OGIB subscribers have had some great wins this year with GeoPark (GPRK-NYSE) and Viper Energy (VNOM-NASD), but my colleague Paul Andreola has had a series of 10-baggers over the last couple years at our sister publication, SmallCap Discoveries.

On Thursday October 18, my colleagues Paul Andreola and Brandon Mackie are hosting their second annual Smallcap Discoveries Investment Conference in Vancouver, Canada.

While it is for their retail subscribers, Paul and Brandon run institutional-conference-style break-out sessions along with the CEO presentations, so at any time during the day you can sit down at the table with the CEO five feet away and ask them any question you want…or listen to your fellow attendees grill them!

This is a VERY intimate setting…and one where meeting Smallcap subscribers is as valuable as meeting the CEOs.   You see, they bring 120 sophisticated smallcap investors from all over the world together with 12-15 of Canada’s most promising growth companies.  And I do mean sophisticated; this is the wealthiest audience I have ever seen at a retail investment conference in my life.

It’s an intimate experience and designed for one thing and one thing only – finding great investment ideas.

I’ve arranged with Paul and Brandon to invite OGIB readers to be part of the exclusive group who will join us at the Pan Pacific Hotel in downtown Vancouver, overlooking the oceans and mountains. You don’t want to miss this one day event–it’s just two weeks away!

In fact, they do such an amazing job, OGIB attendees will get an added bonus–because OGIB research guru Nathan Weiss of Unit Economics is attending all the way from the US east coast!  For those of you who attended the Subscriber Summits in the past, you know that Nathan has made us A LOT of money over the years…and he will be in the audience.  He has graciously agreed to speak with whomever wants him during the breaks and at lunch.

They have hand-selected these companies based solely on their quality and investment promise. Simply put, they’re the best of the best.

Here are some of their Big Wins in the last 12 months:

And management from this company is presenting:

Last year, attendees who met with Kraken Robotics (PNG.V) are up 110% in under a year. Attendees who invested with Hamilton Thorne (HTL) after the event are up 61%.

This year’s line up is looking even better with 11 all-star companies already confirmed. We’ve got undiscovered companies like WELL Health Technologies (WELL.V), who’s CEO Hamed Shahbazi just had a US$238 million exit to Paypal (PYPL-NASD) with his last company TIO Networks.

For some companies like Immunoprecise Antibodies (IPA.V), the SCD Conference will be the only one they attend all year.

Many of Canada’s best emerging growth companies already confirmed. Companies like Immunoprecise Antibodies (IPA.V / IPATF:PINK), and Hamilton Thorne (HTL.V / HTLZF:PINK).

Here’s what we know you’ll get at the SCD conference (that you won’t get anywhere else):

• Exclusive access to the CEOs  We have 11 of the best emerging growth companies already confirmed.  You get to sit down at a table with them & talk directly, any time of the day.
• Cocktail Meet & Greet  Immediately following the event, we will host a networking happy hour. You’ll get the chance here to continue the conversation with fellow investors and CEOs you met earlier in the day.
• Keynote Speakers  One of the best minds in the industry, Ian Cassel, founder of the MicroCapClub, will deliver the keynote the morning of the show.
• Meet Other Smart, Committed Investors  The SCD subscriber base is very small, but very exclusive.

There will be Big Winners from this year’s roster. And no conference gives you face-to-face management access to companies of this caliber.

Ready to find your next investment winner? REGISTER HERE.

Registration takes less than 1 minute and costs only $50.

Yes, there is a charge for this conference, but all proceeds will be donated to The West Coast Kids Cancer Foundation to support kids, parents and families fighting childhood cancer.  We just want you to show up if you say you’re coming.

You won’t want to miss this. There is only capacity to host 120 people. Once we are sold out, that’s it.

Here are the details:

Confirmed Companies:

XPEL Technologies (DAP-U)
Hamilton Thorne (HTL)
Immunoprecise Antibodies (IPA)
WELL Health (WELL)
Atlas Engineered Products (AEP)
Xebec Adsorption (XBC)
Enwave Corporation (ENW)
Renoworks Software (RW)
Network Media Group (NTE)
Sangoma Technologies (STC)
RIWI Corp (RIW)
What: The Smallcap Discoveries Investment Conference – Second Annual

When: Thursday, October 18th

Where: Downtown Vancouver, Pan Pacific Hotel. Use code SDIS1018 for our preferred hotel rate.

Who: Exclusively Smallcap Discoveries members, OGIB subscribers, plus a few select brokers, analysts, and institutional managers

Format: Single day conference. 30 minute presentation slots with group meetings throughout the day (2×1, 3×1, etc). Just like last year.

Cost: $50. This is only so that we know you are coming. We are donating 100% of registration fees to The West Coast Kids Cancer Foundation.

Ready to get an edge in the markets? Click this LINK here to register and let us know you are coming (we have an EXTREMELY limited amount of space – don’t delay).

Paul and Brandon handpick the companies attending. And we ensure senior management is there to present and answer your questions face-to-face in breakout sessions.  Retail investors rarely get this opportunity.

Just as informative are the SCD subscribers attending. They are a committed group of investors–and it’s always great to meet other members and share ideas.

Most of all, this conference will be a lot of FUN. We have met so many great investors and management teams over the years. To get all of them in one place is something we get excited about every day. Trust us, you won’t want to miss this.

To your wealth,

Paul & Brandon & Keith

The energy sector hasn’t represented this small of a percentage of the S&P 500 since the peak of the technology stock bubble in 1999.

No coincidentally–that was one really, really great time to be buying oil stocks.

I pulled the table below from the S&P data archives.  It tells us the percentage of the S&P 500 each sector represented at three distinct points in time (1999, 2007 and Q2 2018).

What I see in the data is incredibly telling; so simple, yet so powerful.

