CANROYs Remain Attractive as Oil-Related Investments

Jim Kingsdale wrote an article on Seeking Alpha yesterday entitled "A Case For Retreating From Oil Investments." I wrote the following piece in the Comments section, but have decided to submit it as a complete article as well. I have been bullish on oil and gas for more than a year, beginning well before oil crossed $100, and I remain so today. Although I have been bullish on oil, I never called for oil to hit $150 this year, or, perish the thought, $200.

In an article I published here in early 2008, I said I expected oil to cross $100, cross $110 and test $120, but then spend most of this year between $100 and $120. That remains my prediction. In my predictions, I did miss the irrational rise to almost $150, and perhaps I will be wrong again and oil will go below $100 and stay there for a while.

But I doubt it.

As Mr. Kingsdale has correctly stated, all the bearish factors he discussed in his article could have been perceived 45 days ago. Indeed, they could have been perceived 145 days ago. So that is not the reason for Mr. Kingsdale's change of heart about the suitability of oil as an investment. Instead, his change of heart is due to his "listening to the market."

But, at most, the market today is telling us that oil was overpriced at $147. It is not telling us that oil is overpriced at $115. Yes, I know that some of the technicians in the crowd believe that oil's recent swoon indicates it's going to $60. But those technicians didn't tell us it was going to go to $147 less than two months ago, so we can all admit that technical analysis of where oil is going to be next week or next month is almost useless.

What does help is a supply-demand analysis, which the author has done, but I think he has missed some very key factors, which I discuss below. First, and perhaps of greatest importance, Mr. Kingsdale dismisses the thought that Saudi Arabia [SA] will reduce oil production because it is "committed" to producing more. I'm not sure what "committed" means, but I know that one phone call from the King could reduce Saudi oil production by 1 million barrels per day [mpd]. I wouldn't be surprised to learn at some future time that some of the 500,000 bpd in increased production that SA ramped up in May and July of this year has already been reversed, and if oil breaches $100 (which it might well do in the next month or two), expect OPEC (not just SA) to announce a reduction of up to 1 mbd at their next meeting.

The King and the Saudi oil minister have said on several occasions that Saudi oil should be saved for future generations. $80 oil would provide a powerful incentive to do exactly that--especially since SA knows that if they wait just 2-3 years, the world oil situation will be much tighter and they will be able to get much more for their oil.

The other factor not taken into account by the author is that a significant portion of marginal oil production today is simply not economical at $70 to $80. Will the Brazilian Tupi and Carioca fields be produced if PBR believes all it can get for that oil is $80? I highly doubt it.

Will the Arctic be drilled (assuming it's allowed) for $80 oil? Again, I doubt it. I realize these are longer-term projects that won't produce in the next 2-3 years, but even today, there are a lot of marginal fields being pumped for $120 oil that will be shut down if only $80 can be gotten for that oil. Many enhanced oil recovery and tertiary techniques, and even oil sands production, are not very profitable at an $80 price point.

Finally, it has often been said that "the cure for high prices is high prices," but the same works in reverse--"the cure for low prices is low prices." If oil goes back to $80, and gas back to $2.50, demand reduction will be muted, if not entirely reversed. This, combined with lower production, will act as a self-correction mechanism to low oil prices.

In summary, I believe that oil will continue to trade between $100 and $120 this year, and that certain oil-related investments are worth holding. Of course, if Israel attacks Iran or the Middle East destabilizes in some other way, oil could well test $150 this year.

In the past year, I have played oil very simply--by buying and holding shares of three Canadian royalty trusts--HTE last year, and PWE and PVX this year. Despite the gyrations in the oil market--and even in the value of these stocks, I am about at break-even with them. But in the past year--which has not been kind to the markets--I have collected about 15% in dividends. Thus, my total return of 15% is not bad given what has happened in the markets in the last 12 months.

And these generous dividends will continue to be paid unless oil goes under $80 and gas under about $7.50, the likelihood of which I believe is very low (well under 10%). Of course, if these stocks drop another 10% (which they might if oil goes to $100), I will buy additional shares which will then yield nearly 17%.

