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  • U.S. Global's Brian Hicks Shares His Summer Plans For Creating The Ultimate Resource Fund

    You may want to rethink those tickets to Hawaii, and instead spend the summer basking in the opportunities developing in three different sectors of the oil market. In this interview with The Energy Report, U.S. Global Resources Fund Manager Brian Hicks shares the names of the juniors that could benefit from the current volatility. Plus, he reveals the dramatic shift he made in the fund this year that allows him to get paid to wait for the market to catch fire.

    The Energy Report: Summer means driving season, which is good news for oil and gas prices. U.S. Global Investors recently published an article that says Americans are driving and flying more than ever. Will energy investors who "sell in May and go away" kick themselves later, when they look at the stock charts for their favorite companies?

    Brian Hicks: The summer driving season is a supportive time for crude oil. Refineries are at very high utilization levels, ramping up production of gasoline, and that creates extra demand for crude oil. We have begun to see inventories come down, which creates physical demand in the marketplace and helps offset high domestic inventories. This is a seasonally strong period for oil, which should alleviate the storage overhang heading into the summer months.

    TER: Oil has been above $60/barrel [$60/bbl] recently. Do you believe we've hit a bottom in oil prices? What can we expect going forward if history is a guide?

    BH: I think we have hit a bottom. Clearly, oil prices below $50/bbl are not sustainable. We simply can't replace global production at that price. It is way below the marginal cost of production, which we think on a long-term basis is somewhere around $75/bbl. Even at $60/bbl, we have more upside to go to reach an equilibrium price. We have come up a ways since the lows set earlier this year. Perhaps we are entering a holding pattern before the next leg up in the back half of the year. But who knows? We are starting to see production growth decline and inventory levels receding, so we could see prices maintain these levels, or get even stronger, if declines accelerate into the summer.

    TER: What are rig counts telling you?

    BH: Rig counts coming down over 50% bodes very well for the price of crude oil. The resetting of global crude oil prices resulted in less drilling, particularly in the U.S. That's why we are starting to see a production response.

    From a historical standpoint, this is the point in the cycle when you want to look at energy stocks. We believe we are in a trough, and heading into 2016 we are going to need to see the rig count come back up-certainly not to the peaks that we had previously, but higher than current levels. As we see production growth decline and demand pick up, inventory levels are going to head down further.

    TER: Are you buying and selling based on Q1/15 results, or are you looking out at Q2/15 or Q3/15 expectations and beyond?

    BH: We're trying to look forward. Obviously, some useful data can be gleaned from current financials, but we're trying to look ahead of the noise and over the horizon to see where oil prices will settle out and the prices that energy stocks are discounting in their valuations. We feel good that energy stocks have found a bottom and have started to come up. We think there is more upside as we get closer to 2016.

    TER: How are you protecting the fund from volatility?

    BH: We are a diversified, long-only mutual fund, so it's not a core strategy for us to short crude oil or energy stocks. But we do try to mitigate volatility through diversification. That means holding companies across the market cap spectrum, in different geographies and with different commodity exposure, to derive a portfolio that is not highly correlated.

    TER: I understand you started investing in some larger caps this year. What prompted that?

    BH: As part of that diversification, and because there was heightened volatility coming into the year, we were trying to find value in stocks that paid a dividend and offered lower volatility.

    In a new energy cycle, the stocks that typically move first out of the trough are the larger caps. We made investments in some major integrated oil stocks, some of which were paying dividend yields as high as 6%, which really helped buffer the portfolio from excess volatility. We were able to pick up some income in the meantime. Historically, when you can buy large companies with high dividend yields, that's a signal of the value to be had.

    One of the companies we added to the portfolio is Royal Dutch Shell Plc (NYSE:RDS.A). When we purchased the stock, it was yielding over a 6% dividend, and the acquisition of BG Group Plc [BRGYY:OTCQX; BG:LSE] was a nice bonus. We're very encouraged by that acquisition. We feel it strategically places the company very well. BG Group puts Shell in regions of the world that look interesting from a growth standpoint, namely in Brazil and Australia. We feel like that's going to be a good platform for Shell, and for a company of its size, to get more growth.

    TER: Are you expecting more merger and acquisition [M&A] activity as we move through this phase of the cycle?

    BH: I think we are going to see the cream rise to the top, and companies that have high quality assets or are strapped with excess debt will become targets. In many cases, at this time in the cycle, you can buy oil reserves in the ground for less than the price of drilling for new reserves. Many market upswings begin with an M&A cycle, similar to the late '90s, when Exxon's $80 billion acquisition of Mobil Oil marked a bottom in the energy cycle.

    We recently saw Noble Energy Inc. (NYSE:NBL) buy Rosetta Resources Inc. [ROSE:NASDAQ]. That gives Noble exposure to new, prolific oil and gas basins of the Eagle Ford Shale and the Permian Basin. I think this is a trend that will continue, as companies look to reduce costs and for strategic bargains. I think we'll see more M&A activity into the summer-perhaps a takeout of a larger independent by a major oil company-which would highlight the long-term value embedded in energy shares at this point in the cycle.

    TER: Your fund's sweet spot has always been the juniors. Are you finding bargains in the junior space? What are you adding to the portfolio right now?

