The Energy Report's  Instablog

Source: Peter Byrne of The Energy Report (4/11/13)

http://www.theenergyreport.com/pub/na/15146

A short-term investor's trash is a long-term investor's ticket to returns, and with resource stocks hitting all-time lows during a time of robust commodity prices, now is the time to snap up promising energy companies, Steve Palmer asserts. As a founder of AlphaNorth Asset Management, of one of Canada's market-leading investment firms, Palmer has a practiced eye for spotting winners in a troubled market. He shares his picks in this interview with The Energy Report.

The Energy Report: In your interview last July, you talked about how market volatility was challenging investors in small-cap Canadian resource stocks. Have prospects changed since then?

Steve Palmer: The resource market has been volatile for a while. I was bullish last July, and I'm still bullish: stocks are that much cheaper now.

TER: What's your global outlook for resource stocks?

SP: Economic growth is accelerating, worldwide. The three largest drivers of global growth are the U.S., Japan and China. The gross domestic product growth rates of these three economies will continue to increase into 2014. Of the three countries, China is the largest contributor to global growth. It just has a huge, growing demand for energy, particularly for oil and gas, and it imports a lot of energy resources. Given this global backdrop, the outlook continues to be very good for energy commodity prices, and that factor will support the coming resurgence in resource equities.

TER: Your AlphaNorth Growth Fund has about 19% invested in energy stocks and about 51% in materials. What accounts for this distribution ratio?

SP: There's no great science behind it. I do not pay close attention to the exact weightings between those two areas. A lot of the investment research that we do is based on assessing specific bottom-up company fundamentals. It just so happens that over the last few quarters, we have identified names in the materials sector that offer better risk versus reward. They are the names that have performed theworst over the last year, so we think that there's significant potential for those stocks to rally going forward.

TER: Do you short firms as well as go long?

SP: Sometimes. But we primarily invest on the long side. There's far more money to be made on the long side than in shorting companies.

TER: What's your hedging strategy?

SP: When we believe that the market is subject to potential correction, or that it is overvalued, we do look to hedge some of our exposure. And when we come across a specific company that seems ridiculously priced, we will consider shorting it.

TER: Which energy firms in your portfolio have the best performance?

SP: The best performer for us is probably a recent addition, Iona Energy Inc. (INA:TSX.V). It is a Canadian oil and gas producer. It recently made an acquisition in the North Sea that will significantly bump up its production. Production results on its Huntington asset are imminent; Premier Oil (PMO:LSE), which has a 40% working interest on the asset, has suggested that flow rates could exceed initial guidance by 20%. Iona's growth profile is expected to increase to over 6,000 barrels oil equivalent per day (6 Mboe/d) in 2013, primarily due to the additional oil coming on-line from Huntington. The company could earn $0.25/share this year, which would equate to less than three times its price/earnings ratio (P/E). It's trading at an enterprise value per flowing barrel of around $45,000, and if production at Huntington does exceed guidance, it would be even cheaper.

TER: Last July, you said that uranium was a reasonable investment. Is that still true?

SP: Yes, I still like uranium in the long term. Japan will restart its reactors, and China is building a significant number of new nuclear reactors. These two factors will drive the uranium price higher. Also the Russian-U.S. Megatons to Megawatts program to dismantle warheads to retrieve uranium and sell it to the U.S. is ending. The program's goal to eliminate 500 metric tons of warhead material will be completed in 2013.That decreases the supply, and will drive up the price.

TER: Is your fund invested in uranium firms?

SP: We have an investment in Ur-Energy Inc. (URE:TSX; URG:NYSE.MKT). That's one of the few uranium companies that operate in the U.S. It has an in-situ uranium mining project in Wyoming. It has received all permits and is expected to begin production in H2/13. Thus far, the company is on budget and on schedule. It has secured four offtake agreements that account for 30-50% of production, and has an exclusive marketing agreement with Nucor Corp. (NUE:NYSE). Contracts have been secured significantly above the current spot prices and above long-term prices as well. Management estimates that the operating cost per pound could be below $15 (the preliminary economic assessment uses $16.12/lb), making it one of the lowest-cost producers. Total capital costs of the plant and well fields are just $31 million ($31M), adding to the robust economics of the project. We expect production to be around 500,000 lb this year and to ramp up to 1 lb next year. We anticipate a rerating of the stock once it becomes a producer.

