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  • Kal Kotecha: Going Against The Grain In The Junior Resource Market

    Economics professor and newsletter writer Kal Kotecha says to obtain superior results, you cannot do what everyone else is doing. He maintains that much of the risk associated with junior resource equities has been beaten out by the herd mentality and that selectively buying what's left presents mindboggling opportunity. In this interview with The Mining Report, Kotecha shares some insights in the current junior resource market to help investors.

    The Mining Report: You're the editor of Junior Gold Report, but you also follow similar-sized companies in the energy sector. Please give our readers an overview of the energy space.

    Kal Kotecha: I've been involved in the space since 2002 and I've never witnessed anything like what is currently happening. In the energy sector, I see the price of uranium increasing, but to see price appreciation across energy stocks, the price of oil must remain near $100 per barrel [$100/bbl]. That $100/bbl benchmark could prove challenging, given the growing supply of shale oil in the U.S. Texas produces as much oil as Iraq or about 3 million barrels of oil per day [3 MMbbl/d]. Most of it comes from two sources: the Eagle Ford Shale in southwest Texas and the Permian Basin in west Texas. Chris Guith, senior vice-president of policy for the U.S. Chamber of Commerce's Institute for 21st Century Energy, estimates that recoverable resources amount to 120 years of natural gas, 205 years of oil and 464 years of coal at current demand levels.

    Fracking has lowered the price of natural gas by about 70% over the previous seven years or so. The price of oil, especially in the U.S, should decrease to $60-70/bbl on average because of shale oil. U.S. dependency on imported oil should lessen, too.

    TMR: You said that the ready availability of shale oil could eventually push crude prices to $60-70/bbl. Is that a near- or medium-term forecast?

    KK: That's a medium- to longer-term forecast. I don't believe in peak oil theory. The U.S.' savior in the oil industry is going to be shale oil, and there is a lot of it. Ultimately, that's going enhance the U.S. economy. Basically everything runs on oil. The U.S. won't have to import as much oil from Saudi Arabia or even Canada.

    TMR: What's your price forecast for natural gas?

    KK: Natural should stay between $4-6/thousand cubic feet [$4-6/Mcf]. It's more expensive in Europe, but in North America the floor should remain around $4/Mcf. I don't think it's going to go back up to $12 or down to $3.

    TMR: You mentioned earlier that you expect uranium prices to rise.

    KK: Uranium is an interesting space. As oil prices slowly decrease, the demand for uranium seems to increase. Geopolitical tensions, especially in Russia and Ukraine, could lead to much higher prices. Russia is a large uranium producer and Western nations might stop importing uranium from Russia if political fires burn much hotter.

    As of last month, China had 21 nuclear power reactors operating on 8 sites and another 20 under construction. China's National Development and Reform Commission intends to raise the percentage of electricity produced by nuclear power to 6% by 2020 from the current 2% as part of an effort to reduce air pollution from coal-fired plants. Ultimately, uranium demand will triple inside six years.

    In India, the government is expected to spend nearly $150B to develop nuclear power over the next 10-15 years. India now has nuclear energy agreements with about a dozen countries and imports primarily from France, Russia and Kazakhstan.

    TMR: In a recent note on Junior Gold Report you wrote, "I smell smoke, but where's the fire?" in relation to the current sentiment in the junior precious metals market. What's your conclusion?

    KK: The current pessimism surrounding the junior precious metal space has largely contributed to the fall in price of the commodities, but the beautiful thing about pessimism and hate towards a market sector is that there is plenty of room for error. Fantastic opportunities arise when great companies have been undervalued due to negative news that does not have a long-term impact on the company. So how do you determine which stocks, in a beaten up resource market, are great buys?

    TMR: Do you have an answer?

    KK: One must understand the essential principles of intrinsic value and the margin of safety. The principle of intrinsic value determines the worth of a stock through a combination of the price and the condition of the company. So no matter how great a company is, it may not always be a good investment. As Howard Marks wrote in The Most Important Thing: Uncommon Sense for the Thoughtful Investor, investment success doesn't come from buying good things, but rather from buying things well.

