Continued from part I
Michael Tsangaris: During 2000, the internet boom, everyone was going into dot-coms except yourself. The internet stocks, a hot sector, so would you say you've had the contrarian stance?
Tim Guinness: No, no, it's not really true that I deliberately avoided dot-com stocks. I was as interested in them as the next man. I've always had an interest in technology stocks. It just so happens that I was very absorbed by the energy sector. I had sold my business to Investec, and they were going to close the energy fund. I'd stayed on as chairman, and I said, "don't close it, it's dreadful timing. The oil price is going to $10 but it won't stay there. It's just not fair on the investors to close the fund at the bottom." They said there's nobody to run it, the fund manager's left, no one else wants to run it, it's too small etc. So I said I'd run it. And that's what happened. That was in November 1998, so all my efforts were on getting a grip on this little energy fund, which prevented me pouring too much money into dot-com stocks in 1999 or 2000. But of course, one should have been investing in them, say, 1990 towards 1996. They would have been fine.
Anyway, this energy fund performed pretty well. Then in 2000 I thought everything got a bit expensive so we moved it very defensively. 2001 and 2002 were tricky, we lost about 8% one year, but this was with the backdrop of the market falling 25%, so it didn't seem too bad. Then in 2003 the oil price, which had recovered from $10 to $25, suddenly started to nudge up through $30 and then $40. I said we've got something very interesting going on here, this is the expansion in demand from China and other emerging economies. It caused the sector to come alive. From 2003 to 2008 we had a great run and we built the fund from $3 million to about $2 billion.
I had left the company by then and set up Guinness Asset Management to run the energy fund for Investec on an outsource basis. Then they said that they wanted to take it back in-house. I said "fine," and in 2008 I launched my own fund. It was a bit of a struggle because of the timing. We got going in April to August. In September we had the Lehman crisis so we had to hunker down but we've now got about $400 million in our Energy funds, and that's alright. $2 billion here we come!
Michael Tsangaris: All optimism, and it's not just on the oil prices coming back.
Tim Guinness: The oil price, by the way, thank God, has come back to a sensible level. Stocks are very cheap, and people should be filling their boots. The US natural gas price is right on its back, it's a huge opportunity. Do you know about the natural gas price?
Michael Tsangaris: It's at $2.74.
Tim Guinness: Something like that. It went down below $2 and I think it'll be $6 sometime in the next two years. We've got plenty of gassy stocks that have the potential to double when that happens. And why is gas going to recover? The U.S. gas industry is a boom and bust industry. They had a boom in 2003 to 2008. They've had a bust. There was no organization like OPEC to come and put a floor under the price. They were over drilling, producing too much gas. They've now savagely cut back the land gas rig count. It has come back in nine months from 935 rigs to 535 rigs. Demand is slowly catching up. Natural demand is growing OK, but by itself it wouldn't work off the large surplus currently held in storage. But there's been an amazing pickup in coal-to-gas switching. Gas has become so cheap that power stations are choosing to run on gas rather than coal.
While gas is in this $2-$3 range, it seems that the coal companies have concluded it's cheaper to burn gas than coal. When the surplus in storage has worked off, the price will then naturally rise and they'll stop switching. But the point is the market will then be back in balance. So it's a very good self-balancing, self-regulating mechanism we've got here. And what should the average price of gas be? It should be set by the marginal cost of extracting the marginal Mcf of gas. The problem is nobody knows what that is because it varies from field to field and so on and so forth. People just make stabs in the dark. We think it's something like $4.50 and we think that then these companies have to make a decent profit margin so they won't start ramping up their rig count enough to destabilize the market until the price goes above $5. But we might be wrong. If we're wrong, if actually the marginal cost of the marginal Mcf is $3.50, it just means that all my companies are going to be decently profitable at a lower gas price than I thought, so that's fine.
Michael Tsangaris: What are the overlooked opportunities in this sector? Such as drill bit manufacturers.
Tim Guinness: Possibly it's LNG and the growth of emerging economy gas consumption. If I look at the oil and gas world the big picture theme that's quite exciting is that world natural gas consumption is going to run for 20 years at 3% per annum, whereas oil growth will only be a third of that. Yes oil will go on growing for at least 20 years because of the motor car and growth in China, India, Indonesia and Brazil. And the Chinese motor fleet is forecast to treble or quadruple over the next 20 years, which is pretty mind blowing. But natural gas will keep on growing much faster than that because it's cleaner and cheaper and it is growing its electricity market share and it will increasingly be used for transport as well. And then we're interested in all sorts of aspects of high gas growth. For example China imports of gas via LNG are going through the roof. China's consumption of gas is going to quadruple over the next 8 years from 10bcf/day to 40 bcf/day and LNG imports may easily supply 20% of this. Then there are opportunities in Australia or East Africa where LNG trains are being built to supply this demand. And we are looking at all kinds of companies in the value train from LNG tanker and gasification vessel operators, to LNG liquefaction and gasification plant builders and engineering consultants as well as to gas focused exploration companies and service companies that focus on them. So that's LNG.
Then there's gas shale in North America - we're looking at companies in fracking, in the horizontal drilling business. Are they overbought or oversold? They go in and out of fashion; you've got to pick your moment. We're interested right now in getting our timing right for exposure to gas shale which may be coming as gas prices recover from very depressed levels. Then there's the next thing oil shale where great strides have been made in its development in the Bakken and Eagle Ford basins in the US. But all the oil shale companies look very expensive at the moment. I wouldn't touch them with a barge pole. But they'll come back. It was just like the oil sands. We bought the Canadian oil sands at just the right time in 2003. They got pumped up in 1999-2000 and came back quite nicely. Another area of interest is in subsea. We think that offshore drilling will continue to be an area of the oil industry that grows faster than onshore. And subsea makes sense because if you can to do things on the seabed you can save a lot of money. You haven't got to build great platforms and then service them. We've got a little company called Helix Energy Solutions Group Inc. (NYSE:HLX), and there are other companies like FMC Technologies Inc. (NYSE:FTI) and so on that you could look at that make subsea trees, pumps, risers, and other components, so that's an interesting sector. We're also interested in a new generation of oil companies focusing on emerging market oil and gas opportunities. Some of them have Western management. Some of them have local management. We own a company called Afren that's basically a Nigerian company, there aren't many Nigerian companies but it's done very well in West Africa after a slow start. We had another company called Dragon which is controlled by ADNOC in the Middle East and has quite an interesting business in Turkmenistan.
Michael Tsangaris: In terms of qualitative aspects of these companies such as management, do you find it harder to maybe trust or analyze?
Tim Guinness: You can say that again, correct.
Michael Tsangaris: But there are probably opportunities because of that.
Tim Guinness: Well you have to adopt a portfolio approach. Take smaller bets and have more of them.
Michael Tsangaris: Waste Management Inc. for example and Airgas Inc. are looking into LNG for their fleet, so do you think companies such as Westport Innovations Inc. (NASDAQ:WPRT) and Cummins Inc. (NYSE:CMI) which are making natural gas trucking engines or Clean Energy Fuels Corp. (NASDAQ:CLNE) are the winners in this sector?
Tim Guinness: It's definitely a good idea to watch them. I think that the uptake of the use of gas for trucking and buses and similar commercial vehicles could be quite significant. But one issue here is: are the engines that Cummins is making big enough as a proportion to their business?
Michael Tsangaris: Well I think I've taken up enough of your time for now. Thank you for talking to me.
Tim Guinness: I enjoyed it.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.