The Energy Report's  Instablog

Source: Peter Byrne of The Energy Report (6/6/13)

http://www.theenergyreport.com/pub/na/15342

Ramping up domestic North American liquid natural gas production for export to pricier international markets could be a game changer for struggling junior explorers. In this interview with The Energy Report, C. K. Cooper & Company's Jeff Grampp tells us why drilling in domestic gas fields for export is a good idea. . .if the Feds play along. And he identifies promising juniors with leaseholds in particularly desirable fields.

The Energy Report: Jeff, if the Obama administration continues to authorize liquid natural gas (LNG) exports, will that benefit the juniors as well as the big producers?

Jeff Grampp: I believe all U.S. natural gas producers will generally benefit from an increase in LNG exports. Historically, the pricing dynamics of natural gas in the U.S. have been linked to local supply-demand dynamics. With an increase in the potential to export, domestic natural gas producers would be able to access higher priced markets internationally, particularly in Europe and Asia. There will also be local economic benefits tied to the creation of jobs at newly constructed exporting facilities.

Of course, an increase in natural gas prices potentially could burden U.S. consumers. Politicians will have to gauge public opinion as new export facilities open and if natural gas prices increase. I believe the situation will not necessarily be governed by Economics 101, where the U.S. would maximize exporting to realize higher international prices, because powerful political factors will be in play.

TER: How does the domestic supply situation affect consumer prices?

JG: We have seen a recent correction from when prices bottomed at the sub-$2 per thousand cubic feet (Mcf) level. The natural gas rig count has gone down tremendously over the last couple of years. But, at the same time, there remains pent-up potential gas supply that's not being tapped, due to the more attractive economics of the oil- and liquids-rich plays. As natural gas prices creep up and export facilities enter the equation, producers may increase activities in natural gas plays. We could also see a yo-yo effect as prices go up, and supply may build up incrementally. But if supply ramps up too much, of course, then prices could fall.

TER: Will exporting gas from North America reduce the supply available for domestic consumption?

JG: If producers can sell natural gas at much higher prices internationally, then it would obviously make sense to access those markets. Supply could be diverted from domestic consumption for export, possibly leading to more uniform global natural gas prices, which would be more similar to oil. As it currently stands, oil is the more transportable commodity, so oil prices tend to trade more in sync around the world, whereas natural gas supply-demand dynamics have historically been a function of regional supply-demand factors. But with more global exports potentially in play, we could see natural gas prices trade more in line internationally in the near future. Therefore, we could see natural gas prices fall in regions where they are higher, and in lower-priced regions, such as the U.S., prices could rise.

TER: What are the obstacles for opening up the North American market to export?

JG: I believe the federal government will be reluctant to allow substantial exports of natural gas early on, given our dependence on fossil fuels to run the economy. The federal government will likely be hesitant to ramp up LNG export facilities, even though international demand may warrant more facilities. The Feds are taking a measured approach in their approval of export facilities, as they are watching to see how early facilities play out before accelerating the permitting process. There are also environmental concerns to consider, in terms of where these operations can be built, especially in Alaska. But there is also political pressure to open up the market for exporting.

TER: If we do start exporting more natural gas from the U.S., what kind of competition would we face globally?

JG: Australia exports LNG. Some U.S. producers are also looking at exporting LNG from their international assets. A vast amount of natural gas potential globally is not being fully realized, partly due to regional supply-demand dynamics. Traditionally, if natural gas demand is low in a local economy, it has not made sense to develop the resource because exporting potential was limited. But if producers can access international markets, where prices are higher and supply is limited, it definitely makes sense to develop the assets.

TER: Is there demand for U.S.-derived LNG in the Latin American and Central American markets?

JG: The demand in those developing economies is not as robust as in Europe and Asia, as they tend to rely more on diesel fuels and oil than upon natural gas.

TER: How do you assess President Obama's recent statement that energy is booming in America?

JG: It truly is booming, due to the technological revolution in horizontal drilling and increased exploitation of oil and gas deposits that were previously considered to be uneconomic. As technology continues to evolve, and with more efficient fracture stimulation and completion methodologies, many previously marginal plays will begin to bear fruit.

TER: With junior energy stocks at all-time lows, what should investors look for when assessing a mid- or micro-cap company in exploration and production (E&P)?

JG: We've actually seen a number of quality junior players appreciate nicely recently. At C. K. Cooper & Company, we look for strong management teams with proven track records. We also try to identify companies with growing production bases and a strong level of current running room for exploiting potential drilling locations. Accessing capital markets to acquire drilling locations and production can work, but there can also be a lot of uncertainty in terms of available capital and obtaining the right asset to integrate into a company, so we like to find companies with solid assets in place, rather than those that will rely primarily on potential future acquisitions.

TER: Is the problem of finding capital improving for the juniors?

JG: Given today's very favorable interest rate environment for issuers, the debt market can often be an attractive source of capital, if junior E&P firms are prudent. Investors should watch out for firms that have overleveraged through accessing the debt side too much. The equity side remains difficult. There is only so much capital available, and equity investors are being judicious in allocating capital to only the companies with the highest returning prospects.