TER: To what do you attribute the low level of prices for uranium over the last year?

SP: Many investors believe that the resource cycle is over, so at the present time, the movement is mostly momentum and liquidation selling. There are a lot of redemptions from resource funds. It's kind of a snowball effect. The resources have performed poorly. The typical retail investor chases performance, so he sells more at the lows. Then when the markets rise, the investors pile in, like they're piling into anything with a yield right now; some of the fixed-income products are hitting all-time highs. And investors are selling the resources as they hit new lows. It's all liquidity driven.

TER: Yet, in this atmosphere, you remain consistently bullish?

SP: I've been early in calling the bottom for the resource stocks before. That was the case in 2008, and the current situation is very similar in terms of the junior resource market. We were proven to be correct when the market rallied significantly in 2009 and 2010. I believe that will occur again this time, and that we are once again at a major market bottom.

TER: How have your funds fared in comparison to benchmarks over the last year or so?

SP: The AlphaNorth Partners Fund, which is our flagship hedge fund, has done quite well considering the state of the junior markets. The Toronto Stock Exchange Venture Index (TSX.V) is the benchmark I use, which is down 58% in the last two years. Our Partners Fund was actually up 2.4% in 2011 and down 6.8% last year. Our Growth Fund, which is a mutual fund that focuses on small and mid-cap Canadian equities, has a significant weighting in the resource space. It has more or less mirrored the returns of the TSX.V since its launch in July of 2011.

TER: Given the volatility and uncertainty of the small-cap resource market, what methods do you primarily look at when deciding whether or not to pick up a stock?

SP: Management is important. On the energy side, we look at the ratio of price to cash flow relative to the peer group. We look at the growth prospects. We look at the ratio of price to flowing barrels of oil equivalent. Those are the main factors.

TER: How do you assess management?

SP: We look at the managers' track records, and how much skin in the game they have in terms of an equity holding in the company. We typically meet management to discuss the business plan and the prospects prior to investing.

TER: What are the advantages or disadvantages of owning small-cap equities in today's market?

SP: Over the longer term, small-cap equities outperform other asset classes, and that's been proven historically. Today, the large-cap equities are doing very well. They have recovered. The U.S. major indices are at all-time highs or very close. The European indices are all doing very well. The Toronto Stock Exchange (TSX) has rallied, but it is lagging behind the other exchanges. The TSX.V, which is largely resource based, is hitting new lows.

There continues to be a huge disconnect in resource equities relative to growth potential and commodity prices. But as the larger-cap names become more fully valued, or more expensive, investors will start to look at underperforming smaller companies that have better risk-reward profiles.

TER: What about oil and gas?

SP: Everyone was negative when gas was at $2 per thousand cubic feet ($2/Mcf). I like to be contrarian whenever possible, so I wasn't particularly negative at that point. I knew that the price would recover. And it is now back to $4/Mcf. The U.S. inventories have come a long way over the last few months in terms of getting back to normal levels. A few months ago, gas inventories were 30% above the five-year average; now they are below the average inventory for this time of year.

Energy names have been caught up in the negative investor sentiment, even though the commodity prices have done quite well. Natural gas has gone to $4/Mcf, and West Texas Intermediate is trading at roughly $95 per barrel ($95/bbl), which is quite a good price historically.

TER: Do you think that the inventory will build up in North America, and that the U.S. will become an oil and gas exporter?

SP: Maybe over the longer term. There's a trend toward that, but U.S. growth is accelerating. The economy is doing much better, and that is going to increase the demand for energy.

TER: What about alternative energy sources? Do you see any growth there?

SP: Yes, I do. That's one of the factors that is helping the U.S. to be more self-sufficient on the energy front, as some of these alternative sources are displacing what otherwise would be demand for oil and gas.

TER: Do you see wind or solar as more worthy of attention from investors?

SP: I assess the alternatives more from a company-specific level. One must be very careful with some of these industries, because they do not make sense from a financial point of view without government assistance. I try to avoid situations where an alternative energy firm is completely dependent on government policies to make money, as policies can change overnight. If a firm is relying on tax credits to compete, that adds a lot of risk to its profile.

TER: But the large oil and gas companies also access tax advantages and subsidies of various sorts. Could those go away as well?

