly where gas prices are going. There's more risk involved.
TER: That sounds like oil is a great longer term, multi-year play because we're expecting the supply to be harder to find, while U.S. demand will eventually go up. Wouldn't that make Harvest still sound like a reasonable multi-year investment?
SDP: Most of its value is in Venezuela. Nobody wants to pay for oil reserves in Venezuela, because you wake up tomorrow and Hugo Chavez could take all your reserves away. It's fraught with political risk. The only reason it went up to $8 is because it had two oil discoveries in Utah that they didn't have before. It is highly significant for the firm, but we're still in the early stages. Frankly, there is a lot that can go wrong; not for these oil discoveries in the U.S., but they have a lot of other exposure too. Venezuela. Indonesia—they're going to be drilling some big exploratory wells there. They could very well drill dry holes. The company is fraught with political and exploratory risk.
TER: What's Harvest's relationship like with the Chavez regime?
SDP: It's a little company operating in Venezuela. They've been there a long time. They just have to deal with the bumps in the road, as they've been able to in the past. They're still there and they haven't been kicked out. Perhaps there's some truth to them saying, "Listen, we're here to help you guys! We're here to develop your oil. If you kick us out, we won't have a company anymore." Is it really in the interest of the Venezuelan government to ruin the future of this tiny oil company that's developing just a couple of fields in their nation? Not really. You probably won't buy Harvest because it's got assets in Venezuela. The reason you buy Harvest is because it's got assets in Utah where they're onto something.
Sven Del Pozzo, until recently, was a senior analyst of the Research Group for C.K. Cooper & Company, a full-service investment bank. Del Pozzo graduated from Queen's University, Canada, in 1996, where he earned an Honors Bachelor degree in Economics. Del Pozzo worked at John S. Herold, Inc. for nine years as an equity analyst covering U.S. and international Exploration & Production as well as integrated oil companies including regulated and unregulated pipeline concerns and coal companies. Mr. Del Pozzo has been a CFA charter holder since 2003 and is a member of the New York Society of Security Analysts.
1) Brian Sylvester of The Energy Report conducted this interview. He personally and/or his family own the following shares of companies mentioned in this interview: None.
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3) Sven Del Pozzo: 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.