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  • Strong Commodities + Weak Dollar = Canadian Energy Investing Bonanza: Chad Ellison

    Source: Peter Byrne of The Energy Report (3/20/14)

    www.theenergyreport.com/pub/na/strong-co...

    Chad Ellison of Dundee Capital Markets is gearing up for a red-hot Canadian energy sector. Commodity price strength and weakness in the Canadian dollar are creating a discount in Canadian oil and gas explorers and producers. In this interview with The Energy Report, Ellison elaborates on why he's excited to be an energy analyst again, and names companies with strong economics and management teams likely to reward energy investors.

    The Energy Report: Chad, is there a major investment theme that you expect to dominate 2014?

    Chad Ellison: From our perspective covering the Canadian exploration and production (E&P) sector, the dominant theme is going to be the weakening Canadian dollar and its relation to higher realized commodity prices. We've recently been seeing strength in both natural gas and oil. Western Texas Intermediate (WTI) has increased and Canadian differentials have come down.

    TER: What's your 2014 price deck for WTI and Brent, especially in light of stronger economic data from China?

    CE: We currently forecast $92.25/barrel ($92.25/bbl) for WTI and $105/bbl for Brent.

    TER: Last year, the price differential between AECO Hub and NYMEX natural gas futures proved to be a significant investment theme. Should investors expect that differential to be a major investment theme again this year?

    CE: I don't believe it'll have the same impact this year. Last year, the AECO blowout was caused by a change in the toll structure on the Canadian natural gas Mainline and gas volumes from Alberta essentially being displaced by cheap Marcellus gas. TransCanada Corporation (TRP:TSX) increased its interruptible service tolls, which caused shippers to fill up storage in Alberta rather than pay the fees to ship down the Mainline. However, we saw an increase in parties signing up for long-term service over the winter, which has worked to reduce the interruptible tolls to a more normalized level. While we may see some potential for volatility in the summer, we shouldn't expect anything as dramatic as last year.

    TER: The cold winter has left gas inventories low. How long do you think it will take to replace those inventories?

    CE: It's tough to say. U.S. natural gas has already returned to previous production levels after the freeze-offs from the cold weather. That said, full replacement of those depleted inventories will be dependent upon weather and demand. If it's not abnormally hot, inventories will be back in the mid-range by the time injection season is done in November. But if gas prices do persist higher, we could see a lot of gas-to-coal switching, as that looks pretty favorable at this time.

    TER: Do you expect the Henry Hub price to drop even more dramatically than it has over the last few days once the Western winter and the polar vortex ends?

    CE: Yes, that's a possibility. The forward strip still shows a decline in spring and a return to the $4 level in summer, but natural gas storage will be below 1 trillion cubic feet (1Tcf) for the first time since 2003. That's a lot of gas that has to be replaced.

    It will depend on the weather. If the recent cold winter is followed by a hotter-than-normal summer, we can expect to see increased power demand, which will slow the rate of injection and could cause high natural gas prices to persist.

    TER: The Henry Hub price of roughly $6/million British thermal units ($6/MMBtu) is about 50% higher than it was a year ago. Are we going to return to those former prices or is it going to be somewhere in the middle?

    CE: It will be somewhere in the middle-we're forecasting an average of $4.15/MMBtu for 2014. The storage indications mean that prices will be in the $4 range, but I can't see them going down significantly until a lot of that natural gas in storage is replaced.

    TER: How are the companies in your coverage universe gaining greater exposure to higher natural gas and crude prices? Are you seeing increased price hedging as commodity prices rise?

    CE: A large portion of the companies in our coverage universe are fairly well hedged already. When the gas price started to turn, companies locked in a lot of their volumes. As you look out on the forward strip for natural gas, the price does decline pretty dramatically in the spring. Although we've seen high prompt-month gas prices, it hasn't allowed companies to lock in that level for the full year.

    TER: Despite higher crude prices, majors like Exxon Mobil Corp. (XOM:NYSE) and Chevron Corp. (CVX:NYSE) are seeing their margins shrink due to higher costs. Does that underperformance allow companies in your coverage universe to find more time in the spotlight, or is there cost creep and trimmed margins in your space, too?

    "The dominant theme in the Canadian E&P sector is going to be the weakening Canadian dollar and its relation to higher realized commodity prices."

    CE: Most of the companies in our coverage universe are smaller junior and intermediate companies. These companies have smaller programs that allow them to be more nimble in deploying capital. We haven't seen any significant cost increases, and several of our companies have even reported successful cost reductions. However, if strong commodity prices continue, I expect we will see increased capital budgets on the other side of spring break-up, which could put some upward pressure on service costs later in the year.

    TER: When picking companies, do you look for those with an ideal mix of oil and gas?

    CE: At the moment, I prefer 60% oil-weighted names. Until this past winter, I would have said the oilier, the better-a lot of the 90%+ oil-weighted companies have traded at significant premiums. But we are now seeing a lot of demand for gas exposure, and companies that are a blend of oil and gas are benefiting on both sides. However, in the medium term, we're still far more constructive on oil than we are on gas.

    TER: The Canadian dollar has fallen dramatically over the last six months. How is the situation affecting the Canadian juniors you evaluate?

