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  • Lithium Demand Will Spike: Daniela Desormeaux

    Lithium Demand Will Spike: Daniela Desormeaux

    Source: George S. Mack of The Energy Report (6/28/12)

    http://www.theenergyreport.com/pub/na/13762

    Consumer demand for iPads and smart phones is on the rise, and electric vehicle sales could jumpstart in the near future. Pinpointing production spikes is no simple task, but Economist Daniela Desormeaux of market intelligence company signumBox has plotted some important points in lithium's demand timeline. In this exclusive interview with The Energy Report, Desormeaux highlights growth areas in the industry and explains why small-cap lithium producers will have room to compete with the big boys.

    The Energy Report: The fourth annual Lithium Supply & Markets Conference in Argentina took place at the end of January. What was the mood at that time?

    Daniela Desormeaux: At that time, people were thinking about how the situation in Europe would impact the industry. I think we have more information about that now, but in January we did not. Regardless, the main drivers behind lithium demand are relatively independent of the economic cycle, and what we see is demand continuing to grow at a healthy rate despite the current situation in Europe. People in the industry know that the main driver of lithium demand is batteries. In the short-term, the economic cycle obviously affects the lithium industry, but from a long-term view I think expectations remain optimistic.

    TER: We saw some lithium price increases in mid-June of 2011 when FMC Lithium Corp. (FMC:NYSE) and Chemetall (a unit of Rockwood Holdings Inc. [ROC:NYSE]) said that they were raising prices on both lithium hydroxide (LiOH) and lithium carbonate (Li2Co3). Will prices continue stronger, or will they stabilize?

    DD: Well, lithium pricing is very interesting to follow because it's not just about the balance between demand and supply; it's determined by what the main lower-cost producers decide to do with prices, which then impacts the rest of the industry. That's the pattern we have seen in the past. FMC and Chemetall did raise prices, and I think they had two reasons for doing that. One is that producers are facing higher raw material costs. The other thing is that FMC and Chemetall are both making some investments in the U.S., and FMC is making investments in Argentina. They need higher prices to justify financing these investments.

    Also, it's important to distinguish between nominal prices and real prices, inflation being another source of price pressure. But short-term prices may be stronger because of inflation and these new investments. prices should remain stable in the mid- to long-term because even as demand is growing, new production is coming into the market. This will help balance the market.

    TER: When it comes to pricing individual lithium products, are grade and purity the most important factors?

    DD: Yes, battery-grade lithium requires a small particle size, and to reduce particle size producers need more processing and energy. That increases costs. Therefore, battery-grade lithium carbonate is more expensive than commercial-grade lithium carbonate. Buyers have to pay for more purity.

    TER: A recent article in Bloomberg Businessweek, "IPad Boom Straubs Lithium Supplies After Prices Triple," was a very positive story, and it moved the market on small-cap lithium stocks. Is this a sign that the lithium market is beginning to wake up?

    DD: I think the industry has already awakened. We have seen a lot of global interest in lithium over the last five years. But my fear is that in some cases there is an overestimation of lithium demand. Lithium is going to be important now and more important in the future because of its use in batteries for electric cars among other things, but it won't replace oil.

    TER: Could these overly robust demand expectation lead to a supply glut?

    DD: In the past, the industry has overestimated demand, and that's why we saw something like 90 projects in the works at one point. But it's impossible for all of these projects to be part of the lithium supply because there is not enough demand in this space for everyone. Thus, most of these projects did not reach production.

    TER: Nonetheless, demand is actually growing. The question is, at what pace?

    DD: The lithium industry has a very promising future, and we think demand will grow at about 8% per year. But it's also important to have a very realistic perspective about the industry.

    TER: Daniela, aren't component makers in transition now from nickel-metal hydride batteries to lithium-ion batteries? How significant is this shift?

    DD: The replacement in the electronic-devices segment is largely already done. That happened in the nineties when Sony Corporation (SNE:NYSE) introduced the first lithium-ion cell. It took less than 10 years for lithium-ion batteries to take 90% of the market. But there is some new demand as well: because of environmental issues, China is prohibiting the use of acid batteries in motor scooters or bikes, so light electric vehicle makers are being forced to change from acid batteries to lithium-ion batteries.