    The principle of the margin of safety involves minimizing risk and then, therefore, minimizing the potential loss of one's money. Dealing with risk is a necessary part of investing, as stock price fluctuations occur and are often unpredictable. If the risk perceived by the herd-general investors who follow the majority-is less than the actual risk, then the returns will outweigh the risks. So when consensus thinks something is risky, the general unwillingness to buy it pushes the price down to where it is no longer risky at all, given it still has intrinsic value, because all optimism has been driven out of the price.

    TMR: What are some metrics to help investors?

    KK: A junior mining company's ability to produce resources at a cost below its market price is essential for its sustainability. Junior mining companies should be judged by their ownership of mines, the quality of these mines and how management has executed similar projects in the past. Determining whether this data has been incorporated into the stock price is essential when seeking undervalued companies. I think this is where a lot of resource investors get duped.

    Do you smell the smoke? I suggest investigating the source. I'd say that the herd is done shouting fire, and smart investors are filling up their baskets with goodies. But don't forget to do your research, check the facts and invest in a contrarian fashion. To obtain superior results, you cannot do what everyone else is doing.

    TMR: Many investors have heard the adage "buy when there's blood in the streets." When should investors reasonably expect to start making money again, given the current market conditions?

    KK: That's a billion-dollar question. A lot of colleagues have predicted prices that have not come true yet. The big upswing in gold in the late 1970s was followed by a collapse and we had to wait 20 years for another upswing. It's already been three years. I don't think we have to wait another 5 or 10 years, but there is going to be a time very soon where investors will be rewarded. I think when the upswing happens it's going to be very parabolic. I think it's going to take wings on its own. Patience will be rewarded.

    TMR: What gold price are you using in your analysis?

    KK: $1,200 an ounce [$1,200/oz]. Many factors go into determining the price of commodities, especially gold and silver. Some of these factors include price manipulation, which cannot be foreseen; geopolitical strife; and import quotas, which are happening in India. However, I remain very bullish on precious metals in the long-term.

    The best buy right now is silver. Silver is a screaming steal at $18/oz. I first started buying silver at around $7/oz in 2003 and I sold quite a bit in the $48 range a few years ago. I'm starting to accumulate silver quite heavily again. The ratio of gold to silver prices is currently around 68:1. I see that going to 50:1. If there's another precious metals mania, perhaps 25:1. Silver demand is also very high. A record 6,000 tons silver was imported into India last year-roughly 20% of global production.

    TMR: What's your advice for investors in the current junior resource market?

    KK: I think a combination of five or six stocks in a portfolio with a mix of junior energy and mining equities is probably a good start. That's what I do. It's difficult for the average investor to follow more than five companies.

    TMR: Thank you for your insights, Kal.

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

    Kal Kotecha is the editor and founder of the Junior Gold Report, a publication about small-cap mining stocks. He was the editor and creator of The Moly/Gold Report, which focuses on critical analyses and open journalism of companies profiting from the precious and base metals sector. The scope of his current activities include worldwide onsite analyses and reporting of developing companies. Kotecha has previously held leadership positions with many junior mining companies. Kotecha completed his Master of Business Administration in finance in 2007 and is working on his Ph.D. in business marketing. He also teaches economics at the University of Waterloo.

    Want 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 recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

    DISCLOSURE:

    1) Brian Sylvester 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.
    2) Streetwise Reports does not accept stock in exchange for its services.
    3) Kal Kotecha: I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
    4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
    5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer.
    6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. 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 (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.

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    Sep 30 2:12 PM | Link | Comment!
  • Keep Truckin': Russell Stanley On How To Snap Up Growing Energy Services Companies

    The oil and gas fields in western Canada are sucking up rental equipment, trucking services and well site accommodation services like the proverbial black hole. Russell Stanley of Jennings Capital, an expert on mergers and acquisitions, knows how to find the margin in the increasingly profitable energy service industry, and explains the rules of this investment game to The Energy Report.