    CE: Companies are essentially paid in U.S. dollars, but their costs remain in Canadian dollars, so the current environment has shaped up to be a big win for Canadian producers. We've also seen oil price differentials narrow since Q4/13. As a result, we're expecting the majority of our coverage universe to post strong cash flow in Q1/14.

    TER: Some of the companies that you cover were having trouble raising cash. However, Tamarack Valley Energy Ltd. (TVE:TSX.V) recently raised $60.2 million ($60.2M) in an equity offering. Is capital more readily available now than it was last year?

    CE: Yes, some capital returned to the space in Q4/13, with a host of companies raising money for acquisitions, acceleration and debt reduction. Overall market sentiment seems to have improved, but it's still selective. The favorite names enjoy access to capital while other names trade at a discount valuation, making it difficult to raise money.

    TER: Tamarack is your top pick. Why does it merit that status?

    CE: First of all, Tamarack has a topnotch management team and has consistently been one of the top operators in the Cardium play. Management remains diligently focused on cost control and has been successful in driving down costs for the company's key plays, which significantly increases the rates of return and economics of those projects.

    Second, the company greatly expanded its inventory late last year with a farm-in agreement with a major, which covers more than 110 net sections of Cardium rights and increases its potential Cardium drilling inventory to more than 10 years. Its recent equity raise gave it the ability to accelerate drilling and earn all the lands that it deems prospective as part of the farm-in.

    Third, the company still trades at a relative discount to its peers. We forecast it to have top growth rates of 30%/share next year while maintaining one of the cleanest balance sheets in the space. While other oil-weighted juniors with these properties trade at 6x debt-adjusted cash flow, Tamarack is just more than 4x.

    TER: Would you call it a value play?

    CE: Absolutely, it's been a value story for a while. Between the farm-in, the equity raise and an acquisition it made last year, Tamarack ranks as one of the best, in my opinion. I think it's only a matter of time until it enjoys that premium valuation, hence our Top Pick recommendation.

    TER: Most of your coverage leans toward light oil, but Rock Energy Inc. (RE:TSX) is riding the revived fortunes of heavy oil. Does Rock have any more room left to run?

    CE: Rock Energy has had a great run, but it still has further upside potential. The company is yet again trending ahead of its guidance. Current production is estimated to be about 4,500 barrels oil equivalent per day (4.5 Mboe/d). That compares to management's full-year estimate of 4.1 Mboe/d and our forecast of 4.275 Mboe/d.

    The company should also be able to take advantage of a pending royalty break at its Mantario oil pool for proceeding with a polymer secondary recovery scheme. Essentially, two-thirds of corporate production is being charged at 25-30% royalty today. That number could drop to 1% in 2015, which could see 2015 cash flow/share come in north of $2 based on our initial estimates.

    The company has also been having some strong initial success in delineating its Viking light oil play, which has added some significant inventory. We'll be looking for an update on these items when the company reports its year-end results in late March.

    TER: The company is planning to drill 27 wells in 2014.

    CE: And that number could grow. The company is ahead of budget on production, and commodity prices are stronger. Management has indicated that it would like to drill one well per section on its Viking acreage to delineate the rest of the land base there, which will go a long way to derisking it and potentially making it a more attractive takeover target.

    TER: What rate of success has Rock had with previous drill programs of this scope?

    CE: It has been successful in all the wells that it's drilled at the Viking project. Additionally, it has an exploratory program that is looking for other pools similar to its Mantario property, and management is budgeting about a 30% chance of success. The company reported a new pool of discovery in its last operations update for a new Lloydminster pool and we anticipate further details as we hear about its Q1/14 drill program.

    TER: Rock has been rumored to be a takeover target for some time. It was rumored when shares were trading below $2, and the price is above $4 today. Who are the potential suitors?

    CE: A larger company would be interested given the low-decline nature of Rock Energy's production. Its first well at Mantario came on at 80 barrels per day (80 bbl/d), and two years later it's still doing 80 bbl/d. It would provide a nice platform of free cash flow that a company could redeploy elsewhere, either to fund drilling or a dividend.

    "We are now seeing a lot of demand for gas exposure, and companies that are a blend of oil and gas are benefiting on both sides."

    Given its interest in heavy oil, most speculation about a potential acquisition has pointed to Twin Butte Energy (TBE:TSX, Not covered). However, Gear Energy Ltd. (GXE:TSX, Not Covered), which had its initial public offering (IPO) last year, is another candidate. The Viking light oil discovery has opened Rock Energy up to a lot of other potential consolidators, including Whitecap Resources Inc. (WCP:TSX.V), Raging River Exploration Inc. (RRS:TSX.V), and the private company, Teine Energy Ltd. (Not Covered).

    TER: Tell us about some other compelling narratives in your coverage universe.

    CE: RMP Energy (RMP:TSX) is one of my favorite names right now. The company recently had a milestone catalyst with the successful completion of its pipeline and infrastructure project at Ante Creek on time. To date, it has had tremendous success drilling a Montney oil pool at Ante Creek, which has produced some of the best economics in the basin. Production had been hindered by takeaway capacity, but this was recently remedied with the commissioning of the company's pipeline expansion in March.

