Seeking Alpha

The Energy Report's  Instablog

The Energy Report
Send Message
The Energy Report features leading investment coverage of fossil, nuclear, renewable and alternative energies. A Streetwise Reports publication. www.TheEnergyReport.com
My company:
The Energy Report
My blog:
TheEnergyReport.com
My book:
The Energy Report Newsletter
View The Energy Report's Instablogs on:
  • Porter Stansberry: Are You Playing The Right Energy Trend?

    Source: Karen Roche of The Energy Report (1/30/14)

    http://www.theenergyreport.com/pub/na/porter-stansberry-are-you-playing-the-right-energy-trend

    Are you cashing in on America's free energy source? Porter Stansberry of Stansberry & Associates is more bullish than ever on what he calls America's "free energy," natural gas. He's stocked the model portfolio of his newsletter, Stansberry's Investment Advisory, with natural gas companies as well as the companies packaging it and moving it. His energy position was by far the highest-producing segment of his model portfolio over the past two years, some of those holdings even having doubled. In this interview with The Energy Report, Stansberry discusses the macroeconomic climate facing North American investors and how to take advantage of a building natural gas trend.

    The Energy Report: Let's start with something that was published in the S&A Digest Jan. 3. The headline was "Porter Stansberry: Why I now disagree with Steve Sjuggerud and Doc Eifrig," who are associates with Stansberry & Associates. Porter, in that article, you state that you're bearish on the market, citing that when the U.S. Federal Reserve stops quantitative easing (QE), interest rates will go up. Rising interest rates could be a catalyst for a stock market crash. Your colleagues feel that short-term interest rates will allow the market to continue to run. To what extent are you in disagreement?

    Porter Stansberry: We are in disagreement because I think the timing is important. Steve in particular believes that the "Bernanke boom," which is the ongoing inflation of the credit market, will continue for much longer. He forecasts that, before this credit market bubble bursts, stocks will reach much higher valuations, 25 or 35 times earnings. That's a lot different than my outlook.

    I believe stock multiples, the price that stocks are trading as a multiple of their annual earnings, are going to decrease substantially as the Fed begins to taper and interest rates rise. Stock price multiples are negatively correlated with real interest rates. As interest rates rise, the market multiple will fall. I see stocks getting less expensive. Steve sees stocks becoming much more expensive. I can't tell you who will be right.

    TER: What's the catalyst for rising interest rates, as there wasn't a reaction to the initial tapering?

    PS: I studied what happened in the bond and the stock markets during previous periods when the Fed stopped manipulating the bond market. In every single case, the moment the Fed announced that there would be a cessation of intervention, stocks declined and interest rates went up. The Fed is still buying $75 billion ($75B) worth of U.S. Treasury debt. It is the world's largest holder of Treasury debt, holding significantly more than the Chinese and the Japanese. The Fed is painting itself into a corner. If it does not continue to support the market, there is no doubt in my mind that prices for fixed income will go down. That means that yields will rise.

    TER: What if the Fed very slowly tapers off the support?

    PS: Let's just be clear about what happened: 10-year rates have gone from 1.6% last May to about 3% recently. Interest rates have almost doubled in less than a 12-month period. That is an enormous move. That changes the value of bonds significantly. It reduces the price almost by 50%. Folks who bought bonds that were yielding 1.6% have gotten killed. The Fed's buying is far more important to the market price of U.S. debt than any other economic variable. If the Fed stops buying, it doesn't matter whether unemployment goes up or down. It doesn't matter whether inflation is higher or lower. Its influence on the market is dominant. You can't expect the market to have the same price when the guy who's buying $1 trillion ($1T)/year of bonds steps away from the market.

    TER: What's going to cause the Fed to step away from the market?

    PS: Two things: There is overwhelming evidence that QE is not solving the country's economic problems. In particular, it is not increasing employment. There are 92 million (92M) Americans who aren't working. There are 50M people on food stamps. That hasn't improved from the Fed spending $3.5T on bonds. The rationale for this policy is nonexistent and the policy has been a failure. What the Fed is doing is economic suicide.

    The Fed knows very well it's going to be incredibly painful to unwind. It has a ticking time bomb in its hands. The Chinese are running balanced budgets. They're running current count surpluses. They're buying up all the gold that comes up for sale around the world, and they're cutting bilateral currency agreements with every large economy in the world. All of this is laying the groundwork for making the yuan convertible in the capital account. What's going to happen to the dollar's role as the reserve currency around the world?

    "Several of our analysts think gold is hitting a bottom, and gold stocks are one of the best values of the market today."

    TER: Do you see a significant devaluation of the U.S. dollar in 2014?

    PS: That's a realistic scenario for this year. Time is slipping away from the Fed. If the Chinese make that step, the Fed is going to have a lot less flexibility. It has to get its house in order; it has to stop this wild experiment with the monetary base for the simple reason that our currency is in constant competition with others. We are at risk of alienating our partners who hold our currency in huge numbers. Ask yourself a simple question: Do I think it's reasonable that the Fed will become the only global holder of Treasury bonds? That's the course we're on.

    TER: If rates go up and markets go down in the U.S., to what extent does that also influence markets across the world?

    PS: We're already seeing some impact-emerging markets have gotten crushed over the last 12 months. More money is on the margin. A 3% yield is more reasonable to a banker than a 1.6% yield. As a result, money is coming out of markets where higher yields are available like Brazil, and that is influencing bond and equity markets around the world. If I'm right and the U.S. yields go to something like 5% or 6%, there will be an absolute catastrophe in emerging market stocks.

    TER: Would that mean lower stock prices in the U.S, and if the yuan becomes a stronger currency, higher stock prices in China?

    PS: There will definitely be higher prices for Chinese equities. There are other key factors in the pricing of Chinese equities that need to be resolved, mostly the issue of the rule of law and the amount of transparency. China's equity markets have been badly damaged by the amount of accounting scandals the country has suffered during the past 18 months. I don't think there will be a quick or easy solution to that reputational problem.

    TER: Then there really is no viable alternative currency to the U.S. dollar in the short term?

    PS: The yuan is actually a very attractive currency and will prove to be very reliable-much more so than the U.S. dollar. I think the Chinese are going to come out with a gold-backed yuan, whether that is done legally or simply a de facto gold backing due to the size of their treasury's gold holdings. I think that they're going to offer a very high real yield, and I think that they'll do a good job, as they have done throughout the last 25 years in developing their economy. The problem, of course, is that the equity markets in China are not very well regulated and there has been a large amount of fraud.