    BH: That has been our core historically. The junior names that look interesting to us are those that, despite cutting capex, are still managing to grow through the drill bit. Other names look attractive simply because their assets are burdened by debt or undercapitalized. On the whole, we're seeing very attractive valuations on a full-cycle basis, which make us quite optimistic.

    TER: Can you name some of the companies that you're optimistic about?

    BH: They are primarily in Canada. The first name is Legacy Oil + Gas Inc. (OTCPK:LEGPF) [LEG:TSX]. This company has significant value. It's not a name that most folks are looking at because it has excessive debt on the balance sheet and is actively trying to manage that debt and still grow production. But it has high-quality oil assets, and a lot of operational and financial leverage to the price of crude oil.

    We think, on a sum-of-the-parts basis, Legacy looks very interesting at current prices. If you look at the proven reserves in the ground and you discount them over the reserve life, and then net out the value of long-term debt, the stock could double from current levels based on a normal full-cycle oil price.

    In addition, it looks as though there are some large institutional shareholders that are trying to unlock more immediate value by breaking up the company, divesting assets or perhaps even replacing management. That could offer additional catalysts.

    TER: Is there another company that reported Q1/15 results you like?

    BH: We're always intrigued by companies that are able to grow through the drill bit with low capex spending. One name we like is RMP Energy Inc. (OTCPK:OEXFF) [RMP:TSX], also in Canada. It has very interesting oil assets and plans to grow production 10-15% this year despite a capital cutback. At current oil prices, the company should be generating some free cash flow, which could be used to lower its debt, although its balance sheet is relatively strong. There are a lot of options for the company and we expect to hear further good news on improved well completion techniques that could unlock further value. We also are encouraged by the robust wells being drilled at its Ante Creek project. When we come out of this low period, it's this type of company that will thrive. It's a company that can increase shareholder value above and beyond just an increase in crude oil prices.

    TER: What will it take for the market to recognize the potential and rerate RMP?

    BH: I think execution is the main thing. The company recently issued a production report that showed it is on the right track. In fact, the estimates seemed fairly conservative given where RMP is producing right now. It is experimenting with some new completion techniques that look like they're enhancing the productivity of the new wells. We think there is positive operational and drilling momentum for the company. It looks as though production estimates are more than achievable. Companies that execute are the names that should outperform.

    TER: How about a dividend-paying Canadian explorer and producer?

    BH: We have been involved in royalty trust companies for some time. It's a model that works well with the right kind of company. Whitecap Resources Inc. (OTC:SPGYF) [WCP:TSX.V] is a bellwether name with high-quality assets and a strong management team. It recently made an acquisition, which further increases its overall growth profile. It pays a dividend of around 5%, so you get paid to own this name as oil prices begin to recover. This is another company that has historically executed on its drilling plan and should continue to offer value for shareholders.

    TER: How, specifically, would Whitecap's acquisition of Beaumont Energy Inc. help to create value?

    BH: This is a textbook acquisition for Whitecap. It is going in when there are difficult times and making an acquisition in a core area in West-Central Saskatchewan. It gives the company upside via some basic water flood developments, helps enhance its overall core area as well as its growth profile, and helps offset declines.

    This type of acquisition is probably something we'll continue to see with Whitecap Resources, especially since the company has the financial firepower to look for strategic opportunities. This is the time in the cycle when Whitecap can enhance its overall platform and increase its production on a per share basis, while others in the industry are starved for capital. It's an opportune time for shareholders in Whitecap Resources to create some value, and in the meantime there is an attractive dividend yield.

    TER: We have talked before about opportunities in service companies. Are you still finding that they are profitable in this environment? Are there some that really stand out to you?

    BH: Some investors would think it's a little early to look at service stocks. We would probably agree when it comes to fracking companies and some of the other service providers, but we think it may be an interesting time to look at drilling companies. We are starting to see market share being overtaken by higher-quality, higher-horsepower rigs that can drill multiple wells per pad, as well as rigs that can move much more quickly to different drilling locations. Their drilling days are shorter, which creates a tremendous amount of efficiency and lowers costs for operators. These are the kinds of drilling rigs that operators are looking for, especially in a low commodity price environment.

    Patterson-UTI Energy Inc. (NASDAQ:PTEN) is starting to garner market share in this space. We think over the next 12-24 months, this market share will continue to grow. The utilization of higher-end rigs should be well over 90%-maybe even sold out in this particular category over the next 24 months-which implies higher day rates for these higher spec rigs. The three or four companies with this capability should do well and should be buffered by any weakness in the oil services space. Then, as oil prices begin to recover and move back up, operators will increase their capital budgets, and they're going to want these premium rigs. The companies we're looking at, such as Patterson, should thrive.

    TER: What advice do you have for investors looking to take advantage of opportunities over the summer without getting burned?

    BH: Investors need to focus on the long term. I know it's difficult to think that way when we're bombarded with negative short-term data points. But current crude oil prices are not sustainable at these levels. We cannot replace global production. Demand continues to grow outside of the developed markets in the emerging world. That does not appear to be changing. If we do not see a higher oil price, we're not going to be able to offset the global decline rate in current production or meet future demand.

    We believe that we are in the early innings of a recovery in this energy cycle. The companies that are able to withstand the volatility are going to do quite well, and get bigger. There's a tremendous amount of opportunity in the energy space right now. We're very encouraged. It's not to say that we couldn't see more volatility, but I would look at that volatility as an opportunity to add to positions because, over the long run, we will see higher commodity prices and higher share prices within the energy patch.

