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  • Three Upstream MLPs With The Discipline To Succeed In The Coming Recovery: RBC Analyst John Ragozzino

    Are you ready for $74 per barrel oil? In this interview with The Energy Report, RBC's John Ragozzino tells us he's anticipating a V-shaped oil price recovery that could bode well for upstream master limited partnerships, the companies that invest in oil and gas assets and have been hit hard by lower prices. He has followed MLPs through the highs and lows, and he knows which had the strength to hedge at the right times and which are liquid enough to take advantage of growth opportunities that could be right around the corner.

    The Energy Report: John, oil and gas prices have rallied a bit recently. Have we established a bottom?

    John Ragozzino: Yes. In our recently published Global Energy Research "Commodity Price Revisions" report, we are calling for a meaningful V-shaped recovery beginning in the back half of 2015 and into 2016. This is not significantly different from our prior forecasts, as we adjusted our price forecasts to $54 per barrel [$54/bbl] from $53/bbl in 2015, and from $77/bbl to $74/bbl in 2016.

    Our thesis on crude oil is largely predicated upon a deceleration of non-OPEC supply growth, as we've seen the U.S. onshore rig count drop by more than half over the last five or six months. Additionally, we are seeing a growing inventory of uncompleted unconventional wells, as operators defer completions to an environment of better pricing and higher returns. When you combine these two factors with a global demand picture that calls for roughly 1.0-1.1 million barrels [1.0-1.1 MMbbl] of annual demand growth over the 2015-2016 time frame, it doesn't take long before the global oversupply situation is largely eroded and we find ourselves back in a state of equilibrium. I think that will be the meaningful catalyst that gets us to higher prices in 2016. Our long-term deck remains unchanged at $84/bbl West Texas Intermediate [WTI] and $90/bbl Brent.

    On the gas side, I wouldn't say that statement holds quite as well, because we continue to see new lows on Henry Hub natural gas prices. We can probably expect a continuation of anemic demand growth until the middle 2015, at the very least. That should mark the beginning of a phase of meaningful coal generation retirement, which could result in 2-3 billion cubic feet per day of additional demand. It's not until 2017 and beyond that we begin to see some meaningful changes on the gas demand side, with liquefied natural gas exports ramping up.

    TER: Based on your new commodity price forecasts, what's the risk profile of upstream master limited partnerships [MLPs]?

    JR: The upstream MLPs are at an elevated risk profile relative to historical levels. At the end of 2014, we believe the upstream MLPs were at a peak risk profile, as prices had been rapidly cut in half immediately after 18 months or so of market backwardation, when many management teams got ahead of themselves and veered off the well-beaten strategy path of robust hedging and price risk aversion measures. Most upstream MLPs typically follow a rolling three- to five-year commodity price risk-aversion strategy that includes the use of fixed price swaps and costless collars to mitigate exposure to price volatility. Many upstream MLPs today are well below their preferred hedge levels due to the temptation to wait for better pricing during that long period of backwardation.

    Management teams reluctant to take a $15-$20/bbl discount for their production volumes two to three years out held off on hedging at the worst possible time, as they saw prices cut in half as opposed to the forward curve simply returning to a normal state of contango. When the price continued to fall, a lot of companies that were crude oil-weighted effectively became victims of their own temptations.

    Today, upstream MLPs are looking healthier after cutting distributions and making meaningful reductions in spending plans for 2015. Capital preservation is the main theme. The passage of the spring redetermination period also lifts a material overhang on the group in general. Everyone has sobered up mighty quick in light of reduced oil prices. The outlook for distributions and spending profiles is far more sustainable than what it looked like going into 2015, which goes a long way to reducing risk compared to levels seen in late December and early January.

    TER: How do you identify an upstream MLP that meets your investment goals?

    JR: It's really pretty simple. A lot of naysayers argue that producing assets in the upstream model don't fit into the MLP structure, because the MLP holds a declining asset that must support a distribution profile that is steady in the worst-case scenario, and ideally growing over the long term. Those two things inherently don't match. But when an MLP employs a disciplined hedging strategy that mitigates commodity price risk, and follows a simple strategy of minimal spending on organic project development while using the cost of capital benefits that the MLP structure potentially affords to grow the business via accretive acquisitions, there is absolutely a place for upstream companies in the MLP structure.

    Longer term, I believe that the maturation of the resource base in the U.S., concurrent with a period of such vast discovery on the unconventional side, has led to a thirst for capital by the exploration and production [E&P] C corporations. This has facilitated a symbiotic relationship between the upstream MLPs and the E&Ps, and resulted in widespread divestitures of many mature, shallow decline-type assets that were likely not getting much appreciation from C-corp investors. Those are the ideal assets for an upstream MLP because they have very low decline rates, low capital intensity levels and, ultimately, they're far more suited to sustaining a distribution in the long term.

    As far as what we look for in specific companies, balance sheet health and liquidity position are at the top of the list. I also look carefully at the asset profile. Ideally it should be a diverse mixture of commodity products. You don't want to be overly levered to oil or gas. There was a time when it was cool to be 100% crude oil-weighted, but you can see how quickly that turns when prices are cut in half. So a diverse production profile is important. A quality asset base, meaning low decline rates [10-12%], and low capital intensity, are also important. Finally, I look for a strong management team, one that is well aligned with unit-holder interests.