    TER: The newsletter writer Harry Dent believes the stock market will crash sometime between January and May. You expect a market correction. But where your views diverge is that Harry believes this crash will be followed by years of deflation. He points to the aging world population and a natural inclination for reduced consumption as you age. You believe there will be inflation as a result of the massive international QE. On the surface, that's a demographic trend versus a monetary trend. In your view, how do these two factors play out?

    PS: Harry, as much as I respect his long career as a publisher and as a pundit, is just completely off base. Inflation is always and everywhere a monetary phenomenon. I don't care how much the population of Zimbabwe has aged or hasn't aged, when you're doubling and tripling your monetary base every year, you're going to have runaway inflation sooner or later.

    TER: So what's an investor to do?

    PS: The easy and simple thing is to own short-term, high-quality corporate bonds, so you could hold things that are going to mature in a year or two. If you're getting 6% or 8% on those bonds, you're going to be protected from inflation, and you'll have the ability to roll them over at a higher rate so that you don't have anything to worry about.

    To protect yourself from loss of purchasing power, you can buy high-quality common stocks that are trading at a reasonable price, but with the ability to increase prices. In my newsletter, I just recommended the shares of Lorillard Inc. (LO:NYSE), which is a tobacco company that has the leading e-cigarette franchise. You can still buy that stock at about eight times cash earnings. It's incredibly capital efficient. It pays about 60% of every $1 of revenue out to its shareholders in the form of cash dividends and buybacks.

    Obviously, precious metals have long been a store of value in a period of inflation. You can buy gold and silver. You can buy real estate. I've been buying real estate pretty much continuously since 2010. I started out by buying slum apartments in South Florida. I then moved into trophy properties as the volume in the market picked up and properties began to change hands. Most recently, I bought a farm. I borrowed some money at 4% and bought a producing farm that will pay for itself. Assuming that interest rates in the U.S. go above 4%, I'll get the money literally for free. Of course, I also expect farm prices to increase, so hopefully soybeans and corn give me a nice profit going forward.

    I don't think there's going to be a crash, but I do think it's going to be very difficult for people who are heavily invested in very expensive stocks. Do you have any idea what the earnings per share multiple on Amazon.com is?

    TER: Twenty?

    PS: One hundred and fixty six. Do you have any idea what Amazon.com's operating margin is? It's less than 1%, yet its shares are valued at 156 times earnings and more than 20 times book value. Investor expectations have become completely untethered to the reality of that business.

    I'm not saying that Amazon is not a good business; it is. But at $180B and already dominating the U.S. retail industry, that company cannot grow fast enough nor can it possibly hope to increase its margins enough to justify investor expectations. The folks who are buying those companies are going to be very sorely disappointed.

    TER: You have an interesting measurement that plays along with this concept called the S&A Blacklist. It includes companies with more than $10B in market cap trading at more than 10 times sales. You use this to determine if the market is getting frothy.

    PS: Over the history of the equity markets, the number of companies that have been able to significantly increase and hold their value once they have been so highly overvalued is very small. Most companies that trade at these kinds of enormous valuations are never able to justify the valuations. Even if the earnings grow, the stock price declines.

    Yes, some of these companies will turn into the next Facebook or eBay, but most of them will not. The ones that can't are going to crash. We keep track of this list because at market bottoms there are fewer than five companies anywhere in the world that are trading for more than $10B and more than 10 times sales, while at market tops, the number of companies that meet those criteria can be more than 12. Today, there are 20 companies on that list, which is the highest number we have seen since the 2000 market top.

    TER: To what extent is that number really just a reflection of having nowhere else to put your money?

    PS: It's a very big reflection of that. The Fed has driven people out of the bond market. People who were looking for reasonable, safe investments have been forced into things like master limited partnerships (MLPs) and real estate investment trusts. They have driven investors into riskier and riskier assets, and it's increased the number of people who are willing to invest in stocks at insane prices.

    TER: Last time we interviewed you, you were very bullish on natural gas. In fact, you said, "I'm more bullish on natural gas today than I've ever been in my life." Is that still true?

    PS: It absolutely is. I'm extremely bullish on the entire export energy complex in America: natural gas, propane, ethane, and everything that surrounds those industries like ships, pipelines and refineries. The entire complex is going to boom for a wonderfully logical reason that everyone can understand: In the U.S., natural gas and its other liquid components are free. Literally, this valuable energy source is being flared, is being burned into the air at lots of drill sites because we don't have enough pipelines to collect it all yet. That is even though natural gas is going for $17/thousand cubic feet in Japan and even though propane is going for $100/barrel in Germany. These are very valuable energy sources that have lots of demand globally. The only thing we have to do to make huge profits is build pipelines, refineries and ships. This is going to be a very long, wonderful market for America.

    TER: How are you playing that opportunity?

    "My energy position was by far the highest-producing position in my portfolio during the last two years."

    PS: I bought some very low-cost equity where reserves are very large. I like Devon Energy Corp. (DVN:NYSE)and Chesapeake Energy Corp. (CHK:NYSE). I like companies like ONEOK Inc. (OKE:NYSE) that own the collection and distribution pipelines. I've bought the refiners and the distributors, like Targa Resources Corp. (TRGP:NYSE), that take the propane and package it on the ships. I've also bought boat companies, like Teekay LNG Partners L.P. (TGP:NYSE), a tanker company that can transport liquefied natural gas (LNG). These have been very lucrative for us. My energy position was by far the highest-producing position in my portfolio during the last two years. We made more than 100% on several of these recommendations, including Chicago Bridge & Iron Co. N.V. (CBI:NYSE), which is building out LNG port facilities around the world. It's a wonderful trend that still has a long way to go.

    TER: The S&A Digest today said that "several of our analysts think gold is hitting a bottom, and gold stocks are one of the best values of the market today." Is it time to think about going into gold equities or do we wait for the correction?

    "I like NOVAGOLD because it has an absolutely ironclad balance sheet."

    PS: I am recommending certain kinds of gold equities in my newsletter at the present time. I like NOVAGOLD (NG:TSX; NG:NYSE.MKT) because it has an absolutely ironclad balance sheet. Whether the price of gold goes up or down this year, there is no way that it can or will go bankrupt. It has around $200M in cash on its balance sheet, and it has two gold projects that have very high-grade ore that are very likely to become mines. I view the shares of NovaGold, which are still below $3, as essentially a call option on the price of gold. This company will certainly be solvent for the next two or three years, and if the price of gold were to go up in that period, the share price would probably go to $10 or $20. It's a safe way to speculate on a higher gold price going forward.