    TER: Thank you for sharing your insights. Have a great summer.

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

    Brian Hicks joined U.S. Global Investors Inc. in 2004 as a co-manager of the company's Global Resources Fund [PSPFX]. He is responsible for portfolio allocation, stock selection and research coverage for the energy and basic materials sectors. Prior to joining U.S. Global Investors, Hicks was an associate oil and gas analyst for A.G. Edwards Inc. He also worked previously as an institutional equity/options trader and liaison to the foreign equity desk at Charles Schwab & Co., and at Invesco Funds Group as an industry research and product development analyst. Hicks holds a master's degree in finance and a bachelor's degree in business administration from the University of Colorado.

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    DISCLOSURE:
    1) JT Long conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report and The Life Sciences Report, and provides services to Streetwise Reports as an independent contractor. She owns, or her family owns, shares of the following companies mentioned in this interview: None.
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  • Now Is The Time To Own The Oil & Gas Leaders: Keith Schaefer

    U.S. shale oil producers have responded to the oil price collapse so quickly, and with such discipline, that they've shown they are able to turn production on and off as if with a light switch. As Keith Schaefer tells The Energy Report, that means it's time to be nimble, and to keep small positions until oil finds a stable new price level.

    The Energy Report: Keith, the first U.S. grassroots refinery in nearly 40 years just began operation in North Dakota. Is the growth in U.S. oil production going to catalyze refinery construction?

    Keith Schaefer: I'm going to say no. U.S. production has peaked and we're doing just fine, so I don't see any great need for more refineries right now.

    There was talk a couple of years ago, particularly in 2012-2013, that with unbridled shale oil growth we would need more refineries. But the producers have been more disciplined than anybody expected in the last three months, with the rig count declining sharply and then staying down. I think we're going to see a drop in U.S. production, so I don't see the need for any new refineries right now. The only thing that could change would be even more demand growth, which we're seeing because of lower prices. Somebody might get the idea that we need another refinery to meet that demand.

    Right now, refinery crack spreads are actually very good. They're $20-25 per barrel [$20-25/bbl], which for this time of year is fantastic. But I don't know if that's good enough to warrant somebody spending tens of billions of dollars to build something new. The other thing is that the refinery industry has been pretty good at incrementally adding light oil capacity around the country. A thousand barrels a day [1 Mbbl/d] here, 2 Mbbl/d there-that has added up over the last two or three years. I don't know what the exact number is, but certainly there's been no problem in getting gasoline to market, as you can tell by the big drop we've had in gasoline prices over the last six months.

    TER: Is the gasoline price going lower?

    KS: No, I don't think the price is going lower. We've had a nice little rally in the last month, with oil prices back to about $60/bbl on the WTI [West Texas Intermediate] and almost $70/bbl on Brent.

    I think it's important that investors realize the gasoline price is based on Brent pricing, not on WTI. We're exporting more gasoline-refined products out of the U.S., so we're competing with foreign buyers for our own energy. I think that's why gas prices are a bit higher than people think they should be; they keep thinking about WTI, not Brent.

    TER: The new U.S. production is lighter than what U.S. refineries were designed for. Are the U.S. refiners retooling?

    KS: Well, a bit. Like I said, you're getting 1 Mbbl/d here, 1 Mbbl/d there, of light oil capacity. Refiners are also trying to increase the amount of distillates they produce, because generally that's a more profitable product-jet fuel and diesel fuel, which is what Asia uses. Asia runs on diesel. That's definitely Brent pricing, so there's more margin in that. Everybody's been trying to reduce heavy oil. The big exception would be BP Plc's [BP:NYSE; BP:LSE] Whiting, Indiana, refinery, which just went from mostly light oil to mostly heavy oil.

    TER: How has the delay in approval of the Keystone XL pipeline and resistance to Canadian pipelines going both east and west affected Canadian oil sands producers?

    KS: So far there is not much impact. The heavy oil discount is quite tight right now because the Gulf Coast is getting a lot of Canadian oil that it never used to get. Enbridge Inc. [ENB:NYSE] has got the Flanagan South Pipeline moving, so it's able to bring 300-350 Mbbl/d more Canadian crude straight to the Gulf Coast than it used to. That's not quite as big as Keystone, but between what rail has done in the last two years, going from zero to just under 200 Mbbl/d, the incremental oil sands production has been able to find a way down to the Gulf Coast. There's actually more Canadian oil now going to the U.S. than ever before. That's great news for Canadian producers.

    As you said, most of the refineries down there are geared toward heavy oil. Keystone probably will start to be important next year or the year after. Rail and the Enbridge Flanagan South line bought Canadian producers one to two years' grace on their growth in production. It's going to hit the wall again very quickly because oil sands production is going to rise anywhere between 50 Mbbl/d and 120 Mbbl/d every year for the next five or six years. Keystone will come back into importance fairly quickly.

    TER: Is refinery construction on the table in Canada?

    KS: Oh yes. The Alberta government is building a refinery, the North West Upgrader. I think it's relatively small-somewhere around 75 Mbbl/d. But from private industry, there is just no appetite for a refinery in Canada. You need a big petrochemical complex surrounding your refinery complex, and you just don't have that in Canada. The refineries are either in Edmonton, Alberta, or in Sarnia, Ontario. Sarnia has a petrochemical complex, but with the government there now, you're never going to see another refinery in Ontario. You might see one in Alberta, but, again, it's not going be as economic because it would just be producing gasoline, and not as many petrochemical products.

