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  • Natural Resource Surprises Galore: PeterEpstein

    The natural resources space has been difficult in recent years. Potash prices collapsed, uranium spot prices hit a nine-year low, the gas market was in glut. Only oil has stayed strong. But Peter Epstein of MockingJay Inc. has found some gems in the resource rubble, and foresees better times ahead. In this interview, Epstein tells The Energy Report who stands to capture the graphite market, how to catch the next wave in potash, and offers his thoughts on when investors might catch a break in the uranium market.

    The Energy Report: Why are you excited about the oil and gas space right now?

    Peter Epstein: Oil and gas is unique in that it hasn't budged when so many commodities have fallen precipitously in price. Coking coal prices, for example, are at multiyear lows. The iron ore price has fallen below $100/metric ton. The uranium spot price has fallen to a nine-year low. But oil prices have held in the $90-100/barrel [$90-100/bbl] range on West Texas Intermediate crude for three or four years, steady and strong. Natural gas prices collapsed in 2012 but have come back fairly strong, only recently giving back a bit of the gains. That's why I like oil and gas. It's a strong commodity. Even with all this talk about a slowdown in China, which causes lots of commodities to fall, oil and gas sticks in there.

    TER: Oil, gas and mining industries are tarred with the same brush by environmental advocates, who describe them as dirty, polluting and environmentally destructive. Can these industries be made attractive to investors who put a premium on environmental considerations?

    PE: Companies are learning the hard way that they have to have a social license to operate, as well as address the increasingly long list of permitting and environmental hurdles. Extractive industries that are dirty and polluting have to clean up their acts. But this is not a new problem; it's been going on for years-or even decades-depending on the jurisdiction.

    Another negative impact for such companies is the longer time frame to production, created by a myriad of factors above and beyond environmental considerations. A longer time frame means more difficulty funding projects, and therefore a lower net present value. Project hurdle rates have to rise to account for the higher risks and longer time frames. This means that industry-wide cost curve increases and commodity prices have to rise in response. Margins will be squeezed somewhat, even if companies enjoy higher commodity prices in the long term.

    TER: What do companies have to sacrifice to achieve environmental goals?

    PE: Companies have to give up profits to meet these new realities. But companies that approach dirty and polluting industries in innovative ways, frequently with the use of technological advances, will be rewarded.

    TER: When uranium's price stalled around $35/pound [$35/lb], everyone bet it was about to rise again, because it couldn't go any lower. Then it stalled again, at about $28.50/lb. What will make uranium mining profitable and attractive again?

    PE: For the first time since April, the spot price has a $3 handle on it, with Ux Consulting quoting it at $30/lb on Aug. 11. It appears that spot uranium may have bottomed at about $28/lb. If the spot price rebounds to even just $35/lb, that could be bullish for the sentiment of uranium juniors.

    Let me point out that the spot price is not the same as the long-term price that most utilities contract at. Make no mistake, $28.50/lb was a nine-year low and a depressed price. Most uranium mines around the world can't do business at $28.50/lb-or at $35/lb. Many analysts believe the price at which new greenfield projects would get the green light is $60-75/lb. That might sound high, but in the months leading up to the terrible Fukushima disaster in March 2011, the long-term uranium price was steady at around $70/lb.

    Globally, the cost per pound to produce uranium has not gone down over the past three years. All mining costs are generally increasing because of the factors we've discussed: permitting costs and time frames, environmental concerns, etc. The market needs a higher uranium price, and we will see a higher uranium price. It's a question of when, not if. Many pundits point to the restart of some Japanese reactors, all of which are currently offline. I agree that this will be a positive sentiment booster, but that alone will not be enough to move uranium prices by all that much, in my opinion.

    Instead of focusing on Japan, the market should be watching China and India, both of which only generate 2-3% of their electricity from nuclear power. That has to change-and it will. Given their severe air pollution problems, the Chinese are going to build new reactors as fast as they can. They will also continue ramping up hydropower, wind, solar-you name it. But nuclear power generation in China is going to be a larger part of a growing pie. China is sitting on $2-3 trillion [$2-3T] in U.S. Treasuries, and it will happily buy hard assets in the form of uranium or uranium enrichment facilities. The Chinese are very active, up to a state-owned entity level, in terms of building nuclear power stations.

    Some analysts point to in-situ recovery operations as potentially profitable. These have low costs and can be profitable at a uranium price of, say, $40-45/lb. But the size of these projects is typically too small to move the needle globally.

    Finally, I would point out that utilities have not been contracting for long-term supplies of uranium since they feel no urgency to do so. That will have to change. Utilities can't wait until 2017 to contract 2018-2023 uranium supplies. As soon as next year, utilities will be back in the market and the long-term price of $45/lb will rise.

    As a commodity that's hit a nine-year low, uranium is out of favor. A lot of the uranium stocks are oversold. But I think there are opportunities in small names.

    TER: Some projections for nuclear power plant construction in China suggest that even with as much construction as it wants to do, the country still won't exceed 10% of its total power needs. Is that going to greatly increase uranium demand?