SP: It's always a risk, but the oil and gas industry is so much bigger. It is a very powerful lobbying group. Consequently, it's a lot harder for the government to change oil policies than it is to change the policies affecting niche areas like solar or wind.

TER: Do you have any parting comments about why you're bullish, and why people should follow your lead?

SP: I'm bullish on small caps because they are the best-performing asset class over the longer term. Yes, they are volatile, but if investors with long-term time horizons can initiate positions during periods of significant market weakness, they can dramatically increase their returns. That's what we have right now. We've had a period of significant market weakness, yet commodity prices are fairly robust, and the large-cap equities are doing quite well. I see the present time as a very attractive opportunity.

TER: When should people sell small caps?

SP: They should sell small caps when they're hitting new highs and everyone is talking about them, or when they become fundamentally fully valued; that is, when the valuation metrics-like the price-to-cash flow and price-to-earnings ratios-go higher than their long-term averages.

TER: It was nice talking to you again, Steve.

SP: Thanks.

Steve Palmer is a founding partner, president and chief investment officer of AlphaNorth Asset Management and currently manages the AlphaNorth Partners Fund, AlphaNorth Growth Fund and AlphaNorth Flow-Through LPs. Prior to founding AlphaNorth in 2007, Palmer was employed as vice president at one of the world's largest financial institutions, where he managed equity assets of approximately $350M. Palmer managed a pooled fund that focused on Canadian small-capitalization companies from its inception to August 2007, achieving returns that were ranked number 1 in performance in its category by a major fund ranking service. Palmer also managed a large-cap fund, which ranked in the first quartile of performance among other Canadian equity pooled funds. Palmer earned a bachelor's degree in economics from the University of Western Ontario and is a Chartered Financial Analyst.

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DISCLOSURE:
1) Peter Byrne conducted this interview for The Energy Report and provides services to The Energy Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Ur-Energy Inc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Steve Palmer: 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: Iona Energy Co. Ltd. and Ur-Energy Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

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

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

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

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

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Email: jluther@streetwisereports.com

Source: Peter Byrne of The Energy Report (4/9/13)

http://www.theenergyreport.com/pub/na/15139

What is the best way to juice up your portfolio for a rich retirement? Natural gas and uranium are here to stay, says Stansberry Research's resident medical doctor and retirement investment guru, David Eifrig. In his interview with The Energy Report, Eifrig shares tips to maintain your financial health-but get plenty of rest and exercise so you can enjoy those golden years.

The Energy Report: David, you've had successful careers on Wall Street and in the medical profession. Why are you now focused on helping people to prepare for retirement?

David Eifrig: The vocation to help others came out of my natural aversion to authority; I don't really like institutions. At heart, I am an anarchist, a Libertarian, a freedom-lover. This mindset inspires me to teach people about how to live self sufficiently. I'm naturally enthusiastic about combining the important issues of finance and personal health, so I thought, why not share my insights with others?

I am a lifelong bargain hunter. And I am evidence-based when it comes to evaluating both medical and financial issues. Porter Stansberry heard about my background in biotechnology, medicine and finance. And he convinced me that reaching out in a newsletter is a more effective way of communicating than seeing one person at a time in a clinic. The Retirement Millionaire combines all of my knowledge and various interests about retirement.

TER: You've written that we're entering a new stage of profitability for investing in stocks. Please explain how economic indicators support this prediction.

DE: One of the main economic indicators of economic resurgence is the cheapness of bank financing. Interest rates between the banks-the Fed funds rate-is super-duper low. Banks access funds at cheap rates and pay savers next to nothing. Banks charge 6-7% for loans and the interest rate spreads make them rich. As the banks do more lending, the loans generate more business activity, and that means more money flows into the economy at all levels.

TER: Do you think there's any danger of excess inventory in energy commodities?

DE: I recently published a chart showing that crude oil inventories in the U.S. are at record highs. But I do not see that phenomenon as creating excess inventory. We are emerging from economic winter. People are starting to fly more and drive more and use more energy. Chinese and European consumers are slowly coming out of hibernation, too. I am not saying that energy demand is going to go crazy, but there are positive signs of pickup. Energy supplies are building up, in part, because we have made huge technological advances. We suck gas, gas liquids and oil out of the ground more than ever, cheapening it. And energy use correlates nicely with cheaper energy as well as with economic growth. U.S., manufacturers are talking about building new plants for the first time in twenty years.