    TER: What is an example of a company that meets your criteria?

    JR: Linn Energy LLC (NASDAQ:LINE) is a turnaround story that, 18 months ago, was probably dealing with upward of a 23% annual production decline rate on a year-over-year basis. Through a series of large divestitures and asset acquisitions, Linn has been able to wear that down to something more along the lines of 15% or so. Something in the 10-12% range would be ideal, but the company is moving in the right direction.

    Management has also strategically positioned itself to take advantage of both organic development opportunities and potential acquisition & development [A&D] opportunities by partnering with large private equity partners such as GSO Capital Partners [Blackstone Group L.P.] and Quantum Energy Partners.

    The bottom line is that this company should be able to continue to grow production and, ultimately, cash flow, without being so heavily reliant upon the traditional public debt and equity markets. Once Linn's balance sheet is de-levered to a more comfortable level and distribution growth is able to resume, the stock will be more attractive to investors. A healthy balance sheet and sustainable distribution growth is ideally what investors are looking for, and this should drive capital appreciation through yield compression.

    TER: Linn made almost half of all the acquisitions made by upstream MLPs since 2008. How is it finding synergies, cutting costs and integrating all those companies?

    JR: On the operations side, Linn's operations and asset integration team is second to none. The team has effectively created an acquisition machine. Over the last 18 months, the company significantly turned the asset base over, taking a high-decline asset base with a lot of production and undeveloped acreage in unconventional plays such as the Granite Wash and the "Hogshooter" and, through a series of asset swaps and divestitures, moved out of these plays and into plays like the Hugoton Basin. These plays are far less sexy and fun to watch, but they make a lot more sense for the upstream MLP model. For a company its size, Linn is actually quite nimble.

    TER: You aren't worried about the cut to its shareholder distribution?

    JR: Only a handful of companies in the group have not cut their distributions at this point. In light of the sector-wide lack of hedging, I see cutting distributions as a sign of being proactive and realistic about the world we now live in, rather than of weakness. Linn was the first to cut its distribution in January. It may have been a bit early, but it was the right decision. Others followed suit soon thereafter.

    TER: What other upstream MLPs are you following?

    JR: Another name we like is Memorial Production Partners LP (NASDAQ:MEMP). The thesis is pretty simple. It is one of the only names that remained disciplined throughout this period of volatility and falling commodity prices. On top of that, the company has had a good run in the acquisition market, growing quickly and efficiently. It has taken its largely natural gas-weighted production profile and turned it into a much more diversified product split. Most importantly, Memorial is one of the most aggressive hedgers of the group, managing a hedge book that extends well into 2019. Management stuck to the script: It removed all the emotion from the decision-making process and followed the playbook as it was written. That is paying off in the stock price, compared to a lot of its peers.

    TER: Memorial just did a redetermination and reduced the borrowing base by 9.7%. Is it still liquid enough to take advantage of acquisition opportunities?

    JR: The conservatism demonstrated in Memorial's hedging strategy has allowed the company to preserve a far healthier balance sheet and liquidity profile than a lot of its peers. Plus, the company was lucky enough to tap the equity markets right before the crack of the commodity and entered the redetermination season with close to $900 million [$900M] in liquidity. The expectation going into the redetermination was for a 10-15% reduction in the borrowing base. For a company of its size and with nearly $1 billion on hand, there is plenty of room for an adjustment of the borrowed base to the tune of about 9%. This move leaves Memorial well positioned to remain quite opportunistic for any emerging A&D opportunities.

    TER: Is there a third company you wanted to talk about?

    JR: The only other upstream MLP that we are currently recommending is EV Energy Partners L.P. (NASDAQ:EVEP). This name is largely natural gas-weighted, but the company recently announced the divestiture of its Utica East Ohio midstream project for $575M in cash to Williams Partners L.P. (NYSE:WPZ). That was a very attractive price in our opinion, providing the company with a meaningful booster shot of liquidity to the balance sheet. This cash is going to allow EV Energy to pay down all its revolving debt and ultimately emerge as one of the best-positioned upstream MLPs for future A&D.

    We are getting to a point where the bid-ask spread on producing assets is settling down and is likely to find some sort of equilibrium soon. I expect the acquisition activity to pick up in H2/15 and 2016. Those companies with additional dry powder to exploit A&D opportunities are going to be able to outperform their peers. EV Energy Partners will be sitting on $650M in cash. The addition of a mature, producing asset worth $500M or more could do a lot to reshape its current asset base, diversifying it into a more balanced product split, and ultimately yielding significant accretion to distributable cash flow per unit. This should help move the company back to its original strategy, which was a traditional, steady state of distribution growth. Following the path of most of its peers, EV Energy's early February distribution cut and reduced capital spending outlook leaves the company in a healthy position currently. I would like to see it get back to a sustainable 3-4% distribution growth number, and I think that this divestiture and reinvestment process is likely the catalyst to do that.