    PE: China expects to start building something like six new reactors every year for the next five years, and that's going to keep ramping up. If your question is how long will it take to get 10% of its electricity from nuclear power, it could take 10-15 years. China thinks long term, and has a lot of U.S. dollars that it would like to transform into hard assets. And it's not just the Chinese who are actively going after uranium and nuclear power. It's Russia as well, and India.

    By the way, both China and India are very active in building hydroelectric dams. But that kind of construction gets an unbelievable amount of scrutiny in terms of the environment, and the fact that tens or hundreds of thousands of people must be moved out of villages to build these dams. Hydroelectric development in China and India may come to a quicker end than people realize. Then, of course, you have coal. The World Bank, the International Monetary Fund, the U.S. and some other major international bodies are saying they're not going to fund Third World coal power plants anymore. Those factors all lead to more nuclear power development.

    TER: Is there another company you'd like to mention?

    PE: CBD Energy Ltd. (OTC:CBDE) is interesting because, in addition to being a solar stock, the company also works with wind and energy management systems. It has over 17,000 [17K] installations, mostly in Australia, and is moving into the U.S. In Australia, 15% of homes have solar. In the U.S., it's estimated that 1% have solar. Even though it's extremely competitive in the U.S. for companies installing rooftop solar panels, the penetration of solar on rooftops of individual homes is still quite low.

    CBD Energy is well funded. It has a strong management team and a long track record. In fact, it has licensed the "Westinghouse Solar" trademark to tell people who it is. It's a real brand name.

    The exciting part of the story is that solar companies can trade at 10-30x revenues. But it's a very competitive, crowded space, and it's hard to tell if those kinds of multiples are fair, or if it's a bubble. In the case of CBD, however, you have a geographically diversified, fast-growing, small company that's trading at a 1x multiple of 2015 revenue.

    TER: The potash space was shaken up in the last year by the collapse of the cartel in Russia. How is that affecting the potash space in North America today?

    PE: Potash is a generic term that refers to a group of potassium-bearing minerals, naturally occurring potassium salts and the products produced from those salts. Potash is a plant's main source of potassium, and is used in fertilizers. For muriate of potash [MOP], prices collapsed after that event. It took a couple of months, but the potash price fell from more than $400/metric ton down to about $300/metric ton. Prices differ around the world, so I'm using a benchmark price that a lot of people refer to.

    MOP is widely used in all types of farming, but it contains a chloride ion that can be detrimental to plant growth, especially fruits and vegetables. Sulfate of potash [SOP] is different. SOP improves yield, quality, taste and shelf life. These attributes are valuable to farmers, so SOP trades at a premium price to MOP.

    SOP prices barely moved at all. It's almost like they're two different products. SOP is a specialty product with one-tenth the market of MOP. A third-party study suggests that demand for SOP would be 2-3 times greater if existing users could ensure security of supply, and if new users were introduced to SOP versus MOP. The premium of SOP over MOP has moved quite a bit because SOP prices were virtually unchanged during the Russian cartel turmoil, while MOP prices fell 25%.

    You can make SOP, but you need MOP as a feedstock to start with. If you have to start with MOP and spend money to process it, the margin is not going to be that strong. Since it is an expensive process, not many companies do it. That's why the MOP market is 50M metric tons/year, and the SOP market is about 5 million tons.

    For MOP, in Saskatchewan alone, there's a huge amount of production. Plus, a number of juniors and both BHP Billiton Ltd. (NYSE:BHP) and Rio Tinto Plc (NYSE:RIO) have projects they could bring online.

    TER: You have an extremely diverse portfolio of companies that you follow. Can you offer some advice for investors looking to build that kind of a portfolio for themselves?

    PE: Investors in natural resources have not been happy campers for the last two or three years. I think it's important to stick with companies that have cash on their balance sheets. Stick to companies already in your portfolio, even if they're down 60-70%, with good management teams that are 100% committed to the company, not management teams involved with five different companies at once. And watch out for the cash burn of companies. You want the cash burn to be minimal, so that your companies can live to fight another day.

    TER: Peter, I appreciate your time and your insights.

    This interview was conducted by Tom Armistead of The Energy Report and can be read in its entirety here.

    In 2011, CFA Peter Epstein left his senior analyst position at a $3B hedge fund and formed MockingJay Inc., a consultancy for companies in the natural resources space and an informal investment adviser to high-net-worth investors, family offices and funds. The company's mission is to increase awareness of select natural resource companies. Epstein's areas of expertise include uranium, coal, potash, gold and oil & gas. He has published hundreds of articles on investment sites such as Seeking Alpha, The Motley Fool and Au-Wire.com.

    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 recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

    DISCLOSURE:
    1) Tom Armistead conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
    2) The following companies mentioned in the interview are sponsors of Streetwise Reports: None. Streetwise Reports does not accept stock in exchange for its services.
    3) Peter Epstein: I own, or my family owns, shares of the following companies mentioned in this interview: CBD Energy Ltd. 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: 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) 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. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

    Streetwise - The Energy Report is Copyright © 2014 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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    Aug 14 3:00 PM | Link | 1 Comment
  • Looking For The Next Big Thing? Jason Sawatzky Has A Suggestion

    For Jason Sawatzky, the word is "oilfield services." They are not glamorous, but they are necessary, and Canada's explorers and producers need oilfield services as they prepare to fill pipelines with natural gas to be liquefied and exported. AltaCorp Capital's director of institutional equity research tells The Energy Report that Canada is pushing hard to approve liquefied natural gas plants, and Canada's proximity to Asian markets gives it an edge. A whole portfolio of companies is poised to support and profit from the business opportunities that will come with that industry.