To me, these stocks offer a wonderful dividend, which also protects against any major drops in the stock price, while offering substantial upside over the next few years.

Disclosure: I hold a large long position in both PVX and PWE.

Comments

[NOWHEREMAN:]

Wait for markets to open before walking that tightrope.
My guess would be that Leh goes the Good stock/bad stock route. Shoving its garbage into a Junk holding stock. But to do so they will have to add some value to it. My guess is further asset sales, like the
hedge group under its control.

You have to remember that they have the ability to tap the Treasury, if they are unable to do so, then they must really be in deep doo doo.

And, what happens to you, if you buy pre announcement and they declare Bankruptcy? I would hazard that Lehman is not in the category of "too big to fail". Sure would send a shiver through the rest of the Financial Sector though.

I am giving you worst case scenerios, this is a Bear Market. Anyone buying anything other than niche, new tech better be prepared to hold for the long haul.

Economies may decouple, stock markets walk in lockstep. Look for companies that have formed a base and have heavy insider buying or stock option grants which they retain.

There is one former High Flyer which has attracted my attention recently, Bove's LTS. Check it out.

2008 Sep 10 12:50 AM

[svosavvy:]

Yeah, I tend to agree with the high potential for the good stock /bad stock route in leh. High in the am and trash by lunchtime. I found the the bear stearns incident highly interesting, takeunders imho are as bad as a failure just with a pretty face put on it. Like makeup on a corpse.

2008 Sep 10 09:07 AM

[svosavvy:]

whoop, get ready I just read the opec quota cut headline. Now last night I could have sworn I heard they were leaving it alone.
Probably to my disadvantage I'm staying away from the bovespa. This whole oil deal scares me a little. The tone of Lula saying "it's our oil" coupled with Iran extending the opec olive branch. Oil is too big a part of the goings on down there for me.

2008 Sep 10 09:23 AM

[svosavvy:]

seems opec is defending the $100 mark. What do you think, is this short term crap or is it an actionable bottom? I am personally wondering if this is the news that ramps energy stocks back up. IMO the freefall as of late probably has some insanity in it of where oh where is the bottom. If this is the bottom for a barrel of oil, I think we find some serious support. My trigger finger is getting itchy for pvx.

2008 Sep 10 10:02 AM

[NOWHEREMAN:]

first, there's a Global unwinding of everything. Since Almost all commodities are traded in Dollars, the demand for it to facilitate this attempt to reliquify is pushing it upward.

Add to the mix, news items in the past 14 days:
NATO is planning the mobilization of troops into the Baltic states. Venez & Russia hold War games in the Caribbean. Iran is testing its missile defense systems. US Warships off the coast of Georgia, ostensibly to deliver Med. Aid. Russian Troops dig in on the Georgian border.

And the Russian/Iranian Nuc. Reactor is scheduled to be activated as early as December. Russian News release which, IMHO, is probably false.

If, and I would use a Big IF, there is an attack, Oil prices would skyrocket. The close to home supplies from Canada and Mexico would receive a Major Boost, It would be like a Tsunami hitting the Gulf of Mexico. But until this happens, the story will continue to be about a Global Recession and both Oil and Alternatives will continue South unless Ike does some serious damage. Don't watch WTI, go with Brent instead which hit $99.

I am watching with particular interest Teekay and a spin off. The Spin off is a pure play on Oil tankers. I believe the symbol is TNK. So while the CanRoys are major beneficiaries of my worst case Scenario, I believe in diversification. Oil may have to travel via Tanker more so than ever before and the yield as the price drops is getting too delicious to ignore.

Svo, if this converation continues, how about moving it to a more current Alpha article?

2008 Sep 11 02:21 AM

[svosavvy:]

OK, pick a relevant article and post back to let me know. btw do you think the opec statement of defending $100 has any teeth. I believe if I read it right I saw a snippet of entities don't want to sell period for less than $100. Thats bold if I read it right. I agree the brent number is more accurate worldwide, I like the wti number just because its whats on the hearts and minds of media and people, I like the sentiment and psychology of the american exchanges. Almost like someone with bipolar disorder. I am dipping my feet in coal soon.