    TER: Speaking of Alberta, how will the election results there affect refiners and oil sands producers?

    KS: I don't know if it's going to affect oil sands or refineries that much. Because of the dirty oil moniker, if there's one thing the New Democratic Party [NDP] government might go after, it's trying to get the image of the oil sands in better shape. I think stronger environmental rules could really help the industry in the long run. That's going to cost some money, and potentially put a crimp into some cash flows. The producers don't want to disturb their tailings; they just want to plant poplar trees over them and let them go back to nature. I don't know if the NDP is going to allow that.

    From a tax point of view, I don't think the elections are going to make much difference. There is talk about raising corporate income taxes, but the reality is that most, if not all, the producers lose money every year on an accounting basis. There's not going to be much impact for the oil patch. Royalties could go a little higher, but I don't see them going much higher. Honestly, the fear is greater than what the reality will be. The bark is worse than the bite.

    TER: Has the price of oil found its new level?

    KS: I think there's a strong argument the price is going to actually pick up over the next eight weeks. The harsh drop in the rig count in the U.S. should now translate into a pretty significant drop in U.S. production, which we'll see each Wednesday when the U.S. Energy Information Administration [EIA] numbers come out. The EIA numbers for the next 6-10 weeks have the potential to drop quite a bit. The Street is very short-term-oriented right now. I think the market could take oil a lot higher than people would suspect because of the emotion that will follow the drop in U.S. oil production in the next 6-10 weeks.

    Here's what I tell my subscribers: Right now there are many crosscurrents in the market, but two things have happened that were a bit of a surprise to the market so far this calendar this year, and both of them were bullish.

    One was that demand has picked up way more than anybody expected, way sooner than anybody expected. Before the oil price crash in late 2014, the market was seeing lots of stories about how oil demand was inelastic to price. It didn't matter what the price of oil was, demand didn't change much at all. You can throw that idea out the window. Even by January that had been completely debunked, and we were seeing 300-500 Mbbl/d or more increase in demand in the States. Right now, we are seeing 700-800 Mbbl/d more demand in the U.S. over last year. When you consider that production is up 1 MMbbl/d, the surplus doesn't look like such a big deal anymore.

    Internationally, we're starting to see some big stats as well. China's up 250 Mbbl/d. Japan's up. Korea's up 110 Mbbl/d. They haven't been able to see the same benefit in the drop of oil that we have because the rising U.S. dollar has taken a lot of that away. Demand has been a big surprise.

    Second, as I said, nobody thought the U.S. producers would have the level of discipline that they've had in dropping the rig counts through this calendar year. The market has been stunned that we're continuing to see rig drops week after week. We had that one big month-February-with 90 rigs a week getting dropped. Even now, it's at least 20 rigs. In Canada, for example, there are only 16 oil rigs working-in all of Canada! That's stunning to me.

    So when we talk about where the oil price is going, nobody knows. When you canvass the analysts, the smartest guys on the Street, the numbers are all over the map. The oil price has jumped 50%, from $40/bbl to $60/bbl. Is it over? I don't know, but I would say that demand's been higher, and it looks like supply is going to be a little bit lower than what everybody thought in January.

    I think we're going to have relatively bullish production numbers and inventory numbers in the States by the end of Q2/15. The numbers could be bullish enough that companies might start to bring rigs back. It's only going to take one or two weeks of the U.S. adding 30 to 50 rigs to put a big stop in the oil price rise.

    I think in the short term-really short term, toward the end of Q2/15 and in early Q3/15-oil can go higher. The U.S. industry has shown that it is so flexible and so adaptable it can bring rigs off and on like flipping a light switch. It's just amazing. Any opportunity these guys have to lock in good margins on their hedging programs at $65-70/bbl oil-if it gets that high-they're going to do it, and rigs are going to come out.

    TER: What are you forecasting on the oil price for this year?

    KS: This is going to be one of the choppiest years for oil we've seen in a long time. Everyone had such confidence in the Saudis' massaging and managing the oil price for the last four years, and the Saudis did do that. We had a very, very tight range for oil from 2010 through to the end of 2014. That's out the window now. It's going to be a lot more volatile.

    I think you're going to see a lot of head fakes, both bullish and bearish, this year. If you talk about whether the price could find a level late this year, I'm going to guess that's somewhere between $60 and $65 per barrel WTI. At that price the big guys have the scale-they can make money. And little guys can't. The high producing core areas of the big plays make money, and the fringe areas don't, so these prices don't warrant spending a lot of money on the fringe.

    TER: Let's talk about some of the companies that you are most familiar with.

    KS: Rock Energy Inc. (OTCPK:RENFF) [RE:TSX] had a great year last year because of its big light oil discovery. The only problem was that the company spent a lot of money in Q4/14 drilling that up as the oil price was collapsing, so its debt levels got pretty high. But it has just figured out a key component to increasing production out of its wells. The company has been adding a lot more sand and getting much better results.

    Rock had to raise money at the bottom, but it still only has 50 million [50M] shares out. You know you're investing in a company that has lots of leverage when it has 50M shares out. The company has been able to hold production steady at 5 Mbbl/d, and actually makes good positive cash flow on that. With Rock, you've got great positive cash flow at these prices, and a real turbo charge in its light oil play if oil prices come back up.