Let’s focus first on 1999:

With the benefit of hindsight we know today that in 1999 investors should have been fleeing technology and expensive consumer discretionary stocks.  At the same time in 1999 investors should have been getting long energy and boring value stocks like consumer staples.

The data shows that in 1999 those stocks that investors should have been avoiding (technology and consumer discretionary) were peaking in terms of their representation in the S&P 500.  Meanwhile at that same time the sectors that we should have been buying (energy and consumer staples) were bottoming out in terms of S&P 500 representation.

Now fast forward to 2007.

At this point in time the energy sector and value stocks like consumer staples have had tremendous runs in the years following the 1999 tech bubble collapsing.

The representation of energy stocks and consumer staples in 2007 is much higher, in fact at peak levels.  Meanwhile the representation of technology stocks and consumer discretionary stocks had plummeted.

Can you guess what investors should have been doing in 2007?

It is called sector rotation!

In hindsight, this is all quite obvious.  The correct move in 2007 was to get out of energy stocks and consumer staples and start getting into tech stocks and consumer discretionary.

Since then while the overall S&P 500 is up 145%–thanks to technology stocks–the energy sector has posted a negative performance of 12%.

Now let’s jump forward in time once again to bring us to where we are today in 2018.

Maybe we can use something that we have learned from history to help us today.

Here are the current sector weightings….

Does anything look familiar?

I should say so……could the sector representation today look any more like 1999?  Here we are almost twenty years later and we are confronted with almost the identical situation.

Both the energy sector and consumer staples have shrunk as a percentage of the S&P 500 while technology and consumer discretionary have once again soared.

Energy sector representation is down to the lowest level in twenty years–when investors should have been buying them hand over fist.

Technology stocks are again almost a third of the market–as they were in 1999 when they should have been avoided like the plague.

I’m not saying that this on its own is an ironclad reason to buy energy stocks and get out of the tech sector today.

But it isn’t just this on its own……

The Price Of Oil Has Roared – Energy Stocks Have Yet To Hear It

The most important factor in the amount of cash flow that an oil producer can generate is what?

This isn’t a trick question, the answer is exactly what you think it is……the price of oil!

Great news then right?

Since bottoming at $26 per barrel in 2016 the price of oil has rocketed higher, not a million miles now from tripling off the bottom.

That is obviously positive for oil producers, but I don’t think many people appreciate just how positive.

The benefit to the cash flow of oil producers from a rising oil price is much larger than most investors realize.

Certainly much larger than even the big move in the price of oil since 2016.

I’ll show you with a very simple example.

Imagine an oil producer that incurs costs operating costs of $25 to produce a barrel of oil.  With an oil price of $30 per barrel that producer is making a profit of $5 per barrel produced.
Simple.

If oil prices then increase to $70 per barrel the cost of producing that oil doesn’t really change much.  Most of the costs of production are fixed — other than royalties.

The cost to produce a barrel of oil at $70 oil prices isn’t much different than the cost to produce a barrel of oil at $30 oil prices.

With production costs relatively fixed at $25 in our example, that means that the oil producer’s profit per barrel then goes from $5 per barrel with $30 oil all the way to $70-$25 = $45 per barrel at $70 oil.

So while the price of oil has more than doubled from $30 to $70 per barrel, the producer’s cash flow has gone up nine fold from $5 to $45 per barrel.

Again to be clear this is a very simplified example because royalties are a variable cost to be considered, but this leverage to oil prices increasing is very real for producers.  Cash flow percentage increases for these companies have moved multiples of the percentage change in oil prices.

With that in mind I have to ask how it makes sense that the price of oil has nearly tripled from the bottom………

Yet the share prices of oil producers which have experienced cash flow increases multiples of that are still stuck in the doldrums?

The answer is that it doesn’t make sense.

The share prices of oil producers should have widely outperformed the rise in oil prices.  Eventually they are going to…..

It Is Going To Look Like A No-Brainer After The Fact

Hey, I get it.

Investors haven’t had a positive experience with the energy sector in so long that they have given up on it.

It is hard to get excited about these companies that haven’t rewarded investors for such a loooooooong time.

But —- history has shown us that this is exactly the time to get into a sector.  When everyone else has left the building.

On top of all of this we know that the sector is cheap.  Cash flows have skyrocketed for these companies with the move higher in oil prices yet the stock prices haven’t moved.

That has compressed valuation multiples.

The energy sector has become a coiled spring.  When it eventually takes off the move is going to be big.  When we look back on in this in the future today will be thought of as a time when getting long the sector was a no-brainer decision.

Here is the important part……..

This no-brainer opportunity isn’t in the future.  You need to do it now.

I’m playing this huge spread via one oil stock…here’s why:

1.  Very fast growing production levels
2.  Some of–if not THE–most profitable production in North America
3.  The Chairman has over $40 million of his own money in the stock
4.  It’s an American play, where there are no discounts or pipeline issues
5.  They have buckets and buckets of cash
I expect this stock will help me retire a lot faster than I ever thought possible–and it’s only $2/share!  Get the name and symbol by clicking HERE.

It just happened to me–the last of my three kids is out the door and on their own in the world.

This brings mixed emotions for me to be sure.

You spend the first twenty years of their lives trying to get them prepared for this day…..now you pray that they can fend for themselves.

I feel blessed, I couldn’t be prouder of my kids.  They will do great.

The behavior of the children of some parents on the other hand is starting to seriously concern me.

The twist here is that the children I’m talking about aren’t human beings.

No, I haven’t been visited by aliens —- the children I’m referring to are actually oil wells that the world is counting on to live up to their parent’s expectations.

And these children have not been performing up to expectations.

Not Exactly A Chip Off The Old Block

In the horizontal oil and gas business, the first well that is drilled on a piece of land or location is considered a parent well.  These wells are drilled into the best location and have the entire oil or gas reservoir all to themselves.

The drilling that comes later that drills up the rest of the field, called infill drilling, is referred to as the child wells.