2008 Sep 11 12:13 PM

[svosavvy:]

Hi paul,

I had no idea about the nato troop buildup, no idea at all. I do know that the good ole us of a would profit greatly from a huge unwinding of ruskie markets and what do you know it has happened this week. Let me know where you want to post in the future. I am in arch coal at $38 let me know your opinion (as I seem to respect it). I am tempted to sell into the hurricane news as I am in the money. Then wait for a future entry point lower, like when it shoots out it's 52 week low. Is this viable?

Thanks,

2008 Sep 12 01:15 AM

[NOWHEREMAN:]

The new article on CanRoy payouts attracted my interest because it presumed dividend cuts. Unfortunately, I was the first to comment.

So I limited my comment to the overtly obvious.

I will look at ACI, I follow JRCC more closely and a thinly traded spinoff from IVN, Mongolian Coal mine, Pink Sheets, Railway already in place directly into China, fully permited and in production. Will not provide symbol. Am not in yet, you'll have to do your own research. TNK pure oil tanker play, SNEN building CNG gas stations in a city of 9 million with stats, if they are to be believed, will double its share price wihin 18 months.

2008 Sep 12 04:52 AM

[ikeone:]

After reading the article and subsequent posts here, I see a lot of investment approaches which could be characterized as "HOPE". However, the cycle favoring commodities has largely ended, and it will likely be 4 or 5 years before these investments show sustainable rises again like they did in the past couple years. About all we can "HOPE" for is bad weather and monthly payouts that don't shrink like the stock prices.

2008 Sep 12 03:16 PM

[NOWHEREMAN:]

Ikeone, Oil is still up 30% annually. Ours is not a manufacturing economy so our output of commodities is largely limited to coal and lumber. And in the Agricultural area, at this point, Ike may impact the midwest again.

As far as Global commodity use is concerned, growth outside of the Developed West will continue upwards for no other reason than because of promises made to their people and fear of internal unrest unless those promises are kept.

So instead of reading what our Media considers Financial news, read the Singapore Times or Financial Times or even the News out of the Middle East, I don't remember the site offhand.

In spite of inflationary concerns, the Asian economies are still expected to grow their GDP on an average of 8%. Demand Destruction and Recessions in the Developed world will allow this to occur at a much lower rate of inflation than would have happened otherwise.

If my worst case scenario occurs, then it won't really matter what happens here.

2008 Sep 12 04:47 PM

[svosavvy:]

Paul, for the life of me I cannot find this new post.
Ikeone, Hope is for people who think we are not exceptionally dependant on current energy forms (I am totally for viable alt energy BTW).I think that demand destruction is (mostly) baloney anyway, or better yet early to the party, when a new and mass distribution viable energy source is ready then we'll talk demand destruction. It's just like when a company enters a space and starts stealing kool aid from the company who has the monopoly. Consumption rises inversely with prices. Unfortunately the truck or ship delivering cng or wind turbine parts or solar panels will probably run on diesel. A crap equity market is a real drag on the alt guys (who have no cash) it gives a head start to the incumbents.

2008 Sep 12 11:00 PM

[svosavvy:]

except boone, boone's got cash

2008 Sep 12 11:06 PM

[svosavvy:]

found it never mind
thanks

2008 Sep 12 11:33 PM

[ikeone:]

Most people spend most of their time following and commenting on absolutely useless factors. People will talk about how smart or experienced management is. People will talk about how great profits have been. People will talk about how “solid’ the balance sheet looks; or how many people live in Asia. These factors are all absolutely irrelevant to what is happening to our investment capital today or next week or next year. All that matters in real life is where we are at with in the cycle of prevailing market sentiment.

The market sentiment now is increasingly negative. And so it should be. We have been through a lengthy period of utter idiocy. People of all walks and areas have been ignorant and wilfully blind to the dangers that were mounting. Now they are suffering for their poor decisions. It is not easy or fun to watch but it is inevitable and cathartic and ultimately necessary to clean out the BS and set up for the next real demand driven expansion.