TER: Stansberry Research recommends several strong buys in energy stocks. Can you talk about why these investments are good candidates for a retirement portfolio?

DE: For retirement capital allocation, I like Exxon Mobil Corp. (XOM:NYSE), which is a classic leader in the oil and gas industry, as are Chevron Corp. (CVX:NYSE), Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE) and Occidental Petroleum Corp. (OXY:NYSE). For decades, these companies have seen business cycles come and go; they have seen political unrest in countries that they do business in. They will keep grinding away, doing business and making returns on their capital, and supporting a nominal amount of income through dividends. It just makes sense to be there with them in the long term. Particularly, if one is worried about the ecological side-that the industry could cut back on fracking-then it makes sense to be in companies that are stable.

TER: Do you think fracking is in danger of being downsized in the U.S.?

DE: The only good science that I've seen on that issue concerns the risk of earthquakes. Companies will want to be more careful around fault lines, but that will not stop fracking.

TER: Is the U.S. poised to become a major gas exporter to the international energy market?

DE: My understanding is that natural gas will increasingly be exported as liquefied natural gas (LNG). The international spreads on liquid gas are incredible. It sells for about $17 per million British thermal units ($17/MMBtu) worldwide, and about $4/MMBtu in the U.S. For example, a gas company calledCheniere Energy Inc. (LNG:NYSE.MKT) is transforming itself from a gas importer to a gas exporter by reversing the direction of flow in pipes connected to the export terminals. It's waiting on governmental permits to commence operations. There is a similar effort being made to do the same thing with crude oil.

TER: How do the junior energy explorers stack up against the large-cap companies?

DE: When the Keystone pipeline and other pipelines from oil-producing regions are in place, the stuff is going to remain relatively cheap. Of course, if it gets too cheap, the companies will close down their wells, because they won't be able to make a profit. But then, with reduced supply, the prices will start going back up, and the companies will put the wells back online. There is plenty of breathing space in this cycle for the juniors.

TER: In a retirement portfolio, what is a reasonable balance between holding large-cap and small-cap energy stocks?

DE: With 20% of a retirement portfolio in the energy sector, it makes sense to hold about 5% in junior energy explorers, and the rest in the larger caps, both domestic and international. With 5% in the juniors, I suggest holding two or three positions, unless one is confident enough to bet it all on one stock.

TER: What's the best way to hedge against inflation in a retirement portfolio?

DE: Sticking with the energy theme: If price inflation rises, the large caps will feel the pressure, because they are close to the consumer level. Vertical integration from drill head to retail pump is an important way to reduce the impact of inflation and keep margins sound.

As an inflation hedge, Stansberry likes TIPS (Treasury Inflation Protection Securities). TIPS are priced off the government's Consumer Price Index (CPI). Some people don't believe that the CPI numbers are exact or worthwhile, but I find them to be useful economic indicators. It all depends on the individual investor's level of comfort with fixed income, bond yields and wherever securities are at in a given moment. As interest rates start to climb, it makes sense to buy floating-rate income funds-the short-term loans that banks and companies make to institutions. They deliver a little bit of increased interest.

The question really is, of course, where do you think price inflation is going to set in? If it's going to happen on the food front, then you can buy integrated food companies, such as General Mills or Tyson Chicken, corporations with pricing power. Similarly, a company like McDonald's, which is close to the consumer, can keep up with inflation through pricing.

Technology tends to not be a very good investment sector in inflationary times because its pricing power is based on who has created the hottest new thing. And if your product is not the latest, greatest and hottest, forget it.

TER: Will energy prices maintain at current low levels, or is inflation going to hit?

DE: There will not be much inflation in the energy sector, because the supply and infrastructure are firmly in place. Look at Pennsylvania, where companies capped producing wells because the price of natural gas dropped to $2/Mcf. Then, it shot back up to $4! If a company can cap a well and then uncap it and make a profit at $3-4, swell. There is going to be a lot of supply emerging if gas goes to $5-6, and then that will drive the cost down again, and the cycle will repeat.

U.S. railroads are talking about converting train engines to natural gas. Wal-Mart is converting its trucks to natural gas. These engines are going off conventional fuel oil because natural gas is really, really cheap. I do not feel like there's going to be runaway inflation on the energy front, because the iron law of supply and demand fluctuates around a market balance.