    TER: What about other parts of the MLP space? Do you have other companies we should be watching?

    JR: The one name that I follow in the refining and specialty products business is Calumet Specialty Products Partners, L.P. (NASDAQ:CLMT). This company is largely viewed as a refining name, which in the current environment is being helped by a favorable fundamental tailwind given the rally we've seen in crack spreads over the last couple of months.

    But if we go back to the end of 2014, it was a different story. The stock bottomed out at about $19-and-change/unit in late 2014, almost simultaneously with a bottom in crack spreads. Then crack spreads skyrocketed almost $10/bbl in less than a week, kicking off a strong rally in Calumet units. There has clearly been a lot of momentum behind units. I admit, we missed the opportunity to upgrade Calumet at its lows. However, following a secondary offering in mid-March, the stock pulled back over 14%, and we decided to get more aggressive on the premise that the fundamentals in the refining market were certainly reflective of better things to come on the refining side of the business.

    With Calumet, however, the most important thing to focus on is the specialty products side of the business, as opposed to the refining side. While the fuels business is in a good fundamental state right now, and the company does employ a risk mitigation strategy that uses hedges, similar to an upstream MLP, to lock in refining margin, it's a commoditized market and very volatile.

    On the specialty products side of things, Calumet produces some 5,000 different products and distributes to customers all over the world. These are very high-margin products with extremely sticky pricing. This means these products benefit when we see a reduction in crude oil prices-products like WD-40 or Royal Purple automotive lubricant. These products are ubiquitous and don't fluctuate with changes in oil prices. Just in Q4/14 alone, the company posted a record gross profit per barrel on the specialty products side of the business, a quarter during which we saw an average WTI crude price north of $70/bbl.

    The Street has largely put the company in the penalty box over the last two years, just because of weak operating performance on poorly timed maintenance downtimes for the refineries, digestion of acquisitions and cost overruns-things that were outside Calumet's control and one time in nature. Now that is cleared up, and we have a clear look at the business and what it can do going forward. I think that we're going to see Calumet outperform its historical levels of operating performance and exceed estimates.

    I think we are in the early innings of Calumet's upward trend and strong financial performance on the specialty products side of the business. Additionally, after the recent offering, the company has secured the necessary funding to complete its pipeline of organic growth projects, which should contribute nearly $140M in additional EBITDA [earnings before interest, taxes, depreciation and amortization] per year over the next 12 months or so. Once the remaining capex on these projects is completed, we expect the company to resume distribution growth.

    TER: What final words of wisdom do you have for investors already in the MLP space, or curious about getting into the space this year?

    JR: A fairly negative sentiment is still lingering around the upstream MLP space. I would say that there certainly is opportunity to be had in the sector right now, but given the underhedged profile of a lot of the upstream names-and the uncertainty that surrounds the commodity market-investors still need to be cautious about their investment decisions and can't be tempted by some of the attractive yields out there. They need to do their homework and make sure they're making prudent decisions and looking for the higher quality names. Selectivity will be key to picking winners versus losers over the next 12-18 months. Like I said earlier, it's going to come down to those companies that are well situated in terms of their liquidity position, balance sheet health, hedge profiles, production diversity and, ultimately, staying power.

    If we see our price deck come to fruition, and there is a meaningful V-shaped recovery, and we find ourselves back upward of $77-80/bbl by the end of 2016, then it's a bit of a different story. The situation would be more universally attractive. But until that happens, the best-of-breed investment strategy will ultimately win.

    TER: Thank you for your time.

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

    John Ragozzino, CFA, joined RBC Capital Markets in 2012, bringing with him more than nine years of experience in institutional equity research. He has followed a number of different sectors including media, entertainment, gaming, and most recently energy. Ragozzino has remained focused on the energy space through his coverage of various subsectors including oil and gas exploration & production, upstream master limited partnerships [MLPs] and oil and gas royalty trusts, the latter two of which he currently covers as one of RBC's three analysts dedicated to the broader MLP space. Before joining RBC, he worked in institutional equity research for a number of large and mid-size investment banks, including Robert W. Baird, Stifel Nicolaus Weisel, Wells Fargo and BMO. He holds a bachelor's degree in business administration [finance] from the University of Colorado at Boulder. He is a CFA charterholder.