2008 Sep 16 12:35 PM

[svosavvy:]

I couldn't agree more with your statement about prevailing market sentiment. Prevailing sentiment from what I understand tells us that oil is going to $80. That is fine, but, then what. Honestly from a valuation point I have found energy equities to be cheaper at $95/barrel than they were last year at $67/barrel, how is that for (irrational) sentiment. So what is happening to our investment capital iyo? Are you alluding to "the greatest transfer of wealth in history" possibly they forgot about the final days of the eastern roman empire in constantinople when they bribed the barbarians not to invade which worked fine until they ran out of money and the rest is history. So, whats the next demand driven expansion? I would say people's decisions (are we talking subprime or energy) are less poor and more ill timed. I place a great deal of weight on solid numbers from a company, that puts in the foundation of the house. I do, however, also place a lot of weight on "sentiment" (irrationality). It is imho the psychological component that allows us an opening to exploit when it is not "perfectly priced". After all the perfect price is the price someone will buy something for.
cheers

2008 Sep 17 01:07 AM

[svosavvy:]

Ok, I totally read you wrong on "our" investment capital, you are speaking of yours or mine. In that I think we are saying the same thing. We both place high value in the idea that something is worth only what someone will give regardless of fundamentals. I realize this having bought pwe at $27.50 last week sometime I still like (not love) my buy. I guess I still stand by it. Where this puts my investment capital is in my conscious decision a while back to take up a position in energy with the proceeds from selling my utility stocks, selling into defensive strength. I still have 2 more buys to make to complete my position, I look at it like going to bat in baseball I have a better chance of hitting a nice ball if I have 3 strikes instead of being all in all at once. I realize maybe I leave grand gains behind by not being all in,but, that is infinitely easier than chewing a bottle of tums when I'm totally wrong. Dollar cost averaging as you will. I decided my best way to hedge uncertainty in the highly emotional energy market is through high yielding dividend trusts that trade with oil. Not to oversimplify, but, at the current distribution basically if you give these guys a dollar they will give you back a penny a month, that is ok in my long term capital picture. I always try to weight the manipulative function in all the media I take in. To oversimplify again, imho all things being equal oil supply lessens with time and major pullbacks on my radar are creampuff pitches.

2008 Sep 17 01:41 AM

[svosavvy:]

took my second swing today and added pvx to the basket at 8.93 on the ex dividend day no less.

2008 Sep 18 09:42 PM

[NOWHEREMAN:]

James Kingsdale's Energy Investment Strategies is my normal Haunt. I've decided to expand my horizon somewhat and instead of sticking only to CanRoys, I believe a pure play in the Double Hulled Tanker area will suffice. TNK, NYSE, Teekay Tankers, current yield is around 20%. I figure I'll be willing to hold on even if the yield is cut in half. Based in the Marshall Islands.

More and more deep Sea platforms, 100s of miles offshore, Pipelines? I don't think so. Single Hulled are outlawed after 2009. Most are under contract for years.

2 tidbits, Middle East news, Zawya.com, Breakeven for Iran is $90, Iraq $110.

2008 Sep 24 03:11 PM

[mn33:]

haven't heard much from jack lately. when he's up 15% on something he's all ready to spout about it. now that pvx and pwe have fallen 50% since he wrote this article 10 weeks ago he's run away and hid. hey jack - how many more shares did you buy and how are you doing on these canroys now?

"But those technicians didn't tell us it was going to go to $147 less than two months ago, so we can all admit that JACK YETIV'S analysis of where oil is going to be next week or next month is almost useless

2008 Oct 31 12:47 AM

[blackjacky2k:]

wasn't there an article about a $50 price target by the end of this year from jack also??


On Oct 31 12:47 AM ptr44 wrote:

> haven't heard much from jack lately. when he's up 15% on something
> he's all ready to spout about it. now that pvx and pwe have fallen
> 50% since he wrote this article 10 weeks ago he's run away and hid.
> hey jack - how many more shares did you buy and how are you doing
> on these canroys now?
>
> "But those technicians didn't tell us it was going to go to $147
> less than two months ago, so we can all admit that JACK YETIV'S analysis
> of where oil is going to be next week or next month is almost useless

2008 Nov 03 01:08 AM