TER: Is there room for alternative energy investments in a retirement portfolio?

DE: Without heavy government subsidies, the alternatives do not work. The conversion of sunlight to electricity is expensive; the places where it's really windy are usually far away from where most people live, so it is not cost efficient to transmit that energy. The maintenance cost for alternative energy infrastructure is also very expensive.

TER: The price of the solar technology has been plummeting, yet many solar firms are going bankrupt. Why?

DE: No one is buying solar because it doesn't work that cheaply-so those firms go bankrupt. That's the nature of capitalism. Of course, one hears stories about people buying solar chips or panels really, really cheaply, and throwing them on their house, or buying them from Wal-Mart because they've been dumped on the market by a Chinese company. People are jerry-rigging them on top of their houses and trying to make solar financially viable. But on a large-scale commercial level, the payback on solar is a long time, especially considering how thirsty Americans are for instant gratification.

TER: Do you think fossil fuels are here to stay?

DE: Fossil fuels are here to stay, absolutely. In practical terms, there is an almost unlimited supply. Saudi Arabia and the Middle East have not started fracking yet, so, think of the amount of stuff they will pull out of the ground when they start fracking. There are plenty of conventional fossil fuels. And, of course, there is uranium for nuclear energy. If you want to make everyone happy, don't build a nuclear power plant on the edge of the ocean in a fault zone! But, if you build nuclear power plants safely, as the Chinese are doing, then we will enjoy very cheap, very safe, and very clean energy for a long, long time.

TER: As a medical doctor, do you have a position on radiation fears?

DE: The fears are overblown. Obviously, you do not want to live near or downwind of a nuclear power plant. We are close to developing technology and drugs to protect people after radiation poisoning. They are probably just three or four years away, so that will be exciting.

TER: Do you have any personal healthcare strategies that enable people to live long enough to enjoy a happy retirement?

DE: It goes without saying-your mama used to tell you this, your daddy used to tell you, too: Make sure you get sleep. Sleep is one of the most important things a person can do for health. I talk to people all the time who say 'oh, I can't sleep' and you ask them about "sleep hygiene" and the room they sleep in has the TV on, the iPad, the phone, lights streaming from the streetlamp, or the door is open to hear if the baby wakes up in the middle of the night. Stuff like that really affects your sleep. Turn the lights off, get the room as dark as you can! Lack of sleep and heart disease are related!

Walking 18-20 minutes a day sounds simple, it sounds easy, but a lot of people don't even do that. If you can't get out for a walk, do what I do: Throw down a big beach towel on the floor and stretch for 15-20 minutes. Exercise affects the joints and the body and secretes chemicals that keep your immune system strong. So those are the two most important items: sleep and movement. And have a happy retirement!

TER: Thanks for the advice, Doc.

DE: You are welcome.

David Eifrig Jr. holds an MBA from Kellogg and has worked in arbitrage and trading groups with major Wall Street investment banks (Goldman Sachs). In 1995, he retired from the "Street," went to UNC-Chapel Hill for medical school, and became an ophthalmologist. Now, in his latest "retirement," he joined Stansberry & Associates full time to share with readers his experiences and ideas. He edits Stansberry's Retirement Millionaire, a monthly letter showing readers how to live a millionaire lifestyle on less than you'd imagine possible. He travels around the U.S. looking for bargains, deals, and great investment ideas. He also writes Retirement Trader, a bi-monthly advisory that explains simple techniques to make large, but very safe gains in the stock and bond markets. Porter Stansberry loves having "Doc" on the team.

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

DISCLOSURE:
1) Peter Byrne conducted this interview for The Energy Report and provides services to The Energy Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: none.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Royal Dutch Shell Plc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) David Eifrig: I or my family own shares of the following companies mentioned in this interview: Exxon Mobil Corp., Chevron Corp. and Occidental Petroleum Corp. 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 and may make purchases and/or sales of those securities in the open market or otherwise.

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

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

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

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

101 Second St., Suite 110
Petaluma, CA 94952

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

Source: Tom Armistead of The Energy Report (4/4/13)

http://www.theenergyreport.com/pub/na/15129

Low natural gas prices and volatile oil prices should not hinder investors in the oil and gas sector. In fact, low prices carry their own benefits. Casimir Capital Analyst Ryan Galloway describes a number of oil and gas juniors with savvy management, impressive development strategies and strong prospects of success that have earned a "Strong Buy" from him. Read more in this Energy Report interview.