    But you have to understand that this is one position in a portfolio of probably 12 or 15 different recommendations. The allocation that I'm willing to commit to gold is still very small. That's the way I prefer to be an investor in gold. I like to hold gold bullion and find these very reasonably priced call options that give me time to wait for a higher price.

    TER: Have you found other gold equities that have that special call-option profile?

    PS: Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX) and Franco-Nevada Corp. (FNV:TSX; FNV:NYSE) are great ways for investors to have exposure to gold without having the risk of shaky capital structures. The key is to have plenty of runway to wait for a higher price. Having said all of this, I want to be very clear: Gold had a 12-year bull market. It is unlikely, in my mind, that that bull market will be followed by a short and painless bear market. I do expect higher gold prices in the future. I don't expect higher gold prices in the short term. I would be surprised if gold was more than $2,000/oz by the end of this year. I'm buying things that give me plenty of upside, but are extremely low risk and have no chance of bankruptcy. I still think you have to see a lot of bankruptcy in the sector. There are just too many shoddily financed junior mining companies.

    TER: Is there anything else you'd like to share with our readers?

    PS: My parting thought is that even if it is painful in the short term, it is incredibly important to the future of our country and to the future of our global economy that the Western governments get their monetary and fiscal houses in order. We cannot continue to run the world with fiat currency that comes spewing out of the printing presses at the rates we have seen over the last two years. The amount of malinvestment that will be caused by the dislocations of these prices and the bad economic decisions that entrepreneurs are going to make based on faulty assumptions about interest rates and market multiples will be very disruptive. The longer it goes on, the worse it will become. We have to get to a point where governments are able and willing to live within their means. We have to get to a point where people can once again count on currencies and market prices. Today, unfortunately, we're nowhere near that position. Until that gets fixed, people have to be very conservative with their personal finances.

    TER: Do you think it will get fixed in your lifetime?

    PS: It will have to, because we're on a collision course for a train wreck if we don't do something urgently to put our fiscal house in order and to get the government out of the business of manipulating the currency and manipulating interest rates.

    TER: Porter, thanks a lot for your time.

    PS: Sure thing.

    Porter Stansberry founded Stansberry & Associates Investment Research, a private publishing company based in Baltimore, Maryland, in 1999. His monthly newsletter, Stansberry's Investment Advisory, deals with safe-value investments poised to give subscribers years of exceptional returns. Stansberry oversees a staff of investment analysts whose expertise ranges from value investing to insider trading to short selling. Together, Stansberry and his research team do exhaustive amounts of real-world independent research. They've visited more than 200 companies in order to find the best low-risk investments. Prior to launching Stansberry & Associates Investment Research, Stansberry was the first American editor of the Fleet Street Letter, the oldest English-language financial newsletter.

    Read what other experts are saying about:

    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) Karen Roche conducted this interview for The Energy Report and provides services to The Energy Report as an employee. She or her 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:NOVAGOLD. Franco-Nevada is not affiliated with Streetwise Reports. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
    3) Porter Stansberry: 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: 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. Please note: model portfolio refers to the recommendations Stansberry makes for his subscribers. He does not personally buy or hold shares of companies he recommends.
    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 © 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

    Jan 30 3:29 PM | Link | 2 Comments
  • Get Positioned Now For The Next Great Natural Gas Switch: Ron Muhlenkamp

    Source: Tom Armistead of The Energy Report (1/23/14)

    http://www.theenergyreport.com/pub/na/get-positioned-now-for-the-next-great-natural-gas-switch-ron-muhlenkamp

    Ronald MuhlenkampCheap natural gas means Americans can buy the equivalent of a barrel of crude for $35. That's the exciting reality that has Ron Muhlenkamp, founder and portfolio manager of Muhlenkamp & Co. Inc., putting his investment dollars behind the next great fuel switch, this time in the transportation sector. With his fund having finished 2013 with a tidy 34.4% gain, he is now eyeing companies poised to outfit the U.S. transportation sector with all things natural gas, from fuel tanks to motors to filling stations. And let's not forget the folks who get it out of the ground. As Muhlenkamp tells The Energy Report, we've only just begun, so there's plenty of room to run with well-positioned companies.

    The Energy Report: Ron, welcome. You are making a presentation at the Money-Show conference in Orlando in late January. What is the gist of your presentation?

    Ron Muhlenkamp: The gist of my presentation is that natural gas has become an energy game changer in the U.S. We are cutting the cost of energy in half. This has already happened for homeowners like me who heat their homes with natural gas. We think the next up to benefit is probably the transportation sector.

    TER: What is behind this game change?

    "Natural gas has become an energy game changer in the U.S."

    RM: The combination of horizontal drilling and fracking has made an awful lot of gas available cheaply. There's a whole lot of gas that's now available at $5/thousand cubic feet ($5/Mcf) or less. I live in Western Pennsylvania, and 30 years ago, Ray Mansfield was in the oil and gas drilling business, having retired from the Steelers. He said, Ron, we know where all the gas is in Pennsylvania; it's just a matter of price. If the price runs up, we will drill more. If the price runs down, we will drill less. Any way you slice it, we are just sitting on an awful lot of it.

    Two years ago, we had a warm winter, and the price of gas actually got down to $2/Mcf. You saw an awful lot of electric utilities switch from coal to gas. Literally in a year, what had been 50% of electricity produced by coal went to 35%. The difference was made up with natural gas.

    In transportation, the infrastructure to make the switch to natural gas has not been in place. We didn't have the filling stations or the trucks. Now, the trucks are just becoming available. You can buy pickup trucks from Ford Motor Co. (F:NYSE) and General Motors Co. (GM:NYSE) that run on natural gas. Furthermore, Clean Energy Fuels Corp. (CLNE:NASDAQ) has established natural gas filling stations coast to coast, every 250 miles on five different interstate highways.

    Westport Innovations Inc. (WPT:TSX; WPRT:NASDAQ) has been producing 9-liter (9L) natural gas engines. Waste Management (WM:NYSE) uses 9L engines on garbage trucks and expects 85-90% of its new trucks to be natural gas-fueled. Westport has just come out with 12L engines, which are used for over-the-road trucks. I don't expect those engines to get adopted as fast as the utility industry made the switch to natural gas, but there has been a fairly rapid adoption in the waste management industry. I think we're on the cusp of a major trend.