    The Energy Report: Jason, what is your outlook for oilfield services industry in Canada for the second half of 2014?

    Jason Sawatzky: We are very bullish on Canadian oilfield services heading into H2/14 and 2015. The only thing that may throw a monkey wrench into the positive view in the short term would be the recent pullback in natural gas prices. We have seen the oilfield services index pull back a bit over the past couple of months. If we see natural gas prices pull back even more, we could see a similar pullback in the oilfield services index and in share prices. Other than that possibility, we remain bullish on the sector.

    TER: Do you think there's more to the pullback in natural gas prices than seasonal fluctuation?

    JS: We've recently had some large injections into the gas storage levels down in the U.S. That's been the reason for the more recent pullback in gas prices. But we are heading into the winter season, and typically gas prices strengthen as we head into winter, as heating-degree days tend to increase and gas usage increases. Even though we've seen a pullback, we expect gas prices shouldn't pull back much more from where they're at today.

    TER: How strong is foreign market demand for Canadian liquefied natural gas [LNG]? Eight or nine Canadian LNG targets are proposed. Can demand support all of them?

    JS: We believe one to three projects will eventually go ahead. The Canadian market would have a hard time handling eight to nine projects just from a labor and infrastructure perspective.

    TER: Are any of the projects in progress right now?

    JS: Not really. A lot of the developers have applied for initial approvals. Many projects are waiting on the British Columbia [B.C.] government's LNG tax package, which is expected in the fall. Companies will decide whether they'll go ahead after that. Petronas (OTC:PNADF) [PETRONAS]/Progress Energy Canada Ltd. has started delineation drilling. It's operating between 25 and 30 rigs right now, and that's the predevelopment phase of delineation drilling in preparation for eventual approval-if that happens.

    TER: There are a lot of LNG projects in the U.S. that have a head start. Can the Canadian projects compete?

    JS: U.S. LNG projects do have a head start, as the U.S. already has infrastructure in place for imports on the LNG side. They're now converting these plants to export. That said, we believe the Canadian projects will definitely be able to compete in building out LNG plants and infrastructure. Just considering Canada's proximity to Asian markets, it can compete. It's all about proximity to the Asian markets.

    TER: What about the petrochemical industry? Natural gas is a feedstock for that industry. Would that be an equally good market for western Canadian gas?

    JS: We think it will also be a good market. The petrochemical industry already exists in Canada, with plants in Edmonton, Alberta, and Red Deer, Alberta. The industry would definitely be a good market for western Canadian gas, but it would be a much smaller market as compared to LNG, given the global demand for LNG.

    TER: Are the First Nations on board with the pipelines that will be necessary to get Canadian LNG to the coast?

    JS: The largest pushback from the First Nations is actually around oil pipelines, due to the potential for spills and the environmental impacts around that issue. Their opposition has been mainly to the Northern Gateway Pipeline, an oil pipeline. Natural gas is a much cleaner energy; the B.C. government and First Nations are on board with LNG and the gas pipelines that would be built around that production.

    TER: What does Canada want from a tax package on LNG, in terms of policy goals and revenue goals?

    JS: Regarding a tax package on LNG, the B.C. government has said it is definitely pro-LNG, given the potential economic benefits for the province if a number of these projects go through-and the economic benefits for Canada as a whole, for that matter. We would expect a tax package in or around the September time frame. We think it's going to be favorable for the industry and for producers.

    The B.C. government is looking to change its provincial tax model, which is currently based on the federal model. The new provincial tax model would be based on a cost recovery system [i.e., less tax would be paid overall, but there would be a higher net present value on taxes].

    TER: You predict one to three LNG projects, out of eight or nine proposed, are going to go forward. Will the successful ones be those making progress now? Or might one of the late starters have a better chance?

    JS: With Petronas/Progress already doing a lot of development drilling, we think that's a pretty positive sign. If the tax package is relatively favorable, we think that Petronas/Progress is prepared to move ahead with its project. Then some of the other larger players, like Chevron Corp. (NYSE:CVX), will be willing to move ahead relatively quickly.

    TER: Would you talk about companies operating in the LNG space? Which companies are of interest, and what is driving their growth?

    JS: Sure. Canadian Energy Services and Technology Corp. (OTCQX:CESDF) [CEU:TSX] is one of our top investment ideas. It's one of the largest drilling fluids providers in western Canada. It currently has roughly 34% market share in Canada, and is growing its drilling fluids business in both Canada and in the U.S. The company is operating in the Permian Basin down in the U.S., which is a large growth area for the company.

    What's driving growth in the drilling fluids business for Canadian Energy Services is demand for more complex drilling fluids. That market is growing in both Canada and the U.S., as wells are drilled longer horizontally. The company offers its customers drilling fluids products that actually lower the total cost of a well, and that can raise overall productivity of a well, which ultimately increases the return for exploration and production [E&P] companies. Canadian Energy Services also has good exposure to the LNG build-out in Canada, and good exposure in the U.S. to increasing activity in plays like the Permian.