The Energy Report: Petroleum prices are largely set by the world market because the product is easily transported via tankers, but natural gas is still regionally priced. Could the development of more liquefied natural gas (LNG) plants in North America affect gas prices?

Ryan Galloway: If more LNG facilities come online in key areas, that will help to reduce regional differentials from excess regional supply. For example, the Kitimat project would be extremely helpful for Montney and Horn River gas in Northeast British Columbia/Northwest Alberta. But a broad, rapid, North America-wide increase in gas prices would still be tricky. A gradual price uptick paired with more stability and reduced differentials is far more likely. Over the last few years, a lot of the North American producers have managed to bring down costs by focusing on liquids-rich gas plays, and they're doing OK despite low gas prices.

TER: Does the U.S. shale gas production threaten gas producers in Canada?

RG: A lot of that impact has already been felt. U.S. shale gas production really started to accelerate in 2008. Last summer, major gas price lows triggered a lot of "release valves," including coal-to-gas switching. At peak times, we saw 8-10 billion cubic feet per day (Bcf/d) in incremental demand. There has been more industrial demand growth as well. If prices do start to decline, that should create enough marginal demand to avoid shutting out gas producers. On the flip side, if gas prices rally quite hard, we could see a reversal on that coal-to-gas situation. Longer term, I see fairly stable prices and a gradual uptick, but I don't see the Canadians getting shut out.

TER: Which oil and gas companies could benefit from an increase in prices?

RG: All of the oil and gas companies benefit quite nicely. But for the gas-weighted players I have under coverage, I like Crocotta Energy Inc. (CTA:TSX). Crocotta is a lean and mean gas producer with $5-6/barrel of oil equivalent ($5-6/boe) total costs and netbacks around $20/boe despite having a 65% gas weighting. It has also grown production about 300% since 2010. In addition to core acreage at Edson, it has a very solid position in the Montney with over 35 net sections where we should see a lot more development in H2/13. A lot of its wells boast 100+% internal rates of return, so if gas pricing improves, a lot of these could go from being good assets to fantastic assets.

Bellatrix Exploration Ltd. (BXE:TSX) is another large, gas-weighted player, also about 65-70% gas. It should see positive support to cash flow (est. at $1.69/share) going forward if pricing improves. What people forget about Bellatrix is its significant Duvernay acreage. It has over 300 potential future wells in the Duvernay needing a $3.5B investment. There's massive potential for Bellatrix on its Duvernay acreage in the event of a gradual improvement to gas prices.

Outside my coverage, I also like Yoho Resources Inc. (YO:TSX.V). It's a junior that's also leveraged to the Duvernay and Montney. It is an early mover in Duvernay and partners with Exxon Mobil Corp. (XOM:NYSE)and Trilogy Energy Corp. (TET:TSX).

TER: Bellatrix Exploration's website describes its strategy as "drilling, development and targeted acquisition." Does it have the balance sheet to support this strategy?

RG: We see Bellatrix having an all-in, net debt position around $260 million ($260M) at the end of 2013. We see that as very manageable at just over 1x exit cash flow rates. It definitely has the cash flow to support a level of debt to continue drilling. With its latest Korean joint venture, Bellatrix also got access to third-party capital, bringing in about $150M from the Koreans to accelerate Cardium development.

TER: How is the company handling the fast growth it has experienced since 2009?

RG: Bellatrix has done it pretty intelligently. In 2012, in advance of this production, the company talked about getting infrastructure in place. That included an 18-kilometer pipeline across the North Saskatchewan River to get access to a couple of plants in the area-the Alder Flats shallow-cut plant, where there's about 15 million cubic feet per day (15 MMcf/d) capacity, and the Keyera Facilities Income Fund (KEY.UN:TSX) Minnehik Buck Lake plant, which has about 100 MMcf/d unused capacity. A lot of that infrastructure is in place to allow it to grow this production quickly. It is also optimizing its efficiency by doing more pad drilling.

TER: Are the gas producers expecting to maximize their returns in the wholesale gas market or in LNG?