    We estimate there are more than six wells with capability of 1 Mboe/d each, with another four in various stages of drilling or completion in Q1/14. Compared to prior production levels, which were probably around 7.5-8 Mboe/d, there's going to be a steep ramp up as this pipeline comes onstream. We believe that its 10 Mboe/d guidance is ultraconservative, and production could be well above 12 Mboe/d in short order.

    We recently sat down with management, and I was impressed with its level of preparation to handle the increase in volumes. The company has a dedicated, 24-hour trucking terminal that will be able to take any volumes that won't go down the Pembina mainline.

    TER: What sort of cash flow are you estimating?

    CE: I'm forecasting production of 11.0 Mboe/d, so I'm ahead of where management is, but ultimately still behind where I think it will end up. That means cash flow/share of $1.31 in 2014, increasing to $1.69 in 2015.

    TER: What other companies catch your eye?

    CE: Surge Energy Inc. (SGY:TSX) is a dividend-paying company that's pursuing a strategy to moderate the pace of development. It is looking to reduce its decline profile in order to maximize free cash flow to fund a dividend and reduce risk.

    Since Paul Colborne took over as Chief Executive Officer and President, he's cleaned up the balance sheet, executed on five oil-weighted transactions and focused on cost reductions that have increased the company's netbacks 32% since Q1/13.

    The company is set to grow 3-5%/year (by management's estimates and our forecast) and offers an attractive 9.4% yield. It is paying debt down to provide greater returns and is cheap compared to some of its peers.

    TER: Tell us about the company's recent exploration success.

    CE: Surge's Valhalla Doig wells were some of the best producers in the basin last year. The company managed to extend its Valhalla play further north, which in turn expanded its inventory. The company is only planning on drilling three to four wells per year in the play, but with initial production capabilities of more than 600 bbl/d, it makes it pretty easy to replace declining production.

    TER: And finally?

    CE: Finally, Cardinal Energy Ltd. (CJ:TSX) is another dividend-paying company. The company just had its IPO in December and is led by the former Midway Energy Ltd. management team. Cardinal was designed to be the ultimate in sustainability. It has a low decline rate of less than 15% on legacy production.

    Cardinal has a low payout ratio and, standalone, the cleanest balance sheet in the entire sector. The company is currently drilling two horizontal Glauconite light wells at its key play, Bantry in southeast Alberta in Q1/14. If results can emulate Cenovus Energy Inc.'s (CVE:TSX; CVE:NYSE, Not covered) offsetting activity, the economics look very compelling.

    We believe that with a clean balance sheet and a decent valuation, Cardinal's team is well positioned to acquire additional assets that fit the company's low-decline model. The $0.65 annual dividend is currently yielding about 5%, although we believe there is room to increase this along with acquisition activity.

    TER: With the declining dollar and narrowing differentials, is it fun to be an energy analyst?

    CE: Absolutely. It has been challenging over the last few years, but when you look at the strength of commodity prices, the weakness in the dollar and the comparative discount that a lot of Canadian energy names trade at compared to their U.S. counterparts, it sets up for a very compelling investment in the Canadian energy sector. The key is to find the companies with strong economics on their plays and a management team that's likely to outperform their guidance. We still see a lot of upside from these levels.

    TER: Thank you, Chad.

    CE: Great talking to you.

    Chad Ellison joined Dundee Capital Markets as an energy analyst in November 2012. Prior to Dundee, he was with Canaccord Genuity's research team with a focus on Canadian domestic junior and intermediate companies. Ellison gained experience providing financing for E&P and oilfield service companies from 2005 to 2010 with GE's financial services arm. He holds a Bachelor of Commerce degree in finance from the Haskayne School of Business at 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 a list of recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

    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 owns shares of the following companies mentioned in this interview: Rock Energy Inc.
    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) Chad Ellison beneficially owns, has a financial interest in, or exercises investment discretion or control over, companies mentioned in this interview: Surge Energy Inc. Dundee Capital Markets and its affiliates, in the aggregate, beneficially own 1% or more of a class of equity securities issued by, mentioned in this interview: None. Dundee Capital Markets has provided investment banking services to companies mentioned in this interview in the past 12 months: Surge Energy Inc. and Tamarack Valley Energy Ltd. All disclosures and disclaimers are available on the Internet at www.dundeecapitalmarkets.com. Please refer to formal published research reports for all disclosures and disclaimers pertaining to companies under coverage and Dundee Capital Markets. The policy of Dundee Capital Markets with respect to Research reports is available on the Internet at www.dundeecapitalmarkets.com. 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.
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    Mar 20 4:10 PM | Link | Comment!
  • Zimtu Capital Analyst Says All Roads Lead To The Athabasca Basin

    Source: Tom Armistead of The Energy Report (3/6/14)

    www.theenergyreport.com/pub/na/zimtu-cap...

    Derek Hamill To the World Nuclear Association, 2% uranium ore is high grade. At 14%, 16% and even 20% uranium, the grades in the Athabasca Basin are astounding analysts and investors around the world. Derek Hamill, Zimtu Capital Corp.'s new head of research, tells The Energy Report about where the investment dollars are moving in the Athabasca Basin, and what areas and companies are worth watching going forward.

    The Energy Report: Derek, thank you for joining us. Why is the Athabasca Basin generally described as the most prolific uranium source in the world?