TER: Is this a good time to buy in the mid-cap E&P sector?

JG: There are good buying opportunities. We just initiated on Midstates Petroleum Company, Inc. (MPO:NYSE) with a Buy rating and an $11 price target. The company had an initial public offering (IPO) in April 2012 with some conventional Gulf Coast assets, and it made two producing property acquisitions this past year in the Mississippi Lime and Anadarko Basin. These two assets give Midstates significant running room in two midcontinent plays with lower-risk, liquids-rich horizontal drilling opportunities. On the Gulf Coast assets, Midstates is testing horizontal wells in conventional reservoirs with some pretty encouraging early results. The firm has a very strong management team, and we see a lot of upside with the name.

TER: What names are attractive to you in the natural gas space?

JG: On the gas side, we like FX Energy Inc. (FXEN:NASDAQ), which has assets in Poland. It has several large exploratory blocks and recently announced a very solid production test on an exploration well in a 100%-owned block outside of its Fences concession. The Fences concession has been one of FX Energy's more successful blocks and news of the company's drilling success outside of the Fences concession is particularly positive. FX Energy plans to drill more wells near this most recent find after it acquires three-dimensional seismic data and there is good potential in 2013 for FX Energy to capitalize on its recent success.

TER: How do international pricing dynamics affect FX Energy's position in the Polish market?

JG: Most of Poland's natural gas is supplied by Russia, with natural gas prices in Poland being quite high given its lack of domestic production. FX Energy's strategy has been to take advantage of the localized natural gas pricing dynamic. In the long term, it would not be out of the question for Polish imports of LNG to impact natural gas prices in Poland, but it seems unlikely to have a major impact over the next couple of years. For the time being, these guys are producing natural gas in the right place given that they receive nearly $7 per Mcf.

TER: Moving back to North America, are there any other companies that canny investors should buy?

JG: We really like the Wattenberg Field names at C. K. Cooper & Company. We cover Bonanza Creek Energy Inc. (BCEI:NYSE), PDC Energy Inc. (PDCE:NASDAQ) and Synergy Resources Corp. (SYRG:NYSE.MKT), which all operate in the Wattenberg Field. We like finding smaller players in areas with a lot of offset operator activity, particularly by the larger independents and majors. The two largest players in the Wattenberg Field are Noble Energy Inc. (NBL:NYSE) and Anadarko Petroleum Corp. (APC:NYSE). Both of these companies are spending billions of dollars testing aggressive down-spacing and upside potential in a variety of targets in the field. That activity allows the smaller firms to sit back and watch, and then play catch-up in the patterns that work. Noble and Anadarko are testing different "benches" in the Niobrara and the underlying Codell formation. Their de-risking of the potential of the targets then trickles down to the Bonanzas, PDCs, and Synergys. These smaller companies are starting to do their own testing of aggressive horizontal targets, because the big guys have shown that it works.

TER: How big is the Wattenberg Field?

JG: It is a relatively smaller field within the DJ Basin in northeastern Colorado. It's a liquids-rich play with well costs typically running between $4-5 million ($4-5M). Noble is also drilling long lateral wells to enhance recoveries, and is seeing encouraging results. Companies are targeting different benches within the Niobrara Formation, which are generally referred to as the A bench, the B bench and the C bench. The Codell Formation underlies the Niobrara and is also prospective for horizontal development, potentially yielding four different horizontal targets. And the firms are testing down-spacing, with as tight as 40-acre spacing for a horizontal well. Ultimately, there could be between 8 and 16 horizontal wells per target in a section, which could translate to significant value for these companies' leaseholds.

TER: How do you assess the potential for mergers and acquisitions (M&A) in the Wattenberg, given the lack of equity capital available at the moment?

JG: M&A definitely comes into play in the Wattenberg. Given that the Wattenberg is a relatively small field, with very few players holding significant acreage positions, it stands to reason that Noble or Anadarko could look at expanding their positions through M&A deals. Conversely, a large company not yet in the Wattenberg Field would likely need to go through one of the smaller companies with leaseholds to establish a sizeable position. Many E&Ps have also tried to find similar success outside of the Wattenberg Field in the greater DJ Basin, but results have been mixed. We really like the Wattenberg Field because it offers good upside potential that is lower risk.

TER: Do companies like Noble and Anadarko have capital available for M&A?

JG: Their ability to raise capital would likely be a little easier than smaller independents, given their size, reputation and longevity as public companies. They are not small companies with unproven management teams trying to raise equity to explore vast acreage positions. The capital markets generally like having the comfort of knowing their capital is being allocated to something that could generate a solid return and is also lower risk. For the larger players, convincing the market that expanding leaseholds in the Wattenberg Field is a good play should be a no-brainer.

TER: How do you set your buy and sell target prices?