The challenge for horizontal operators is determining exactly how many children each parent well should have and where to place them.  The profitability of the entire field depends on getting this right.

Too few child wells leaves a lot of oil in the ground.  The producers won’t make that mistake.

But too many child wells crammed into the field causes other problems.  Besides overspending, too many child wells incould create fracture interference between the existing producing parent well and the newly fractured infill/child well. (The industry also calls this communication between the wells, and this is one instance where parent-child communication is unwanted.)

Fracture interference is when the hydraulic fractures from one well burst through and into another well.  Any fracture interference impacts the production from both the parent and child well.

With the oil industry now getting past the first wave of drilling in all horizontal plays, figuring out how to best manage infill drilling is very important.  I believe that managing the child wells correctly is the single biggest issue that will determine the ultimate long-term success of horizontal producers in US shale.

Oil services giant Schlumberger (SLB-NYSE) has been studying the issue and has amassed case studies on a massive number of wells in all the horizontal plays—thousands of wells.

I hate to say it but the initial results don’t look great….

Schlumberger CEO Paal Kibsgaard recently gave an update on what the company has observed at the 2018 Barclays CEO Energy-Power Conference (1).

He focused specifically on what Schlumberger is seeing in both the Eagle Ford and the Permian.

Kibsgaard looked first at the Eagle Ford where child wells went over 50% per year way back in 2015.

That is how a horizontal play goes: the early wells are almost all parent locations.  As the play is drilled up there are fewer parents to be drilled and infill/child drilling takes over.

What Schlumberger is seeing is that per dollar spent on drilling and fracturing—the child wells are performing MUCH WORSE than the parent.

In other words, while the child wells might produce more oil because of longer laterals and more proppant—the cost increases for drilling these bigger wells are even greater.

That makes for less profitable wells; child wells have lower returns on capital invested.

The graph below is from Kibsgaard’s presentation.  It shows how the amount of production relative to total proppant used has steadily dropped since 2011—close to a 50 percent decline on average.

The percentage of child wells being drilled in the Eagle Ford has already reached 70% and, in the 3-year period since this percentage broke the 50% level, there has been a steady reduction in unit well productivity.

To make up for this, the industry just drills longer and longer wells and pumps higher and higher amounts of sand and water into them.

Production numbers still look great, but it is requiring more and more spending to achieve them.

The Schlumberger CEO believes that the ability to continue to drill longer and inject more seems to be coming to an end, both from a technical and commercial standpoint.

The trend in the Permian looks very similar….just not as far along since the horizontal development here kicked off later.

The percentage of child wells in the Permian is now bouncing around 50% (graph above), and Schlumberger is already starting to see a similar reduction in unit well productivity that has been seen in the Eagle Ford.

Production growth per share, which is makes stocks go up (increasing production but not adding debt or issuing new shares)—is driven by compounded rate of return.

At high rates of return, cash can be recycled quickly and production can grow faster.  At lower rates of return companies don’t have as much capital to spend since it takes longer to come back out of the ground.

Schlumberger is strongly suggesting that oil production in the Permian—the oil growth engine of the western world—will slow, now that child wells make up more of production.

Why The World Needs These Children To Shape Up

The parent wells drilled in the U.S. horizontal plays have carried a heavy load for the world in recent years.

The North American production base, which makes up just 20% of global oil supply—has covered up to 70% of the oil demand growth since 2010.  Stop and think about that for a minute. Those are some astounding numbers.  There really is very little growth in oil production anywhere outside of the USA and Canada. This was initially the Eagle Ford and Bakken and then the Permian took over.

The consensus thinking today is that the Permian will continue providing 1.5 million barrels per day of annual production growth for the foreseeable future.

It better, because the world is counting on it.

Schlumberger’s Kibsgaard made it clear in his presentation that he thinks that the trend of underperforming child wells should have the market questioning that assumption.  He cautions that as the rate of infill drilling increases—this potential (likely?) problem gets bigger.

He also notes that the industry really has no idea how these reservoirs will perform as we continue to inject billions of pounds of proppant and billions of gallons of water into the ground each year.

These are uncharted waters.

These child wells are not destined to always disappoint.  The industry is sharing data and continuously learning.  Since the year 2000 we have all learned to not bet against the innovative skills of these operators.

If it wasn’t for that innovation we would be staring at $200 per barrel oil today.

At the same time we can’t assume that this problem is going be taken care of.

If these children don’t start filling the shoes of their parents—in terms of economics—there will be a big hole to fill in global oil supply.

EDITORS NOTE: This is all VERY bullish for oil.  I am especially bullish on oily US plays–and the Bakken is one of the best.  My favourite is a fast-growing $2 stock that is doing so well, management has almost $50 million of their own money in it!  They know they’ve got the goods…get my full report on the company BEFORE its next ops update–click HERE .

Keith Schaefer

New global shipping fuel rules promise to upset the world’s crude slate for a couple years—causing havoc for investors and producers.  In Part I, I explained how much pollution the shipping industry creates, and how shipowners are adapting.  In Part II here, I explain what macro concerns there are for refiners, heavy oil & US shale oil producers, and gasoline around the world.

Refiners–First World Should Do MUCH Better than Developing World

According to The Canadian Energy Research Institute (CERI), the worldwide refining complex produces about 3.2 mbbl/d of HSFO—High Sulphur Fuel Oil that is used in about 65% of the worldwide shipping fleet of 90,000 ships rely on HSFO.

This is from worldwide demand of a little over 7 mbbl/d.

Scrubber installations and non-compliance (this would be shipowners just ignoring the new environmental rules) will preserve some of that demand; Goldman Sachs says about 1.7 mbbl/d.  The rest will be replaced by low sulphur fuels–LSFO.

This means big changes to the balance of products produced by refiners.

But changing the product mix is easier said than done.  Simple refiners, like those in the developing world can’t really do much about their mix.  That’s a big reason compliance in the developing world is expected to remain low.  They are going to have too much heavy fuel oil.