    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.Top of Form

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    DISCLOSURE:
    1) JT Long conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an employee. She or her family own shares of the following companies mentioned in this interview: None.
    2) The following companies mentioned in the interview are sponsors of Streetwise Reports: None. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
    3) John Ragozzino: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: A member company of RBC Capital Markets or one of its affiliates managed or co-managed a public offering of securities for Calumet Specialty Product Partners LP in the past 12 months. A member company of RBC Capital Markets or one of its affiliates received compensation for investment banking services from Calumet Specialty Product Partners LP in the past 12 months. RBC Capital Markets is currently providing Calumet Specialty Product Partners LP with investment banking services. RBC Capital Markets has provided Calumet Specialty Product Partners LP with investment banking services in the past 12 months. A member company of RBC Capital Markets or one of its affiliates expects to receive or intends to seek compensation for investment banking services from Calumet Specialty Product Partners LP in the next three months. RBC Capital Markets is currently providing Linn Energy LLC with non-securities services. RBC Capital Markets has provided Linn Energy LLC with investment banking services in the past 12 months. A member company of RBC Capital Markets or one of its affiliates received compensation for investment banking services from Linn Energy LLC in the past 12 months. A member company of RBC Capital Markets or one of its affiliates managed or comanaged a public offering of securities for Linn Energy LLC in the past 12 months. A member company of RBC Capital Markets or one of its affiliates managed or comanaged a public offering of securities for Memorial Production Partners LP in the past 12 months. A member company of RBC Capital Markets or one of its affiliates received compensation for investment banking services from Memorial Production Partners LP in the past 12 months. RBC Capital Markets is currently providing Memorial Production Partners LP with non-securities services. RBC Capital Markets has provided Memorial Production Partners LP with investment banking services in the past 12 months. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. 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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  • The Three Principles That Guide Randall Abramson's Oil & Gas Investment Strategy

    The market analysis tools used by Randall Abramson of Trapeze Asset Management Inc., suggest that the broad market has been fairly valued for about a year. But by applying apples-to-apples metrics to companies in the energy sector, Abramson has found specific equities trading well below their estimated appraised values. By the end of 2015, Abramson predicts oil prices will rise back to $70 per barrel or more, and undervalued energy equities should propel toward fair value. In this interview with The Energy Report, Abramson pinpoints some unloved energy companies poised for the rebound.

    The Energy Report: In a recent research report, you looked at the macroeconomic picture through the lens of value investing. You call the macro view "complex" and "historically unusual." In the context of certain uncertainty, could you please provide us with three principles that guide your investment decisions in today's market?

    Randall Abramson: The reality of the day is that we have historically low interest rates and a number of crosscurrents moving through the economy. At Trapeze Asset Management we've developed tools, some of which we have systematized since the big downturn in 2008-2009, to cope with periods like this. We use our valuation model from a bottom-up perspective to tell us where the individual bargains are, and from a top-down perspective to tell us, in general, whether the markets or sectors are overvalued, undervalued or fairly valued. Today, our work tells us that the market has been hugging fair value pretty closely for about a year, which is unusual. That one tool helps us establish where the markets are and where they ought to be heading.

    The second thing that guides us is the macroeconomic overlay. We have an economic composite and a momentum indicator, both of which are designed to predict whether there is a recession coming and/or a market debacle-not a typical correction but one of those 20% or more doozies. At the moment, our economic composite is showing smooth sailing, not just in the U.S. but also in other global economies. Our momentum indicators show relatively smooth sailing too, though a few countries, including Russia, Brazil and Peru, have negatively triggered.

    And, finally, we try to determine which way the world is going. Disinflationary pressures and the ascent of the U.S. dollar have pushed down the resource sector, and most commodity prices have been badly hurt. The stagnation in many economies around the world has resulted in highly accommodative monetary policies. That's a reason we like the resource sector: We think that reflation is around the corner.

    TER: Fair value would suggest that we're not in a bear market for energy stocks, but clearly we are.

    RA: There's no question that the sector has been in a bear market because we define, like most people, any drop greater than 20% as a bear market. Yet it's the most unusual energy bear market I've witnessed in my 25 years in the business. It's rare to get a selloff like this that is not precipitated by a recession. The demand for oil is ever growing. It normally rises even in a recession.

    The decline started after Brent crude went to $120/barrel [$120/bbl]. It was too far above the marginal cost of production, which is usually what holds the price in check. Then you had the serious rise in the U.S. dollar, which started bringing down most commodity prices because they're priced in U.S. dollars. At the same time you had excess supply driven by the U.S. shale boom. Then, in November 2014, OPEC said that it would not curtail oil production, knowing that would drive oil prices even lower to force production cutbacks around the world. That was probably the right thing to do, but I don't think even OPEC expected to see oil at $40/bbl.

    TER: What are your near-term and medium-term forecasts for oil and gas?

    RA: It's always hard to tell where things are going in the near term. But when you look out, say, six to nine months, you're likely to see a substantially higher oil price. That's because it's unbelievably rare to be trading below the average all-in cost of production. The all-in cost of production is in the $55-60/bbl range. While Brent has gone back above those levels, WTI [West Texas Intermediate] is still below. It's not sustainable.

    Case in point: We have seen the number of U.S. drilling rigs collapse from more than 1,900 to just over 1,000 since last fall. That hasn't translated to lower U.S. oil production yet, but it's coming. If you're not out there finding more oil, and you have abnormally high decline rates-U.S. shale oil wells tend to decline much faster than conventional oil wells-you're setting up for a decent production decline in the next 12-18 months. And, even if U.S. production were to merely flatline, the global supply/demand equation is tight enough that the ever-growing demand should quickly create a supply deficit.

    TER: You still like some energy names, even with oil at around $50/bbl. Is it about finding specific narratives with catalysts in a bear market?

    RA: First of all, you have to have a forecast that the bear market is going to end, which we do. As I said, the price for oil has overshot to the downside, below the average all-in cost of production. There's an adage in economics: Gluts beget shortages and shortages beget gluts. Clearly, we had a "mini-glut" because of the U.S. shale overhang, but we can end up in a shortage position rather quickly.