    TER: Are we back to pre-recession demand levels for lithium?

    DD: I think this industry is really very interesting in that regard. Despite the recession, some expect the battery industry to grow 20% this year. By the end of the year I think that total demand will be higher than previous levels.

    TER: Where are we now on the demand curve for lithium? At the foot? Near the peak?

    DD: We are getting close to a breaking point. This will occur when electric cars become affordable for many consumers. We have seen this happen in some countries where there have been lots of subsidies, but it's difficult to believe that European governments will continue with these subsidies, given economic conditions. But the numbers could be amazing. For example, the iPhone contains something like 5 grams (5g) of lithium carbonate while a battery for a car can have 30 kilos (30kg) of lithium carbonate in it. The difference in the numbers is huge. I do think we are approaching a change in the growth trend-a breaking point.

    TER: When will we hit that inflection point?

    DD: That's a very good question. I think it will be after 2015. The situation in Europe will impact the uptake of electric cars. There are also some analysts who believe that China is slowing down as well. We'll have three or four years before we see a massive taking off of the lithium-ion battery industry. It may be sooner or later depending on the economic situation, of course, but I think we are approaching it.

    TER: Can small-cap lithium companies compete with the large companies on scale and margin?

    DD: I think the answer is yes, because so far what we have seen is the big three lower-cost producers (Chemetall, FMC and Sociedad Química y Minera de Chile S.A. [SQM:NYSE; SQM-B:SSX; SQM-A:SSX]) are giving the space for newcomers to enter the market. Years ago, I did not think they would do that. I thought they would lower prices to where most of these new projects couldn't be profitable. For example, if the big three lowered prices to, say, $2,000 per metric ton ($2,000/mt), most of these new projects wouldn't be profitable. But they haven't done that. That's a signal that they are giving room to these newcomers to enter into the market because the demand is growing and the supply, so far, has not grown at the same rate. Smallcaps will have a chance, but of course they will have to compete against each other because room for new companies is limited. If too many come into the market, prices will start to go down, and that of course will impact those smaller companies. Ultimately, I think that the market will be balanced and the lowest-cost new producers will be part of the supply chain.

    TER: Lithium equities' performance has been very weak over the past 16 months, even with this recent uptick in lithium prices. With the exception of the Galaxy Resources Ltd. (GXY:ASX) and Lithium One Inc. (LI:TSX.V) merger that is happening now, why aren't we seeing more consolidation?

    DD: This global economic situation has had an effect on almost all publicly listed companies. The lithium industry is especially sensitive to that. On the other hand, the economic situation is very much related to what has happened with oil prices, and the oil price is very important to the uptake of electric cars. It is very important to know how the industry works and what the main forces are. We see the main trends in the lithium industry pointing to a very promising future. For example, we have seen many new large-scale energy storage projects that use huge batteries. This will represent an important source of demand, as will electric bikes in China.

    TER: You have recently said that demand for lithium hydroxide would grow from 20% of lithium commodity consumption to 30-35% of lithium consumption by 2020. How can investors play this growth in lithium hydroxide demand?

    DD: That's a very interesting question because the market for lithium hydroxide is mainly for lubricating grease. New batteries are being developed, the lithium-ion phosphate battery, for example, that use lithium hydroxide instead of lithium carbonate. So, we expect a higher growth rate for lithium hydroxide than for lithium carbonate in the case of batteries. And this is very interesting for the companies that plan to produce lithium chemicals from spodumene (pegmatites), because the process of producing lithium hydroxide or lithium carbonate from lithium concentrate (obtained from spodumene) is very similar in terms of costs. Chinese lithium chemical producers can either produce carbonate or hydroxide directly from the concentrate. This gives them an advantage over brine producers because SQM, Chemetall and FMC have to produce the lithium hydroxide starting from the lithium carbonate.

    TER: My understanding is that lithium hydroxide is the choice of some manufacturers, including Chinese battery and car manufacturer BYD Company Ltd. (BYDDF:OTCBB), of which Warren Buffett owns approximately 10%.