    TER: Can you mention another company?

    KS: This is a year for small bets. With the uncertainty and volatility around commodity prices, there's no point in making any big bets this year. Legacy Oil + Gas Inc. (OTCPK:LEGPF) [LEG:TSX] is a Tier 2 producer in Canada that has just enough debt to be outside the market's comfort zone, but if oil goes back to $80/bbl, its debt levels actually come in line. In addition, the company has an activist investor group with quite a track record of creating value.

    TER: FrontFour Master Fund Ltd. is nominating a slate of directors for Legacy. Is that something that investors should be worried about?

    KS: No, they should be excited about it. Last year, this investor group ousted the Renegade Petroleum board, sold Renegade to Spartan Energy Corp. [SPE:TSX], and Spartan took that asset and improved production so fast its stock doubled in about three months.

    The team at Legacy has lost the Street a bit. For a couple of years, Legacy's reserve reports didn't keep up with spending, and so the Street has slowly abandoned the team. The straw that broke the camel's back for FrontFour, and a few of the other investors in the company, was when the board decided to guarantee CEO Trent Yanko's personal loan for some stock.

    Would the company be able to perform better with a different management team? I don't know. But I would say that the market has great respect for the asset base, particularly in Saskatchewan. Even the Turner Valley asset in Alberta is a very low-decline asset, which is what the Street likes right now. I think it's a case where the sum of the parts is greater than the whole. Because of the anticipation of what FrontFour and the other investors might be able to do with the company, Legacy should have an extra bid under it this year.

    TER: With the uncertainty in renewable fuel policy and the question of using a food crop for energy, is ethanol a smart investment?

    KS: The reality is that ethanol right now makes sense. Even if the renewable fuel standard [RFS] didn't exist, there would still be an ethanol industry. It might not be quite as big as we've got right now, but there would definitely still be an industry, because ethanol produces octane cheaper than anything else.

    Valero Energy Corp. (NYSE:VLO) is invested in corn ethanol in 11 plants. Ethanol didn't make any money for Valero last quarter, and the stock still had a fantastic run-up to pretty much all-time highs. The crush spread for ethanol through the rest of this year is actually pretty good. It's in the mid-$0.40 per gallon range. Valero produces more than 1 billion [1B] gallons of ethanol per year. Going forward, ethanol should actually be quite a positive contributor to Valero's top line, and especially to the bottom line. Not only that, Valero has shown that it actually gets better margins and pricing than most of the pure ethanol producers. It's a pretty smart cookie in that division. I think ethanol is going to be a big positive for Valero for the next three quarters.

    TER: Can ethanol compete with crude at current prices without mandates?

    KS: It absolutely can. But the reality is that it's a political issue. If the renewable portfolio standard were withdrawn, there would be a large contingent that would just stop using ethanol altogether. Certainly the integrated refinery companies would have no incentive to use it; they should use their own oil. But groups like Valero, which aren't as integrated, or the independents, like Marathon Oil Corp. [MRO:NYSE], Northern Tier Energy LP (NYSE:NTI) or Alon USA [ALJ:NYSE], would continue to use ethanol as much as possible because it makes economic sense right now. If we ever went back to a situation like 2012, where there was a drought, corn prices spiked, and it made no economic sense to use ethanol, these companies would drop ethanol like a dirty shirt and go straight with oil. That would absolutely have a big impact on the industry. The RFS really only kicks in when corn prices are high. The ethanol market works on market-based economics when corn is this low in price.

    TER: Valero's share price since February has been at its highest 52-week level. What's driven that performance?

    KS: A couple of things. Ethanol last year did great. And now Valero and all the other refiners are seeing the pipeline stocks in the last 3-4 years do really well. Those stocks have the best charts in the industry. And there's almost no volatility in them. They have been the best-performing stocks you could ask for in an energy portfolio. The multiples are very high because the Street likes a steady tolling charge. It doesn't like revenue based on commodity risk.

    What we're seeing now is refiners saying, "Hey, we want to have those bigger cash flow multiples, like the pipeline stocks. They're stealing our lunch. We're going to integrate our own logistics into a separate company. We're going to take every bit of revenue we get that's not commodity-related and put it into a master limited partnership [MLP] structure, which gets a much higher multiple like midstream or pipeline companies."

    Valero, in particular, has a lot of assets. It's one of the biggest refineries in the States. It figures it's going to be able to add almost $1B/year in assets in the next five years to put into these higher-multiple MLPs, where the cashflow multiple is going to be a lot greater. That's a great extra uplift underneath the stock for the next three or four years.

    TER: Has Northern Tier Energy done better or worse since Western Refining Inc. [WNR:NYSE] bought out its managing partner share?

    KS: In some ways, better. Fundamentally, the company has outperformed. Northern Tier is a one-refinery company in Minnesota. Before Western Refining took it over, it always underperformed financially against the bigger industry benchmark for that area, which is called PADD 2. Since the Western Refining guys have taken it over, the company has done a much better job at running the business and has been able to outperform the benchmark. I say kudos, because the stock value increase for Western Refining over the last five years is $5/share to $45/share. I'm so excited to have that team at the helm of Northern Tier. I think it's going to do fantastic.

    TER: What is the major trend in your advice to your newsletter subscribers now?