    Globally, supply amounts to 94 million barrels per day [94 MMbbl/d] versus demand of about 93.5 MMbbl/d. Demand has been growing smartly, thanks to countries like China and India. But the problem for the oil market is that U.S. supplies went from 6 MMbbl/d of supply to 9 MMbbl/d in three years. That has now flatlined just above the 9 MMbbl/day mark and I suspect it will drop. In Q1/15, global oil demand rose by 2 MMbbl/d year-over-year. So U.S. production doesn't have to drop far before overall demand outstrips supply again. That will, at the margin, quickly bring prices back up.

    TER: So even though U.S. oil inventories are at their highest point since 2001, you see that changing quickly?

    RA: Yes, because global inventories are relatively normal. It's only U.S. inventories that are bloated. Some people believe refineries are intentionally building supply because they see problems ahead. Refiners are known for being pretty adept. There has been commentary about the amount of heavy oil that is needed to import for refining. Heavy oil imports have been jacking up and leading to some strange inventory levels in the U.S.

    TER: In the report I referenced earlier, you aptly noted that investors are often giving up returns in the rush to safe investments, like government bonds or slow-growth blue-chip equities. How do you and your team balance risk versus reward?

    RA: A number of ways. I'll divide it between bottom up and top down. From a bottom-up perspective, we look for a margin of safety. That means if the price is trading at or above our appraisal, using our discounted cash flow models as fair value, we're not interested. A stock needs to be trading at a discount to fair value, because if something goes wrong we want to make sure there's a margin of safety. To make a sufficient return that beats your hurdle rate, you want something to go from at least $0.80 on the dollar back up to a dollar, and collect the dividends and growth in the company on top of that. We screen more than 1,200 large-cap stocks-the largest in the world, and a number of medium- and small-size companies, too-looking for those that are trading at less than $0.80 on the dollar. That's one piece of the puzzle.

    Then you want to do your due diligence, to make sure that you understand the businesses you're buying. They shouldn't be subject to regulatory issues that could alter the entire business, or leveraged to a point where the business could be in peril. At the same time, you want to avoid what we call "value traps," where the stock might be cheap, but it's cheap for a reason. Therefore, you want to focus on earnings revisions and near-term happenings in the business.

    From a top-down perspective, you want to monitor not for your typical 3-6% corrections, but for those 20% or more drawdowns in the market. Those usually arrive when recessions come.

    TER: What are some other names that you have positions in?

    RA: One that is farther afield is Orca Exploration Group Inc. (OTCPK:ORXGF)[ORC-A:TSX.V; ORC-B:TSX.V]. The company produces more than 90% of Tanzania's natural gas, about half of which is used to produce power. The stock has been stuck in the CA$3/share range for the longest time as Tanzania struggles with corruption issues. And the national utility, TANESCO [Tanzania Electric Supply Co. Ltd.], has not been meeting its obligations to Orca and other companies on a timely basis, even though things have improved since the World Bank got involved more than a year ago.

    Orca is also not producing at the levels the market expected by now, but a pipeline slated for completion years ago is finally going to be commissioned in a few months. Hopefully, that pipeline will deliver enough Orca natural gas to help alleviate the severe brownouts Tanzania has experienced for many years. In the meantime, Orca is remarkably cheap. The company has more than US$60M cash and is owed more than US$60M by TANESCO and has no debt-there's about CA$2.50/share of net working capital, including amounts we expect Orca to ultimately collect from TANESCO. You're nearly getting all the reserves for free. And the 2P reserves are worth in excess of CA$11/share according to the company's third-party engineers.

    TER: Is the company's move into Italy an attempt to mitigate risk in the stock?

    RA: It's an attempt to diversify, and management liked what it saw there.

    TER: Tell us about Orca management and some of its key people.

    RA: Chairman and CEO David Lyons has had a large ownership stake for many years. He spun out Orca from PanOcean Energy Corp., a successful company that ran for many years. Its primary investment was in Gabon, so he knows what it takes to operate in Africa. Lyons ultimately sold PanOcean to Addax Petroleum [AXC:TSX] in 2006. I think that Orca will get sold, too. In November 2014, the company announced that there were unsolicited expressions of interest, either in the entire company or its assets. Something may already be afoot.

    TER: Why hasn't that created more of a run on the stock?

    RA: People are simply scared of Tanzania. A country that does not pay its bills on a timely basis does not sit well with most investors. People pay a premium for safety, and they discount things that they're concerned about. Our job is to determine whether those risks are real. While we don't believe there are material risks here, resolving Orca's issues has taken way longer than we'd thought.

    TER: Are there any other equity stories you'd like to tell us about?

    RA: We like the oil and gas service space as well. One name in that space is Paris-based Technip S.A. (OTCPK:TNHPF) [TEC:EP; TKPPY:OTC]. Technip is one of the leading oil and gas service companies, offering both subsea and onshore/offshore services, everything from soup to nuts in the business. The stock has been knocked down, along with the whole energy space, to the point where it's trading at about 4.7 times EV:EBITDA versus about 7 times for the group and 10 times for names like Halliburton Co. [HAL:NYS]. We think it's a serious bargain. It's just a lesser-known name.