    The Energy Report: Are oil and gas field services in Canada a high growth sector?

    Russell Stanley: Energy prices drive oil and gas field construction and infrastructure development in western Canada. Other drivers include the need to build out liquefied natural gas [LNG] facilities and rail facilities.

    Jennings Capital targets service companies with market caps in the $50 to $200 million [$50-200M] range. These names tend to have fewer analysts following than do the larger names. We like companies that rent out niche-type equipment at high margins. These firms are typically low headcount businesses with a lot of operating leverage. Oil and gas field demand is so strong that these companies must source equipment externally to extend their fleets and meet commitments.

    TER: What defines a service company in this context?

    RS: The definition is fairly broad. We cover companies that operate oil and gas field rental equipment, and a broad group of what we call services to the services. These companies may be employed by an exploration and production [E&P] company directly, or by one of the companies that services the E&P.

    The service equipment supports oil and gas field infrastructure and construction, which is seasonal. But it can also be used for projects managed by utilities or governments that aren't seasonally dependent. Extending the customer base enhances revenue stability, mitigating the impact of the spring breakup. The challenge right now is that traditional oil field demand is so strong that service companies' fleets are stressed. We call that a Hollywood problem, though.

    TER: What happens during spring breakup?

    RS: During spring breakup, the ground thaws in the northern parts of Alberta and Saskatchewan. The resulting moisture prompts a lot of road bans. The E&P and service firms are not allowed to move heavy equipment because of road instability. As a consequence, drilling activity slows down, as does demand for related services. The spring quarter of the year is generally the weakest quarter for companies in the energy service space.

    TER: Is spring breakup the time when the E&P companies are offline? What about during really cold winter weather?

    RS: The E&P companies in the northern parts of the provinces like the colder weather. Ground conditions are ideal in the winter. This past winter was longer and colder than normal, and more conducive to rig activity. Drilling in western Canada was at relatively high levels, which supported the service companies.

    TER: Do you advise investing in small, growing energy service firms, or in buying shares in companies in the business of acquiring the small firms?

    RS: Investing in smaller companies can offer short-term advantages to investors. The speed of execution of a business plan is a simple metric to understand. And investing in a quality startup that is following its business plan is always a good bet. Of course, many of these firms are privately held.

    But on a mid- to long-term basis, we are seeing more and more merger-and-acquisition [M&A] activity for a combination of reasons. The larger, more liquid companies have easier access to capital. Smaller companies can run into challenges raising the money they need to pursue immediate growth opportunities. That provides an opportunity for a larger player to acquire the small firm. We are also seeing an increased level of centralized procurement by the end customer. The E&P companies prefer to make one phone call to a service provider. From the customer's perspective, it is more efficient to deal with a large service company that can offer a fuller suite of products and services.

    TER: Are acquirers proving to be good managers after the acquisitions close?

    RS: The challenge on a post-acquisition basis is preserving the customer base of the company acquired. Small, private companies have often been in operation for 20-30 years. They often have excellent brand value on a local basis. They have longstanding customer relationships. The acquirer does not want to erode that goodwill. The challenge is to optimize the synergies while maximizing overhead savings and cross-selling opportunities.

    The companies we cover do a good job in that arena, and it is a skill we applaud. A key factor in maintaining a smooth transition in M&A is that all the involved parties understand that the buyer's intent is to continue with current management. We like to see the former owner/operators of acquired private companies incentivized to stay on board with earn-out provisions and blocks of stock in the business.

    TER: How can a service company best increase its margin?

    RS: We like private companies that are running flat out. Their fleets are extended. They are renting third-party equipment to support customer demand. They have great customer relationships. When they have trouble renting to meet increasing demand for services, they inject capital to expand the fleet. It is better to buy the equipment necessary to meet demand; renting equipment from a third-party reduces margin.