    DD: That's correct. BYD is working on the lithium-ion phosphate battery, which uses lithium hydroxide in the cathode, and I think this company will be a very important player in the future. Its K9 electric bus is being tested in many cities and if successful it will represent an important step towards the electrification of transportation.

    TER: Daniela, what do you tell investors who want to invest in lithium?

    DD: You have to look at the battery industry, because it is going to be crucial. Today it represents 30% of total lithium demand and we estimate that in 10 more years, it will represent about 50% of the demand. So far, there aren't any substitutes for lithium in batteries. But who knows what will happen in the future. In any event, the lithium industry shows a very promising future, and among all of the commodities it represents one of the highest expected rates of growth.

    TER: Thank you, Daniela.

    DD: Thank you. I enjoyed it.

    Daniela Desormeaux is an economist and an expert in industrial chemicals and natural resources. Prior to starting with signumBox, she was strategic marketing manager at SQM, where she was responsible for market intelligence on lithium, iodine and other industrial chemicals.

    For more insights into promising lithium equities, check out Chris Berry's exclusive interview with The Energy Report.

    Want to read more exclusive 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 Exclusive Interviews page.

    DISCLOSURE:
    1) George S. Mack of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
    2) The following companies mentioned in the interview are sponsors of The Energy Report: Lithium One Inc. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
    3) Daniela Desormeaux: From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

    Streetwise - The Energy Report is Copyright © 2012 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.

    The Energy Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report.

    From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

    Streetwise 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
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    Jul 05 4:08 PM | Link | Comment!
  • Six Lithium Companies Chris Berry Likes

    Six Lithium Companies Chris Berry Likes

    Source: The Energy Report Editors (6/28/12)

    http://www.theenergyreport.com/pub/na/13755

    Chris Berry knows an opportunity when it is rolling toward him. The House Mountain Partners founder sees the potential demand electric vehicles-and their batteries-will bring to the lithium market. While he waits for the impact predicted automotive, energy storage and generation innovation demand will have on the space, he has been busy researching companies using his 10-Point model to determine which juniors have the best chance of making it to the finish line. In this exclusive interview with The Energy Report, Berry names the six companies that stand out from the fleet of explorers trying to stake their ground before they run out of momentum.

    The Energy Report: You have been following the very crowded lithium space for some time. While predicted expanding energy storage demand (see Lithium Demand Will Spike: Daniela Desormeaux) has not yet had a big impact on prices, the number of companies in the space seems to be swelling by the month. Of the army of explorers getting into the lithium business, what are the top names in your book?

    Chris Berry: I categorize earlier-stage companies into three "buckets": incubator, mature and legacy. Incubator companies are extremely early stage and offer the highest short-term upside, but we know the least about the deposit in question and management teams might not be as seasoned as we would like. Mature companies are those with some history under their belts and an understanding of the geology and metallurgy of a given deposit with more experienced management teams. These companies also typically have NI 43-101 resource estimates or feasibility studies in place, which give investors a sense of potential economics of a deposit. Mature companies are those in production and generating earnings and cash flow. A legacy company is one which is in production and is generating cash flow and earnings. Management is typically very senior and has extensive experience in the natural reource business. Examples in the lithium space would be Talison Lithium Ltd. (TLH:TSX) or Sociedad Química y Minera de Chile S.A. (SQM:NYSE; SQM-B:SSX; SQM-A:SSX).

    One mature lithium company that has received a lot of attention lately is Western Lithium USA Corp. (WLC:TSX; WLCDF:OTCQX). Perhaps the biggest news here is the appointment of a new chairman of the board. John Macken will step in for Ed Flood. Ed founded Western Lithium and is handing over the reins to John, who has been on the board of Western Lithium since 2008. This should be a seamless transition, which can help strategically position the company as it moves toward a production decision. John has a multitude of experience with "majors" such as Ivanhoe Mines Ltd. (IVN:TSX; IVN:NYSE), where he served as president and CEO and focused on the development of Oyu Tolgoi in Mongolia and at Freeport McMoran Copper & Gold (FCX:NYSE) where he was involved in the development of the Grasberg Mine in Indonesia as a senior vice president of Strategic Planning.