    TER: What's the next catalyst for Technip?

    RA: It's just about the oil price recovering. The service sector tends to be higher beta, and moves more dramatically. We need to see higher oil prices. When we wake up toward the end of the year, you should see a significant recovery of most players in energy services.

    TER: Are there any other stories you'd like to share with us?

    RA: I'll give you one more: Weatherford International Ltd. (NYSE:WFT), which is also in the oil and gas service space. Weatherford has been in turnaround mode after it added too much debt. But it sold divisions, cut costs and de-levered. Like Technip, once the price of oil and gas recovers, you could see a material recovery in the price of Weatherford.

    TER: What has the macro picture of the last five or six years taught you as an investor on a micro level?

    RA: In general, we've learned from our macro tools that when they are not giving us red flags to remain fully invested, the market will continue to climb the wall of worry. While it's doing that, until there is something to actually worry about, you need to be fully invested, assuming you can find bargains. Otherwise, cash becomes a significant drag to your portfolio.

    TER: Thank you for talking with us, Randall.

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

    Randall Abramson, CFA, is CEO and portfolio manager of Trapeze Asset Management Inc., a firm he cofounded in 1999 shortly after founding its affiliate broker dealer, Trapeze Capital Corp. Abramson was named one of Canada's 'Stock Market Superstars' in Bob Thompson's Stock Market Superstars: Secrets of Canada's Top Stock Pickers (Insomniac Press, 2008). Trapeze's separately managed accounts are long/short or long only, and have either an all-cap orientation or large cap-only mandate via the company's Global Insight model. Abramson graduated with a bachelor's degree in commerce from the University of Toronto in 1989, and his career has spanned investment banking, investment analysis and portfolio management.

    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.

    Bottom of Form

    DISCLOSURE:
    1) Brian Sylvester conducted this interview for Streetwise Reports LLC, publisher ofThe Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
    2) The following companies mentioned in the interview are sponsors of Streetwise Reports: None. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
    3) Randall Abramson: I own, or my family owns, shares of the following companies mentioned in this interview: Orca Exploration Group 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 determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
    4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
    5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer.

    6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

    Streetwise - The Energy Report is Copyright © 2014 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (NYSE: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

    Apr 23 5:41 PM | Link | Comment!
  • Joe Reagor: Four Uranium Companies Poised To Profit From The Growth Of Nuclear Power

    Nuclear power is enjoying a renaissance, and the world will soon need more uranium. Up to 50% more within a decade, says Joe Reagor of ROTH Capital. In this interview with The Mining Report, he explains that the share prices of uranium juniors remain low because the uranium spot price has not yet risen to reflect the increased demand just around the corner. This provides a great opportunity for canny, long-term investors, and Reagor identifies four companies that have the means to profit from the inevitable need for their product.

    The Mining Report: The 27th annual ROTH conference was held in California last month. What's the purpose of this conference?

    Joe Reagor: We provide management access to our client base and provide exposure for the smaller-cap companies that are somewhat under-covered by the Street.

    TMR: How would you sum up the sentiments of the participants?

    JR: In the mining sector, I heard a bit of cautious optimism. Conditions seem to be improving, but the strength of the U.S. dollar is not helping most commodity prices. However, if you operate outside of the U.S., margins are improving.

    TMR: With all the concern about a possible stock-market bubble, was there perhaps a feeling that miners may be due for a revaluation because they produce things of tangible worth?

    JR: There has been more generalist interest in mining recently because of the fear that the broader market is getting a bit frothy in certain sectors. This lends support for diversification and investment in mining companies because, as you said, they do produce hard assets and can benefit should the overall market underperform.

    TMR: Since we last spoke, the spot price of uranium topped $40/pound [$40/lb], and is now just above $39/lb. What are the fundamentals that have undergirded this rise?

    JR: There was a significant supply overhang after the Fukushima disaster of 2011. Then there were two large sales that occurred after that, probably inventory liquidation, perhaps from Japan. We reached the bottom last summer.

    The supply overhang peaked again due to increased production from Kazakhstan. But that is no longer a problem. Kazakh production is no longer growing, and some of the larger uranium projects globally have been put on hold. That has allowed the inventory level to return to normal levels and has enabled a more sustainable pricing point.

    TMR: Where do you see uranium going for the duration of 2015?

    JR: There will be additional demand as nuclear reactors come back on-line in Japan, and as China completes new ones. So, I think the price will continue to trend upward, perhaps to $50/lb by year-end, although we might continue to see small pullbacks.

    TMR: China's demand for new reactors is dependent on burgeoning economic growth. Will China continue to expand as it has in the recent past?

    JR: I'm not a macro expert on that subject, but my opinion is that China will continue to grow at a rate that will inspire envy in Europe and the U.S., but it will not be the double-digit growth we became accustomed to. China needs to produce more power for a growing and more affluent population, so it will need reactors. For that reason, I think China's uranium needs may grow faster than its economy overall.