    A good example of a company using these tactics is Enterprise Group Inc. (OTC:ETOLF) [E:TSX.V]. Enterprise is involved in oil field construction and equipment rentals, as well as in serving the local utilities and transportation markets in western Canada. It is currently injecting capital to displace the use of third-party equipment to drive margin improvement.

    TER: The charts show that Enterprise enjoyed a four-fold increase in share value during the past year. What do you attribute that to?

    RS: We attribute Enterprise's performance to its strong M&A strategy. Enterprise recently announced an LNG acquisition in the Fort St. John area of British Columbia. Its last significant acquisition was Hart Oilfield Rentals in early 2014. It acquired a couple of companies in 2013. The companies Enterprise acquired sold at very attractive prices, usually 3x trailing EBITDA. Most are operating in niche markets, offering a service or a line of equipment that is in high demand. Because Enterprise is a public company, it has excellent access to the capital markets. It can support the growth of the acquired companies on a post-strength action basis.

    TER: What financial metrics do you look at in an M&A candidate?

    RS: The most popular target from an acquirer's standpoint is a private company that has grown organically and needs capital support to make it to the next level. Trailing EBITDA is the metric that acquiring companies look at in determining the worth of an acquisition target. Most transactions are getting done between 3x and 4x trailing EBITDA on a normalized basis, excluding exceptions consistent with the operation of a private company. Usually the buyers want a mix of cash and stock, and a provision that ensures the continuity of management.

    TER: What other names are you following in this M&A and execution space?

    RS: We have just launched coverage of CERF Inc. [CFL:TSX.V]. CERF recently completed a combination with Winalta Inc. We have a $5/share target and CERF's stock's is currently trading at about $3.50/share. CERF provides equipment rentals to both the oil field and construction markets in western Canada. The Winalta transaction was a $70M equity and debt deal, which added exposure to the well site accommodation space, which means providing shacks that allow staff to live and work in close proximity to rigs operating in extreme weather conditions. Well site accommodation is a high margin business. CERF's existing rental business was doing gross margins in the neighborhood of 35-40%. The well site accommodation business has gross margins of over 60%. On top of that, CERF is paying a dividend yield of 6.7%. It is a relatively high yielding stock with a very attractive earnings growth profile.

    TER: Are private equity investors interested in the energy services M&A game in western Canada?

    RS: We are seeing more interest from private equity. Private equity firms are starting to participate in managing public entities acquiring the oil and gas field service companies, but that game is still in the fourth inning.

    TER: Thanks for the insights, Russell.

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

    Russell Stanley has recently returned to Jennings Capital, having first joined the Toronto office in August 2007. He has worked in the brokerage industry since 1997, with the last 10 years in equity research. He has previous experience covering companies in industrial, consumer and health products, technology, alternative energy, bulk commodities and mining services. Stanley looks for underfollowed micro- and small-cap companies with strong earnings growth potential and solid management teams. He holds a master's degree in business administration from the Schulich School of Business [York University], and 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 recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

    DISCLOSURE:
    1) Peter Byrne 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: Enterprise Group Inc. Streetwise Reports does not accept stock in exchange for its services. 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.
    3) Russell Stanley: 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: Jennings Capital was a member of the syndicate for Enterprise Group Inc.'s last equity financing. 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 what 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 (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

    Tags: ETOLF, Energy, Oil Gas, M A
    Sep 25 1:18 PM | Link | Comment!
  • Where To Look For Yield During A Time Of Low Gas Prices: Elliott Gue

    With gas prices stuck at historic lows for the foreseeable future, bored investors can look toward master limited partnerships to increase profit yields on energy portfolios. Elliott Gue, energy investment strategist of Capitalist Times, spends his day finding great energy deals in the margins and curves. In this interview with The Energy Report, Gue does the dirty work and gives us his strategy so that investors can golf, yacht, and have fun without worrying about losing the value of their savings to inflation.