    I think John's history of advancing projects across different commodities and in various parts of the world will be a key strength of Western Lithium going forward. Junior mining companies in markets today will need to act with both a strategic and creative vision to survive. I will be watching Western Lithium closely to see John's vision unfold.

    The strong economics of WLC's King's Valley clay lithium deposit speaks for itself and I won't belabor them here. This is also a U.S.-based asset in a mining-friendly state, another intangible not currently reflected in the company's share price.

    Nemaska Lithium Inc. (NMX:TSX.V; NMKEF:OTCQX) is a mature lithium play I have on my watch list. The company has made some notable strides in recent months and has successfully positioned itself to be included amongst advanced development lithium plays. The company filed two U.S.-based patents for a process it has developed to produce both lithium hydroxide and lithium carbonate. This methodology has demonstrated a lower cost of production as electrolysis is used to reduce overall soda ash consumption. Input costs for mining companies are on the rise, so you must pay attention when a company is confident enough to stand up and demonstrate a method to potentially lower its cost of production. Successfully receiving these patents is a key catalyst for the company going forward.

    Talison Lithium Ltd. has been and continues to be our favorite amongst the oligopoly of lithium producers. This is a legacy play that has been in the lithium business for 25 years but started publicly trading only recently. We continue to own shares in the company. It recently completed its phase 2 expansion at its Greenbushes open pit lithium mine in Western Australia. This was done both on time and on budget. This will double the company's production capacity and position it as a dominant force in an industry where it is already one of the world's largest lithium concentrate producers. In a recent Morning Note, we wrote that with the completion of this expansion project, it just got much tougher for junior mining lithium plays to break into this industry. TLH has been able to increase pricing of its products while at the same time lowering production costs. This is a key advantage. As capacity utilization of its new plant ramps up, we expect to see increased cash flow and profitability generated by the company in coming quarters. Any junior mining company looking to compete with this sort of powerful story must demonstrate some profound competitive advantages.

    TLH is now researching the possibility of constructing its own lithium carbonate plant to capture additional value along the supply chain. A decision on whether or not to move forward with the plant should be forthcoming by the end of 2012. The tentative plan is for the company to produce 20,000 tons per year of lithium carbonate with plant construction commencing in 2015. There will, of course, be additional costs here should the company proceed with the project, but it is too early to speculate on those costs and how the company will choose to finance them.

    Lithium One Inc. (LI:TSX.V) was my favorite amongst the advanced development stories in the lithium space. I say "was" my favorite, as its shareholders recently approved the takeover of the company by Australia-based Galaxy Resources Ltd. (GXY:ASX). The deal was recently finalized to give Lithium One shareholders 1.96 common shares of Galaxy, which equated to CA$1.55/share, a 35% premium to Lithium One's recent closing share price. The deal size was about CAD $112 million (NYSE:M) and is expected to close on July 3, 2012. This deal typifies the merger and acquisition activity I expect to see pick up in coming months as I think it is complimentary to each company's shareholders. Lithium One management has built a solid story around a world-class asset and has in turn rewarded shareholders. I will be watching Lithium One management in their future endeavors as they have demonstrated the ability to reward their shareholders.

    Continuing my focus on the lithium triangle in South America, Lithium Americas Corp. (LAC:TSX; LHMAF:OTCQX) is another mature lithium play I am following. The company recently released a robust definitive feasibility study (NYSE:DFS), which increased the size of the measured and indicated NI 43-101 resource and cemented the Cauchari-Olaroz brine resource in Argentina as the third largest in the world. The DFS showed an NPV at an 8% pre-tax discount rate of US$738M for the first of two production phases of this project. The production plan here supports both production of lithium carbonate and potash, which should help keep cash operating costs low. I also like this as it offers the company a second product to sell should lithium carbonate demand falter. The study currently has these costs listed at US$1,332 per ton of lithium carbonate (including a byproduct credit from potash production). With lithium carbonate selling for approximately US$6,000 per ton and LAC anticipating selling 10,000 tons of lithium carbonate per year starting in 2015 (though ramping up to 15,000 tons in 2016, and then 20,000 tons in 2017 going forward), you can begin to get a rough sense of the potential economics of this project.