    Derek Hamill: There are a few factors that make the Athabasca Basin region of Saskatchewan and Alberta the best place to look for, and mine, uranium. Grade is the number-one factor. The average grades for a few of the bigger deposits in the Basin are above 15% U3O8, whereas the world average is far below 2% U3O8. The next important factor is that Saskatchewan is a great place to build a mine, and has been since the 1950s. There is all the necessary infrastructure (roads, power, mills) in most of the region. The western region of the Basin, including Fission Uranium Corp.'s (FCU:TSX.V) Patterson Lake South (PLS) project, does not have existing power or operating mills. But given how this deposit and potentially others are developing, it's just a matter of time.

    TER: What are the shortcomings of the Athabasca Basin compared to other uranium-producing basins?

    "Fission Uranium Corp. has brought renewed optimism for exploration in the southwestern areas of the Basin."

    DH: Infrastructure is a major factor that influences the economics of a potential mine. In the last few decades, the exploration in the western section of the Athabasca Basin has been markedly quiet compared to the east, where Cigar Lake, McArthur River and other mines and mills are located. The PLS area is relatively remote compared to the eastern section of the Basin. Additional exploration in the region will likely prove up another deposit, so over time the western side will build comparable infrastructure. However, there will need to be material investment to develop the necessary infrastructure in the western areas of the Basin.

    Another shortcoming of some deposits in the western region is the depth. The Cigar Lake mine illustrates this point quite well. The deposit is located between 410-450 meters (410-450m) below the surface, far too deep for cheaper open-pit mining, and the entire deposit needs to be frozen in order to prevent flooding. In 2006, a breach of this freezing technology caused significant delays. The project had an original start-up date of 2007, and is now expected to be producing by the end of Q2/14. Keep in mind though that many deposits in the Basin, including the PLS project, are at conventional open-pit mining depths.

    TER: I have seen high praise lavished on Fission's PLS deposit. What's the reason for that?

    DH: As mentioned, most of the past exploration and all the production in the Basin comes from the eastern side of the Basin. PLS has brought renewed optimism for exploration in the southwestern areas of the Basin that surround the discovery. Additionally, PLS is close to the surface, meaning open-pit mining of fairly high-grade uranium is an option.

    TER: Is there another deposit in the basin that comes close to PLS?

    DH: Right now in production is McArthur River, and Cigar Lake should start producing this year. Both are operated by Cameco Corp. (CCO:TSX; CCJ:NYSE). Average grades for both are listed as 14-16%. Once Cigar starts, McArthur and Cigar will be the two largest high-grade uranium mines in the world.

    "UEX Corp. is also a candidate for near-term production."

    Cameco is by far the largest producer in the Basin, followed by AREVA SA (AREVA:EPA). Denison Mines Corp. (DML:TSX; DNN:NYSE.MKT) holds an interest in the McLean Lake mill and in several near-term producing deposits. Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK), which purchased the Roughrider deposit in 2012 from junior Hathor Exploration for $654 million ($654M), appears to be advancing its deposit fairly aggressively. UEX Corp. (UEX:TSX) is also a candidate for near-term production with its Shea Creek and Hidden Bay projects.

    TER: How does grade affect price?

    DH: The major uranium producers, such as Cameco, AREVA and Denison, generally negotiate the price of uranium on long-term contracts. These companies also process all the ore in the three mills situated in the eastern region of the Athabasca Basin. It is not like other commodities, where the final product is sold on a fluid or open market. The producers generally control the mining and milling of the ore into a product called yellowcake, which is about 70% uranium. At this point, the yellowcake is either further refined in Canada or shipped directly to customers in the U.S. or overseas.

    Cameco's estimated cash costs at Cigar Lake could be somewhere around $18/pound ($18/lb) or less. High-grade ore can help control operating costs. Many uranium analysts believe that a long-term price of $60/lb U3O8 is needed to properly incentivize investment and maintain production for close to one-third of the world's high cost production. I believe the fact that Paladin Energy Ltd. (PDN:TSX; PDN:ASX) is placing operations at its Kayelekera mine in Malawi on care and maintenance (after continued operating losses) illustrates the material difference in cost structures that exist for producers outside the Basin.

    There are also some external factors. Saskatchewan is a politically friendly, stable environment, with an established regulatory and tax environment. There's technical expertise in the area as well. Grade is only one factor in the mining and milling economics of a deposit. The less material that you have to physically mine, truck and process, the more lucrative your operation.

    TER: You have reported the average compound annual growth rate of several forecasts of electricity generating capacity from 2010 to 2025 as 2.6% for nuclear and 6.3% for non-hydro renewables. That's a higher growth rate for renewables than for nuclear. Why is nuclear a better target for investment?

    DH: Nuclear is not necessarily better; there's actually tremendous room for both. Nuclear reactors can supply consistent electricity generation, night and day, over a long operating life, 40-60 years. The fuel costs represent 10-15% of the total cost of running a nuclear reactor. Even during the uranium price spike in 2007, operating costs for a nuclear reactor in the U.S. did not increase. That's an attractive property. Of course, nuclear can help reduce CO2 and SO2 emissions, which also makes the technology attractive in places like China, where air quality is an issue.