    TER: Canadian Energy Services acquires a lot of its technology in mergers and acquisitions [M&A]. Does it do its own research and development too?

    JS: It does. When this company first started out, it very quickly became a market leader on the drilling fluids side in Canada. A lot of that was through its own research and development, and through providing proprietary drilling fluids products. But it has done a lot of M&A as well.

    Canadian Energy Services has acquired a company called JACAM Chemical Co. Inc. down in the U.S.-a $240 million [$240M] acquisition. That acquisition transformed the company, and gave it another growth area in terms of production chemicals. It was a very positive transaction, and the stock has reacted accordingly.

    TER: What was Canadian Energy Services looking for in the JACAM acquisition?

    JS: It was looking to diversify its operations. The company's main operation is drilling fluids, which is tied heavily to the drill bit. You can have a lot of volatility in that business when commodity prices fluctuate. Production chemicals are a lot more stable in terms of business, as they are used on wells that are already producing. You have more stability and are less tied to the drill bit on the production chemical side, so it evens out the revenue stream.

    TER: How does the company fund its M&A?

    JS: It funds the M&A through debt, through equity financings and through cash flow from the business. On the equity financing side, Canadian Energy Services recently did a $75M equity financing and issued some debt as well-about $75m in debt.

    TER: How extensively is the management invested in the company?

    JS: The management team is heavily invested, and has been since the start of the company. Management and directors currently own 18% of the stock. They have skin in the game, and that's been reflected in how well the company's done over the past number of years.

    TER: Is there another company that might benefit from LNG development?

    JS: Newalta (OTCPK:NWLTF) [NAL:TSX] is one of the three largest oilfield waste providers in Canada. The other two are Secure Energy Services (OTC:SECYF) [SES:TSX], which is a public company, and a private company called Tervita Corporation.

    If LNG goes through in Canada and one to three projects go ahead, that will create a lot of activity in western Canada, which in turn will generate a lot of oilfield waste for companies like Newalta to handle on the back end. Newalta wouldn't be on the front end of the LNG development-that would be the drillers and the frackers. It would be on the back end, handling the oilfield waste generated from the increased LNG-related activity.

    TER: Newalta's industrial division has underperformed recently. Now the company is talking about selling it. Where does that stand right now?

    JS: The company engaged an advisor a few months ago to conduct a strategic review of its industrial assets, and it's working through that right now. We believe that we could see either a sale of a portion of the division or sale of the entire division by the end of this year. We think that will be positive for the company, given that the industrial business for Newalta is a lower-margin business compared to its higher-margin oilfield waste business. When Newalta does eventually sell off its industrial assets, it will take those proceeds and reinvest them into the higher-margin oilfield waste business.

    TER: Will that materially change the way Newalta operates?

    JS: It provides the company with more capital to invest in some of its higher growth areas. For Newalta, that would be its heavy oil business, which is centered on waste processing for steam-assisted gravity drainage [SAGD] and mining operations through onsite locations and fixed facilities. Another growth area for Newalta would be U.S. expansion. It's growing in the U.S., providing onsite and satellite oilfield waste services. Those would be the two main growth areas where it could redeploy capital.

    TER: This is a pretty diversified operation. Do you see one of the units as representing the core business, and the others just supporting that?

    JS: Once Newalta sells its industrial position, it becomes a pure-play oilfield waste provider in Canada and the U.S. We think that's going to be the focus for the company. Wells are aging in western Canada, produced water is increasing every year, and the amount of waste is increasing as horizontal wells are being drilled longer. We think these are all positive drivers for Newalta's core business of oilfield waste management.

    TER: Do you foresee any other sales or acquisitions?

    JS: Other than the industrial assets, no. And in terms of acquisitions, not anything in the near term. Over the longer term, if Newalta were to do any acquisitions, it may be in the U.S., buying smaller oilfield waste providers in certain plays. That would be the only potential acquisition.

    TER: Speaking of acquisitions, Canyon Services Group Inc. (OTC:CYSVF) [FRC:TSX] purchased Fraction Energy Services. How did the market respond to that?

    JS: The market responded favorably to that acquisition, which was about 8-10% accretive. It allows Canyon to develop a more comprehensive fracking fluid management solution, offering both fracking and water frack fluid management services. Eventually, the goal for Canyon is to offer frack water recycling services. When the frack water is taken from the well, the company would be able to recycle it and frack with the same water. Down the road, that's what Canyon is looking to do.

    TER: Any other companies that you're excited about at this moment?

    JS: Generally, around LNG development in Canada, I would note some of the companies that we believe are on the front lines, or who will benefit from LNG development. That would include some of the largest drillers in Canada. Some of the smaller drillers, like Western Energy Services Corp. (OTC:WEEEF) [WRG:TSX] or CanElson Drilling Inc. (OTC:CDLRF) [CDI:TSX.V], will benefit from the LNG build-out on the front lines.

