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Chris Damas
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Chris Damas is principal of BCMI Research, an independent equity research and trading company based in Barrie, Ontario. He has a biochemistry degree from McGill University followed by three years of industrial research at the M.Sc. level. At the age of 23, Damas had co-authored journal articles... More
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  • Egyptian riots mean selling forest products  0 comments
    Jan 28, 2011 2:22 PM | about stocks: DIA, GLD, CEO, PCL, PCH, RYN, TLM, TMBCF, CADNF, WFTBF, CFPZF
    The market was faced with another “Black Swan” event over the past few days, with the revolt in Tunisia spreading to Egypt and Yemen. We've been paring back on our forest product stocks, some of which we have held for a year, and buying more of our sole energy play.
     
    The DJIA (DIA) bellwether was down 118 points at 11,871 early this morning, in a case of “Sell on the News” of decent US Q4 GDP (3.2%) and good earnings reports from major components. But the selling magnified due to fears civil unrest in Egypt would spread to Saudi Arabia.
     
    The North African Arab world has erupted in violence. If you’ve been to Egypt (and I have), you’ll know it is a paternalistic society with rough justice for its poor, under-age population.
     
    When I visited the resort town of Sharm el Sheikh in 2002 as a visiting SCUBA instructor, I was told by the resident ex-patriate (mainly British) instructors that no liability insurance in Egypt was necessary to maintain. That’s usually a big cost for dive instructors.
     
    They told me the Egyptian State would never allow a mere mortal (if injured) or his family (if killed during dive lessons) to sue a dive Company or instructor for negligence. Even if they were a tourist. At least not in Egypt. 
     
    I learned that food, fuel and lodging were dirt cheap in Egypt, but the booze was watered. I spent a couple of weeks in Dahab on the Red Sea and rented a camel to explore the Sinai Peninsula. Post 9/11 beachfront property was on sale ($80 US/m2), but you had to worry about the original Bedouin owner showing up to claim his right.
     
    The average Egyptian doesn’t have a whole lot in the way of civil liberties. The rich Egyptians in Sharm get there for holiday on a brand new Boeing 777 and own villas along the waterfront, driving Mercedes. That's where President Hosni Mubarak keeps a vacation enclave as well.

    I was befriended by a 23 year old Egyptian “what you want, I get it” entrepreneur in Sharm. I spent the next few weeks learning about the average Egyptian's way of life, at least in the area I visited (not Cairo or Alexandria). However,  I also met and talked to the crews of the dive boats, who were often merchant seamen from the port of Damietta.

    My guess is Mubarak better liberalize and improve conditions in the country or he could have a full scale revolt on his hands. Note the market is starting to discount such unlikely events as Saudi Arabia picking up the Muslim contagion and the Suez Canal being embargoed.
     
    A similar situation of abject poverty for its youthful population exists in Yemen. This is complicated by the strength of the tribal lords and increasing al-Qaeda influence in the country. 

    A quick check of the relevant EIA Country Analysis briefs shows that Egypt poduces and consumes approximately 700,000 bbl/d of oil and Yemen produces approximately 300,000 bbl/d of oil and consumes approximately half of that, exporting the rest. Neither is a factor in oil export markets, but both sit  along the critical Red Sea/Suez canal shipping route where much oil passes through in both direction. Egypt and Yemen are both increasing LNG exports as natural gas reserves are being exploited.

    Which brings me to my energy stock – the major Canadian and international oil producer Nexen (NXY), once the Canadian arm of  Occidental Petroleum (OXY).  I think things are so different in Yemen that, even Nexen losing their presence in that country would be a non event and even a beneficial thing.

    If you will recall, Talisman (TLM) suffered reputational and valuation damage operating in Sudan, and eventually sold out.
     
    Nexen was the worst performing stock on my TSX 60 screen yesterday and closed at $23.71 down 83 cents (3.4%), much to my consternation, as the stock had been showing technical strength.  Just recently, I sold some NXY at $25.02 US on serious strength, but now it was starting to look like a sick puppy.
     
    During the recent CIBC Institutional Investor conference in Whistler, British Columbia, Nexen said they were in intense negotiations with the Yemeni government to renew their PSA (Production Sharing Agreement) and drilling leases.
     
    So with the Egyptian and Yemeni uprisings on international TV yesterday and today, Nexen was trading down on fears they will lose their Yemeni oil fields.
     
    My stock call is this: the popular uprising will give Ali Abdullah Saleh, the long-standing Yemeni President, even more reason to cut a deal with Nexen to generate oil revenues to appease the tribal lords and pay off relevant parts of the power elites. Rather than being overthrown, I see Saleh throwing the dissenting population, including the jihadists, a bone or two. i.e. he's going to need Nexen to stay put and continue produce royalty cash flows. 
     
    Muslims, I believe, are at heart, supplicating in their attitude, at least to each other. It is the radical al-Qaeda faction that is aggressive. I was woken up many a night by the four-a-day call to prayer (one is at 3am) and was amazed at how diligent the Dahab villagers were in taking heed.  Not sure of course whether this is true in the cities.
     
    Nexen historically enjoyed significant +100,000 bbl/day oil production from its Masila and other blocks in Yemen but this has dwindled and reserves are in decline. Pre-royalty oil production averaged 43,370 bbl/day during the first nine months of 2010, versus 48,800 per day in 2009.