    The Energy Report: Elliott, you recently wrote in Capitalist Times that "unless last winter marked the onset of a new ice age, the underlying supply-and-demand trends that prevailed before the polar vortex are always going to win out." Based on the charts that accompany that article, what are those trends?

    Elliott Gue: Last winter was really cold and, as a result, natural gas demand was very high. Natural gas stores in the U.S. were drawn down much more rapidly than normal. At the same time, there were production disruptions. It was so cold in the Rocky Mountains that producers were not able to service their wells. Natural gas production plummeted and gas prices shot up.

    The underlying trend remains very bearish for gas prices, however. The demand for gas did ease after the winter heating season, lowering prices, but there has been resurgence in production, and storage levels are back up. The electric power utilities thrive on cheap gas, and production is growing even faster than rising demand. There are simply oceans of gas out there that we have not yet tapped, like the Haynesville Shale in Louisiana. I expect that gas prices in the U.S. will remain low, and, consequently, electricity prices will continue to hug the bottom relative to the rest of the world.

    TER: Given the situation, who will be the winners?

    EG: The biggest winners are going to be companies that consume gas, rather than companies that produce gas. A lot of energy companies are moving away from gas toward producing more oil and natural gas liquids. Electricity prices in China are twice what they are in the U.S. Reversing a long trend, Chinese companies are building out manufacturing capacity in the U.S. The aluminum smelting industry stands to benefit tremendously, because its manufacturing process is linked to the price of electricity.

    TER: Who do you like in aluminum?

    EG: We like Century Aluminum Co. (NASDAQ:CENX), which is an aluminum smelter. Century takes aluminum oxide and, using a process that requires a lot of power, turns the oxide into aluminum, which is then used in thousands of products. Century is buying power in the U.S. on the spot, which means that it pays prevailing market prices. As a result, it is buying power at a steep discount to what its European competitors are paying.

    Demand for aluminum by the automobile industry is expanding, because the federal government's Corporate Average Fuel Economy [CAFÉ] standards require automakers to boost the fuel efficiency of entire lines of cars and trucks. Ford is meeting the standard by increasing the amount of aluminum used in its vehicles. The 2015 Ford F-150 pickup truck is 750-1,000 pounds lighter than the 2014 model. It is expected to sport a fuel efficiency of 30 miles per gallon [30 mpg]. No standard-size pickup truck in the U.S. has ever achieved 30 mpg in terms of fuel efficiency. The low natural gas prices in the U.S. will continue to be a big boost for companies like Century Aluminum, which require an awful lot of power in their factories.

    TER: Are energy investors today looking for short-term profits in the hurly-burly of the stock market, or are they looking for steady income vehicles?

    EG: Steady income investments are in demand. Back in 1999-2000, you could put money into a certificate of deposit, a money-market account, or even a savings account and still get interest rates of 5-6%/year. Now, you can't even get 1%. Income-producing stock sectors, like utilities and real estate investment trusts [REITs], are yielding at near historic lows, under 3%. Investors are starved for steady-stream income vehicles. This highlights the attractiveness of master limited partnerships [MLPs], which are typically used by midstream energy companies. The MLPs own assets like pipelines and natural gas storage vehicles. They offer higher-than-average yields, which permits investors to earn better than average returns.

    TER: Are the best opportunities for steady income flow emerging from the established MLPs, or from those MLPs making initial public offerings [IPOs]?

    EG: We focus on MLP IPOs because the yields on many of the large, traditional MLPs have fallen-not because they have cut dividends or distributions, but because the MPL industry has rallied so much. I see a lot of value in new MLP listings-companies that have just gone public as MLPs. Exchange-traded funds [ETFs] and institutional money is strongly attracted to the largest and longest-standing MLPs, such as Enterprise Products Partners L.P. (NYSE:EPD). Buying MLPs en masse inevitably drives down the yield. Still, investors are so hungry for yield that they are piling into the traditional MLPs, which can increase the valuation of the larger, more established names.