JG: Our price targets are generally based on net asset value. We evaluate the company's current proved reserves and back out any debt and senior securities to get a proved value for the common equity. We then value the upside potential on the company's acreage by calculating how many wells it could potentially drill, and estimating how much a given well is worth on a net present value (NPV) basis. We then assume that these wells get developed over a number of years to arrive at an NPV of the company's entire leasehold position. We believe this generates a value that is comparable to what a fair value price would be for the company in an M&A deal, which is often how value is realized for micro-, small-, or mid-cap names.

TER: Do you have any final investing advice for people looking to get into or stay in the junior energy space?

JG: It's important to identify a strong management team that can execute a development plan. Look for companies with strong assets and good offset operator activity that will allow them to risk share or jointly determine the best and most efficient way to develop the assets.

TER: Thank you very much, Jeff.

JG: You are welcome, Peter.

Jeff Grampp is a senior analyst in the research group at C. K. Cooper & Company, a full-service investment bank. Grampp joined C. K. Cooper & Company in 2011 and has been instrumental in publishing research and assisting in covering E&P companies across the firm's entire oil and gas universe. Grampp is primarily responsible for covering the E&P sector at C. K. Cooper, with a focus on mid- to micro-cap names. He is currently a CFA Level III candidate and is a licensed FINRA broker: Series 7, 63, 86 and 87. He received his master's degree in business administration from Chapman University, where he also received a bachelor's degree in business administration and accounting with emphases in finance and marketing.

DISCLOSURE:
1) Peter Byrne conducted this interview for The Energy Report and provides services to The Energy Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: none.
2) The following companies mentioned in the interview are sponsors of The Energy Report: FX Energy Inc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Jeff Grampp: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Bonanza Creek Energy Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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Source: Tom Armistead of The Energy Report (6/4/13)

http://www.theenergyreport.com/pub/na/15334

Stepping away from the pack, Andrew Coleman of Raymond James Equity Research is making a contrarian forecast for an oil glut in 2014. Shale oil production is on the ascent, with the United States joining Saudi Arabia on the supply side, while China's hunger for oil may be sliding and demand in developed countries remains in decline. In this interview with The Energy Report, Coleman explains his thinking and names the producers best positioned to capitalize on the turbulence ahead.

The Energy Report: Why are you expecting an oil glut in 2014?

Andrew Coleman: Because of the evolution of North American shale oil plays, we are on track to add about 3 million barrels (3 MMbbl) of new supply over the next five years. Yet we know oil demand has been falling across the developed nations and is still weak coming out of the global financial crisis. Those developments point toward a glut.

TER: Saudi Arabia surprised you last year by cutting production when oil was more than $110 per barrel ($110/bbl). Why would Saudi or other suppliers not do that again?

AC: What hurt production outside the U.S. last year-and helped keep the demand side a little more in balance-was that Saudi cut 800,000 barrels a day (800 Mbbl/d) in Q4/12, sanctions in Iran reduced exports by about 800 Mbbl/d as well, conflict in Sudan took 300 Mbbl/d offline and the North Sea average was lower by about 130 Mbbl/d. These reductions kept last year's supply more balanced than we thought it would be. Going forward, Saudi's ability or willingness to cut is certainly going to be tested, because by our model the country may need to cut 1.5 million barrels a day (1.5 MMbbl/d), about double what it cut last year. It would have to do that for a longer period of time, given the amount of excess storage that could show up on the global markets.

TER: But, as you just pointed out, Saudi Arabia's cut came in the context of actions by other players. The other players are going to be as unpredictable as they were last year, aren't they?

AC: Certainly. That's a big risk to our call. The other players are very unpredictable as well. I think Saudi has two years of foreign currency reserves at its current spending level. The country doesn't have a deficit right now, so the question is, would it be willing to tolerate a deficit? Most other countries have deficits, but that doesn't mean Saudi will. It is hard to predict because we're dealing with personalities and governments, as opposed to hard numbers. We're going to keep watching, and we'll adjust our forecast if some of those scenarios play out.

TER: Was Saudi Arabia's production cut driven by a policy change?

AC: Saudi Arabia cited internal demand issues in its production cut. The cut may also reflect an adjustment to offset the start-up of Manifa, which occurred last month.

TER: If the glut does occur, which benchmark crudes will be most affected, whether by going up or going down?

AC: In the U.S., production of light oil will dramatically increase due to the shales. Without the ability to export, we are already seeing prices of West Texas Intermediate (WTI) reflecting that "stranded" lighter barrel. We see light imports being backed out of the U.S. as early as this summer as well. Finally, as infrastructure bottlenecks are removed onshore, we see risk to Gulf Coast prices (e.g., Light Louisiana Sweet). With much of the U.S. refinery infrastructure having been geared to process heavier barrels, the large growth in light barrels has already driven WTI prices to a discount with Brent. Risks to Brent could come down the road if European and Chinese demand remains tepid.

TER: Will Venezuela's production decline continue?

AC: With Nicolas Maduro running things down there now, we see Venezuelan production remaining flat for the next couple of years. Volumes declined each of the past four years.

TER: What role will other players in the oil space have in either creating or preventing the glut?