    TER: That fuel switching in the power industry has been going on since 2008. Is it still progressing at the same rate or is it picking up?

    "The big switch is over in utilities. But we've barely begun the transition with transportation fuel."

    RM: It's pretty much leveled off. In fact, there's probably a little bit less gas used than when gas was below $3/Mcf. The latest numbers I've seen show that we're running about 37% coal and about 33-34% gas. Going forward, I think coal use will continue to decline, and natural gas use will continue to rise. The big switch is over in utilities, and it will be gradual from here. But we've barely begun the transition with transportation fuel.

    TER: So the game has changed for the power industry, and the transportation industry is next. What other changes do you foresee in the future?

    RM: We will continue to use more natural gas and less crude. Right now, for equal amounts of power, crude oil is priced at about three times the natural gas price in the U.S. That is too wide a spread to ignore, economically.

    The Natural Gas - Crude Oil Spread

    natural gas crude oil spread
    source: Bloomberg

    Incidentally, in Europe, natural gas is still at $12/Mcf. It's on a par with crude. Most European chemical plants use a crude oil base to make chemicals. U.S. plants use a natural gas base. Natural gas becomes ethane, then ethylene, then polyethylene and then plastic. So producers of plastics or the feedstocks for plastic in the U.S. now have an advantage they didn't have before.

    "The natural gas price advantage will be with us in North America for quite a long time. It's huge."

    In Japan, the natural gas price jumped from $12 to $16/Mcf just after the tsunami wiped out the Fukushima nuclear power plant. To ship gas from the U.S. to Japan, the cost of compression, liquefying and decompression is about $6/Mcf. Executives at U.S.-based companies like Dow Chemical Co. (DOW:NYSE) are saying they don't want the U.S. to export gas because that would drive the price up. But domestic gas consumers already have that $6/Mcf advantage. Meanwhile, in Williston, N.D., the natural gas price is effectively zero. Producers still flare it because they don't have the pipelines to take it out of the area. So this price advantage will be with us in North America for quite a long time. It's huge. That's why we call it a game changer.

    price of energy

    TER: So how can investors take advantage of these changes?

    RM: Well, any number of ways. We hold some fracking services companies, like Halliburton Co. (HAL:NYSE). We own a couple of drillers, including Rex Energy Corp. (REXX:NASDAQ). And we invest in the people who build natural gas export facilities, such as Fluor Corp. (FLR:NYSE), KBR Inc. (KBR:NYSE) and Chicago Bridge & Iron Co. N.V. (CBI:NYSE).

    I already mentioned companies building natural gas-fired engines, including Westport, which makes a kit to modify a common diesel engine. And because natural gas will require new, larger fuel tanks, investing in companies that build natural gas tanks is another way to play it. One of the disadvantages of natural gas versus gasoline or diesel is compressed natural gas takes about three to four times the volume to get the same range. Liquefied natural gas (LNG) takes about two times the volume. Of course, compressed natural gas is stored in pressure tanks, so it takes a pressure tank of larger size. Fuel tank conversions have been almost as expensive as the engine conversions. 3M Co. (MMM:NYSE) has gotten in that business, as has General Electric Co. (GE:NYSE). There's another outfit called Chart Industries Inc. (GTLS:NGS; GTLS:BSX), which has already run a good bit.

    "We want a foot in each of these camps because we're not quite sure who the ultimate winners will turn out to be, but we know what the product lines will have to be."

    We want a foot in each of these camps because we're not quite sure who the ultimate winners will turn out to be, but we know what the product lines will have to be. Don't forget about the companies that own the LNG export facilities-Cheniere Energy Inc.'s (LNG:NYSE.MKT) facility should be up and running in probably 2015, but, again, that stock has run up a good bit, too.

    Pipelines will benefit from the switch. One of the biggest pipelines in the country is Kinder Morgan Energy Partners L.P.'s (KMP:NYSE) Rockies Express Pipeline, which stretches from Northern Colorado to Eastern Ohio and ships gas east. Kinder Morgan recently filed to reverse the flow on part of the line. Right now, in Western Pennsylvania, we have a glut of gas. A few months ago, they reversed the flow of the pipeline from the Gulf Coast that used to come up to Western Pennsylvania. There's a whole lot going on.

    TER: After some serious oil train derailments in recent months, pressure is building now to increase pipeline capacity, but there is also pressure on producers to reduce flaring, which is happening on a huge scale in the Bakken Shale. How will the economics and the operations of Bakken producers be affected if they can't flare and pipeline capacity is not increased?

    RM: The Bakken is primarily an oilfield; the gas is a byproduct. We hear a lot about the Keystone XL Pipeline, which is meant to carry oil from the Bakken south. I can't speak specifically, but if you're going to lay an oil pipeline from the Bakken, you should lay a gas pipeline alongside it. You can ship oil by rail, but it's not economic to ship gas by rail. One way or another, the oil will be shipped.

    TER: Bill Powers, the independent analyst and author of "Cold, Hungry and in the Dark: Exploding the Natural Gas Supply Myth," says gas prices are going to rise steadily to as much as $6/million British thermal units ($6/MMBtu) because U.S. gas production has peaked and now is now flat or declining. Do you agree with that?

    RM: Our production of gas has not peaked and is not declining. We are using fewer rigs drilling for gas, but each well, particularly if you drill horizontally instead of just vertically, is producing so much more gas. Production is not declining and isn't likely to for at least a decade. At current rates, we can drill in Pennsylvania for another 50 years. Yes, you drill the best wells first but also, over time, you get a little bit better at timing this stuff. I'd be very surprised if the price in the next decade gets over $5/Mcf for any extended period of time because there's an awful lot of gas that's very profitable at that price. I'm willing to make that bet with Bill Powers. But even $6/Mcf gas would equate to $55/bbl crude, which is still a huge spread and wouldn't negate my general argument.

    TER: What's your forecast for gas prices in 2014?

    RM: My forecast is $4/Mcf, give or take $1. We just had a big cold snap on the East Coast. What used to happen is any time you had a cold winter, the price of gas jumped. For instance, in 2005, when crude was selling about $50/barrel ($50/bbl), gas began the year at about $7/Mcf, which was on par with crude, but in the wintertime, it doubled and ran up to $14/Mcf. The recent cold snap took gas all the way up to ~$4.20/Mcf. Gas is going to be in that range for a long time.