    Oftentimes, if you search for a symbol for a new MLP, it will show that there is no yield. The reason is that the MLP has not yet paid its first quarterly distribution. It is a good strategy to jump in early on new MLPs, before they become too popular. Investors can get a good price until the MLP starts paying out distributions, and displays its income potential for all to see and grab.

    TER: What IPOs do you like in the MLP space?

    EG: One new IPO that we are looking at is Cypress Energy Partners LP (NYSE:CELP). It went public in January 2014. Cypress is in the wastewater business. Oil and gas fields produce large volumes of water that contains all kinds of contaminants, and that water must be disposed of in a regulated fashion. Cypress injects wastewater into disposal wells underneath the drinking water table.

    There is also a need for recycling fracking wastewater, so it can be used in another round of fracking. The technology to do that already exists, but it is more expensive than disposing of wastewater in an injection well. The future holds more recycling opportunities because reusing expensive water can cut costs. For instance, in Southern California, water prices are very high because there is a drought, so using recycled water makes sense. Cypress may enter that space as well.

    The second part of Cypress' business is pipeline integrity, monitoring pipelines for signs of weakness that might cause a spill. Obviously, with high-profile pipeline spills and reputation-damaging ruptures over the last five to 10 years, focus has shifted to this business. Companies are spending cash to make sure their pipelines are safe.

    Cypress yields about 6.5%. The average MLP yields about 5.5%, so Cypress delivers an above-average yield. It has a lot of growth potential because both of its businesses are necessary. I expect its distributions to grow at an annualized pace of 10-15%, plus the 6.5% yield.

    TER: Which other MLPs do you particularly like?

    EG: One of our favorites is Memorial Production Partners LP (NASDAQ:MEMP). It owns mature oil and gas fields in Texas and the Rockies, and an offshore field in California that went into production 70 years ago. Predictable rates of production from these fields back the company's strong, 9.6% yield. Of course, if oil and gas prices fall, Memorial would have to cut its distribution. To prevent that scenario, it hedges most of its production five years into the future-meaning that Memorial does not have any real exposure to the volatility of commodity prices.

    TER: Have you spotted any undervalued oil and gas production majors?

    EG: The problem with Exxon Mobil Corp. (NYSE:XOM) and Chevron Corp. (NYSE:CVX) is their slow production growth in recent years. These companies are overvalued by any metric-price:book value, price:cash flow, price:earnings. We look for smaller integrated names. These are still massive companies, but not as gargantuan as Exxon and Chevron.

    For instance, Eni S.p.A. (NYSE:E) is an integrated oil company that is partly owned by the Italian government. It trades at a discount to the big U.S. and northern European energy firms because it is based in Rome. The financial crisis in southern Europe has hit the Italian economy hard, and investors tend to shun firms listed in Rome. The reality is that most of Eni's assets are in Africa, where Italy had a longstanding colonial relationship. Eni's main products are natural gas and crude oil-priced in dollars, not euros. So Eni has had very little exposure to the risky Italian situation, yet it trades at about half the valuation of Exxon.

    TER: If the majors are experiencing a slowdown in production growth, how can the smaller firms do better?

    EG: Exxon has trouble growing because, for a field to move the company's stock needle, it has to be massive. Eni can exploit smaller projects in Africa and generate relatively greater production growth. It has a number of major finds in Mozambique that are due to come on-stream over the next few years. An additional benefit is that Eni yields about 5%, whereas Exxon yields around 2-3%. Eni is offering a much higher yield alongside production growth in the outlier regions.

    TER: Are there other large companies in that smaller space that you like?

    EG: Total S.A. (NYSE:TOT) is a French company. It trades at a discount because it is based in Europe. It offers a yield of about 5%. It is not quite as strong a production growth story as Eni, but it does have a number of interesting projects coming online in the Arctic, near Norway.

    TER: What junior explorers and producers do you have your eye on?