    The company will be filing the DFS and then will begin focusing on catalysts, including the receipt of environmental permits and negotiating financing arrangements with its two strategic partners, Mitsubishi Corp. (MSBSHY:OTCPK) and Magna International Inc. (MGA:NYSE; MG:TSX). While it is true that capital expenditures for this project did rise in the DFS, the company traces it back to increases in the cost of soda ash and lime, which are two of the main reagents used in lithium carbonate production. I would expect company management to look at ways to optimize their production processes and insulate against risks associated with input costs. Also, Argentina has recently proven to be a somewhat problematic place to do business, but thus far company management has been able to navigate.

    A final name in the lithium space to watch is Orocobre Ltd. (ORL:TSX; ORE:ASX). I have long regarded Orocobre as the "big brother" of the junior lithium industry as it has been involved in lithium for some time and has demonstrated to other juniors how to build a successful company through developing strategic relationships and not losing focus on developing a world-class asset. This company also has a mature lithium/potash play in Argentina and was just awarded the final permit necessary from the Expert Committee of Jujuy to move forward with the development of its flagship Olaroz low-cost lithium brine/potash project. This is a huge win for the company and puts it at the head of the pack to become one of the next major lithium producers in 2013. With the potash credit, the company anticipates a cost per ton of $1,230. As I said above, with a ton of LCE priced at approximately US$6,000, and Orocobre tentatively producing 16,400 tons LCE per year, the economics of this project are sound indeed.

    As part of the permit approval, Orocobre will join forces with Jujuy Energia y Mineria Sociedad del Estado (JEMSE), which will take an 8.5% stake in the company. Jujuy Energia y Mineria Sociedad del Estado acts as the investment arm of the Jujuy provincial government. While there are those who may not like the company having to partner with a provincial government through granting an equity stake, I think it gives the Jujuy provincial government "skin in the game" and a vested interest in seeing this project through to positive cash flow. Additionally, Orocobre has strategic relationships with Toyota Tsusho, Mizuho Bank and JOGMEC, all of whom can help with the financing necessary to put this project into production. I would not anticipate more share dilution based on these relationships and the ability to attract project debt financing.

    TER: Thank you for sharing those names.

    With a lifelong interest in geopolitics and the financial issues that emerge from these relationships, Chris Berry founded House Mountain Partners in 2010. House Mountain firmly believes that the emerging quality-of-life cycle emanating from Asia is a "game-changer" that will affect everyone throughout the world for decades. With that in mind, the firm focuses on the intersection of three topics: 1) The evolving geopolitical relationship between emerging and developed economies; 2) The commodity space; and 3) Junior mining and resource stocks are positioned to benefit from this phenomenon. Chris spent 14 years working across various roles in sales and brokerage on Wall Street before founding House Mountain Partners. He holds an MBA in finance with an international focus from Fordham University and a BA in international studies from the Virginia Military Institute. He invites readers to receive a complimentary subscription to Morning Notes, which provides analyses of emerging geopolitical, technological and economic trends. Go to www.discoveryinvesting.com.

    Want to read more exclusive 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 Exclusive Interviews page.

    DISCLOSURE:
    1) The following companies mentioned in the interview are sponsors of The Energy Report: Talison Lithium, Lithium One, Lithium Americas, Nemaska Lithium and Western Lithium USA. Interviews are edited for clarity.
    2) Chris Berry: I personally and/or my family own shares of the following companies mentioned in this interview: Talison Lithium. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.

    Streetwise - The Energy Report is Copyright © 2012 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.

    The Energy Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report.