Complex refineries in Europe, North America and in China have more options.

For one, they can better utilize existing coking capacity.  Coking takes heavy residual oil from the primary refining circuit, breaks apart the longer hydrocarbon chains and produces light fuels and naphtha.

North American refineries now have excess coking capacity.  The onslaught of light crudes from shale plays has meant that many refineries designed to take in heavy oils have shuttered some of their coking capacity.  That capacity will now get fired back up.

Second, complex refineries have more flexibility in feed stocks. And that’s going to impact the crude market.

Shifts in Oil Demand–Which Crude Grades Will See More Demand

If you thought the shifts in refined products were difficult to keep track of, wait till you look at oil.

Remember, crude oil is really a mix of different hydrocarbons.  Refining is separating that mix into many different products; what products are produced depends on the type of crude.

As a rule of thumb, a light crude produces light products, like gasoline and naphtha.  A heavy crude produces heavier products, like fuel oil and even asphaltines.

Not surprisingly the big winner from IMO 2020 are expected to be the light crude benchmarks, like Brent and LLS—Louisiana Light Sweet.

These crudes have strong “middle-distillate” yields.  A middle-distillate refers to a range of products that are heavier than gasoline but lighter than fuel oil.  Low sulfer marine fuels—LSFOs–will be made of various middle distillates.

So IMO 2020 should be good for light oils – but only if they aren’t too light.  It could turn out to be a negative for very light oils – like what comes from US shale.

Shale oils are so light that they don’t produce a lot of middle distillates.

Morgan Stanley pointed this out earlier in the year, saying they expected to see North American light oil discounts.  One reason was refining capacity, which isn’t equipped to handle the volumes.  The other reason was that they expected “middle distillates” to account for much of the demand growth.  And if US shale oil doesn’t make them, then demand for that same shale oil could be lower.

Finally, what does the rule change mean for heavy crudes like Western Canada Select (WCS)?

It’s likely negative, but just how negative is anyone’s guess.

WCS has a high sulphur content and on the face of it, that should lead to more of a discount.

Some are sounding alarm bells.  CERI said it could “widen Western Canada Select crude’s discount to West Texas Intermediate, historically $13/bbl, to $31-33/bbl.”

Goldman Sachs, in a 48 page report dated Sept. 5 2018, is a bit less pessimistic but still thinks spreads could double by 2020 before subsequently falling:

But there are others that aren’t so sure.  Much will depend on which products command the best prices and how refineries can maximize the output of those products.

Some think that shale oils could be the bigger victim.  A heavy sour crude like WCS produces a lot more middle-distillates than light shale oils and it won’t run the risk of flooding the market with gasoline, which is a primary product from light shale oils.

A lot is going to depend on product prices and refinery runs.  To sum it up, it’s about as clear as mud.  And that makes it tough to plan strategies for investors, producers, refiners and large gasoline consumers as it’s just not clear yet who will be the winners and losers will be—despite there being billions on the line here.

Shifts in Shipping–Which Vessel Types Will Be In More Demand

Apart from the competitive advantage for ships that have scrubbers, the rule change will likely be a net positive for the shipping industry.

High fuel costs will encourage slow steaming (which lowers fuel consumption).  Slower ships is effectively reducing supply.  Estimates are that the result is an “effective” reduction of the global fleet of between 2-3%.

Source: Eagle Bulk Shipping

A second consequence will be that more of the older ships (>15 years)–that can’t justify scrubber retrofits and have poor fuel efficiency–just get scrapped.

One vessel type that is uniquely positioned are clean product tankers (MR, LR1 and LR2).

Clean tankers typically carry products like gasoline, jet fuel or diesel fuel.   The shift to middle distillate marine fuels means increased demand for these vessels.

Scorpio Tankers (STNG-NYSE) CEO Robert Bugabee recently said that even at the low end of forecasts you are still looking at 6% incremental demand for clean tanker vessels.

As for timing, the deadline is January 1, 2020, but if the fuels are going to be there on time, the changes need to start before then.  The Market is already seeing scrubber orders stack up.  Soon (maybe early to mid-2019) the refiners will begin to shift product.  Charter rates on ships will begin to rise.

It’s going to be a whole new world come 2020.  I have found one investment as a play on IMO 2020 that is already looking like a winner–up 40% in just two weeks!  But I’m looking for even more.

Be ready when that happens—because these oddball stocks that I find in the corners of the global energy complex—like LNG shipping in 2010 and ethanol stocks in 2013—are often my biggest wins!  Sign up for your risk-free trial to my OGIB service TODAY—click HERE.

Keith Schaefer

Here’s some trivia: What segment of the transportation sector represents 7% of fuel demand but accounts for 90% of SO2 (sulphur dioxide) and NOx (nitrogen oxides) emissions?

The shipping industry.

Lately there have been several reports out about upcoming changes to sulphur regulations being passed by the International Marine Organization (IMO).

There could be billions of dollars on the line for energy investors as the Market is unsure if this will mean a large surplus of heavy crude for a few years.

US brokerage firm Goldman Sachs puts out a 48 report on September 5^th titled “IMO 2020 Challenging but Solvable”.

In July the Canadian Energy Research Institute (CERI) also put out a 113-page report titled “The Economic Assessment of International Maritime Organization Sulphur Regulations on Markets for Canadian Crude”.

These reports detail some big changes to the shipping and refining industry when IMO 2020 comes into effect.

Shipping’s Dirty Secret

It’s a little-known fact that the shipping industry is one of the worst polluting industries in the world. A single container ship can produce as much pollution as 50 million cars.

Why? Bunker fuel. More specifically: high sulphur fuel oil (HSFO). It’s the fuel most commonly used by shipping vessels.

HSFO hits over its weight to global emissions.

Burning HSFO produces more carbon dioxide than gasoline, diesel or other lighter fuels. But worse, HSFO has high concentrations of SO2 and NOx. These are primary contributors to smog, soot and acid rain.