    EG: Noble Energy Inc. (NYSE:NBL) centers its production on the Niobrara Shale region in Colorado and Wyoming. The Niobrara is not as fully developed as the Bakken Shale, but the Niobrara's wells are among the most spectacular plays in the U.S., ranking only behind the Bakken in terms of profitability. Noble is one of the largest acreage holders in the Niobrara. It has set up a very aggressive drilling program for the next three to five years. As people become more aware of what is going on in the Niobrara, and as production expands, entrenched names like Noble will attract lots of attention and capital.

    TER: Is Noble international?

    EG: Three years ago, Noble discovered a massive gas field off the coast of Israel called the Leviathan. While natural gas prices in the U.S. are very low, that is certainly not the case in Europe and Israel. The massive Leviathan gas field is strategically important to Israel. Noble will be able to produce natural gas from this field, sell it domestically, and bring down the cost of natural gas in Israel. It will also be able to export liquefied natural gas [LNG] to Europe. Currently, Europe imports the majority of its natural gas from Russia. With the ongoing political turmoil in the Ukraine, the Europeans are keen to diversify their supply sources.

    TER: When will the Leviathan start producing?

    EG: Noble is drilling a number of delineation wells. These wells will evaluate the size and productivity of the play. The flow of news is good. I suspect the Leviathan will go into production in the next two to three years. It will ramp up in 2019, as the company's LNG plant goes live.

    TER: With the differential in natural gas prices, what's happening in the refining space? Where are the best buys?

    EG: The refining space is the biggest beneficiary of the surge in U.S. oil production. At the end of 2013, the U.S. overtook Saudi Arabia to become the world's largest oil producer. That is an amazing statistic when you consider that just 10 years ago, we were talking about how much more oil the U.S. was going to have to import from Saudi Arabia to meet domestic demands. And oil production in the U.S. continues to grow.

    But one of the side effects of that growth is that U.S. oil prices are far lower than in other parts of the world. The key international global oil benchmark is Brent crude. It is trading around $100-105/barrel [$100-105/bbl]. The key U.S. oil benchmark is West Texas Intermediate [WTI], and that is trading in the low-to-mid-$90s.

    In other parts of the U.S., oil prices are even lower. In Midland, Texas, in the heart of the Permian Basin play, oil prices are trading around $74/bbl, which is a massive discount to international oil prices. Due to the lack of pipeline capacity, there is a glut of crude oil in certain parts of the U.S., and that fact is depressing prices. Obviously, that is not good news for producers, but it is great news for refiners.

    TER: Why?

    EG: Refiners are manufacturers. A refiner's largest cost is the price of crude oil. If a refiner can buy oil at a deeply discounted price, that will enhance its profit margins. Refiners located near Midland purchase crude at a steep discount and sell gasoline and diesel fuel at high prices. Plus, the U.S. government does not allow the export of crude oil, but it does allow the export of refined products. And international prices for refined products are sky-high.

    TER: What refiners do you like?

    EG: Valero Energy Corp. (NYSE:VLO) is the largest independent refiner in the U.S., with refinery assets primarily located around the Gulf Coast area. A lot of production flows toward that region because pipelines in the U.S. are set up to transport oil to the Houston area, where the refining industry is strong.

    Looking at smaller refiners, we keep tabs on Alon USA Partners LP (NYSE:ALDW). This MLP has a refinery in Big Spring, Texas, near Midland. It benefits from the low Midland crude oil prices and selling its refined products at very high markups. It currently yields about 16%, and that is super.

    TER: Of the Big Four firms in the service sector, which ones are the best positioned in today's economic climate?

    EG: Four of the largest oil services firms in the world are Baker Hughes Inc. (NYSE:BHI), Halliburton Co. (NYSE:HAL), Schlumberger Ltd. (NYSE:SLB) and Weatherford International Ltd. (NYSE:WFT).