    From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

    Streetwise 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

    Jul 05 4:05 PM | Link | Comment!
  • Falling Oil Prices Offer Great Stock Buying Opportunities: Byron King

    Falling Oil Prices Offer Great Stock Buying Opportunities: Byron King

    Source: Zig Lambo of The Energy Report (7/3/12)

    http://www.theenergyreport.com/pub/na/13792

    The "experts" had been talking about oil prices going to $130 per barrel. Now there's talk of $50-60 per barrel oil. Either end of that spectrum is not sustainable in the long run, says Byron King. In this exclusive interview with The Energy Report, he explains why he believes prices will settle in the $80-100 range. In the meantime, the recent pullback offers some interesting buying opportunities for investors ready to pounce when the market finds a bottom, as well as some names investors can nibble on right now.

    The Energy Report: Things have been pretty hectic on the global economic and financial fronts lately and the energy markets seem to be defying the expectations and predictions of many analysts. What's your take on where we are and where things are headed?

    Byron King: We're living with volatility, most of which is due to international currency and exchange rates. The dramatic decline in the euro has caused a capital flight to the U.S. and a strengthening of the dollar, which results in lower oil prices. The other big macro-type issues include the looming economic slowdown in China. More news stories are coming out about negative demand indicators in China, which will definitely be bad for Chinese consumption growth. The country may use less oil than people forecast. The Saudis are producing at least 1 million barrels per day (MMbbl/d) in excess of what they normally would. So, between the rising dollar, slowing growth and excess production in Saudi Arabia, we're seeing these gyrating low prices.

    TER: One hundred and thirty dollar per barrel oil and $5 a gallon (gal) gasoline failed to materialize as predicted, and now there's talk of $60/bbl or even $50/bbl oil in the shorter term. Some oil analysts are now predicting $3/gal gasoline by early November. What's your expectation?

    BK: Extremely high or low prices aren't realistic for the long haul. The world economy will hardly function with $130/bbl oil. The airline industry shuts down right away and much of the rest of the world will suffer accordingly. A $5/gal gasoline price makes for an instant U.S. recession. Whatever economic strength we saw in late winter and early spring got stuck in the mud when gasoline prices went over $4/gal on the East Coast and toward $5/gal in California. All of a sudden, the U.S. economy lost traction, and we're sliding back into recession.

    And while the world economy can't deal with high oil prices, Credit Suisse's $50/bbl oil prediction, though it may happen, would not last long. For one thing, the seven sisters of oil exporting-Saudi, Iran, Nigeria, Kuwait, United Arab Emirates, Russia and Venezuela-simply cannot afford under $85/bbl oil because they have their own bills to pay. Those lowball prices could be reached because of events, but they won't remain because of supply-and-demand economics.

    TER: Is the $80-90/bbl range reasonable?

    BK: This morning, West Texas Intermediate (NYSE:WTI) oil was trading in the $78/bbl range. That's rather low by recent standards. A WTI price of $80/bbl is enough to keep the North American oil industry working. A $90/bbl level for Brent, the international standard, will keep the international oil industry alive. It will tighten things up for the big oil exporting countries, but they'll be able to avoid bread lines and riots. The number that oil has to find is $80-85 in North America and between $90-100 internationally.

    TER: Have upside speculators been chased out of this market at this point?

    BK: This is still a trader's market, with rising prices and falling prices. For people with a really strong stomach and money to play the short term, have at it, boys. This is your market. The last thing the traders want is for oil to stay static at $85/bbl, though the rest of the world might like that for budgeting and projecting purposes. For traders, the last couple of months have been terrific. The people who understand the market and are successful over the long term know that you sell on the way up and buy on the way down. It's a question of understanding the market dynamics. As Mark Twain said, "If you're going to throw your eggs in one basket, you have to watch that basket." When you're trading at the margins and a move one way or the other could wipe out your capital, you have to keep your eye on things. But the big oil thinkers don't worry about today's headlines. They need to think about the very long term.

    TER: Big companies are usually able to absorb oil price fluctuations, but what happens with the smaller companies during periods of low prices and volatility?

    BK: It's been a tough world out there for small companies without deep pockets. The energy business, in general, is for companies with money. A small gold miner versus a small oil company carries a difference of at least one or two orders of magnitude. The equivalent of a $20 million ($20M) gold company would be a $200M oil company. With the small guys, the big concerns right now are geographic and economic.