AC: Prior to about 2009, we were in a world where there was one marginal producer of oil (Saudi), and one marginal buyer of oil (China). Now we're in a world that has two marginal suppliers of oil, those being the U.S. and Saudi. We have not added any new marginal buyers of oil. The question remains, is that marginal buyer of oil-China-as hungry for oil as it has been in the past? We also know that as economies develop, they become less energy-intensive. And, factoring in the potential growth of natural gas consumption, that drives our caution.

TER: Denbury Resources Inc. (DNR:NYSE) depends heavily on CO2 flood for its production. Will that be economically feasible if a glut occurs?

AC: Yes. Denbury is profitable in the $50 per barrel ($50/bbl) range. Most of its current production comes from older oilfields that it owns on the Gulf Coast. The company's CO2 is also on the Gulf Coast-in fact, the company has the only naturally occurring CO2 source outside the Rocky Mountains. And it has the advantage of a pipeline that ties those CO2 assets to its producing fields on the coast. Because the oil is produced next to the infrastructure used to refine it, Denbury doesn't have to spend a lot of money on transportation, which helps the economics.

"The evolution of North American shale oil plays has us on track to add 3 MMbbl of new supply over the next five years."

I'm not worried about Denbury being able to economically produce oil because it is cycling CO2, an injection process by which the company puts CO2 in the ground, displacing (and producing) oil as it goes. The company doesn't have to drill hundreds of wells every year to increase production. All it has to do is get the facilities working and then maintain them, versus continually deploying a lot of new capital in the ground each year.

TER: CO2 flooding is not necessarily more expensive than drilling brand new wells, is that correct?

AC: Correct. The two processes present different sets of challenges. If you are going to drill new wells, you need to come up with the drilling rig, well tubulars, hydraulic fracturing fluids and frack sand, and you must build roads and pipelines to connect those wells. If you are going to do a CO2 project, you've got to get the CO2, which costs a little bit of money, and you need injection pumps. Much of the initial infrastructure (roads, wells, etc.) is already in place.

It is a slightly different business model but is still based on extracting additional barrels from historically large accumulations. Finding risk is very low, leaving the bulk of the costs as development in nature only. It's a business model that you don't see a lot in the exploration and production (E&P) space. Most players with CO2 assets - the ExxonMobils (XOM:NYSE), the Chevrons (CVX:NYSE), theConocoPhillips (COP:NYSE) of the world-have those assets embedded in much larger organizations, as part of their core businesses. Most of the E&Ps that we focus on, because of their growth nature, are drilling wells on a continual basis to replenish and add to production.

TER: With rare exceptions, Denbury has been stalled below $20/share for more than four years. You bumped your target price from $23 to $24 based on your pricing model. If the model says Denbury can reach that level, why hasn't it done so before?

AC: A few years ago, the company was bringing on one of its biggest fields, Tinsley. It was the largest project the company had undertaken up to that point and some operational hiccups caused it to miss some production targets. As a result, management initiated a stock buyback program, and added to the technical team by bringing in Craig McPherson from ConocoPhillips.

"With much of the U.S. refinery infrastructure geared to process heavier barrels, the large growth in light barrels has already driven WTI prices to a discount with Brent."

Over the last couple of years the company has put more process in place and structured its operations and technical teams to manage its multiple large-scale CO2 floods (aptly titled "Operations Excellence"). Over the last 18 months, management has slowly inched up its tertiary production outlook and now is saying it's going to come in at the high end of guidance. The guidance has slowly trended up as the company has been able to get more control on the operational side. That is why the stock has risen from where it was a couple of years ago, from $11-12/share to where it is now ($18). To get into the twenties, it would be helpful to have a little bit of oil price support. It would also be helpful to see production growth expectations pick up as the company brings on more of its large-scale fields.

Management has also been discussing ways of accelerating cash flows from the build-out of its tertiary oil business. The creation of a master limited partnership (MLP) is one way, though management hasn't decided yet. If you look at how some E&P MLPs are structured, you could make a case in which Denbury would trade from the mid-twenties to the low thirties. My price target reflects continued execution as well as the potential of a little more color on how an MLP might work for the company.

TER: Do you think converting to an MLP would increase the value of the stock?

AC: Potentially. Assets with low maintenance capital do well in an MLP. Maintenance capital is the money needed to keep production flat. If you think about the CO2 floods, they might fit nicely because drilling capex is low. Once you get those facilities up and running, then incremental costs involve getting more CO2, as opposed to getting rigs and steel and frack sand, etc.

While Denbury may not, at this point, grow 40-50% like some of the premier shale players, growing in the 10-15% or maybe 15-20% range could be attractive for an E&P MLP. Investors would have long-term visibility on production growth and the company would be relatively stable, so it could then project the cash flow stream that could be dividended out to investors.

TER: Energy XXI (EXXI:NASDAQ) has posted disappointing results recently and management has announced a $250 million ($250M) buyback program. What does management hope to accomplish?

AC: Management is trying to draw attention to the fact that it expects to have free cash from the asset that it produces from, which is not something we've seen a lot of companies focus on historically in the E&P business. Most E&P companies are growth companies, with historically high levels of reinvestment of cash flows to fund future growth.