About 65% of the worldwide shipping fleet of 90,000 ships rely on HSFO. Diesel is next at about 25%.

But that’s about to change.

The IMO is cleaning up the industry. They have a goal to reduce greenhouse gas (GHG) emissions 50% by 2050, and are pursuing a member agreement to eliminate CO2 emissions entirely.

Those are the long-term goals. In the short run the target is sulphur.

IMO 2020 is an agreement among member nations to reduce SO2 content from marine fuels from 3.5% down to a cap of 0.5% starting in 2020.

The consequence will be a big reduction in HSFO demand. HSFO will only be used on ships having scrubbers that can remove the worst of the pollutants.

It’s a big change, a sudden change. It’s going to have repercussions in three key areas:

1. Shipping
2. Refining
3. Fuel Distribution

Today we’ll look just at shipping–because that’s where I’ve found a great stock pick to play this IMO 2020 rule change.

Shipping – The Wild West

Cruise ships have long been a favored destination of gamblers. The reason? Once you are out on international waters, national gambling laws no longer apply.

The high seas are open season for lawlessness. The analogy works for the shipping business. While individual countries can create rules, they can only enforce them within the narrow borders of their own harbors.

Trying to get the shipping industry to stick to rules has always been a challenge.

That’s why when the IMO first floated new limits on SO2 emissions (back in 2016) no one paid it much attention.

IMO is a UN body. Their responsibility is to ensure shipping is safe, efficient and that pollution is controlled.

But like a lot of UN bodies, the IMO is only as strong as its members. They can proclaim whatever they want, but if the members don’t back it up with action it’s a whole lot of words.

It wasn’t until they put teeth into IMO 2020 this February that the markets took notice. They proposed an all-out ban on non-compliant fuels in the tanks of ships. The only exception to the ban would be if there was exhaust cleaning technology (ie. scrubbers) installed on the ship.

Each member country would inspection ships upon entering their ports and/or at refueling bunkers. Most of the large shipping regions are onboard with the rule. But compliance won’t be perfect. Emerging market regions outside of China are expected to see 50% compliance at best.

Nevertheless with North America, Europe and China onboard its become clear to the industry that the rule is going to stick.

Shipowners are looking at their alternatives.

What’s a Shipowner to do?

Shipowners that use HSFO have 2 choices:

1. Switch to low sulphur fuel oil (LSFO)

2. Install scrubbers to clean the fuel before using

A third choice is switching to LNG. But LNG is a long-term solution. The rule change will lead to more LNG fueled ships. But in the short run, converting a ship to LNG is not a realistic option.

Switching fuels is the easiest choice. Shipowners basically do nothing: wait for 2020 and fill the ships with a low sulphur fuel like marine gasoil (MGO).

The problem with fuel switching is that the fuel options are going to be expensive.

The forward curve is projecting HSFO prices at around $325/mt in 2020. MGO (or an equivalent low sulphur fuel) looks to be much higher, around $650/mt.

That’s a doubling of fuel costs.

The cost is highest for the biggest ships (the one’s that consume the most fuel). Take for example a VLCC (very large crude carrier). Tanker broker Poten and Partners estimates the following:

Assuming a time charter rate of $38,250 per day, a VLCC owner using MGO fuel would need to charge its charterer $14.87/ton to move its cargo from the Middle Easy to the Far East. The same ship using HSFO (ie. equipped with scrubbers) could charge $11.14/ton.

That’s a significant difference. More than 30%. To put it another way the ship using HSFO can generate a $12,500/day premium on its charter price compared to the one using MGO.

The shipping business always operates on thin margins.  Having a 30% advantage over the competition is a big deal.

Scrubbers

With shipowners crunching these numbers it’s no wonder they are looking closely at scrubbers.

A scrubber is essentially a filter system installed on the exhaust stack. Before the exhaust escapes into the atmosphere, a liquid mist in the scrubber adheres to SO2 molecules and “captures” it. The remaining exhaust goes out the stack while the SO2 sludge accumulates below.

Scrubbers aren’t very hard to make. They are really just a bunch of metal and piping. But the scrubber industry has traditionally been a small, niche one. It simply doesn’t have the capacity to retrofit a worldwide fleet of 70,000 ships.

Nor does it make sense to retrofit all the ships with scrubbers.

There is a bit of game theory here. The value of installing a scrubber comes from the expectation that not everyone else will. Less scrubbers, more to gain from the fuel spread.

Still, the list of ships lining up to install scrubbers is increasing every day.

In the last two weeks the Market saw announcements from Eagle Bulk Shipping, Star Bulk Carriers and Sembcorp Marine. Last month Frontline announced they were even taking a 20% stake in a scrubber manufacturer.

On the new-build front, the #1 trade magzine for shipping, Tradewinds, quoted one shipbroker as saying, “There is no charterer willing to take a newbuilding without a scrubber”.

Scrubbers aren’t cheap (they can cost between $2-$5 million depending on the ship). But Goldman estimates a payback of under 2 years on current spreads.

Goldman Sachs forecasted 3,000 scrubber installations by the end of 2020 and 4,500 by 2025. This on a worldwide fleet of 70,000 ships. Consider that only about 400 ships had scrubbers at the end of 2017.

This is a HUGE opportunity… and OGIB subscribers are profiting from it. The one ‘scrubber stock’ I bought last week is already up 40%–in under two weeks!

In Part II of this series on IMO 2020, I’ll explain the oil and fuel implications of this initiative. This is where the numbers can get Really Big. What will this mean to heavy oil spreads–will they be larger for longer? What about US shale oil, that produces almost no middle distillates that’s needed as the new fuel for shipping… for investors, each answer is worth billions of dollars.