    TER: Your advice to investors in natural gas is to get exposure to exploration and production companies, service companies and even LNG plant constructors. What about the LNG plant owners, the pipelines and the railroads?

    RM: The pipelines will do well. They've already been bid up. The railroads will benefit from oil and gas, but they're getting hurt because coal tonnage is way down, CSX Corp. (CSX:NYSE) just reported. So for the railroads, it's going to be a wash. They'll haul less coal and more oil. The railroads won't haul gas. How much oil they haul is an open question. We're about to tighten restrictions on how tank cars are built.

    TER: What did well in the Muhlenkamp Fund last year?

    RM: The fund was up 34.4%. We did very well in biotech stocks. We did very well in financial stocks. We also did well in some energy stocks. Airlines did well for us. Incidentally, airlines benefit big time from cheaper energy, as you know. So it's fairly diverse.

    TER: How are you adjusting your portfolio this year?

    RM: Not too much has changed. We're no longer finding many good companies that are cheap. So we're monitoring and adjusting a little bit around the edges. We do think banks have further to go. We think the economy will grow somewhere between 2.5-3% this year. We've owned no bonds for the past couple of years, but with the Treasuries now, the interest rates on the longer end are high enough so that savers can get a little bit of return.

    TER: I was surprised to see a really sharp drop in November for Fuel Systems Solutions Inc. (FSYS:NYSE). Why did that happen?

    RM: Fuel Systems makes conversion kits for cars to burn compressed natural gas. In places like Pakistan, 40% of the cars run on natural gas; this is not new technology. A number of its customers decided to make these kits in-house. Fuel Systems is a small position of ours, but, yes, it got hit in Q4/13 when it announced that a number of its customers decided to produce their own kits. One of the nice things about this is there's no new technology involved. We've been using natural gas as a power source for generations. What has changed is the amount that's available reliably at a cheap price.

    TER: There was another sharp drop in Clean Energy Fuels in October. What happened there?

    RM: Clean Energy, so far, doesn't make a profit because it has been shelling out all the money to build all these filling stations. It's just taking a little longer than people expected. The stock is compelling at these levels. A number of these companies ran. Westport doubled, and we took some profits. It's now back down, and we should do a Buy rerating. There is volatility in this stuff, but the economics are undeniable. We still managed a 34.4% gain this year, which isn't bad.

    "Royal Dutch Shell Plc is building natural gas fueling stations in concert with another truck stop operator."

    Clean Energy has signed a joint venture with Pilot Flying J to build natural gas fueling stations at Flying J truck stops coast to coast. Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE) is doing a similar thing in concert with another truck stop operator. For instance, the Port of Long Beach, Calif., passed a rule several years ago that the trucks on the port need to burn natural gas. The Port of Hamburg, Germany, has contracted to put a natural gas-fired power unit on a barge so that when cruise ships come into the harbor, instead of running their own power off their diesel engines and generators, they'll use this barge to supply power to the cruise ship because natural gas exhaust is cleaner than diesel exhaust.

    TER: A couple of other companies had surprising drops- Rex Energy and Westport Innovations. Rex rose all year until October or November, when it suddenly dropped. Westport also dropped suddenly. You had a wild ride in your portfolio, didn't you?

    RM: We bought Rex at $13/share, and it went to $22 or $23, and it's now $19. I can live with that. The dips give you a chance to load up again. That volatility is why we have a diversified portfolio. That's why you don't just bet on three stocks.

    As an investor, most of the time what you're looking for is to find a difference between perception and reality. Today, we have two realities: One is the price of crude oil, and the other is the price of natural gas. So it's literally an arbitrage if you can buy energy either at the equivalent of $100/bbl or at a third of that. Four-dollar gas is equivalent in energy content to about $35/bbl crude. So I can buy my energy either at $100/bbl or $35/bbl. Economics says that spread is too wide. It won't necessarily close, but it sure as heck will narrow a good bit. For instance, I own no conventional oil companies. I think the price of oil will be coming down.

    TER: So what companies in your portfolio look most promising?

    RM: If you really want to get me excited, we can talk about natural gas, which we've been talking about. We could talk about biotechnology, which is exciting but I don't understand it as well. We can talk about U.S. manufacturing, but that's basically based on cheaper energy. I just bought more Rex. At these prices, I'm buying Westport. I just bought Chicago Bridge. I just bought KBR.

    TER: What is your main motivation in buying these companies? Is it just the stock price or is there something about the management of the company or the technology?

    "I want to buy Pontiacs and Buicks when they go on sale. I don't want a Yugo at any price. I would like to buy Cadillacs, but they don't go on sale very often."

    RM: We're in the investment business. What we rely on is good companies, and we look to buy them when they're selling cheaply. Our first measure of how well a company is run is we start with return on shareholder equity. So we like companies that are at least above average in return on shareholder equity. I cannot yet say that about Clean Energy, but we do think Clean Energy is at the forefront of something that's needed for this transition. We're always looking for good companies. Then the question is whether you can buy them at a decent price.

    My phrase is: I want to buy Pontiacs and Buicks when they go on sale. I don't want a Yugo at any price. I would like to buy Cadillacs, but they don't go on sale very often. But if I can get Buicks when they're on sale, I'll make good money for my clientele. We think that the companies we have are at least Buicks. If we can get them at Chevy prices, that's when we buy them. I will not pay an unlimited amount for any company.

    I've never seen a company that was so good it didn't matter what you paid for the stock. To us, value is a good company at a cheap price. Some people bottom fish. They look to see when they can steal companies, and there are times when you can make money that way. But at that point it's not often a very good business, and there aren't too many well-run companies at bargain basement prices. So it's very unusual for us to buy a weak company or a weak industry.

    TER: Ron, this has been a good conversation. I appreciate your time, and good luck with your Money-Show presentation.

    RM: Thanks; it'll be fun.

    Ron Muhlenkamp is the founder and portfolio manager of Muhlenkamp & Co. Inc., established in 1977 to manage private accounts for individuals and institutions. In 1988, the company launched a no-load mutual fund as an investment vehicle for all investors, large or small. Muhlenkamp is an award-winning investment manager, frequent guest of the media, and featured speaker at investment shows nationwide. His work since 1968 has been focused on extensive studies of investment management philosophies, both fundamental and technical. As a result of this research, he developed a proprietary method of evaluating both equity and fixed-income securities, which continues to be employed by Muhlenkamp & Co. In addition to publishing his quarterly newsletter, Muhlenkamp Memorandum, he is the author of "Ron's Road to Wealth: Insights for the Curious Investor." Muhlenkamp received a Bachelor of Science degree in engineering from M.I.T. in 1966, and a Master of Business Administration degree from the Harvard Business School in 1968. He holds a Chartered Financial Analyst (CFA) designation.