    Some of the fracking companies will benefit as well, such as Canyon Services Group, Trican Well Service Ltd. (OTCPK:TOLWF) [TCW:TSX] and Calfrac Well Services Ltd. (OTCPK:CFWFF) [CFW:TSX].

    Another big area that will benefit from LNG build-out is camp accommodations, so we would highlight companies such as Horizon North Logistics (OTC:HZNOF) [HNL:TSX] and Black Diamond Group Ltd. (OTC:BDIMF) [BDI:TSX] as being able to provide pipeline and LNG-related accommodations on the west coast.

    TER: You threw a number of companies into that basket. Is there anything particularly outstanding about any one of them?

    JS: Certain companies within the Canadian oilfield services space are going to benefit more than others. Frackers and the drillers will benefit the most initially, and then the accommodations segment. Generally, if we do get one to three LNG projects approved and we look at the amount of capital coming into the basin, we think that oilfield services in Canada is the way to play the LNG theme.

    TER: Thank you very much for your time today.

    This interview was conducted by Tom Armistead of The Energy Report and can be read in its entirety here.

    Jason Sawatzky is director of institutional equity research at AltaCorp Capital Inc., where he focuses on oilfield services. Prior to joining AltaCorp, Sawatzky was an associate analyst covering oilfield services at Stifel Nicolaus. Prior thereto, he worked at Cormark Securities, covering oilfield services and E&P companies for four years. Sawatzky holds a bachelor of commerce degree in finance from the University of Alberta, and a bachelor of arts degree in sociology/psychology from the University of Calgary.

    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 recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

    DISCLOSURE:
    1) Tom Armistead conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
    2) The following companies mentioned in the interview are sponsors of Streetwise Reports: None. Streetwise Reports does not accept stock in exchange for its services.
    3) Jason Sawatzky: I own, or my family owns, 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: CanElson Drilling Inc., Canadian Energy Services and Technology Corp. 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. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

    Streetwise - The Energy Report is Copyright © 2014 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

    Aug 07 3:37 PM | Link | Comment!
  • Africa: New Land Of Opportunity? Ashley Kelty Points To The Positives

    Oil and gas plays in Africa are no day at the beach, but they are more promising than the press would suggest, says Ashley Kelty, oil and gas equities analyst at Cenkos Securities Plc. Africa has locals with oil patch skills, abundant, accessible reservoirs and less volatile fiscal regimes than investors might think. In a wide-ranging interview with The Energy Report, Kelty riffs on shale in the U.S., basement reservoirs throughout the world and the news out of Africa. The investment opportunities are many.

    The Energy Report: You have described market sentiment toward the exploration and production [E&P] sector as "bearish." What would turn that sentiment around?

    Ashley Kelty: It would be better to say that, more specifically, sentiment toward oil and gas in the London market is bearish at the moment. However, I would say the opposite for the U.S. market. If you look at the indexes for U.S. independents comprising the Standard & Poor's North American Exploration and Production [E&P] Index, versus the U.K.'s Financial Times and London Stock Exchange [FTSE] Alternative Investment Market [AIM], you would see that they're diverging at a rapid rate. In Q1/14, the U.S. independent sector went up around 28%, whereas in the U.K. it fell 18%. For some investors in the London market, sentiment remains very negative and very bearish against the sector. This is not the case in the U.S., which I think is largely buoyed by success of both majors and independents in onshore unconventional [shale] plays.

    To reverse negative sentiment in the U.K., it will come down to macroeconomic factors, particularly the ongoing quantitative easing across Europe and the U.S. Simply, savers are being penalized. People are looking for yield, which has driven them out of equities. It certainly has hampered the resources sector.

    In the U.K., I believe what the market is looking for is consolidation through mergers and acquisitions [M&A], with a consequent recycling of capital into new and earlier-stage companies. Unfortunately, a lot of pretty poor offerings have come to market in recent years, which haven't performed particularly well. There haven't been enough success stories in the last few years to convince people that the fundamental resource plays are worthwhile. That's certainly the case for mining and oil and gas.

    TER: What are your forecasts for oil prices?

    AK: For my models I'm using $105/barrel [$105/bbl] flat for Brent and $100/bbl flat for West Texas Intermediate. I think, to be honest, that we're going to bounce. Certainly in Brent, I think price will move around the $100-110/bbl range for the next few years.

    A lot people are talking about whether a U.S. move into export mode will have an impact on global oil prices. I don't believe it will. My feeling is that the key factor will be the levels in production within OPEC. As it stands now, the likes of Nigeria and Venezuela are not in a position to increase production. But Saudi Arabia still has the swing capacity to manage levels of production. It believes the world is comfortable with $100/bbl oil. If the U.S. were to become a major exporter, it would be more likely to impact disruptive production from the likes of Libya and other countries in North Africa. Saudi Arabia would rather choke back production to maintain those levels than have the price decrease, or see oil prices rising materially. It would prefer for oil to stay within a manageable range rather than see large levels of volatility.

    TER: Africa appears to be the new frontier for oil and gas development. What do you see going on there?