With Energy XXI recently taking production guidance down to 10% for the next 12 months, it's going to have a little more capital available to buy back shares. By my model, assuming the oil price is around $95/bbl net, the value of the company's proved reserves alone is somewhere in the $30/share range. If the company buys back shares for $25/share, that is 15-20% cheaper than what the assets are worth. That gives the company no credit for any future drilling potential, too. Gulf Coast players tend to trade at some of the most conservative multiples in the E&P peer group, but that doesn't reflect the fact that they generate a lot of cash flow.

TER: What's behind the disappointing results?

AC: The company had some exploration wells that didn't pan out. That happens when you drill wells with chances of success that are 30% or lower. The offset is when a high-potential well of that magnitude works; it covers the cost of the past unsuccessful tries and then some! If you look at Energy XXI's capital budget, it has roughly $500-600M of base capital for its base assets. It is going to spend $100-200M on higher-risk, higher-potential exploration stuff. So 15% of its annual program is directed at these high-risk/high-potential wells.

"Most E&P companies are growth companies, with historically high levels of reinvestment of cash flows to fund future growth."

Over the last two or three years, management spent a lot of money on the Ultra-Deep Shelf (UDS),and it has recently started to balance that by adding exploration drilling around its existing fields. It signed joint ventures with Apache Corp. (APA:NYSE) and ExxonMobil and will test some play concepts that were generated in-house, as well as working with its partners, McMoRan (MMR:NYSE) and Plains Exploration & Production (PXP:NYSE) on the UDS. Freeport McMoRan Copper and Gold Inc. (FCX:NYSE) recently completed its acquisitions of McMoRan Exploration and Plains Exploration.

The reason Energy XXI missed production numbers was also partly due to lingering weather impacts from last fall's storm season.

TER: Energy XXI's initial strategy was to grow through acquisition, and it did have five large acquisitions, the last one completed in 2010. How well has it performed with the acquired assets?

AC: The acquired assets are probably 60-70% of the inventory the company can drill now. Getting assets from Exxon, and a couple of years before that from Mit Energy Upstream, Energy XXI was able to high-grade and increase its inventory. Hopefully the company is done integrating the assets, but it's a continuous process to high-grade a portfolio, drill your best projects and optimize those projects as you go. I look to see that continue. In fact, Energy XXI recently brought its reserve engineering in-house.

Over the last few years, partly because the company was smaller, it let third party engineers handle 100% of its reserves for year-end reporting. Most larger companies do that in-house, and then use reserve engineers to audit the process for consistency. By bringing the engineering in-house, Energy XXI is trying to show the market that it has a bigger organization-that it has the bigger skill set-and it wants to be more in tune with taking prospect sizes and prospect targets that match its capital program with expectations.

TER: What is the company's strategy now? Is it still planning acquisitions or it is going in new directions?

AC: The strategy continues essentially unchanged. First, it wants to invest in as many high IRR capital projects as it can. The CEO has said that for every dollar invested in the current year, he expects to get $1.50-2.00 in cash flow out of the ground. From that standpoint, the company can continue to spend money to get more returns, but it must balance that with trying to find the next company makers-those bigger projects that support multiple well developments and new platforms.

For the organic portfolio, the company also has to manage whether it can buy assets that would consolidate parts of its fields in the Gulf of Mexico-and do that at an attractive price. Energy XXI is always looking at acquisitions. It's always looking at optimizing the drilling program. With the share buyback, the company has tried to put a little more emphasis on the fact that it recognizes the value of cash flow to investors beyond the growth side of the E&P business.

TER: Bonanza Creek Energy Inc. (BCEI:NYSE) has been a strong performer for you, but its recent earnings report was a miss right across the board. You've cut its target price from $41 to $40. What caused that miss?

AC: Coming out of last year and into Q1/13, Bonanza Creek had a slowdown in activity due to its rig schedule and winter weather. The company is in the right play in the Niobrara oil shale formation, where it is a small-cap player surrounded by Noble Energy Inc. (NBL:NYSE) and Anadarko Petroleum Corp. (APC:NYSE). It was getting its program ramped up in earnest, but the slowdown caused it to come in below expectations for the quarter. In all fairness, at Bonanza's analyst meeting in April, management discussed the slower start to the year.

"If the price spread between oil and natural gas remains wide, we'll see continued evolution toward natural gas use across our economy."

Fundamentally, Bonanza stock still is underleveraged. Its debt is less than current cash flow; it's going to grow north of 60% this year; it continues to have access to inventory; and it is testing multiple zones to increase its inventory potential. From that standpoint, the stock still looks compelling and still has lots of growth in front of it. That is why I only took the target down by a dollar.

TER: You make it sound like growth is simply built into the company's current direction. Does Bonanza not need to improve something in operations to get results?

AC: Not really. Bonanza Creek's going to drill 70+ wells this year in the Niobrara. It is testing 5-acre downspacing in the Cotton Valley, it is testing long laterals in the Niobrara B bench and it is testing the Codell zone for the Niobrara as well as the C bench in the Niobrara.