    Energy Consumption: Nuclear Vs. Wind and Solarnuclear wind and solar
    Source: BP Statistical Review 2013

    The biggest knock against nuclear energy has been the enormous capital costs of building reactors. Westinghouse Electric Co. is designing the AP1000, focused on simplifying the process-passive safety systems, fewer moving parts, etc. Hopefully, this kind of innovation can help control capital costs.

    In China, nuclear power is growing at a 10-year compound annual growth of about 14.5%, but it still represents only ~2% of the country's electricity production, so there is tremendous potential for nuclear power as well as renewables.

    Nuclear Reactors Worldwide

    uranium prices
    Source: IAEA|PRIS, WNA

    TER: Most analysts are expecting the price of uranium eventually to rise from its current low. How will a higher fuel price affect the growth rate of nuclear power generation?

    DH: I doubt it will. As I said, fuel costs are only 10-15% of the nuclear reactor. The demand from nuclear electricity generation going forward will have a strong influence on uranium pricing, but the price of uranium shouldn't have a huge influence on the decision whether to build nuclear reactors.

    I know there's been a lot of talk of a nuclear renaissance, but it's complicated. The West, outside of France, hasn't shown much of a commitment to nuclear energy. In fact, last year the U.S. prematurely closed four reactors. It doesn't seem like there is much support for the industry. China appears committed, but will take a few years for the country to really become the uranium market mover. In the current environment, I don't see uranium prices materially increasing. Again, that's why the Athabasca Basin is an important region.

    TER: Are Canadian uranium producers seeing any benefit from the termination of the Non-Resident Ownership Policy?

    DH: Not in particular. I wouldn't be surprised to see some Chinese utilities invest in the Basin, but I don't see them becoming mine or mill operators. It would make more sense to partner with a company like Cameco.

    TER: Is anyone visibly benefiting from the policy change?

    DH: Companies out of Asia have expressed fairly robust interest in investing in the Athabasca Basin's uranium exploration. This has more to do with long-term growth in commercial nuclear generating capacity in Asia than with any Canadian policy change.

    TER: You have a half-dozen uranium companies in the basin under coverage. What are some of their strengths and weakness?

    DH: Zimtu Capital Corp. (ZC:TSX.V) has equity exposure to several uranium exploration companies, including, most recently, Lakeland Resources Inc. (LK:TSX.V). The major strength we at Zimtu look for as a project generator are the people actively involved in a project.

    Lakeland Resources is a great case in point. The company has a strong technical team with a clearly defined business strategy, and has added some serious uranium expertise to the advisory board. Lakeland has a large land package, much of which has historic data. Lakeland's focus has been to enhance this historical data with modern at-surface geological and geophysical techniques before partnering the individual projects for drilling. In this way, the company is able to diversify some of the exploration risk by working on multiple targets at the same time. The large land package also allows Lakeland the freedom to act as a property vendor. If there is a weakness in this strategy, it is that by partnering, Lakeland sacrifices some of the upside in the event of a discovery.

    NexGen Energy Ltd. (NXE:TSX.V) has benefited from its location near PLS, so it's an attractive area play. NexGen has also proven to be able to raise capital during tough market conditions. Zimtu is a shareholder of the company.

    Skyharbour Resources Ltd. (SYH:TSX.V) is part of a syndicate, the Western Athabasca Basin Syndicate, that shares in the costs of exploration. We don't have any direct exposure to Skyharbour or the syndicate, but it is a different business model that, if done correctly, makes sense. Of course, efficient cooperation among four equal partners may take some work.

    I'm not a geologist. My background is in finance, so I like to look at many different strategies and promote diversification.

    TER: You have highlighted a lot of difficult variables in assessing the uranium space. Do you have some parting advice for people who would like to take a look at it?

    DH: For investment in nuclear, in terms of mining and exploration, it's a pretty simple strategy. You already know the major producers, such as Cameco and AREVA in Canada. In the U.S., there are a few smaller low-cost operations. So if you are a cautious investor, your money will probably be best with current producers. Next you have the near-term producers of which there are only a handful. Then there are the junior miners in Canada. Those that are in the Athabasca Basin hold a lottery ticket to a monster deposit. Hathor Exploration is an excellent example of a company that in 2006 had a market cap of about $6M, discovered the world-class Roughrider deposit in 2008, and was bought by Rio Tinto in 2012 for $654M. You need to look for a junior with a good portfolio of projects and the right people in order to make a discovery. I would caution people looking at uranium exploration companies to try to diversify. The Athabasca Basin is a low-cost producer. So if the uranium price remains under distress, the Basin should attract both domestic and foreign exploration dollars.

    TER: Thank you, Derek.

    DH: Thanks, Tom.

    Derek Hamill completed his Master of Financial Analysis and Professional Accounting at La Trobe University, a leading Australian academic institution, and holds a bachelor's degree in economics from the University of Calgary. Between degrees, Hamill worked for several years as an investment executive for ScotiaMcLeod, a leading Canadian wealth-management firm. As the newly established head of research for Zimtu Capital, Hamill provides long-term outlooks for various commodities and updates on key internal portfolio holdings. He has access to an impressive array of experienced and knowledgeable industry professionals who are associated with the Zimtu family. Zimtu's circle of industry contacts includes all aspects of the mineral exploration and development process, from first acquisition of mineral claims to the cutting of the ribbon at mine opening.