Editors Note: Finding oddball energy stocks like this ‘scrubber stock’ is what makes investing fun, and lucrative. These are stocks that go from obscurity to mainstream quickly, creating huge capital gains for shareholders. Be ready for The Next One–click HERE for your risk-free trial subscription to OGIB

Keith Schaefer

Shhhh…keep very quiet…about LNG in Canada I mean…it’s happening right now under everyone’s noses…but don’t tell anyone…sshhhh

On the surface and their LNG Canada project in Kitimat BC have not announced a Final Investment Decision, or FID.  They keep publicly kicking an official decision down the road.

Privately however, beneath the surface, on-the-ground activity is screaming this $40 billion project is a GO.
Shell and LNG Canada are stealthily doing everything they can to get ready for their project…hiring, spending money, ordering camp beds etc.

The signs that LNG Canada is a go are out there for anyone paying attention…..

1. In late July the oilfield services company Black Diamond Group (BDL-TSX) announced that it had been awarded a $42 million contract to build a work camp for the pipeline that would transport natural gas to the LNG Canada project.
2. On July 18^th LNG Canada launched a Twitter account.  It is a bit hard to imagine the marketing department would do that without approval from within.
3. On August 16, Shell started dredging in the port of Kitimat so their huge LNG carrier ships could come right up to the terminal dock.
4. They started a ‘workforce accommodation center’ and they’re now creating ‘habitat offsets’ to minimize environmental impact of construction.
5.  The staff count in the LNG Canada offices on site has increased from 5 to 50
6. Legacy facilities from the previous occupant of the site (Methanex) have been torn down and expensive brand new Komatsu equipment is on-site now, ready to be put to work

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Click on image to go to video.

See my interview with Proactive Investors’ Steve Darling on the “stealth” LNG in Canada

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It’s the same with Chevron (CVX-NYSE)/Woodside LNG project (called Kitimat LNG), also located in Kitimat BC.  Chevron is a couple years behind Shell, but they’re acting in a very similar manner–no formal public commitment, but plenty of action:

1. the application for an environmental protection notice for site runoff
2. The site is being re-scoped to make the project larger than initially planned
3. They’ve chosen the consortium that will construct the facility (JGC/Fluor)

The Kitimat LNG project will trail LNG Canada by 18 to 24 months, but it is moving.  It makes sense to have Kitimat LNG lag LNG Canada so that the labor force isn’t stretched and costs can be better controlled.  (Their Australian LNG facility was built at the same time as 2 others nearby, and all 3 projects went WAY over budget.)

LNG Canada alone will need 10,000 construction workers–and Kitimat is only 9,000 people!

Everyone Has Given Up On West Coast LNG–For Good Reason

Shipping Liquid Natural Gas from Canada to Asia should be very profitable–as Asia’s benchmark price, called JKM, is about US$9.60/mmBTU.  In Canada, natural gas is about US$1.30 or so, but it is volatile.  It’s one of the most profitable arbitrages in energy I see anywhere in the world right now.

Canada desperately needs another natural gas export market.  Asian LNG imports are soaring.  So it’s no wonder the world’s energy majors want to spend tens of billions here developing LNG export facilities.

But the once-bright future of billions in LNG spending in Canada had turned dim over the past couple of years.  A once hugely promising opportunity seems to have been wasted away.

First there was provincial election in British Columbia in May 2017. The left-wing New Democratic Party (NDP) joined forces with the anti-hydrocarbon Green Party and upended the pro-business Liberals (that must sound weird to my American readers!) to form a coalition government.

That obviously wasn’t good for LNG.

That puts the Greens in a strong position.  Without their continued support the NDP is sunk……and the Greens really don’t want LNG.  Just check out the tweet below from Green leader Andrew Weaver from January 2018:

Weaver flat out states that he’ll disband the coalition over LNG, and force a new election.

Shortly after the NPD/Greens took power, the leading LNG consortium at the time, led by Malaysia’s Petronas, pulled the plug on its $36-billion Pacific Northwest LNG megaproject.  That was another step backwards from ever getting LNG off the ground. (Petronas recently bought 25% of Shell’s LNG Canada.)

The clock is ticking here.  A decade has already passed and LNG in British Columbia has gone exactly nowhere.

But that is about to change in the snap of a finger.

Why So Shy About Telling Us That They Are Ready To Roll?

I love the intrigue — but why aren’t these folks willing to tell us that they are excited to commence these huge projects?

Two reasons, that are kind of the same reason…..

First, announcements only attract protests in Canada. We have learned this the hard way over the past decade……NOTHING GOOD comes out of presenting or updating anything to the public about oil and gas related projects going forward.  (Shell and Chevron execs must be so grateful that Kinder Morgan in Vancouver is attracting all the protesters!)

All that a positive FID announcement is going to do is create headaches, bottlenecks and problems.  So why bother? It is much better to just put your head down and do your business quietly.  The response to project announcements from the oil and gas industry is for the press and environmentalists to shoot first and never ask questions.

In this business keeping things on the “down-low” is surely the way to go.

Second, it is without question in the best interests of these projects to not embarrass the minority NDP government.

The NDP ran on the premise that they would kill LNG and the huge hydro-electric Site C dam. BC Premier John Horgan then subsequently approved the Site C megaproject that he had argued against….so he is already on the hot seat with some of his base.

And of course the NDP coalition partners–the Green Party–are 100% opposed to LNG going forward.  You saw what Weaver tweeted earlier this year.

But…Premier Horgan needs some northern seats to win the next election, and without LNG there isn’t going to be much increased prosperity up there by the time that election rolls around.

And realistically the BC Government is heavily incentivized to support LNG.  The Shell LNG Canada project would result in $40 billion of spending in the province and create direct Provincial revenues of more than $22 billion over the next 40 years.

The reality is that Shell, Chevron and their respective partners are going to be able to work with the NDP……if they continue to do so very quietly.

As for timing for  real news–a positive FID from LNG Canada–look for mid-October.  On October 31, 2018 there is a drop-dead date for British Columbia’s LNG incentive package (PST exemption, repeal of LNG income tax, break on electricity costs and cap on carbon taxes at $30/tonne).