RG: It's a bit of a mix. Given that U.S. and Canadian production is around 77 Bcf/d currently, there won't be enough LNG offtake for that. The producers will benefit indirectly from LNG sales operated by other majors. LNG is extremely capital intensive, so the bigger guys will be involved and have some of the option value. Regionally, smaller players will benefit indirectly from the pricing on the wholesale market.

TER: Can geography make a big difference in a company's profitability? Can a company like Sterling Resources Ltd. (SLG:TSX.V) take advantage of the European desire to free itself from dependence on Russian natural gas because of its location in Western Europe and Romania?

RG: Yes. Sterling Resources has quite a good gas-weighted portfolio, especially in the U.K. as well as in Romania. That should really help it in terms of its ability to take advantage of high European gas prices. In the U.K., for example, we've seen prices as high as $11 per thousand cubic feet ($11/Mcf) on some forward contracts. Sterling's core asset is an offshore asset called Breagh, set to come online this August. That will add about 45-54 MMcf/d net. That will make Sterling hugely leveraged to high U.K. natural gas prices. Going forward, Romania is a big deal for Sterling as well, where they have a lot of discoveries offshore. In late 2013 and 2014, the company plans to conduct additional exploration and appraisal to help prove what it's quoting as a "gas hub" around existing discoveries known as Ana and Doina. You can put together those two offshore-Romania gas discoveries with numerous other prospects in the area, build gas infrastructure and then pipe that onshore.

The nice thing is that historically, Romania has had price regulation that keep gas prices in the high $3/Mcf range, but as a member of the European Union (EU), it has been getting a bit of pressure to allow free-market pricing to prevail. Laws passed very recently are going to put pricing toward the $10/Mcf range by 2018 and probably sooner on the industrial side. Prices there are set to increase rapidly, and there are good gas discoveries and additional prospects to appraise and explore in offshore Romania. The issue for Sterling is just prioritizing which ones it wants to go after first.

TER: Palliser Oil & Gas Corp. (PXL:TSX.V) ships an increasing percentage of its heavy oil by rail. Is its operating efficiency enough to offset the premium it pays for that?

RG: Absolutely. Palliser is a heavy oil producer and we've seen fairly large differentials on heavy oil this year. While Palliser hasn't disclosed figures on what kind of incremental benefit it gets from rail, we're estimating that depending on the differentials it is experiencing, it could get between $6-15/barrel ($6-15/bbl) in improved netbacks. Even a small change to that netback is quite material to the overall cash flow for the company. Other heavy-oil operators have needed to get additional equipment on some of their oil batteries to reduce the amount of water in their oil to meet rail specifications, but Palliser actually installed a lot of that equipment in the first place, which helped the company save money in the long run.

TER: When the Whiting refinery comes online, how will that affect Palliser's share price?

RG: Whiting is fairly important for heavy oil producers because that upgrade will increase the capacity for heavy crude, currently around 20% of its throughput, up to 85%. That will bring on about 420 thousand barrels per day, which should help to alleviate some of the oil differential we're seeing between heavy and lighter blends in Alberta. It should help to improve cash flows for the company, and hopefully share price appreciation will follow.

TER: Is Iona Energy Inc.'s (INA:TSX.V) focus on the North Sea permanent, or is it just a springboard to future expansion elsewhere?

RG: Management at Iona is well experienced in the U.K. North Sea. Neill Carson and Brad Gunn, Iona's CEO and CFO, were also founders of Ithaca Energy Inc. (IAE:TSX), another successful offshore U.K. player, and the rest of the management team is very experienced in U.K. offshore. It makes sense for them to go after the assets that they know, and they've done a good job of it so far.

Iona's game plan in the past has been to secure smaller fields that have been ignored by the larger players, and do this at discounted costs, and then get them developed and tied back into existing facilities. This minimizes its infrastructure risk and minimizes delays associated with building new infrastructure. So we see it continuing with a U.K. focus for the foreseeable future.

The key asset it just acquired, Huntington, is likely going to be onstream imminently. Then it is going to continue with U.K. development of an asset called Orlando, which should bring on about 7,500 barrels per day oil net in late 2014, Kells in 2015 and then another asset called West Wick to follow. I see Iona advancing with quite a good pipeline of development-oriented assets in the U.K. for the next few years. What I like about Iona is that, by 2014, it could be putting out nearly $0.90/share in cash flow versus where it's currently trading, around $0.68/share. This could be a story that really takes off again.