    Read what other experts are saying about:

    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) 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: Royal Dutch Shell Plc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
    3) Ron Muhlenkamp: I or my family own shares of the following companies mentioned in this interview: General Motors Co., Clean Energy Fuels Corp., Westport Innovations Inc., Halliburton Co., Rex Energy Corp., KBR Inc., Chicago Bridge & Iron Co. N.V. and General Electric. 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 © 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

    Jan 23 6:19 PM | Link | 1 Comment
  • Five Ways To Play The End Of The Natural Gas Renaissance: Bill Powers

    Source: Tom Armistead of The Energy Report (1/16/14)

    http://www.theenergyreport.com/pub/na/five-ways-to-play-the-end-of-the-natural-gas-renaissance-bill-powers

    Bill PowersShale gas is not the foundation of U.S. energy security that conventional wisdom claims it is, says Bill Powers in this interview with The Energy Report. But as shale gas peters out, the law of supply and demand will drive gas prices up. Powers, an independent analyst and author of "Cold, Hungry and in the Dark: Exploding the Natural Gas Supply Myth," sees a good future for gas-leveraged junior companies, and shares his top ideas as demand and price skyrocket in tandem.

    The Energy Report: Bill, you published a book six months ago, "Cold, Hungry and in the Dark: Exploding the Natural Gas Supply Myth," questioning the conventional wisdom of shale gas. Have events supported your thesis?

    Bill Powers: Yes, absolutely. Several of the predictions I made in the book have come true since the book hit the shelves in July. First, we've seen numerous shale plays head into decline. We've seen big declines from the Haynesville as well as the Barnett. The Fayetteville is in decline; there have been further declines in the Gulf of Mexico and Wyoming. But what has really changed is the North American natural gas market has become extremely unbalanced, which was what I had predicted would come to pass sometime in the 2013-2015 timeframe. The cold weather over the last six weeks has accelerated what I have been talking about in the book.

    TER: How so?

    BP: I predicted that gas prices would lead to layoffs and industry supply disruptions, and that's already occurred. We've seen paper mills in New Hampshire lay people off because natural gas prices in New England were north of $50/million Btu ($50/MMBtu) for a period and remain very high. We've also seen incredibly high prices in New York, and this is a time of record production coming out of the Marcellus. These are really the first examples of the violent price spikes and industrial shutdowns we will see in other parts of the country.

    Across the U.S. over the next several years, I predict we will see spikes of very high prices, which will fall back to higher levels than they previously reached. Then, as the next weather event comes, prices will spike to new highs. That has already happened in New England and other areas of the Northeast in part because those areas are supply-constrained due to limited pipeline availability, but also because of increased demand.

    The Northeast has also had several nuclear power plants close. Just recently the Vermont Yankee closed. Nuclear power plants have closed over the last decade or so in Maine as well as Connecticut. Much of this capacity has been taken up by increased natural gas demand for electricity generation. So you've had constrained supply because of the limited pipeline capacity and increased demand. In addition to the new demand from electricity generation, significant new demand in the Northeast has come from people converting from heating oil to natural gas furnaces.

    Also, there's been a huge disappointment in supply coming from Canada into the Northeast U.S. because Sable Island production offshore Nova Scotia has been so low compared to some very lofty original expectations. We've just had Deep Panuke come on in late 2013 after several delays and many cost overruns, but the pipeline that services those offshore fields in Nova Scotia is not even close to full, and the fields will be depleted fairly rapidly over the next three to seven years. This will be a period of continued supply constraints for New England. The Marcellus and Eagle Ford are the only two fields that are still growing, and I expect the Marcellus to flatten out in 2014. Additionally, we are going to see supply constraints throughout much of the rest of the United States over the next several years.

    TER: The pipeline companies have acknowledged that there's a supply constraint. Haven't any of them made plans to extend lines to the Northeast?

    BP: Yes, that is happening, and some of them are probably going to increase throughput from the production growth in the Marcellus, but there will be significant calls on Marcellus production, which is probably going to peak this year.

    The U.S. Energy Information Administration late last year put out a white paper that talked about how gas production is becoming more efficient. But this white paper did not include the Barnett Shale, which is in steep decline now. It's true, efficiencies have been gained over the last several years, such as the way fracking has changed, and operators are becoming more efficient in fracking, with longer laterals. But what is really happening is the completion of the inventory of previously drilled wells.

    When companies ramp up their drilling activity, they often will drill more wells than they actually complete due to lack of pipeline capacity. Just recently, there have been about 200 wells in the Marcellus that were waiting for pipeline connections or to be fracked. A lot of those wells have been fracked over the last six months and the inventory continues to go down. I believe that inventory will be depleted by Q1/14, and given the drilling activity, the very high decline rates of the wells and the number of rigs running in the Marcellus, further growth is not supported. The Marcellus is still a very significant field, the biggest in the United States. When it peaks out it will probably plateau for a while, depending on activity levels, but it still will not be able to make up for falling production in nearly every other region in the United States. When this happens, we will see price spikes more frequently.

    A really good example of the damage high prices can cause outside of the Northeast is Mexico. In August 2012, landed LNG prices in Mexico were $3.17/MMBtu. In August 2013, Mexico had landed LNG prices over $16. Despite its increase in gas production, demand is outstripping supply. Mexico is having a gas crisis that has forced the closure of numerous cement, steel and glass plants. There have been thousands of layoffs in Mexico because of extremely high natural gas prices. There's not yet the pipeline connectivity into the United States to alleviate this crisis. What we're seeing is very high LNG prices, and as the U.S. needs to go back in to the world LNG market, this is going to impact U.S. consumers over the next several years. In my book I completely refute the notion that the U.S. will ever become a significant exporter of LNG and recent events in the Northeast show why.

    TER: So, you're still expecting the gas boom to peter out in the next five to seven years? Is that still the timeframe?