    AK: It has changed over recent years. Five years ago, nobody wanted to look at East Africa. It was seen as just a gassy province, with no way of monetizing it. Then a couple of years ago, everyone got very excited about East Africa and the potential for large-scale liquefied natural gas [LNG] production. But in many respects, the industry has been caught out with the sheer scale of gas reserves found there. We are seeing huge discoveries in Mozambique and Tanzania, and people are comfortable that there is enough to justify large-scale LNG developments. The issue now is the level of scalability. Key issues will be funding these developments and the logistics of building them in remote areas, with little existing infrastructure. These successes have led to most of the acreage being held by the majors, with smaller scraps remaining for the independents.

    Over the last couple of years, the industry has focused its attention back on West Africa. It is looking at different plays, such as the Atlantic Transform Margin along the most westerly part of Africa, around Mauritania all the way up to Morocco, looking for the next Jubilee field, as well as investigating Brazil analogs, such as the pre-salt play in Angola, and exploring the southern edges of the Transform Margin all the way down to Namibia.

    The key is that Africa is still largely unexplored. Aside from a few areas, the level of well density is still very low, relative to the likes of the Gulf of Mexico or North Sea, so there's enough for both the majors and independents to go after-and to attract investment.

    Some African countries are opening up toward foreign investment and becoming more politically stable, and people are looking to invest in that. But African E&P activity is also skewed somewhat, even in established areas, by the moves of U.S. majors and independents, who have been retrenching back toward the U.S. to focus on domestic onshore production. Opportunities have opened up in Nigeria, Ghana, Angola, Egypt and other countries as U.S. companies have focused efforts on the likes of the Permian Basin and Bakken Shale, as they see huge returns there without the political risk.

    TER: Why has it taken so long for African oil and gas to develop? Why is growth only now occurring?

    AK: Growth actually has been occurring for years and years. When you look at the African continent, the wealth of opportunities, even in specific countries, is huge-and there are both on- and offshore opportunities. In southern Kenya, I saw a company that had a number of blocks that would be equivalent to half the Norwegian North Sea in terms of actual acreage. The scale is far more vast than any other established basin. In that sense there's been so much more to go for. Explorers have been going for the lower-hanging fruit in some of the established basins, but much in Africa is relatively unexplored.

    TER: What countries or regions of Africa are the hottest prospects today?

    AK: At the moment industry focus has shifted away from East Africa. Most of the perceived quality acreage in East Africa offshore has been acquired by the majors. They're busy drilling that up. The issue there is monetization of the resource, and the scale of the multitrain LNG developments that will be required. Both investors and management are concerned about funding these. They're wondering about the billions that will be required, and whether long-term LNG prices in Asia will be strong enough to justify these developments, particularly as you have Australian LNG projects coming on stream. The Fukushima earthquake and the disruption to Japanese nuclear power have helped LNG prices, as I think they will for a long time. The question is whether large companies are willing to press the button in East Africa without some guarantee those prices will hold up.

    The focus is going back to West Africa. Companies are now looking at the pre-salt in Angola and at Ghana, which prospectively looks very good. You could say that about a number of countries. The ongoing unrest in northern Africa-Egypt, Libya, Algeria-has made people somewhat jittery about going for more conventional plays there.

    TER: Where do you expect to see growth in Africa five years or more from now?

    AK: Growth will come from the development of LNG. Once LNG facilities are built, I think a number of companies would look to monetize their discoveries and resources, which at the moment are arguably stranded. The majors would encourage that development, as it would lower the marginal cost for them.

    I think there will also be a movement toward greater onshore exploration and development in Africa, which has been seen as difficult largely due to political stability issues. Now, both E&P companies and investors are more comfortable with looking at onshore exploration as domestic infrastructure and end markets are improving. Plus the fact that vast, underexplored basins could offer better returns, particularly as offshore acreage and the low-lying fruit is disappearing.

    TER: The news out of Africa is full of war and insurrection, terrorism, corruption and repressive government. But the continent is also home to some of the fastest growing economies in the world. What's the investment climate there really like?

    AK: It's still hard, to be honest. You really have to know where you are operating. But given the supernormal returns oil and gas can offer-particularly given that export of oil/gas can be to a global market-the market is not particularly sensitive to whether you get your gas from Ghana or Egypt or Mauritania. It's more about quality, and whether you can deliver the product. Because you're selling into a global market, and also because petroleum revenue is one of the main sources of foreign income for these countries, oil and gas investment is seen as comparatively stable. Countries don't want to discourage investment from these huge companies.

    Companies are also finding that there are locals who actually have the needed skill sets. Given the wider industry problem of a lack of experienced personnel, I think companies are seeing Africa as a great opportunity to train up locals for the future. It also satisfies local content laws, and the investment in that is worthwhile.

    Issues of corruption and unrest have certainly hampered onshore development in Africa. I think companies have felt the onshore security risks are too high, whereas offshore it is less of an issue, since local insurgents don't have boats that can take them 30-40 miles out to sea. Plus, governments are very protective of offshore developments. I think insurgents recognize that even if they do initiate a coup, they will need investment from oil and gas companies to generate the revenue that they require. In that sense, I think oil and gas is one of the more attractive sectors to be in, because locals identify it as a primary revenue driver.