It doesn't need to do anything more than continue drilling and hit its targets in terms of ramping the rig count. With four operated rigs presently, the company is doing everything that management said it would do and that allows Bonanza, based on my bottom-up activity model, to hit my $40/share target.

Additionally, across the play you've got the LaSalle Plant, which DCP Midstream Partners, L.P. (DPM:NYSE) is building. The plant should come on line at the end of the summer. That provides additional capacity to enhance volume growth for players in the basin. The Niobrara is a play that works. You've got sufficiently large companies in the play to keep capital and facilities growing. Bonanza Creek is falling right in line there, and keeping up with its peers.

TER: What other companies are you excited about right now?

AC: My favorite stock is Anadarko. The biggest story for Anadarko will be the resolution of the Tronox Inc. bankruptcy case. After that, the company has numerous operational catalysts on the horizon, including 1) an ongoing process to partially monetize some of its Mozambique gas assets; 2) its Yucatan exploration well (operated by Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE) in the deepwater Gulf of Mexico; 3) the sale of its Brazilian assets; and 4) ongoing drilling/testing of its extensive onshore shale inventory (e.g. Niobrara, Eagle Ford, Marcellus and Utica).

The company has established itself as a premier explorer, and with the Tronox case resolved, Anadarko is also an attractive takeout candidate. In our net asset value (NAV) model, I see its shares as worth up to $130 each, but have assigned a $105 price target given visibility on near-term cash flows.

TER: Do you have any parting thoughts on the oil and/or gas markets that you'd like to share?

AC: Yes. From our macro view, we're cautious about the oil outlook. We've got a lot of production, and we're unclear about the strength of demand on the oil side in the next 6-18 months, going through 2014. On the gas side, after bottoming last year, gas looks like it is poised to be higher down the road, which makes us more constructive there. We have to see more evolution on the demand side, be it in the short term with power plant construction or in the longer term with the quest for use of compressed natural gas as a transportation fuel.

If the price spread between oil and natural gas remains wide, we'll see continued evolution toward natural gas use across our economy. That will be good for everybody. It should help unlock value for the manufacturing space. It should also unlock value for consumers, who won't have to spend quite so much to heat their homes and fuel their cars. It would ultimately kick-start the next big wave of economic expansion on the back of affordable natural gas in the U.S.

TER: Andrew, thank you for your time.

AC: My pleasure.

Andrew Coleman joined Raymond James Equity Research in July 2011 and co-heads the exploration and production team. Since 2004, he has covered the E&P sector for Madison Williams, UBS and FBR Capital Markets. Coleman has also worked for BP Exploration and Unocal in a variety of global roles in petroleum and reservoir engineering, operations, business development and strategy. Coleman holds a bachelor's degree in petroleum engineering from Texas A&M University and a master's degree in business administration (finance and accounting) with a specialization in energy finance from the University of Texas at Austin. He is a director for the National Association of Petroleum Investment Analysts and a member of the Texas A&M Petroleum Engineering Industry Board, the Independent Petroleum Association of America's (IPAA) Capital Markets committee and the Society of Petroleum Engineers (SPE).

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DISCLOSURE:
1) Tom Armistead conducted this interview for The Energy Report and provides services to The Energy Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Energy XXI and Royal Dutch Shell Plc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Andrew Coleman: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Raymond James & Associates lead-managed a follow-on offering of Bonanza Creek Energy Inc. shares within the past 12 months. Raymond James & Associates makes a market in shares of Energy XXI. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews 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.

Streetwise - The Energy Report is Copyright © 2013 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part.

Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported.

Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734.

Participating companies provide the logos used in The Energy Report. These logos are trademarks and are the property of the individual companies.

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Source: JT Long of The Energy Report (5/30/13)

www.theenergyreport.com/pub/na/15324

Calling the energy space underowned and a great value, Frank Holmes and Brian Hicks of U.S. Global Investors view shale oil plays as integral to an energy renaissance. Still, to hedge their bets, the two experts recommend diversification across the entire natural resources sector, including agriculture and food. In this interview with The Energy Report, they list opportunities in upstream oil and gas production, refining stocks, master limited partnerships and potash.

The Energy Report: Frank, you wrote a contrarian manifesto of sorts at the beginning of May titled "A Case for Owning Commodities When No One Else Is." It showed that energy is the most underowned class by a long shot. That situation was last seen at the end of 2008, just before a major rally in natural resource stocks. Is history repeating itself?

Frank Holmes: To a certain degree, yes. The big difference is that America, thanks to the new introduction of fracking technology, is in a different position than the rest of the world. This is positive for America's trade deficits and its costs of manufacturing.

The population of the rest of the world continues to grow. China and India account for about 40% of the world's population growth. Both countries import energy. There is not enough water in China for it to benefit from fracking.

Brian Hicks: Water is a very large constraint in fracking, along with other geologic factors. Over the last several years, the game changer has been the development of shale plays here in the U.S. We now import less oil than China because of the amount of shale oil we have.