    KS: Caution and small positions. Pretty much everything we bought in 2015 is up, simply because the commodity prices have done better than I expected on both the oil and gas. Now is a time when I think we need to be very cautious, stay in lots of cash. A fat pitch, as Warren Buffett says, will come into the market that we should be able to latch onto. Right now that's hard to see. Just stay in cash. Stay in small positions, and only own the leaders. They always have a higher valuation, but you always buy up in a down market. Buy the leaders and have patience.

    TER: Thank you very much for your time.

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

    Keith Schaefer is editor and publisher of the Oil & Gas Investments Bulletin, which finds, researches and profiles the growing oil and gas companies that Schaefer buys himself, so Bulletin subscribers know he has his own money on the line. He identifies oil and gas companies that have high or potentially high growth rates and that are covered by several research analysts. He has a degree in journalism and has worked for several Canadian dailies, but for more than 15 years has assisted public resource companies in raising exploration and expansion capital.

    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

    Bottom of Form

    DISCLOSURE:
    1] Tom Armistead conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
    2] The following companies mentioned in the interview are sponsors of Streetwise Reports: None. 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] Keith Schaefer: I own, or my family owns, shares of the following companies mentioned in this interview: Rock Energy Inc., Legacy Oil + Gas 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

    May 19 1:48 PM | Link | Comment!
  • Four Canadian Juniors Poised To Gain In The Oil And Gas Recovery: Angelos Damaskos

    With crisis comes opportunity, as the saying goes, and Angelos Damaskos, principal adviser of the Junior Oils Trust, has capitalized on the panicked selloff of junior oil and gas companies to build positions in four promising names in Western Canada. In this interview with The Energy Report, he explains why oil prices could reach $75 per barrel in the near future, and why companies making good money now will make much more on the upswing, with great benefits to shareholders. In addition, he highlights two Australian companies with highly prospective projects.

    The Energy Report: The prices of West Texas Intermediate [WTI] and Brent have recently rebounded to about $60 per barrel [$60/bbl] and $65/bbl, respectively. Where do you see them going for the rest of the year?

    Angelos Damaskos: The oil industry expects oil to recover to $75/bbl in the near term because this is the global marginal cost of production. The longer oil trades below that price level, we lose supply not only from the North American shale industry, but also from the longer-term producing projects: the Canadian tar sands and the Brazilian offshore basins.

    The oil price has recovered by 20-25% from January's lows but remains 50% lower than last year's highs. As a result, there has been a dramatic drop in income and earnings, which has been met with big cutbacks in capital expenditure [capex] and development drilling. The length of time oil trades below $75/bbl is a clue to how strong the recovery might be once a supply-demand balance is again achieved.

    TER: With regard to shale oil, some believe that the oil price collapse has broken that industry for the foreseeable future. Do you agree?

    AD: I do not. Shale oil technology has advanced tremendously over the last few years, which is why production has advanced so rapidly. It is now far easier to map and understand the geotechnical characteristics of shale reserves. It's purely a matter of spending the capex necessary to develop as many wells as possible to increase production. The minute oil prices recover to $70-75/bbl, or perhaps a little higher, shale drilling will recommence almost immediately.

    TER: Some blame the oil price collapse on lack of demand. How much do we know about oil consumption?

    AD: It's not clear what caused the collapse. We believe it might have been a demand shock resulting from a slowdown of the Chinese economy or in some of the emerging markets. This, combined with a rapid growth in production, particularly from North America, might have tipped the balance to oversupply and sparked the initial price drop. Then the momentum traders and the hedge funds got involved and pushed prices down to the $40-45/bbl we saw in January.

    The International Energy Agency [IEA] and other reputable bodies indicate that oil demand remains steady and might have actually grown in 2014. The IEA projects slight growth in 2015. If we accept that global economic growth has stabilized, demand for oil should remain fairly firm and might actually be further stimulated by today's lower prices.

    TER: In contrast to the price of oil, there has been no rebound in the price of natural gas. Why not?

    AD: We have been fairly bearish on U.S. natural gas for some time given the oversupply from shale projects. Gas production growth has exceeded 30% over the past five years. Until the very large liquefied natural gas [LNG] export facilities planned in Western Canada come onstream, low prices will likely prevail.

    European gas prices trade much closer to the equivalent per-crude-barrel price because European uses of natural gas have evolved over a much longer period of time and do not suffer from infrastructure constraints, legislative tariffs or bans on trade flows.

    TER: Elite opinion in Western Canada is strongly against new pipelines and energy export facilities. Is it possible these facilities could be prevented for political reasons?

    AD: We believe that economics will prevail eventually, and persuade the people and their legislatures to permit the infrastructure necessary to Western Canada's energy resources. Keep in mind that large-scale natural gas production is a relatively recent development in British Columbia [B.C.], so it will take some time for the population to resolve the political issues engendered by this development.

    TER: How bad do you expect the Q1/15 earnings reports from the majors will be?

    AD: The latest reports across the board for major producers have reflected the sharp drop in oil prices. In a few cases, short-term hedging may have provided some insulation, but the reality of the scale of lost income is likely to be shown in the Q2/15 reports.

    TER: Will this lead to an increase in M&As?