    It's because of the overall investment and security of supply that African countries, particularly countries such as Mozambique, Tanzania and Kenya, support the oil and gas industries. I think they've recognized that the service sector is a need they can fill pretty quickly. The service sector does not need as much expertise as the upstream element, and there's a far greater opportunity for local content. Recognition of these industries as being primary revenue sources for African nations has made the investment climate easier.

    There's also been far less volatility in the fiscal regimes in Africa. In fact, there have been more changes in the fiscal regime in the North Sea in the last 10 years than in most African countries. People still commonly believe that Africa is always chopping and changing. Those nations have now recognized that it doesn't help to keep changing things for the sake of an extra few percent, which in the short term looks good, but in the long term does not.

    The investment climate in Africa is particularly attractive for E&P. I think services companies are now seeing an opportunity to grow their businesses on the continent, and are looking at Africa as a place to which they can export their technologies, so they will have the early-mover advantage. If you look at the U.S. onshore, you've got the likes of Schlumberger Ltd. (NYSE:SLB), Halliburton Co. (NYSE:HAL) and so on, all with large positions. But across Africa, Schlumberger will not have the same position. In some countries in Africa, that would allow Halliburton to gain a greater position. I think companies see greater opportunities to build positions in a relatively low-competition market.

    TER: The Chinese seem to have been doing their best to lock up Africa's oil and gas resources and make it their own oil patch. How are the companies you cover meeting that competitive challenge?

    AK: Perhaps three years ago, the Chinese were very aggressive. The Chinese economy was growing fast, and some of the U.S. majors and independents were retrenching back home. Their exit strategy was largely to sell to the Chinese. The Chinese were acquiring development and production; they weren't generally acquiring exploration acreage. They were also targeting countries that were generally seen by the western powers as being very difficult-politically corrupt, dangerous, unstable-which the Chinese seem to be far more comfortable dealing with as opposed to the western nations. They've managed to build a big position in Africa.

    In terms of opportunity, smaller companies and independents-the likes of Ophir Energy Plc (OTC:OPHRY) [OPHR:LSE] and Tullow Oil Plc (TLWO) [TLW:LSE]-are still exploring, which is something the Chinese haven't been actively doing. After the initial land grab, the level of activity has not been sustained.

    In addition, in the last couple of years the level of Chinese M&A has dramatically fallen off. For example, a U.K.-listed company in Chad, Caracal Energy Inc. (OTCPK:CCAXF) [CRCL:LSE], is being bought by Glencore International Plc (OTCPK:GLCNF) [GLEN:LSE], a large commodity business-not by the Chinese, who were seen by the market as the most likely takeout partner, given the fact that the Chinese had the acreage adjacent to Caracal's.

    I also get the feeling, having been on the ground, that the way the Chinese operate does not always sit easily with some African governments. The Chinese do not, on an anecdotal basis, appear to be very keen on local content, and are far less willing to negotiate and work with local governments than some of the Western powers. But that's anecdotal and hearsay.

    TER: Can you give us more detail on the companies you cover that are operating in Africa-their prospects for M&A, their prospects for further growth? What are their recent successes?

    AK: Ophir Energy focuses largely offshore. It's had some great success in East Africa, partnering with the likes of BG Group Plc (OTCQX:BRGYY) and Statoil ASA (NYSE:STO). However, it was taking large working interests and looking to farm down. It stated it was planning on farming out some of its acreage, which has not happened to the extent anticipated. That has upset the market somewhat.

    However, today Ophir's interest seems to be more on proving up its positions in both Tanzania and Equatorial Guinea. It's focused on offshore. The company has made bids for other companies that didn't come off. It looked to a deal with Premier Oil Plc (OTC:PMOIF) [PMO:LSE], but the Premier board rejected that. It was particularly disappointing given that Premier is an established developer and producer, but has a poor record with the drill bit, and generally has only managed to grow its business through acquisition, rather than through organic exploration success.

    Tullow has long been a darling of the stock market. It's a very good company, and has expanded into many jurisdictions in Africa that other companies wouldn't touch-and has been very successful doing so. It had a fantastic run of exploration success a number of years ago-15 or 20 successful wells in a row. However, in the last couple of years the company has had a comparatively poor success rate. It's had a few dry holes.

    The problem for Tullow is that the market expected continued success. If you look at Tullow on a five-year basis, it has above-average, or above-sector-average, success rates. It also had tax issues in Uganda, which caused a few problems. However, fundamentally, Tullow has among the best understandings of Africa in terms of personnel and culture. Tullow is certainly the go-to guy for operations in Africa.

    TER: Many jurisdictions in Africa come with high risks, and high risks can earn high rewards. But some companies you cover operate in politically safer jurisdictions. Is their profit potential less for taking the safer path?

    AK: No, not at all. Their profit potential is still fantastic. I think oil and gas can [and does] offer supernormal returns. The issue comes down to an investor base not willing to go for high-risk/high-reward. I think the only reason people are investing in Iraq is because the volumes are so huge as to make a difference. In terms of the actual revenue the company gets relative to the government tax take, it is minuscule.