    TMR: According to a report by Cameco Corp. [CCO:TSX; CCJ:NYSE], the amount of uranium required to service the growing number of nuclear reactors will increase from 155 million pounds [155 Mlb] annually today to 230 Mlb annually within a decade. Can this need be met?

    JR: There is some apprehension about whether uranium production can grow to that level. One source will be uranium as a mining byproduct. In the past, uranium produced by certain mines was treated as waste, but, if needed, this could enter the market.

    Multimillion-pound uranium projects in Canada and in the U.S. would likely see increased investment should uranium rise above $55/lb. And Kazakhstan can increase production significantly, even though it already produces one-third of world supply.

    TMR: Assuming that uranium demand does indeed rise to 230 Mlb annually, how would that affect the price?

    JR: In the short term, price spikes of up to $100/lb are possible. In the long term, we're looking at a price in the $60-70/lb range. The problem of price spikes could be solved with offtake agreements, whereby utilities help fund the development of uranium projects in return for contracts to buy uranium at fixed prices.

    TMR: Given the recent success of uranium exploration in Saskatchewan, will there be a rush to develop these projects should the uranium price top $55/lb?

    JR: Not necessarily. The uranium industry is now well aware of its supply-and-demand dynamics. A price above $55/lb will encourage additional development, but not of any projects that would result in significant oversupply. Most of the world's active uranium mines are very profitable at $55/lb.

    TMR: How finely can uranium demand be calibrated?

    JR: Current uranium demand is 155 Mlb, plus or minus 5%, assuming no additional reactors. Reactor lead time is up to five years, and that is more than enough time to source new supply.

    TMR: Can you explain how the price of uranium is determined by long-term contracts signed by utilities and what the current state of this process is?

    JR: Contract-price uranium has enjoyed a premium over spot price. This has trended down to only a couple of dollars a pound, but historically it has been closer to $10/lb. Utilities generally seek to sign contracts to buy uranium two years into the future. But they will sometimes take delivery 6 to 12 months early and have it sent to their concentrators. The ultimate purpose of these contracts for utilities is to provide price stability for energy consumers. And to the miners, these contracts guarantee financing.

    The great majority of uranium is sourced via contracts, with only 5-15% provided by the spot market.

    TMR: It has been suggested that the price of uranium is likely to increase soon because several large 7 to 10 year contracts are coming to an end. Do you agree?

    JR: Some larger producers, such as Cameco or AREVA SA [AREVA:EPA], have contracts with utilities coming up for renewal. There is a essentially a quoted contract price out there that's well known and then an assumed inflationary rate beyond that. I think the utilities are likely to simply renew these contacts with their existing producers. The bigger concern is that the Japanese utilities have not renewed contracts and don't have offtake agreements, so they might be forced into the spot market.

    TMR: We often hear the uranium market compared to a game of chicken between suppliers and utilities. Is this a useful metaphor?

    JR: It's a bit overstated. Suppliers use this comparison in order to suggest that the price of uranium is going to increase, but when we compare in importance the overall cost of running a nuclear power plant versus the cost of 500,000 lb [500 Klb] to 1 Mlb of uranium, the latter is not all that crucial.

    Utilities are not that incentivized to haggle over a few dollars a pound, as the suppliers would have you believe. Utilities can now make up any supply shortfalls from their contracts in the open market, and that could lead to a tighter spot market.

    TMR: Would you talk about mergers in the industry?

    JR: It's been three months since the merger of Energy Fuels Inc. (OTC:UUUU) and Uranerz Energy Corp. (NYSEMKT:URZ) was announced. The deal is transformational in that it creates multiple avenues of producing returns for shareholders. Energy Fuels had been a conventional uranium miner and producer. Adding Uranerz will give it an in-situ recovery [ISR] method of production and therefore the flexibility to fluctuate between the two methods as needed. ISR also provides a low-cost option should the uranium price flatten or trend downward. And the merger also provides the new company with additional cash flow to reinvest into larger uranium conventional projects should the uranium price reach the $55-60/lb range.

    TMR: You recently noted that revised growth plans for the new company will not be available until the merger is complete. Are there any clues as to what those plans might be?

    JR: U.S. companies are prohibited from providing such guidance. I'm sure Energy Fuels would prefer to provide it to shareholders and analysts, but it can't.

    TMR: In your March 23 research report, you wrote, "Q4/14 was a poor quarter for [Energy Fuels], as the company made no significant uranium sales. . .we anticipate a similar sales schedule in 2015 to that of 2014, with [the company] producing only 70 Klb of uranium and drawing down inventories to meet contract sales volumes of 800 Klb." Is this model sustainable?

    JR: Well, Energy Fuels has contracts beyond this year. I believe the contracts do get a little smaller as we go out, but Energy Fuel's goal is to produce only from its conventional mining methods what it needs to deliver into those contracts. Should the uranium spot price rise above $50/lb, Energy Fuels would be able to increase production.

    On the other hand, should the spot price remain flat, we'd expect the company to produce just enough to meet contracts, with perhaps a slight amount beyond that to provide a cushion. The 75 Klb is just it finishing up the Pinenut mine in Arizona. Next year, Energy Fuels will switch to its Canyon mine in Arizona, which is expected to produce the 700 Klb it will need for next year's deliveries.