So now you know….but  SSHHHHH!!! Don’t tell anyone.  They’re trying to keep it a secret.

EDITORS NOTE: The Bakken is Back!  Bakken oil actually gets a higher price than WTI most days now. It’s incredibly profitable, and this $2 Bakken stock will stun investors with its growing cash flow and production.  The time is NOW for this Bakken stock–click HERE to get the name and symbol.

If one of your children tells you that they want to become a commodity hedge fund manager —- tell them to try something else.

Making money in that particular field is incredibly hard.

Just ask anyone on the long list of commodity focused hedge funds which have disappeared over the past five years.

The Wall Street Journal recently quoted numbers from the data group eVestment. Two-thirds of global commodity hedge funds that were operating in March 2012 before the oil crash have now shut their doors.

That is a shockingly large percentage of funds that have closed.

We aren’t just talking about the weakest hands folding.  The extinction list includes some of the biggest names in the game including Armajaro Asset Management, Clive Capital, Centaurus Capital and Brevan Howard.

The list of the unfortunate also includes Andy Hall — known amongst oil traders simply as “God” for his ability to accurately predict the direction of the oil market.

Hall shuttered his main Astenbeck Capital Management fund last summer……just as oil prices started to rally.

You know you are in a difficult business when even “God” can’t make a go of it.

How Then Has The OGIB Portfolio Has Continued To Thrive?

While two-thirds of hedge funds operating in the commodity/energy space have disappeared as well as many of my newsletter colleagues…..the OGIB portfolio (my seven figure real money portfolio) has continued to chug along producing positive results.

I initially launched the Oil and Gas Investments Bulletin at the bottom of the Great Recession in March 2009.  The timing was not an accident—it was very clear to me at the time that we were then looking at the buying opportunity of a generation.

Since then the energy markets have lived up to their rollercoaster reputation.  Up, down and sideways.  You name it, we have seen it.

Through the end of December 2017 the OGIB portfolio has posted the following annual returns (2009 is from inception through year-end):

2009 – Gain 123%
2010 – Gain 64%
2012 – Gain 37%
2012 – Gain 1.7%
2013 – Gain 20.5%
2014 – Gain 18.0%
2015 – flat  0.0%
2016 – Gain 28.0%
2017 – Gain 17.0%

The portfolio has posted some really big years – five of the nine being up more than 20 percent.

What I’m most proud of is the fact over these nine years the OGIB has not had a single down year.  That is despite oil prices that have ranged from as high as $110 per barrel down to as low as $26 per barrel.

I’ve kept making money in every conceivable environment.

How was I able to achieve this despite an oil crash for the ages, a natural gas price permanently in the doldrums and legendary oil traders being forced out of business?

Believe me when I tell you that it isn’t because I’m overly intelligent.  My wife and kids will verify that!

I believe that I have been able to achieve these results because of four key principles that I use to frame my investing decisions.

Here they are:

OGIB Principle #1 – Never Make Big One Way Bets on Oil

I never believe that I know where oil and gas prices are going, but I’m willing to bet on a hunch.

I don’t buy oil at the bottom, but I buy it more and more on the way up.

I believe that most of the hedge funds that were forced out of business during the downturn were far too exposed to one-way commodity price trades.  They forgot the “hedge” part of their fund business meant that they weren’t supposed bet so heavily in one direction.

Small investments on oil price moves leave me with Big Money to invest in company specific bets.  It’s about being flexible, and I’ll talk more about that in Principle #3.

But most of the time if you ask me where commodity prices are going my answer will be “I don’t know”……which are three of my favorite words by the way (because they are used far too seldom by almost everyone).

OGIB Principle #2 – Buy Quality Companies.

I almost always have my portfolio positioned to perform no matter what the commodity market does.
What I mean by that is that I am only interested in owning companies that can excel in all commodity price environments.

What are the attributes of a company that can perform that magic trick?

It is pretty simple really.  These companies have:

• Pristine balance sheets
• Strong cash flows
• Excellent hedge books
• Low cost / high margin assets
• Industry leading recycle ratios (for producers)
• Proven management with skin in the game

I’m not talking about companies that have one or two of these attributes.  I’m talking about companies that often have all of them.

It takes serious discipline — but if you insist on having every single one of those boxes ticked BEFORE you buy shares in a company your success rate will go way up.

You end up owning far fewer stocks and often don’t buy anything for weeks at a time…but it is worth it.  Trust me.

These companies do well in both strong and weak commodity prices.  When the bottom falls out the commodity market these high quality companies are well positioned with cash to spend.  That allows them to pick up excellent assets for pennies on the dollar as the weaker hands in the industry fold.

This checklist is about having discipline as an investor….not a high IQ.

(There are rare times to buy the highly levered, debt laden high cost producers—like when I doubled my money in a month on high cost Approach Resources at the start of the Permian mania in 2017…but you want to be a seasoned investor to try that.)

OGIB Principle #3 – Oil isn’t the only game in town. Be flexible.

When I launched the OGIB service in March 2009 it was because I was ready to get long oil and oil stocks.

That was the right time for oil; oil and the Market had double-bottomed out the 2008 crash.  Since then, when the oil stocks weren’t working due to a flat or declining oil price, I’ve made money with
1. LNG shipping companies
2. U.S. refineries
3. ethanol producers
4. solar inverters
5. geothermal power producers
6. energy re-sellers
7. energy storage
8. The EV Trade—Electric Vehicles—in buying lithium and cobalt companies
In fact, I usually make MORE money with these oddball subsectors because they are not as well followed and are less efficient than oil producers.  Most oil stocks worth owning are widely followed.

The most money I’ve ever made was in ethanol in 2013 & 2014, as first Green Plains (GPRE) and then Pacific Ethanol (PEIX) were 5 baggers in months.