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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 owns shares of the following companies mentioned in this interview: None.
    2) The following companies mentioned in the interview are sponsors of The Energy Report: Fission Uranium Corp., UEX Corp. and Zimtu Capital Corp. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
    3) Derek Hamill: 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: Zimtu Capital has a financial relationship with both Lakeland Resources and NexGen Energy. To my knowledge we have no relationship with Skyharbour. 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.
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  • A Pair Of Top Picks, A Risky Pair And An Ace In The Hole: Justin Anderson Shows His Hand
    Source: Tom Armistead of The Energy Report (2/27/14)

    http://www.theenergyreport.com/pub/na/a-pair-of-top-picks-a-risky-pair-and-an-ace-in-the-hole-justin-anderson-shows-his-hand

    Justin AndersonSince its inception in 2007, the Salman Partners' Top Pick Index has made a 251% return. The index is a huge pot for investors in the international oil and gas space to bet on, but it's not for the untutored. Salman Partners Analyst Justin Anderson walked The Energy Report through the risks and returns of the game. Find out how he plays his hand.

    The Energy Report: Justin, welcome. Tell us about Salman Partners Top Pick Index. Why was it established?

    Justin Anderson: Top Pick Index was established to contrast the performance of our company's favorite investment ideas against a Canadian benchmark of general stocks and to see how those investment ideas performed. Analysts look at the stocks under their coverage and then they try to pick one or two stocks that they think are going to be the best performers in that group over the next 12 months.

    TER: What's the track record? Do Top Picks generally perform as advertised?

    "Over the last two years, the Top Pick portfolio has returned 38% versus 21% in the general S&P Index."

    JA: So far it's been a really good track record. Since inception in 2007, the Top Pick Index of Salman Partners has had a 251% return versus the benchmark index, which has returned 30%. Over the last two years, the Top Pick portfolio has returned 38% versus 21% in the general S&P Index.

    TER: Canacol Energy Ltd. (CNE:TSX) just earned the Top Pick recommendation in December. How did that happen?

    JA: Over the last half of last year, Canacol was increasingly interesting for us, especially when it made a discovery called Labrador in the Llanos Basin of Colombia. That was an important discovery, not just for the intrinsic value of the discovery itself and the potential long-term cash flow that it would add to the company, but also because it meant that Canacol was going to be able to get to the finish line with respect to some of its other assets. What I mean by getting to the finish line is that Canacol has built up a very impressive Middle Magdalena basin unconventional position, very sensitive to time and funding. This conventional discovery at Labrador unlocked some less noticeable value in its Middle Magdalena position. That got us very interested. Then, when it made an additional discovery in the Llanos Basin called Leono, that discovery by itself looked really good, but the compounding benefit to the rest of the portfolio was very strong, so we upped it to a Top Pick.

    TER: What are the most exciting positives about Canacol?

    JA: To use a baseball analogy, I think Canacol is not really looking for the solid base hit. It's looking to hit a home run. This company really wants to go big. That's exciting, when you have a management team that is aggressively looking to make a multiple big return for its shareholders. The reason it's in that position, as I said, is that it built up this large unconventional position in Colombia. It's a position that, in terms of acreage, is second only to Ecopetrol SA (ECP:TSX; EC:NYSE), the national oil company there. Should the unconventional Colombia space ever take off, look out. This is a company that will perform extremely well if that happens.

    TER: What's the biggest concern?

    JA: I think it's the other edge of the same sword. If the unconventional Colombian space never does take off, if some of the initial well results are not that great, then you could get in a situation where that acreage becomes less important overall. I think that's actually the biggest risk to the company as well. The nice thing about Canacol is that it has a very robust conventional portfolio that gives you a lot more downside protection in that scenario than some other companies that may be so exposed.

    TER: South America is not the most stable operating environment. What are the political and security conditions in Canacol's main operational areas of Colombia and Ecuador?

    JA: For Canacol, I think the main issue is in its heavy oil portfolio. That's in the center of Colombia; it has a bunch of heavy oil blocks. Those blocks are very close to some previous FARC strongholds, FARC being the organization that has been agitating through violence in the country to cause a communist revolution. Because of that proximity, people have been dissuaded from ramping up development activity in the area. It has affected Canacol's heavy oil exploration appraisal work. I think that's the biggest risk that it's exposed to. On the plus side, I don't think stockholders really care about its heavy oil position at this point, and it's of tertiary concern to the market.

    TER: What about Ecuador?

    JA: Ecuador is much more of a basket case than Colombia. Ecuador is problematic because it's not just lingering terrorist groups; the government itself is the issue. That being said, the contract Canacol signed with the government of Ecuador is one that provides much lower netbacks. It is a direct service agreement with the government. It's an isolated issue for the company; I don't really see any risk there.

    TER: You created an unconventional portfolio for the Middle Magdalena unconventional play. Why?