    TMR: How does Canyon compare to Pinenut with regard to costs? And are there significant costs associated with switching production from Pinenut to Canyon?

    JR: We won't know the cost metrics until Canyon actually begins production, but I expect them to be similar. There's going to be a development cost for Canyon, probably $10-20 million [$10-20M], but the good news is that the Pinenut workforce is being transferred to Canyon, so there will be no significant severance costs.

    TMR: Around the middle of February, Energy Fuels' shares were trading around $6.50 but then fell to $5.03 by the beginning of April. They've since recovered to $5.26/share. Did the share-price fall surprise you?

    JR: I've been a bit surprised in general by the underperformance of the small-cap uranium producers in the face of the steady flow of positive news regarding the uranium price. This provides an opportunity to investors, in my opinion.

    We're maintaining a Buy rating and an $11 target price for Energy Fuels until we get further guidance. My overall view is that the Uranerz acquisition will result in a stronger, better company. Its current valuation is based solely on Energy Fuels, so there is upside for the combined company, even though reworking the numbers may or may not result in a higher valuation after the fact.

    TMR: How does Uranerz make the new company better?

    JR: By providing a lower-cost production footprint. Nichols Ranch will be an ISR producer and is expected to have significantly lower operating costs than those of conventional mines such as Canyon. Uranerz is also bringing some contracts that Energy Fuels can deliver into. Plus, Uranerz's additional ISR projects give Energy Fuels additional future production flexibility.

    TMR: How important is flexibility in today's uranium market?

    JR: Given the potential for price shocks, up or down, having flexibility in its production schedule and investment decisions is a significant differentiator for Energy Fuels. It stands apart from the other uranium juniors that have solely conventional or ISR production.

    TMR: So ISR capability allows the new company to move more quickly based on possible spikes?

    JR: ISR can reach production faster but cannot reach the same magnitude. ISR also allows fluctuation of production flow rates without significantly altering production costs. With conventional mines, production fluctuations can significantly alter operating-cost metrics.

    The advantage of conventional mines is that they are more scalable. So one would expect a shift to conventional mining should we see a big increase in the uranium price.

    TMR: What other junior you follow has seen a significant drop in its share price?

    JR: Uranium Resources Inc. (NASDAQ:URRE) fell from above $1.80 in March to $1.27.

    TMR: Why did that happen?

    JR: First, the company raised additional capital necessary to continue to fund development of its assets, and the additional dilution forced the valuation down. That offset the uptick in the uranium spot price.

    Second, Uranium Resources provided an update on its pounds in the ground resources and reserves, which showed some larger than expected reductions at certain properties. When the company made a land swap agreement on Roca Honda, it didn't provide the exact details of how many pounds were leaving the resource. This turned out to be more than we previously thought.

    This company is more of a long-term call option on uranium. It has no production today, and a uranium price of $48/lb would be necessary for it to move forward on its assets. On March 23, we reduced our target price from $3.50 to $2.25. This company's assets are vast, so investors who believe that the uranium price will spike will be interested in it.

    TMR: What's the best strategy for investors seeking to benefit from the expected growth of nuclear power?

    JR: There are two strategies I like. The first is targeting companies that are not getting full credit for assets that are expected to go into production in the next few years. The second is targeting companies, like Energy Fuels, whose portfolios are diversified enough such that they can wait out flat uranium prices.

    TMR: So you see uranium miners as a long-term investment?

    JR: Yes. The lead time of new uranium mines is long. So the ability to change the stories of these companies does not usually happen overnight, unless there is an acquisition, such as Energy Fuels buying Uranerz.

    As I said earlier, we expect higher uranium prices, but we haven't seen these companies move because most lack financial flexibility. Should the price of uranium reach the $60-70/lb range, these companies will show the cash flow level needed to justify higher valuation, in our opinion.

    TMR: Joe, thank you for your time and your insights.

    This interview was conducted by Kevin Michael Grace of The Mining Report and can be read in its entirety here.

    Joe Reagor is a research analyst with ROTH Capital Partners, providing equity research coverage of the natural resources sector. Prior to ROTH, he worked in equity research at Global Hunter Securities and at Very Independent Research, covering a wide array of resources companies including metals [steel and aluminum], mining [gold, silver and base metals] and forest products [containerboard, OCC, UFS and pulp]. Reagor earned a Bachelor of Arts in economics and mathematics from Monmouth University.

    Want to read more Mining 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 Mining Report homepage.

    DISCLOSURE:

    1) Kevin Michael Grace conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He 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 Streetwise Reports: Energy Fuels Inc. and Uranerz Energy Corp. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
    3) Joe Reagor: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
    4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
    5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer.

    6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

    Streetwise - The Mining 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 (NYSE: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 Mining Report. These logos are trademarks and are the property of the individual companies.

    101 Second St., Suite 110
    Petaluma, CA 94952

    Tel.: (707) 981-8999
    Fax: (707) 981-8998
    Email: jluther@streetwisereports.com

    Apr 14 2:42 PM | Link | Comment!
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