    If you're in the natural gas business in North America, you have to be deeply concerned. Natural gas prices are at historical lows and the cash flow just isn't there to support much development. A small company may have tens or hundreds of millions of dollars tied up in leases. If you don't somehow drill or exploit these leases in one way or another, you're going to lose them. So not only would you not be drilling or extracting, but you'd lose your leases, too. That's a terrible predicament.

    So what will we see in North America? There will be some cutbacks in drilling. It's already happening, but we're going to see more of it. It will affect the smaller drillers and service companies first. The big guys-Halliburton (HAL:NYSE), Schlumberger Ltd. (SLB:NYSE) and Baker Hughes Inc. (BHI:NYSE)-will also feel it but, they have much deeper pockets and they're large and international. So we'll see some rigs get stacked, but I don't think we'll see as many as some of the gloom-and-doomers are forecasting. A lot of these smaller companies have to keep their geologists and engineers working and drilling or all of that money that they spent on leases in the last five to ten years goes down the drain.

    Overseas is another story. You almost have to take each country as you find it. Argentina is a disaster with what's going on with Repsol YPF SA (REP:BMAD). A couple of weeks ago, a company called Pan American Energy LLC saw its operations literally overrun by rioting workers-one of the largest and oldest fields in Argentina was almost shut down because of political issues and labor unrest.

    Look at Poland. A lot of people were thinking Poland was going to have its own shale gas revolution, but a couple of weeks ago, Exxon Mobil Corp. (XOM:NYSE) decided to pull out of Poland after a couple of bad wells. Now, the cynics are saying that Exxon is getting better deals from Russia. Russia is the big fish that Exxon wants to land, so it's going to walk away from Poland.

    One more country I'd throw in is Libya, which was a big oil producer. With the recent shale revolution, its exports almost ceased. Now, it's put a lot of things back into shape, but what I hear is that many of those repairs were jerry-rigged and could start breaking down. Secondly, the security situation is not nearly as good as the operators would like to see.

    TER: Do you think that there will be enough cutbacks in domestic natural gas production to trigger a price rise in the foreseeable future?

    BK: Prices have to rise, and they probably will rise sooner than conventional wisdom suggests. I'm sort of a contrarian by nature, but the fact is they're giving gas away as it is, so I don't see much downside from here. I do see upside potential, as well as more demand from more places. We're already seeing a complete upheaval in the electric-generating industry with coal-fired plants. There are no new ones being built and they're scaling back on upgrading the old ones because they may not operate long enough to pay back.

    That has impacts elsewhere in U.S. industry, such as with companies that do the engineering and supply the parts, engineering and such for upgrading pollution controls on coal plants. They're about to enter their own mini-recession because of lack of business. Natural gas is also playing havoc with the renewable energy space. Natural gas-fired energy is so cheap that the windmill guys and the solar guys are losing the battle of economics on that alone. I expect to see slightly less gas supply and likely more demand than what people have anticipated.

    TER: What are some of the oil and gas majors that would be good shots to weather the ups and downs?

    BK: In the international realm, Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE) is in very good shape. It is a wonderful, technology-based company that has deep pockets and a very aggressive plan to grow its resources and reserves over the coming years.

    Another one that I think is just a spectacularly well-run company is Statoil ASA (STO:NYSE; STL:OSE), of Norway. It is truly one of the world leaders in offshore work and has made a major commitment in North America. People in North America should know there's a new kid on the block. I think we're going to see great things from Statoil.

    Further down in North American domestic plays, I'm keeping my eye on a company called Denbury Resources Inc. (DNR:NYSE). Denbury is a very advanced independent as independents go-and is making a lot of good moves in the tertiary recovery area using carbon dioxide to get the last drops of oil out of reservoirs.