    AD: The proposed takeover of BG Group Plc [BRGYY:OTCQX; BG:LSE] by Royal Dutch Shell Plc (NYSE:RDS.A) illustrates the opportunity available to cash-rich companies. Shell, like other supermajor, integrated companies, has been suffering from declining reserve life and insufficient production replacement for years. Its 2014 reserves replacement ratio was 49%, of which only 17% came from exploration. Meanwhile, its 2014 reserves life index declined to 11 years from 12.3 years in 2013.

    TER: Do you believe that Shell's takeover of British Gas was a good decision?

    AD: In the present environment, it is cheaper to buy proven reserves than pursue expensive and risky exploration. British Gas carries substantial debt and had to take huge writedowns as a result of the price drop because many of its assets have been impaired. Nevertheless, BG offers Shell very large proven reserves and production in a global portfolio, as well as attractive development projects in emerging regions such as Australia and Brazil. Shell got BG at a very attractive price, and this deal sorts out its declining reserves problem. Shell also gains a much-larger global presence and will likely realize savings deriving from the elimination of duplicated functions.

    Shell expects the oil price to recover to $90/bbl by 2018. So the industry is fairly bullish on long-term oil prices, and we expect the pace of M&A to accelerate.

    TER: What do you make of the rumors of a possible takeover of BP Plc (BP)?

    AD: I don't think anyone would be interested in taking over BP, frankly. This company still suffers from a huge overhang from the Macondo disaster in the Gulf of Mexico, with the potential of a huge liability settlement with U.S. authorities. BP also has large exposure in Russia with its TNK joint venture, which, given the sanctions against that country, would preclude any majors touching BP. In any event, there are far more attractive targets than BP.

    TER: You have said your investment philosophy in energy is based on the idea that "smaller oil and gas exploration and production [E&P] companies tend to outperform their larger counterparts." Can we expect these smaller companies to do even better vis-à-vis the larger companies in the near future?

    AD: Generally, smaller oil E&Ps can outperform on the upside. They can, however, also underperform in a bear market, with small caps dropping by more than 50% in the last six to nine months. It is well understood that when oil markets are in a crisis, investors tend to sell the smaller caps first.

    These selloffs have historically produced great buying opportunities. The majors have suffered less due to their diversification in storage, transportation, refining and retail operations, but they will also be less responsive when prices rise. As oil prices recover, the recoveries in small caps could be startling, but investors must exercise extreme caution, as not all boats will rise with the tide.

    TER: What are the attributes of bargain energy juniors?

    AD: The main attribute of an energy junior is that it is primarily E&P-focused. The full spectrum of its operations is focused on buying acreage, proving up, and producing oil and gas. That gives the junior much higher operational leverage to the oil price. For instance, a junior U.S. E&P with a $45/bbl marginal cost of production now makes about $8-9/bbl in profit. So if oil rises to $65/bbl, its profitability more than doubles.

    Unfortunately, leverage can be manifested financially as well. E&Ps reliant on the public market for funding are likely to suffer for long periods in this environment. Investors will be unwilling to pay for risky exploration given the apparent oversupply, even if it is understood to be short-term. Over-indebted operations will be forced to battle with bondholders and bankers, in the meantime paying high fees and costs that could have very detrimental effects on their operations.

    TER: Many of the juniors hammered by the markets in the last six to nine months boasted low costs of production, healthy margins and good management. Will such companies need to wait for oil to reach $75/bbl before their shares recover?

    AD: Investors tend to sell indiscriminately in times of panic. However, as we have seen oil prices rebound in the last three months by 20% or so from January's lows, some of the better small caps have seen their share prices double.

    TER: How has the weak Canadian dollar affected Canadian oil and gas producers?

    AD: It has been a bonus to domestic producers. The Canadian dollar has depreciated 22% against the U.S. dollar since 2012. This has reduced labor and other supply costs for producers and increased the value of U.S. dollar-denominated sales.

    More important is that the oil-price collapse has resulted in a great deal of idle capacity in drilling and other service companies. As exploration and drilling have fallen dramatically, service providers have been compelled to lower prices. Drilling costs have decreased by 25% as a result, and could fall a lot further.

    TER: Will Canadian producers benefit from the "dollar discount" long-term?

    AD: We strongly believe that the Canadian dollar has been oversold. Global investors have preferred U.S. dollar assets because of the perceived security and safety of the U.S. economy. However, the multitrillion-dollar debt that the Fed carries on its balance sheet is unlikely to ever be repaid given the U.S.' current and projected economic growth rates. As a result, the Fed is likely to favor depreciation of the U.S. dollar.

    In addition, the Canadian dollar historically has been closely correlated to the oil price because the Canadian economy is so reliant on oil exports. Therefore, an oil price recovery should strengthen the Canadian dollar.

    TER: Let's get into specifics. Which are your favorite Alberta oil and gas juniors?

    AD: We have taken advantage of recent weak equity values to strategically deploy cash reserves in our portfolios. One of our latest and largest holdings is in Yangarra Resources Ltd. (OTC:YGRAF) [YGR:TSX.V], which operates in the Cardium, one of Western Canada's most economic oil regions. The company recently announced a 114% increase in its 2014 reserves while keeping finding and development costs of developed producing reserves at $26.36/bbl, with a recycling ratio of 1.6 times. Its 2014 production/replacement ratio was 179%, while its Proven and Probable reserves life index increased to 34 years. These are exceptional results. Companies such as Yangarra are not only able to survive in a low-price environment-they also have long-term viability and the long-term potential, if prices recover, to grow production dramatically over the next couple of years.