    BP: I think it's happening sooner than that. Production has been flat in the United States since early 2012. Canada soon will start to export gas to Asia through British Columbia, and the Marcellus is likely to peak in 2014, but despite gas prices that are now over $4/MMBtu, you are still seeing very limited activity for gas-directed drilling. Until that picks up, U.S. supply is going to go down; how far down is still open, but the market is becoming increasingly unbalanced. Shale gas focused companies still cannot generate free cash flow at today's prices and many have severely damaged balance sheets due to the weak prices of recent years. For example, Chesapeake Energy Corp. (CHK:NYSE) just sold 130 million cubic feet per day of production, 40 uncompleted wells and 200,000 acres in the Marcellus, to Chief Oil & Gas (private) because Chesapeake is financially distressed. It still cannot make money at today's prices and it had to sell very good acreage to Chief at a fire-sale price.

    People might think this is a one-off or this is just one company, but Chesapeake is the second largest producer of natural gas in the United States. It's the largest shale gas producer in the world. It has drilled more shale gas wells than anybody else. Its gas production declined 10% in 2013 according to its most recent investor presentation and it will fall again in 2014, simply because the company has completely given up drilling gas wells.

    It's not just Chesapeake who fired its CEO, replaced several members of its board, largely walked away from the shale gas business and fired 20% of its workforce. The same thing happened with Encana Corp. (ECA:TSX; ECA:NYSE). It fired 20% of its workforce along with its CEO. EOG Resources Inc. (EOG:NYSE) also has walked away from the shale gas business. In 2013 its natural gas production declined 15%. This is not a small company; it is a top-20 producer in the United States. This is very significant; you're seeing the biggest producers largely turn their back on shale gas. Without these large producers accelerating drilling more wells, U.S. production will head into a significant decline.

    Now that the inventory of wells in the Marcellus is largely depleted, there's very little chance that U.S. production is going to remain flat in 2014. It will probably decline. This is really going to put upward pressure on prices. The spikes in New England and New York have been largely weather-related, but this is going to happen more and more often, and it will happen on less severe weather. It will happen in other areas of the country, such as California, where the San Onofre nuclear plant has shut down. This summer, when it gets hot in California, we may see spikes similar to what happened at the turn of the millennium.

    Up to 50 gigawatts (50 GW) of U.S. coal-fired generation will be shut down in the next two years to comply with MATS, the Mercury and Air Toxics Standards that are being enforced by the EPA. That's between 15% and 20% of U.S. coal-fired generation. There will be more demand for natural gas for electricity generation. Also in 2013, five nuclear plants have closed. These nuclear plants serve a big part of the electricity base load. A lot of that electricity generation is now being pushed toward natural gas. You're seeing the market become more and more unbalanced. This is only going to be exacerbated as Canada diverts more of its gas exports to Asia through British Columbia than to the United States because the prices in Asia are well into the double digits. Even with the recent spike in U.S. gas prices, it's still far more economic to send it to Asia. That will begin later in 2014 when the Kitimat LNG facility opens.

    TER: Natural gas prices in Canada and the U.S. have been on a roll, but they had a good run above $4/MMBtu for a month last spring too. They have not been able to sustain above $4/MMBtu since August 2011. What's your forecast for 2014?

    BP: I expect prices to move between $5-7/MMBtu simply because we are seeing huge drawdowns in the storage. We had a record withdrawal in the United States for the month of November. We had the biggest withdrawal of all time-285 billion cubic feet (285 Bcf)-in December, which happened before winter even set in. In January, we expect to see another record draw. I believe by this spring we will see prices close to $5/MMBtu, and they will move higher later in the year because it's going to be very difficult to refill storage.

    We should see storage fall well below last year's end-of-winter low. We are more than 500 Bcf below last year's levels. This would put us at a very low level of storage at the end of the winter heating season. I believe this will push prices somewhere between $5-7/MMBtu later this year. Then we will see a consistent march higher over the next two to three years and we will see spikes, depending on the weather. How high prices go will depends on the severity of it.

    Right now, there are very few companies that make money even at $4/MMBtu. We saw that from the financial statements of all the big shale gas players; even at today's prices, it's still not that economic, so we will not see increased natural gas-directed drilling until prices are closer to $6/MMBtu. This leads us to another issue that I think is not widely recognized: In 2008, the last time we saw a sustained spike in natural gas prices, we had 1,300 to 1,600 rigs drilling for natural gas and about 350 drilling for oil. Now that is completely reversed in the United States. For companies to drop oil-directed drilling rigs and move them to natural gas, we will need to see some significantly higher prices. I think that will lead to further imbalances.

    TER: Baker Hughes Inc. (BHI:NYSE) has acknowledged that the number of gas and oil rigs is no longer the measure of production that it used to be because so many laterals are running off each pad now. Are you accounting for that?

    BP: Yes, absolutely. While there is no doubt rigs have become more efficient and pad drilling has had a lot to do with that, a factor that is very difficult to quantify is the quality of rock into which these laterals are being drilled. Anyone who's familiar with the oil and gas business can tell you that the best wells will be drilled first and that you will drill into progressively lower-quality rock. While you can drill numerous wells off one pad, you still are going to need more rigs as you drill into lower-quality rock. We've seen increases in production in areas like the Marcellus, but a lot of this has to do, as I said earlier, with the completion of inventoried wells-wells that were drilled but waiting on completion. We are going to need a lot more activity in natural gas-directed drilling to keep production flat. At today's activity levels I don't see it and due to the high decline rate of these horizontally drilled wells and the length of them, it's going to require more and more activity. This will happen only at significantly higher prices.

    TER: Canada's gas exports are blocked to the south, east and west. What does that mean for the future of its gas producers?

    BP: Blockage is not the problem. The U.S. has imported gas from Canada for over 35 years, but Canadian production had declined significantly over the past 12 years before flattening out in 2013 at around 13 Bcf. U.S. exports were down substantially over the last five years, so there's plenty of Canadian export capacity into the United States; it's just not being used because of low prices and the significant decline in Canadian production. There's plenty of Canadian export capacity into the United States, whether it's from the Alliance Pipeline or from Nova Scotia via the Maritimes Pipeline. That's nowhere close to filling the hole due to very poor exploration results offshore Nova Scotia and resistance to the further exploration of shale in New Brunswick.

    The reason Canada will greatly reduce its exports to the United States over the next five years is it's building out an enormous capacity in British Columbia to export gas to Asia. Petronas bought Progress Energy Canada Ltd. for $5 billion ($5B) and is building an $11B facility in British Columbia to export gas to Asia. We're going to see numerous applications for LNG export facilities approved in the next several years, and we're going to see a huge buildout in British Columbia to export gas from the Horn River Basin and the Montney to Asia.