    JA: Unconventional positions, especially in the international locations, are extremely sensitive to initial results. You might have a very large position, but the fracking response, the geology and the capex/opex of the initial wells are going to have a major impact on the long-term development of the play-then slap political risk on top of that. We wanted to look at unconventionals in a unique way, rather than value all of that acreage in one blow. We built a stochastic or Monte Carlo model to try to capture the range of scenarios that those sensitive initial conditions could provide. That's why we set up this separate unconventional portfolio. The effect that you get is a much more tailing effect: Either things go very poorly and you get no value or things go extremely well and you get a huge amount of value. There isn't really much of a middle ground for these emerging unconventional plays.

    TER: Why was it necessary to separate the unconventional portfolio from the other parts of your portfolio?

    JA: A conventional prospect is more independent. If you have five conventional blocks, it makes sense to value them separately and then aggregate the results of those valuations, whereas with an unconventional position, you might have the same five blocks, but in this case they're either all going to work or none of them will work. It's much more common to see significant correlations between the successes or the failures, as opposed to a conventional portfolio, where it's completely normal for, say, two of the five blocks to work out.

    TER: Outside North America, shale development has an uneven record. Why is Canacol's holding of 545,000 net acres of Colombian shale a positive thing?

    JA: If you asked people in North America 10 years ago what would be the status of the Eagle Ford or the Montney or the Bakken, I think people would probably have been very skeptical about how those plays would perform. Ten years later, we're seeing massive growth in these resource plays. There's absolutely no reason why some of the best quality resources around the world won't see the same kind of activity that those plays have seen. We've seen it in North America first simply because we've got the most stable political environment, but the rocks are the same around the world and you're going to see the same booms in other countries.

    The question simply becomes, where are we going to see the next boom? The answer to that question is, you've got to have great-quality rocks. We see some of that in Colombia. We see some of that in Argentina. We see some of that in places in Africa, India and China. Then the next question you have to ask is, considering those most prospective areas, where is the most likely place to see near-term capital flows? That's really a political question. In this department, Colombia actually shines for its relative stability. Combine quality rocks with good political environment, and Colombia starts to look pretty attractive. Obviously there's still a lot of uncertainty as to which way the tail will go in this one, but I think it's a pretty good speculative bet.

    TER: One of the problems that has affected the viability of shale oil and gas outside the U.S. is that the quality of the rocks is different in new areas, like Poland, for example, than what they were anticipating.

    JA: It depends on the location. I would argue that the best rocks in the world for unconventionals outside of North America are probably in Argentina, in the Vaca Muerta. That is an extremely high-quality resource. I would say that Colombia is comparable in quality to Argentina and the Eagle Ford. It's not as big, but the quality's likely there. Arguably the quality is actually a more important factor for early-stage development than quantity alone.

    TER: Is Canacol management looking for a buyout?

    JA: I think they're open to it. One of the great things about Canacol is its management is very down to earth. They're there to return money to shareholders, as opposed to some companies where we see them establishing a corporate kingdom. Canacol is focused on shareholder value. If a company comes in that offers that, I think they would go for it.

    TER: Parex Resources Inc. (PXT:TSX.V) is another Top Pick. Why?

    JA: Parex is an interesting company. It's a company that has a very undervalued production stream. It's trading at multiples far below comparable companies in Canada and the U.S. Nearly all of its acreage is in the Llanos Basin of Colombia. The Llanos Basin is known for high decline rates, quick payout times and light oil.

    "You can't just look at the reserves; you have to look at acreage as well."

    What happens is, investors are very focused on the near-term reserve number, and they do the calculation against production and say, oh, this is a short reserve life. Then they apply a significant multiple discount to the company. The problem is you can't just look at the reserves; in some cases you have to look at acreage as well. Parex has enough acreage where reserve adds are a foregone conclusion. It has built up such a robust position of acreage that it is going to book new reserves in the future.

    Not all exploration acreage is equal. This company is sitting on exploration acreage that will become reserves. I think the market is not giving it any value for that when in fact it should be. That's the source of the opportunity with Parex, where the actual reserves in the future will be much more than the current reserves, but you're only paying depressed current reserve multiples to get access to the stock.

    TER: The Parex stock has trended up since July of last year. You recently reiterated your Top Pick recommendation and raised your target from CA$9.30 to CA$10/share. What is the driver here?

    JA: The strategy's working. We got really excited about this name mid-2013, when Parex had some drilling success, started to diversify its portfolio and also made some acquisitions to expand its acreage running room. All of this put the company in a position to apply its operational expertise to these different plays and take advantage of that.

    What we've been seeing over the course of the last nine months is the company executing on the strategy, adding reserves. We just saw a great reserve number recently. The stock has climbed. That's being partially driven by reserve adds that the market seemed surprised to see.

    TER: Parex is indexing its oil price to Brent instead of to West Texas Intermediate. What's the significance of that?

    JA: It probably just underscores even further the ridiculousness of the low multiple that it's trading at because its production is more valuable than a lot of the Canadian domestic production, which is getting more depressed realized prices. When you look at the production multiples you just say, how is this possible when the company's selling its crude to Brent prices? It just exaggerates the opportunity that much more.

    TER: Africa Oil Corp. (AOI:TSX.V) is not a Top Pick; it's a Hold. Is that because of the risky neighborhood it's in?