FH: The U.S. has had huge success in drilling and exploring for natural gas, followed by all this gas coming onstream. The inverse of that was when drilling rigs slowed down because gas prices were falling. The rig count went to an all-time low.

"Very few North American natural gas plays are economic at a price below $4/Mcf."

People do not realize that looking for energy is like being a gerbil on a wheel-you have to drill continuously to replace production. When drilling slowed down to a fraction of what it had been, gas prices went up. What are they now, Brian?

BH: They fell as low as $1/thousand cubic feet ($1/Mcf). Now we are in the $4/Mcf range. We had a clear overshoot to the downside. Now we are back to a more normal level.

We are in the shoulder months for natural gas. If we see a warm summer, the gas price could easily approach $5/Mcf. Right now, people are in a wait-and-see mode.

The natural gas market looks constructive. There is more commercial usage. The rig count is down. If we start to see more demand on the horizon, natural gas prices could go back to $5/Mcf pretty quickly.

TER: Do you agree with the Porter Stansberrys of the world, who say the U.S. will be a gas exporter within the next few years, or do you lean toward the Bill Powers' school of thought, that wells will be decimated a lot faster than anticipated and there is no supply glut?

BH: I do not think we have a supply glut. We have had a severe oversupply for the last few years, but that has started to change. The change is reflected in rebounding equity prices and a more normal price range for natural gas. In terms of government policy, natural gas is considered a winner, with coal losing market share.

"We have seen a pretty good lift in upstream oil and gas producers here in the U.S."

Very few North American plays are economic at a price below $4/Mcf. To incentivize more capital investment in natural gas drilling and build a stronger rig count, we need to see prices sustained above $4, closer to $4.50-5. If gas falls below $4/Mcf and stays in that range, the rig count will continue to erode and supply will diminish.

This year's somewhat longer winter shored up the overall inventory picture, which is more or less back to normal. If we have typical summer weather, we could enter the heating season with inventories slightly below average.

The new wells being drilled-the shale natural gas plays-come on at very high rates and decline very quickly. For some plays, questions remain as to where their flow rates will bottom out. Despite the strong supply response of this new technology, there are still question marks as to what the normalized rates will be.

TER: Almost 19% of your Global Resources Fund is in energy stocks: 9.98% in oil and gas and 8.8% in energy infrastructure. Which is the biggest growth area: exploration, production, transportation or services?

BH: We have seen a pretty good lift in upstream oil and gas producers here in the U.S. Internationally, a number of stocks are trading at compelling valuations that could go higher. On the service side, we have seen a good bounce year-to-date.

"The expansion of the U.S. crude oil supply has prompted a massive need for pipeline infrastructure."

Refining stocks is an area we see as an inverse derivative play of new production in shale oil plays. The refiners are the beneficiaries of all of the crude coming on-line. They can source cheaper feedstock and produce refined diesel product at lower costs than their global peers. The U.S. is exporting large quantities of refined product. The margins of refining companies have expanded, and they are generating a lot of free cash, paying dividends and buying back stock. Thematically, we have enjoyed the refining space at the larger cap level because of that competitive advantage.

We also see that competitive advantage reflected in chemicals, another source of strength. Even more broadly, this energy renaissance is helping lower manufacturing costs. It has benefited the overall U.S. economy.

More upside potential remains in services. If the North American rig count expands, I think pressure pumping and drilling stocks will improve. We have invested for a number of years in an offshore theme: infrastructure, supply, manufacturing. A lot of capital is being spent in the offshore space off Brazil and in the Gulf of Mexico. That is another area that looks compelling.

TER: What are some examples of stocks in your portfolio that have done well in each of those areas?

BH: Starting in the refining space, HollyFrontier Corp. (HFC:NYSE) had a very good 2012, as did Marathon Petroleum Corp. (MPC:NYSE). Both benefited from strong midcontinent refining margins.

In upstream oil and gas production, we own Pioneer Natural Resources Co. (PXD:NYSE), which has a lot of opportunities in the Permian Basin. It expanded its overall resource by doing some lateral drilling, and is seeing big success there.

In the services area, I mentioned the offshore theme. Hornbeck Offshore Services (HOS:NYSE) has started to gain traction with increased drilling activity in the Gulf of Mexico. It is an offshore supply boat company. You are starting to see significant earnings power generated in the Gulf of Mexico because of increased day rates and more activity after the Macondo oil spill.

TER: You have four master limited partnerships (MLPs) in your fund. What role do they play in balancing your risk exposure?

BH: Our energy infrastructure allocation comprises mostly MLPs. You might think of higher dividend-paying, higher-yielding stocks as lower growth, but that is not the case with these MLPs.

The expansion of the U.S. crude oil supply has prompted a massive need for pipeline infrastructure. In the South Texas Eagle Ford shale play, we see tangible signs of pipeline takeaway infrastructure. We like investments that pay us a dividend every quarter-some between 5-7%-and that are growing at double-digit rates because of the build out taking place in MLPs. We think that could continue for some time.