    We're also seeing booming demand for Canadian users. Demand for the oil sands has gone from about 1.5 Bcf per day (1.5 Bcf/d) toward 2 Bcf/d. We've seen fertilizer plants open in Canada due to the low natural gas prices and the high prices for fertilizer. Due to the decline in Canadian production over the last 12 years and increased demand in exports to Asia, the United States will be left with a very unbalanced market. It's certainly going to lead to higher prices, because Canadian producers just now have been able to stabilize their production, but only after a significant fall and a pickup in activity.

    TER: How will the opening of Mexico's oil and gas industry to foreign investment affect this market balance and the companies you follow?

    BP: The law has changed, but it's still unclear what type of terms will be offered to foreign companies. Iraq offers a useful comparison. Iraq has had difficulty attracting large companies to invest because the terms are so difficult. It will be interesting to see whether the Mexican government will allow foreign companies to make money in Mexico. If the terms are very difficult, it will not be able to attract investment. But, if it allows reasonable terms, I think there are plenty of companies that would be able to help stabilize Mexico's declining oil production and probably grow its natural gas production significantly, because the Eagle Ford Shale extends into northern Mexico. But as that is an area where there has not been any foreign investment, it will be interesting to see how that plays out.

    TER: Do any of the companies that you follow look as if they might get involved in the Mexican industry?

    BP: The service companies have already been active in Mexico for years under contracting. I think you will see companies such as Calfrac Well Services Ltd. (CFW:TSX) and Trican Well Service Ltd. (TCW:TSX) increase their Mexican business as overall activity levels increase in Mexico. It's difficult to see at this early stage what independents would be active in Mexico. A lot of this will depend on what terms are being offered. The service companies will certainly move toward some of the more difficult basins, such as the Chicontepec, which has been very, very difficult. It's a tight gas field. And as other fields similar to that, other tight gas plays and the Eagle Ford Shale in northern Mexico get developed, this is certainly going to help North American-based service companies such as Trican and Calfrac.

    TER: Have any technological innovations in the last year or two improved the prospects of success for small E&P companies?

    BP: What I think has helped, and one of the things we're seeing, is the way the wells were fractured in the Bakken. Rather than fracking outward, away from the wellbore 1,000 feet (1,000 ft), Bakken fracks are now designed so there's a larger perforation, but the fracks do not go as far out from the wellbore, only a few hundred feet. The idea is that there's a lot of reservoir that can be drained that is very close to the wellbore.

    This will help improve the economics of fracturing wells, because for smaller companies drilling $8-million ($8M) wells, these are expensive ventures. Things that can improve the recovery per well per frack stage certainly will help the smaller companies grow as the wells become more economic.

    What is exciting for the smaller companies is that with oil prices $92-100/bbl, and gas as it moves above $5/MMBtu later this year, cash flows should improve significantly. I think this will lead to much more activity for the smaller companies and will definitely lead to some exciting developments and a lot more investor interest in the space.

    TER: Can you name some of the companies that you're excited about right now?

    BP: Certainly. In Canada I have three names that are very exciting. Bellatrix Exploration Ltd. (BXE:TSX)has an excellent portfolio of assets. It has grown production. This is a company that will benefit from higher gas prices; it is very leveraged to gas prices. It's continuing to develop its Duvernay Shale. It acquired a company last year that temporarily depressed its stock price. I think that this company should be able to grow its production significantly over the next several years and do it profitably.

    A company that will probably sell itself over the next six months or so is Advantage Oil and Gas Ltd. (AAV:TSX; AAV:NYSE). It has really proven out its Glacier play in the Montney over the last several years. Through this winter's drilling season it should be able to prove up quite a bit more acreage. This will really help it. The higher gas prices are certainly going to help Advantage. As prices move higher, this is a company that should have a very good year in 2014.

    I'm a director and shareholder of Arsenal Energy Inc. (AEI:TSX). We're active in the Bakken in North Dakota as well as the Deep Basin of Canada. I'm very excited about what I'm seeing going on there. I'm also excited about a couple companies in the United States. One is Southwestern Energy Co. (SWN:NYSE). It did take a write-down on its Fayetteville Shale assets last year. However, this is a very profitable business, especially with higher natural gas prices. It still has more than 3 trillion cubic feet (3 Tcf) of proven reserves in the Fayetteville and has had very good success in the Marcellus. This is a company that can make a great deal of money at today's prices, and it's big enough that I think institutional investors will be very attracted to Southwestern Energy due to its leverage to higher natural gas prices.

    The other one in the United States that I really like is Denbury Resources Inc. (DNR:NYSE). It's very leveraged to the price of oil. It has been growing its production and just initiated a dividend. It has also been actively buying back its own shares. It generates a significant amount of free cash flow. Over the next several years, that free cash flow is going to grow significantly, and there's very little exploration risk for Denbury because it is buying depleted fields. It has been able to bring these fields back to life through CO2 injections. Those are five companies I think have a very bright 2014.

    TER: You've been very forthcoming. Do you have some closing guidance or advice for investors?

    BP: The resource sector is very difficult and requires quite a bit of research, but I think prices, depending on the company, are going to be very helpful. Some companies that have struggled over the last several years due to weak natural gas prices will have a very bright future. There are a lot of opportunities for companies to grow cash flow per share and production per share and do it without really increasing their capex. This is a very exciting time to be in the space. As always, I think for investors who can spend some time and get to know some of the companies I just mentioned and plenty of others, there are a lot of opportunities out there.

    TER: Thank you very much. This has been a very interesting conversation.

    BP: Thank you. It's been great being here.

    Bill Powers is an independent analyst, private investor and author of the book "Cold, Hungry and in the Dark: Exploding the Natural Gas Supply Myth." Powers is the former editor of the Powers Energy Investor, Canadian Energy Viewpoint and U.S. Energy Investor. He has published investment research on the oil and gas industry since 2002 and sits on the Board of Directors of Calgary-based Arsenal Energy. An active investor for over 25 years, Powers has devoted the last 15 years to studying and analyzing the energy sector, driven by his desire to uncover superior investment opportunities. Follow him on Twitterfor ongoing updates.

    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) 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: None. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
    3) Bill Powers: I or my family own shares of the following companies mentioned in this interview: Arsenal Energy Inc. 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 © 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

    Jan 17 1:48 PM | Link | Comment!
Full index of posts »
Latest Followers

StockTalks

More »

Latest Comments


Posts by Themes
Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.