    TER: Yangarra announced a $20 million [$20M] bought-deal financing on April 28. How strong is its balance sheet?

    AD: This is a prudent company. It has low debt, but it likes to boost its reserves. Its share price is up 100% since January. It took advantage of this recovery to raise some equity to have more firepower to do deals. It is best positioned in its territory to consolidate and buy weaker competitors, enhancing its acreage position and making it even better positioned to grow reserves and production when oil prices increase. In this environment, the best approach is to raise equity rather than debt.

    TER: Which other Alberta juniors has the Junior Oils Trust invested in?

    AD: Two. The first is RMP Energy Inc. (OTCPK:OEXFF) [RMP:TSX], which produces approximately 44% oil/56% gas in west-central Alberta. Even though it has cut its capex program by half, RMP still expects to grow its production by 10-20% in 2015. Like Yangarra, it has little debt, and its debt-to-cash flow ratio is well under 1:1, meaning it could pay debt back in less than a year. It expects to generate 2015 free cash flow of more than $100M at $50/bbl. RMP is another company that will live to prosper when the price of oil recovers.

    TER: RMP shares lost 50% of their value from February to March, falling from $5.50 to $2.75/share. Shares have since risen to about $3. Is this a company that must await oil rising to $70-75/bbl for its share price to recover?

    AD: Some companies become more attractive to investors at different times. Once RMP further confirms its position with the publication of its quarterly reports, investors will realize that the company offers extremely attractive fundamentals compared to its low gearing and its growth in reserves, despite a capex cut.

    What we like about companies such as RMP is that they are sensible. They trim capex very quickly to adjust to their free cash-flow-generating capacity, and will not overspend just to increase revenues. RMP wants to make profits and increase its value for the benefit of its shareholders. It will wait until the oil price recovers before increasing capex. This goes back to the point I made earlier about the remarkable operational flexibility of the North American shale oil industry.

    TER: And the third Alberta junior you've invested in is?

    AD: Tamarack Valley Energy Ltd. (OTC:TNEYF) [TVE:TSX.V]. Even though it carries more debt than Yangarra and RMP at two times forecast cash flow, it has recently made some very attractive acreage deals that should expand its reserves dramatically. It has a reputation for very tight cost control and some of the most productive wells in the Wilson Creek region. This is another company that stands to benefit as the oil price recovers.

    TER: Tamarack announced a 78% increase to reserves and record Q4/14 production on March 12. How big could it become?

    AD: The company has a huge acreage position, so it's a matter of how much capex it can mobilize and in what manner. This is another sensible company that didn't leverage operations too quickly based on what turned out to be overly optimistic projections of the short-term oil price.

    TER: Tamarack is on track to reduce its net debt to less than $118M by the end of Q2/15. Does that lessen your concern about its balance sheet?

    AD: Because this company has done some recent deals to greatly expand its acreage, we think its bankers will be pretty relaxed concerning loan coverage issues. Tamarack is in a secure position going forward.

    TER: Which B.C. natural gas junior do you like?

    AD: Despite low natural gas prices, a few companies have managed to thrive regardless. Our favorite is Painted Pony Petroleum Ltd. (OTCPK:PDPYF) [PPY.A:TSX.V], which operates in the Montney Formation in northeast B.C. It announced in March that it has increased its reserves by 68% to 2.9 trillion cubic feet equivalent with a recycling ratio of 5.1 times. This is an enormous base on which to build production.

    As mentioned above, a typical hurdle for B.C. shale gas producers has been infrastructure. They need processing plants and pipelines to help bring production to market and build cash flow. Painted Pony has recently consolidated its position in this regard with a very large processing plant deal to be completed this year. This will increase its production and access to market and grow its cash flow. This company's balance sheet is very strong and is thus able to support successful growth. Furthermore, we believe that Painted Pony's acreage position and its resource base make it a very attractive takeover target. It is quite viable even at low gas prices, and presents many other attributes of attractive valuation that could deliver much higher value to shareholders.

    TER: A final word: What is your advice for energy investors?

    AD: They should invest in top-tier management teams at an attractive valuation with good potential to grow, even at lower prices, based on solid balance sheets. Should oil prices rise faster, these companies will also be best placed to benefit, as well as consolidate with other participants in their regions.

    Investors should avoid overleveraged and oversold operations even though they might seem potentially undervalued. Many companies have fallen 90% or more from their highs because of their great indebtedness. These look tempting, but they could be the classic value trap, where you buy into a potential recovery that never occurs because the fees and expenses associated with deleveraging force these companies to their knees.

    TER: Angelos, thank you for your time and insights.

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

    Angelos Damaskos is the founder and CEO of Sector Investment Managers Ltd. of London, a regulated investment advisory company. He is the principal adviser of the Junior Oils Trust and the Junior Gold Fund. The Junior Oils Trust focuses its investments in smaller oil and gas exploration and production companies. An investment banker, Damaskos worked a decade for the European Bank for Reconstruction and Development. He holds a bachelor's degree in mechanical engineering from the University of Glasgow and a master's degree in business administration from the University of Sheffield.

    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) 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 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) Angelos Damaskos: 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. My Junior Oils Trusts holds shares in Pony Petroleum Ltd., RMP Energy Inc., Tamarack Valley Energy Ltd. and Yangarra Resources Ltd. 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

    May 12 1:56 PM | Link | Comment!
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