With MLPs, you get the added benefit of a strong inflation-adjusted yield that will increase along with prices for the underlying commodity, and at a faster rate than consumer price index inflation.

TER: What are some of the best performers in the MLP space?

BH: Kinder Morgan Energy Partners L.P. (KMP:NYSE) has been a strong performer for us. We have owned Plains All American Pipeline L.P. (PAA:NYSE), but sold that after a big move.

Enterprise Products Partners L.P. (EPD:NYSE) is a major name in the space. Williams Partners L.P. (WPZ:NYSE) has done well for us also.

TER: You also invest in fertilizer, in the form of potash. Why are you bullish on agriculture? What is the best way to invest in that space?

BH: We are very bullish on agriculture and food from a long-term, thematic standpoint.

The overall theme is rising income levels in emerging markets, which increases demand for protein, whether from cattle or chicken. More protein requires more feed, so you can see demand for corn strengthening. Global population growth and per-capita income growth are also driving the demand for more food.

We have chosen to play that in two ways with companies that package and produce food and protein, such as Tyson Foods Inc. (TSN:NYSE) and Smithfield Foods Inc. (SFD:NYSE).

You also have the fertilizer stocks such as PotashCorp. (POT:TSX; POT:NYSE); CF Industries Holdings Inc. (CF:NYSE), which produces nitrogen, also used in fertilizer; and The Mosaic Co. (MOS:NYSE). Those stocks have done very well over the years, and should continue to do well given the macro theme.

TER: Is that your advice for contrarians looking to profit in the energy sector-diversification?

BH: This is an unprecedented time with respect to macro policy, considering the economic conditions in Europe, the expansion of the money supply in the developing world and central banks increasing their balance sheets. There are lots of crosscurrents. We have chosen to negotiate those crosscurrents by being diversified. Our resources fund is balanced across the spectrum of natural resources.

Within the energy sector, we have an allocation in all segments of the energy value train: refining, MLPs, upstream oil and gas production, domestic and international stocks. Having our hand in all of these areas helps us navigate volatility and capitalize on mispriced stocks wherever we find them.

We try not to make large, concentrated bets in any one particular area. This strategy makes sense whether you are an institutional investor or an individual investor. We look for sustainable, long-term themes-companies that can generate cash flow in bullish commodity environments or in a commodity environment that is not quite so bullish. In other words, we look for lower-cost producers with solid management teams.

TER: Frank and Brian, thank you for your time and your insights.

FH: Thank you.

BH: It's been a pleasure.

Frank Holmes is CEO and chief investment officer at U.S. Global Investors Inc., which manages a diversified family of mutual funds and hedge funds specializing in natural resources, emerging markets and infrastructure. The company's funds have earned many awards and honors during Holmes' tenure, including more than two dozen Lipper Fund Awards and certificates. He is also an adviser to the International Crisis Group, which works to resolve global conflict, and the William J. Clinton Foundation on sustainable development in nations with resource-based economies. Holmes co-authored "The Goldwatcher: Demystifying Gold Investing" (2008). Holmes is a former president and chairman of the Toronto Society of the Investment Dealers Association, and served on the Toronto Stock Exchange's Listing Committee. A regular contributor to investor-education websites and a much-sought-after keynote speaker at national and international investment conferences, he is also a regular commentator on the financial television networks and has been profiled by Fortune, Barron's, The Financial Times and other publications.

Brian Hicks joined U.S. Global Investors Inc. in 2004 as a co-manager of the company's Global Resources Fund (PSPFX). He is responsible for portfolio allocation, stock selection and research coverage for the energy and basic materials sectors. Prior to joining U.S. Global Investors, Hicks was an associate oil and gas analyst for A.G. Edwards Inc. He also worked previously as an institutional equity/options trader and liaison to the foreign equity desk at Charles Schwab & Co., and at Invesco Funds Group Inc. as an industry research and product development analyst. Hicks holds a master's degree in finance and a bachelor's degree in business administration from the University of Colorado.

Want to read more Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Interviews page.

DISCLOSURE:
1) JT Long conducted this interview for The Energy Report and provides services to The Energy Report as an employee. She or her family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: None. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Brian Hicks: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Frank Holmes: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
5) The following securities mentioned were held by the Global Resources Fund as of 3/31/13: HollyFrontier Corp., Marathon Petroleum Corp., Pioneer Natural Resources Co., Hornbeck Offshore Services Inc. Kinder Morgan Energy Partners LP, Enterprise Products Partners LP, Williams Partners LP, Tyson Foods Inc., Smithfield Foods Inc., Potash Corp. of Saskatchewan Inc. (PotashCorp.), CF Industries Holdings Inc. and The Mosaic Co.
6) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
7) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer.
8) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews 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.

Streetwise - The Energy Report is Copyright © 2013 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part.

Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported.

Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734.

Participating companies provide the logos used in The Energy Report. These logos are trademarks and are the property of the individual companies.

101 Second St., Suite 110
Petaluma, CA 94952

Tel.: (707) 981-8204
Fax: (707) 981-8998
Email: jluther@streetwisereports.com