    Operating in a stable environment, such as in the North Sea or onshore U.S., is very attractive. A large amount of the market will follow that. You're looking for profit, and these companies will grow, but the main driver is that you're not looking for discoveries to be transformational. Those companies make accretive discoveries or accretive transactions, but don't need to be transformational to get the market excited. There is certainly an appetite for more traditional, stable environments and production, rather than for huge, elephant-hunting exploration in Africa. Also, for companies operating outside Africa, such as in the U.K. and U.S., it's easier to attract capital. They have an advantage in that they are able to secure comparatively low-cost financing to develop their asset bases, which companies in Africa would not be able to do.

    TER: What companies do you cover that operate outside of Africa?

    AK: Ithaca is focused on development and production, and has grown massively in the last couple of years. It has a large development called Stella that should come on stream the middle of next year. Stella will more than double the company's production and will lift output from around 15 thousand barrels a day [15 Mbbl/d] to over 30 Mbbl/d. That will move Ithaca up to the next tier in terms of production companies in the U.K.

    Given that the company is not concentrating on exploration, the level of cash flow it will generate will be significant. The company is thinking about returning cash to shareholders once Stella is on stream. Now that it's moving into a phase where it may pay a dividend, as well as offer capital growth from its development activities, Ithaca has strongly piqued the attention of investors.

    Hurricane is particularly interesting in that it's targeting the basement reservoirs in the West of Shetland Basin. It has two discoveries, each of which is more than 200 million barrels [200 MMbbl] in size, which is particularly significant given that the average size of discoveries in the U.K. over the last four years has only been 25 MMbbl. Hurricane's discoveries are sufficiently big to attract the majors.

    The basement play has been largely ignored in the U.K. It is potentially a game changer for companies, particularly West of Shetland. BP's massive Clair Ridge development, sits at the other end of the Rona ridge from where Hurricane is active. BP is looking at the third phase of the Clair development and says the field could have 8 Bbbl of oil in place. Given that BP has produced oil from basement with earlier Clair well tests, the potential offered by productive basement reservoirs could add a significant amount to that. In fact, BP has invested in Hurricane. The U.K. government is very keen to see the basement reservoirs developed, and is making noises about offering tax losses for the basement play, which could certainly improve the economics.

    TER: How are basement reservoirs different from shale or other unconventional reservoirs?

    AK: The main difference is that a reservoir is essentially an impermeable rock, such as granite, so the oil is not actually held within the rock, but within the fractures. The key to developing basement reservoirs is being able to intersect the fractures within the reservoir.

    Hurricane's chief executive, Robert Trice, is arguably a world expert on fractured reservoirs. Hurricane has identified and built a very extensive model that understands these fracture networks. It recently drilled an appraisal well on its Lancaster discovery West of Shetland to assess the commerciality of its discovery. The initial well produced about 2.5 Mbbl/d from a well that had intersected one to two fracture zones. This time, the company drilled a well with a 1-kilometer horizontal section that intersected nine fracture zones, to see whether this would flow at commercial rates, deemed to be 4 Mbbl/d-and it flowed under natural pressure over 5.3 Mbbl/d. When the company used artificial lift, the well flowed at a capacity-constrained 9.8 Mbbl/d, which was far in excess of the 4 Mbbl/d needed.

    TER: The well maintained that level over time?

    AK: Yes. Hurricane tested the well over a three-week period; the result was fantastic. A lot of people in the industry were interested. I think the opportunity for the company to attract a farm-in partner is going to be tremendous.

    Hurricane is very close to infrastructure too. It also has several potential options for early production-one is via tie-back to a nearby field called Solan, which is operated by Premier Oil. This could deliver production, by 2016, of about 4 Mbbl/d, which would help fund the wider Lancaster development. Other options include the use of a VPU [versatile production unit].

    The scale of Hurricane's resource is such that the majors should be interested because of the impact on their reserve replacements. Hurricane's two discoveries are 440-470 MMbbl, depending on whether one of them is purely oil or a mix of oil and condensate, but there's certainly plenty that the company could give up to attract the interest of the majors. At 25 MMbbl, majors aren't interested; at 100-200 MMbbl, they're very interested.

    This development doesn't actually require unconventional technology. It doesn't require fracking. It's not high pressure. The only thing different is that it's a different kind of reservoir. Basement reservoirs are very prolific in Vietnam and can be found in Egypt, Yemen and Venezuela. In fact, there are fields onshore U.S. that have been producing since the 1960s from basement, but it's certainly not a play that has been actively targeted.

    TER: Ashley, thank you for your time.

    This interview was conducted by Tom Armistead of The Energy Report and can be read in its entirety here.

    Oil and gas equities analyst Ashley Kelty has more than 14 years experience in the oil and gas sector. Kelty joined Cenkos Securities Plc from the Lloyds Banking Group [formerly Bank of Scotland] oil and gas team, where he was responsible for the management of a portfolio of debt clients. He both led and assisted in raising debt for numerous oil and gas companies, including Dana Petroleum, Faroe Petroleum, Serica Energy, Valiant Petroleum and PA Resources. He has also worked for Enterprise Oil and Andersen Consulting [now Accenture].

    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 recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

    DISCLOSURE:
    1) Tom Armistead conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
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    3) Ashley Kelty: I own, or my family owns, 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: 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.
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    Tags: IACAF, OPHRY, Energy, Oil
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