    JA: There are two major issues there. One overriding issue is, will it see development anytime soon of some of the impressive discoveries that it has made over there? Africa Oil is not far from Uganda, where there have been significant discoveries that no one has been able to monetize, and Africa Oil's nearby discoveries are newer. Yes, the company is in Kenya. It's a little bit closer to the market, but at this point, there's still not as much oil discovered there as in Uganda. It is earlier stage. It's going to take more time to appraise it. There's still a lot of risk that it won't find enough oil there to justify a major development and pipeline project.

    The other issue is, it's a really exciting stock. Africa Oil has done some incredible things in terms of exploration. Unfortunately, an analyst doesn't necessarily look at how well the company is performing. We look at how we think it will perform in the future relative to the expectations, which are reflected in the stock price. From that perspective, I see a company that could go one of two ways: It's either going to perform very well if it's able to make some more discoveries, perhaps extend the trend a little further north and find well over a billion barrels in that basin. Alternatively, if it's unable to open up any other basins in the area and there's a risk of stranded oil discoveries, then the stock could get killed. A buyer of the stock is going to go one of those two ways, big upside or big downside. The question then becomes, what price are you willing to pay? The current price just doesn't give me a compelling reason to say it's a good bet.

    TER: When do you think you'll have a clearer picture of its prospects?

    JA: I think it's going to be over the next six months. It's doing a ton of drilling this year, which is exciting, both in the Lokichar, where it's had its discoveries, and outside the basin. I think the Lokichar wells are far less important than the wells outside the basin. It's drilling on Block 9, for example, in a different basin. It's drilling north of its discoveries and it's also doing some work in Ethiopia. If any one of those three other play concepts that it's tinkering around with turns out to be successful, then it'll be an excellent story. We should know that in the next six months, but I think that all three of those other plays are very risky. Investors are taking on a big risk. If all three do not work then you could be in a tough situation with the stock.

    TER: Mart Resources Inc. (MMT:TSX.V) is another hold and also another African operator. What's the status of its Umugini pipeline?

    "If Mart Resources Inc.'s.Umugini pipeline gets commissioned, production goes past 20,000 bbl/d and the losses are cut to under 5-10%, that would be a positive thing for the stock, there's no question. It's certainly a possible scenario."

    JA: It's under construction. It's been unfortunately delayed by forces beyond the company's control. Estimates are that it should be completed midyear 2014.

    TER: How will the pipeline's completion benefit Mart's stock price?

    JA: I think people appreciate that the company needs the pipeline to make the operation more robust. That is probably reflected in the stock. I don't actually see a huge potential from the pipeline completion alone. I think the more important thing will be production. If everything goes perfectly, the pipeline gets commissioned, production goes past 20,000 barrels/day through the line and the losses are cut to under 10% or 5%, that would be a positive thing for the stock, there's no question. It's certainly a possible scenario. The greatest concern for me is how much capacity is behind the pipe. How much can Mart ramp up production once the pipeline is installed?

    Talking to investors who hold the stock, I think there are a lot of high expectations for how much capacity is behind the pipe. If you compare that to the reserve numbers, I'm a little skeptical over how much it will be able to push through there. The other issue I have is regarding the Pioneer tax status that has come to an end for the company. It started this year. Once it chews through all the tax credits, that will start to affect the cash flows in a material way as well.

    TER: How will Mart ensure the Umugini pipeline will be more secure than the one it's using now?

    JA: It will have to do the same things it's doing now, trying to make agreements with the government about the losses. It is encouraging see recent news that it's talking to the government and establishing a committee to review the losses. Just having two export options will be a good thing for the company. That, more than specific details of what it's going to do to protect the pipeline, is important.

    TER: You have a lot more companies than those four under coverage. What are you really excited about right now?

    JA: The other one to highlight would be Gran Tierra Energy Inc. (GTE:TSX; GTE:NYSE.MKT). It has been our Top Pick for a long time. Just recently, we rated it a Buy only because we felt Parex and Canacol were even more compelling stories, but Gran Tierra remains a very exciting story. It's made major discoveries in Peru and it's a long-term, value-player's dream because it's getting a very cheap multiple on its reserves right now and has a lot of extra-exciting exploration in Peru.

    TER: Justin, you've given us a lot to think about. I appreciate your time.

    JA: Thank you.

    Justin Anderson joined Salman Partners in December 2011 as an oil and gas investment analyst. He is the founder of the research company Xedge, which specialized in rigorous stochastic analysis of oil and gas exploration portfolios. Previously, he worked for the investment banking energy group at BMO Capital Markets, after having worked on energy company strategy and valuations at McKinsey & Co. Anderson completed a Bachelor of Science in mechanical engineering and a Bachelor of Science in Russian studies at the University of Calgary. He then completed a Master of Science in aeronautical engineering at MIT, with his research and thesis focus on energy economics. While at MIT, Justin founded and commercialized a high-tech company called Waybe and was an executive chair of the MIT Energy Club.

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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 owns shares of the following companies mentioned in this interview: None.
    2) The following companies mentioned in the interview are sponsors of The Energy Report: Mart Resources Inc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
    3) Justin Anderson: I or my family own shares of the following companies mentioned in this interview: Canacol 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: We seek to do business with all of the companies mentioned (other than Ecopetrol) but have never done any business with them in the past. 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 op

    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

    Feb 27 7:06 PM | Link | Comment!
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