TER: TAG Oil Ltd. (TAO:TSX.V) website notes that two Canadian independents, Addax Petroleum (AXC:TSX) and Tanganyika Oil Company Ltd. (TYK:TSX.V), were acquired by Chinese majors. Is TAG looking for a buyer?

RG: Everyone is potentially for sale for the right price. What TAG is looking to do in the near term is advance its East Coast shale prospects in New Zealand. It is a massive unconventional oil resource play, and TAG is looking to drill that imminently to see what kind of oil shale potential it has on the East Coast. I think it wants to see how that goes before it even considers selling the company, because there's huge value there. Apache Corp. (APA:NYSE) recently exited the joint venture for reasons unrelated to technical feasibility of the shale. TAG has already gotten other interest from parties that might be looking to establish a new joint venture. But I think TAG wants to see what it has before looking at any other options, because it's pretty confident in the potential of oil shale in New Zealand.

TER: What is TAG's reason for focusing on exploration and production in New Zealand?

RG: New Zealand has conventional production but also huge unconventional potential on the East Coast. So when management was first getting into New Zealand, it had a view that conventional supplies worldwide were approaching a peak and there was a need to look for unconventional resources worldwide. We had started to see horizontal, multistage frack technology in North America. So the expectation was if you could find some interesting assets globally, especially in a politically safe jurisdiction like New Zealand and that is closer to demand centers like Southeast Asia, then you could have potential to develop an unconventional resource base. That's what TAG likes there. The resource assessment it got for East Coast was pointing to 12 billion barrels (12 Bbbl), so it's a huge prize.

TER: Share prices for both TAG and Sterling have fallen over the last year. What makes them strong buys, in your opinion?

RG: First of all, big conventional production is finally arriving. TAG has behind-pipe oil and gas wells that need to be tied in. We've been waiting a little while to get that in place, but we hear that it's ready to rock and roll and move forward with a big production ramp up, currently from around 2 thousand barrels oil equivalent per day (2 Mboe/d) to between 4-6 Mboe/d. Second, TAG is advancing on the East Coast shale with a likely spud date in late April or early May for the first vertical stratigraphic well. So if it sees the oil that it's expecting, that could be absolutely massive for the stock. Once you've drilled a few shale wells to delineate the resource, a large area becomes very prospective for additional shale oil drilling and development.

The last reason that TAG is a strong buy is that this summer it is also likely to be drilling a deep gas condensate prospect called Cardiff. Based on what other operators have seen in the same formation nearby, Cardiff could have the potential to be a 30-MMcf/d producer. There is significant upside to the stock in multiple areas over the next few months.

As for Sterling, it has just raised $63M to improve its financing situation. Sterling still needs to work out a few details on its lending facility to unlock the Breagh cash flow, but I'm confident it can renegotiate the terms successfully. Breagh plus the Romanian assets and the other assets it has in its portfolio should provide additional value going forward. That's why we're pretty positive on Sterling's prospects longer term, now that it has come out of the challenges it had earlier this year.

TER: Any final parting thoughts you'd like to share?

RG: There are good quality domestic names, but at some point, I think the internationals are going to attract interest as well. We've had a very risk-off environment in the past year. That could gradually improve in 2013. With the oil differentials in place, uncertainty on oil pricing in North America from pipeline bottlenecks and the Alberta budget situation adding uncertainty on the royalty and tax side, it's very plausible that you could start to see internationals looking more competitive, with very interesting risk-return profiles.

TER: Ryan, thank you very much for your time today.

RG: Thank you very much.

Ryan Galloway joined Casimir Capital in 2011. He was previously at Wellington West Capital Markets, where he covered domestic and international E&P companies. Prior to Wellington West Capital Markets, he spent six years at Encana with experience in financial reporting, strategic planning, business development and public policy. Galloway holds a Bachelor of Commerce from the University of Alberta and is both a CFA Charterholder and a Certified Management Accountant.

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1) Tom Armistead conducted this interview for The Energy Report and provides services to The Energy Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: none.
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3) Ryan Galloway: I or my family own shares of the following companies mentioned in this interview: Bellatrix Exploration and Iona Energy. 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: Bellatrix Exploration, Iona Energy, Sterling Resources, TAG Oil and Palliser Oil & Gas. 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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