    Schlumberger is the largest. It is also the most respected and, technologically, the most advanced. People sometimes make the mistake of thinking that the energy business is not high tech. The energy business is one of the most high-tech industries. It is producing oil from deepwater plays, drilling in water that's 10,000 feet [10,000 ft] deep, with wells that can be 35,000 ft long. Bidding on big deepwater developments, and big onshore projects in the Middle East, is a very competitive business. These projects are so heavily bid that the pricing is not great, because companies are competing on price to win business.

    Schlumberger has developed certain unique technologies that the rest of the Big Four services firms don't have. These are typically techniques that allow companies to drill a well using less water, drill a well quicker than its competitors, and locate oil in underground rock formations with seismic waves that map the rock formations. As a result, Schlumberger is able to charge high prices for its unique services, and its margins are much higher than those of its competitors.

    Weatherford has been the worst of breed over the last five years. It had an accounting scandal-an irregularity in its international accounting for taxes. That matter has been settled, which means Weatherford's management team can return to focusing on operations. The company is spinning off noncore businesses that were not returning high margins. The $1 billion [$1B] from these spinoffs can be used to pay down Weatherford's debt load, which is a big positive.

    Operationally, Weatherford has artificial lift, a technology that can produce more oil from mature fields. That lifting ability is very much in demand, because there are a lot of mature fields around the world, and oil prices are high enough to make it profitable. Once Weatherford gets rid of the small businesses that have been acting as a headwind on profits over the last five years, its managers will be able to focus on the firm's competitive strengths, such as artificial lift.

    TER: What advice are you giving readers about adjusting portfolios for the fall?

    EG: Stocks have been steadily on the rise, and we have not seen very many corrections. The correction we saw this summer was on the order of 5% on the S&P. Be prepared for a 5-10% pullback in the broader market. We regard a pullback as a buying opportunity for a lot of the names that I have mentioned.

    Longer term, the economy is in good shape. Growth is accelerating after too many years of weak growth. Growth generates a big tailwind for stocks. We have been selling out of the names that have done very well for us, taking our profits off the table or reducing our exposure. It is all about having cash in reserve to take advantage of the lower prices when they come around, as they always do.

    TER: Thanks for talking to us, Elliott.

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

    Since earning his bachelor's and master's degrees from the University of London, Elliott Gue has dedicated himself to investment in the energy sector, and was been referred to in the official program of the 2008 G-8 Summit in Tokyo as "the world's leading energy strategist." He has also appeared on CNBC and Bloomberg TV and has been quoted in a number of major publications, including Barrons, Forbes and The Washington Post. Gue's expertise and track record of success have also made him a sought-after speaker at MoneyShows and events hosted by the Association of Individual Investors. Gue has contributed chapters on developments in global energy markets to two books published by the FT Press, "The Silk Road to Riches: How You Can Profit by Investing in Asia's Newfound Prosperity" and "Rise of the State: Profitable Investing and Geopolitics in the 21st Century." Prior to founding the Capitalist Times, Gue shared his expertise and stock-picking abilities with individual investors in two highly regarded research publications, MLP Profits and The Energy Strategist, as well as the long-running financial advisory Personal Finance. In October 2012, Gue launched the Energy & Income Advisor, a semimonthly online newsletter dedicated to uncovering the most profitable opportunities in the energy sector, from growth stocks to high-yielding utilities, royalty trusts and master limited partnerships.

    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 recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

    DISCLOSURE:
    1) Peter Byrne 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. Streetwise Reports does not accept stock in exchange for its services.
    3) Elliott Gue: I own, or my family owns, shares of the following companies mentioned in this interview: Enterprise Products Partners L.P., Cypress Energy Partners L.P., Memorial Production Partners L.P., Exxon Mobil Corp., Chevron Corp., Eni S.p.A., Total S.A., Noble Energy Inc., Valero Energy Corp., Alon USA Partners L.P., Baker Hughes Inc., Halliburton Co., Schlumberger Ltd., Weatherford International Ltd. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
    4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
    5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer.
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