    Nexen is guiding Yemen 2011 pre-royalty production at 28-35,000 bbls/d, and total pre-royalty production at 230-270K boed (barrels of oil equivalent per day).

    Yemeni government royalties averaged $36.31/bbl in 2010, leaving Nexen with a netback averaging only $23.45 on an $80 oil price. Yemeni 2011 prodution after royalties would only represent 8% of Nexen's mid-range total energy guidence.

    Nexen reported only 23 million barrels of SEC compliant reserves in Yemen as of December 31, 2009, versus a total reserve base of 1.011 billion boe (only 2.3%). However, an extension of the PSA in Yemen would allow Nexen to book significant additional reserves.
     
    One of Nexen’s weaknesses has been lack of production growth, which has been flat for the last few years, as well as commissioning and upramping problems at its new technology Long Lake SAGD and upgrader facility.

    But we are buying Nexen mainly for its fantastic Brent crude netbacks, and for the better production growth that lies ahead. Other than Yemen, the Company has energy exploitation and future reserve growth coming from five different areas: the North Sea, the Gulf of Mexico, Long Lake, Nigeria and Horn River/Liard, which is a natural gas play that could double the Company's entire reserve base.
     
    I expected Nexen to rally today and the stock is now trading at $24.31 up 60 cents or over a dollar off today's low. Today's big crude rally (February WTI crude up $3.45 at $89.09) is helping out too.

    North Sea Brent crude of which Nexen produced an average 104K bbls/day in the first nine months of 2011 (96.8K in 2009), is trading at  $99.52, a plus $10 premium to WTI. North Sea oil production is royalty free (at least so far) and Nexen netbacks should be in the $90 range in Q1 2011. Hedges in place are put options and Nexen is open to benefit from higher oil and natural gas prices.

    A catalyst for a rating upgrade on Nexen's substantial  $5.7 billion long term debt position is the sale of its conventional Canadian heavy oil properties last year, and its 65% interest in Canexus Income Fund, which closes in early February. These and other non-core asset sales  raised $2.2 billion in cash and will reduced consolidated debt by $500 million (all dollars Canadian). 

    Our estimate, based on $90 Brent oil for Nexen 2011 CFPS is $5.50 and our 2011 price target is 6 times this figure, or $33 CDN, a 35.8% potential return. The Company has stated it would make approximately $5.30 per share cash flow at $90 WTI.  Nexen reports is year end on February 17. Finally, we believe widely-held Nexen would be a compelling take-over candidate for an oil major.
     
    Gold has rallied today – up $20 to 1,338 on the February futures. Earlier today, it traded at a low of $1,307.70. Part of the reason I continued to be bearish on gold was the lack of movement on the Egyptian news yesterday. It appears to have come around, but I wouldn’t bet on it. SPDR Gold ETF (GLD) has rallied, but note the gold ETF sold another few tons yesterday.
     
    In spite of the common knowledge that we just aren’t producing enough gold these days to keep up with demand, production for 2010 was 2,650 tonnes, up 3%. That was after 2009 gold production was up 7%. So mines are producing more gold every year, and it is investment demand that has been soaking it up. If the latter turns down, then gold will fall. I am betting on $1,150/oz gold before it gets back to $1,400 (Gold bugs, hold your fire, I have a thick skin and won't notice you).
     
    Forest Product stock trading notes:
     
    We are unloading Plum Creek Timber (PCL) and Potlach Corp (PCH) at $41.80 and $37 respectively, based on valuation and because we think the lumber rally is stalling out for the time being. Also, Plum Creek reports Q4 Monday (44 cent analyst average estimate) and PCL has often under-earned estimates at this time of year.
    By our estimate, Plum Creek is trading at 31 times trailing earnings and Potlach is just managing to cover its rich
    $2.04 REIT distribution. These valuations are now rich, although if US West Coast log exports to Asia accelerate, we would reenter these REIT's on weakness and subject to the status of US new home sales and housing starts.
     
    Tembec reported weak quarterly results on Thursday and the stock sold off mightily to $3.95. We maintain a buy, but in the face of overall market weakness, believe the stock could have some more downside before reasserting itself. We continue to hold another Specialty Cellulose producer, Rayonier (RYN).
     
    We have taken profits on Cascades at $7.20 as they had a big boost from their minority interest in Boralex. Boralex received over $20 million in the stock of AbitibiBowater (ABH) from the latters succesful emergence from Chapter 11 bankruptcy in late 2010.
    Cascades does not report until February 23.

    Fibrek, another forest product stock we have been recommending, has also been subject to our taking some profits @ $1.34-8. Fibrek reports on February 23. 

    West Coast lumber and pulp producers Canfor and West Fraser Timber continue to hit eight month highs due to the Chinese lumber demand story. We’d take some profits here and wait for earnings (Canfor reports February 14).

    Better to wait until the dust settles with the DJIA taking its first significant plunge in 2011, and buy these stocks back later when the opportunity presents itself.
     
     


    Disclosure: I am long NXY, RYN, OTCPK:TMBCF.

    Additional disclosure: The BCMI Report and BCMI Flash is disseminated to clients and subscribers anywhere from 12 to 24 hours before appearing in Seeking Alpha.
    Stocks: DIA, GLD, CEO, PCL, PCH, RYN, TLM, TMBCF, CADNF, WFTBF, CFPZF
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