    In Canada, I've been following a company called Cenovus Energy Inc. (CVE:TSX; CVE:NYSE) for two years now. It is a very rapidly growing player within the Alberta oil sands play. It has lots of acreage and lots of investment to grow things with very good economics. The one major issue for Cenovus and for all of the Canadian oil sands operators is access to markets. The Keystone Pipeline debacle was not good for the oil sands players. At the same time, the Canadians are moving very firmly toward finding another way of doing it. We may or may not see that northern pipeline get built to the upper Pacific Coast, but there is certainly a plan in place to take some of that Alberta oil sands product down to Vancouver for export, which will be to the long-term, strategic detriment of the U.S. Regardless of who is president next January, we will see some sort of a Keystone Pipeline expansion to move more oil sands product out of Alberta and down into the U.S.

    TER: Can you give us a little more detail on the revenues and market caps of Denbury and Cenovus and where you think they might be going?

    BK: Cenovus is a $32 billion ($32B) market cap company. The price:earnings (P/E) is around 12. It is making money, and it pays a nice dividend-2.8%. It's been a bit of a sleeper for many investors, but I think Cenovus is a great choice for investors looking for exposure to the Canadian oil sands plays. It is a good, strong idea with a lot of upside and a lot of growth potential, and it pays a nice dividend while you're waiting.

    Denbury has a $5B market cap. The P/E is about seven, with no dividend. This is a stock where I'm looking for internal growth to bring the capital gains back to investors over the long haul.

    TER: What other companies are interesting at these levels?

    BK: I'm a big fan of the oil service sector. Right now, Schlumberger is trading down around $60. Schlumberger is one of those companies that almost never gets cheap because too many people know how good it is. When it trades in that low-$50-60 range, I always consider it a buying opportunity. When oil prices recover, that $60 Schlumberger stock is going to be an $80-90 stock. If you can just bear with the market gyrations, it's almost a guaranteed 40-50% gain.

    Right now, with things as volatile as they are, investors want to be very careful about going too deep into these very turbulent waters. To the extent that you do go in, it would be with companies that have a really strong upside such as Cenovus or Schlumberger.

    TER: Do you have any thoughts on Encana Corp. (ECA:TSX; ECA:NYSE)?

    BK: Encana is also a very strong Canadian firm. It has almost a $14B market cap and a relatively high P/E of 27. But the dividend yield is a nice 4%. If you're looking for yield, Encana would do it for you, but with a P/E of 27, I think it's priced more like a growth stock than others. In this oil market, I don't know if management can really live up to those kinds of expectations. I'm not negative on it; I'm just saying, be careful.

    TER: To summarize, what do you think the average investor should be doing these days if they want to play the energy markets?

    BK: I would be very wary of most gas plays just because of the economics. I would also be wary of the oil service sector, with the exception of Schlumberger, which happens to be cheap but won't be cheap for long. In terms of the larger oil plays, I'd suggest Statoil for international and technical competence with a good growth profile in front of it and, in the oil sands, Cenovus. I don't want to give too long of a list to the investors out there because this is not the time to be too bold.

    This market could confound people greatly. We're at the beginning of a presidential election cycle where government statistics and government announcements will become completely meaningless because everything will become politicized. There are many beaten-down ideas out there. The market is filled with underpriced value, but you want to find the best of the best of those underpriced values. I think I've given a few names in this discussion. I'll be able to sleep well at night if investors act on those.

    TER: Should we wait a little bit for the oil market to bottom out before it's an ideal time to get in or should people be averaging in?

    BK: I think people should view the market as trying to find a bottom. Right now, it's OK to nibble, but it's better to watch and wait.

    TER: You've given us a good overview of where you think the market might be headed and some good names to look at. Thanks again for your time.

    BK: Thanks for having me.

    Byron King writes for Agora Financial's Daily Resource Hunter. He edits two newsletters, Energy & Scarcity Investor and Outstanding Investments. He studied geology and graduated with honors from Harvard University and holds advanced degrees from the University of Pittsburgh School of Law and the U.S. Naval War College. He has advised the U.S. Department of Defense on national energy policy.

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    DISCLOSURE:
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    2) The following companies mentioned in the interview are sponsors of The Energy Report: Royal Dutch Shell Plc. Streetwise Reports does not accept stock in exchange for services. This interview was edited for clarity.
    3) Byron King: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.

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