By being flexible and willing to go to all corners of the energy sector I’ve been able to find significant winners when the oil market wasn’t offering any.

OGIB Principle #4 – When You Are Wrong – Get Out QUICK.

Of the 368 commodity hedge funds that were in business in March 2012 only 130 remain.

Most of those 130 are operating with greatly reduced portfolio sizes.

There is no doubt in my mind that the people who were running all of those hedge funds that had to shut down were very high IQ individuals.  They were smart, likely too smart.

I expect that their high level of intelligence was likely a big part of their downfall……because it made them unwilling to admit that they were wrong.  They took positions and rode them all the way down.

The extreme self-confidence that these high IQ fund managers have isn’t always a blessing.  Fortunately that isn’t a problem that I have to worry about!

When the market tells me that I’m wrong….I listen.  I listen quickly!  And when I don’t—I lose.
No stubborn, foolish pride on my part ever.  I’m in this to make money—not to be proven smarter than the next guy.

And I always remind myself that making money is the easy part.  Keeping it is much more difficult.

Limiting my losses has been a huge reason why the OGIB portfolio has consistently gone up.

What I’m Doing With The OGIB Portfolio Today

I’m watching the tide, not the waves.  That means that I think the oil market is getting tighter, and prices are going higher.  I am in love with a $2 stock that has some of the best land imaginable in a prime US play.

Management owns over $35 million of stock, and it’s very profitable oil.  A combination of factors is keeping this stock under the radar, but come Labour Day I expect BIG increases in production and cash flow.  This company is a GREAT way to trial my research service…to get the name, symbol and full report, click HERE.

Keith Schaefer
Publisher, Oil and Gas Investments Bulletin

The rally in WTI oil prices that began at $42 per barrel in June 2017 and touched $77 in June 2018 (an 83% increase in a year) has fizzled in recent months.

If you were wondering what took the air out of the oil market oil trading superstar Pierre Andurand suggests that you look towards China.

I think he is onto something…..and that you shouldn’t be giving up on your oil stocks just yet.  In fact it is likely time to be buying more.

Andurand recently tweeted:

The weak oil physical market is not only due to more OPEC oil on the water. It is mainly due to China destocking. Their low imports are not sustainable. They have been very low for 3 months. Their imports could go back up 2mbd any time now.

Andurand then also tweeted the following graphic.  It provides estimates of China oil imports from several reputable sources:

It’s east to see what he is talking about.  Chinese imports have clearly fallen hard since May—down from 7.9 million bopd (barrels of oil per day) to just 5.9 million bopd.

A two million barrel per day drop is certainly more than enough to suck the momentum out of oil prices.
In his tweet Andurand notes that he doesn’t believe that this drop is sustainable.  What he doesn’t provide is the reason why he believes that.

I don’t doubt that he is right, but opinion without reasoning isn’t of much use to us — so let’s try and fill in that blank.

China Imports Are Down – Chinese Teapots Are The Reason Why

China has two classes of refineries.

The majority (roughly 70 percent) of China’s refining capacity rests with the state-owned oil majors — Sinopec, CNOOC, Sinochem and PetroChina.

The Chinese government is fully behind those companies.

The rest of the refining capacity (the other 30 percent) is controlled by independent operators.  These refiners are often called “teapots” both because of their small size relative to the state owned giants and because of their ramshackle appearances.

On average the teapot refiners have a refining capacity of 70,000 barrels of oil per day.  The range is from as low as 20,000 barrels per day up to 100,000 barrels per day.

The Chinese government doesn’t give a hoot about this motley crew.  The teapots are competition for the state-owned operations.

Prior to 2016 the Chinese government restricted the teapots from directly importing crude oil — the essential refining feedstock in their business.  Instead the teapots were forced to purchase their oil from Chinese state-owned oil companies at a price above market rates.

That obviously took a chunk out of profits.  The Chinese government was ok with that.

Then in 2016 the Chinese government had a change of heart and decided to grant the teapots oil import licenses.  A sudden act of kindness?  No, this was an effort to help compensate for production shortfalls from state-owned oilfields.

China needed more oil and granting these import licenses helped secure it.

With lower input prices–avoiding the state mark-up on oil purchases—the teapot refining profitability soared.  The good times rolled and the keep rolling for a couple of years.

On March 1, 2018 those good times ended.

You see, prior to being allowed to import oil, the teapots had squeaked out a profitable existence largely thanks to a tax loophole.  That loophole had allowed them to declare fuels such as diesel and gasoline as “other oil products” and thereby avoid a consumption tax.

The Chinese government allowed this because some refining capacity on top of the state-owned amount was needed.  This loophole remaining open allowed the teapots to survive.

With the teapots now not just surviving, but thriving, the Chinese government had no reason to keep the loophole open.

As of March 1, 2018 that loophole closed—and the consumption tax now in place is severe—$38 per barrel on gasoline and $29 on diesel.

That will take a bite out of income.

Not only have the good times ended but many of the teapots are struggling just to survive.  With cash flows crushed, the teapots have had to greatly reduce the size of their refining activities—and therefore are purchasing/importing a lot less oil.

Some of the teapots even closed for maintenance during May and June rather than operate at a loss.  Those refineries aren’t importing any oil.  It is expected that many of them won’t ever reopen under these conditions.

Now take a look at Andurand’s graph again (below).

The consumption tax was enacted March 1, 2018 — the decline in Chinese oil imports starts immediately thereafter.

I think we have found the “why” that we were looking for.

The Teapot Refineries Have Slowed –
Chinese/Asian Consumption Hasn’t

The Chinese teapot refineries are really the middle man.

They refine crude oil into the finished products that are consumed in China and in various other parts of Asia.

While the teapot demand for importing crude may never rebound—somebody has to supply those finished products.  Those consumers don’t care who refines the gasoline or diesel they are using.

The state-owned refineries will pick up some of the slack–their utilization rates will increase.  The Chinese government will like that.  The best-run, most efficient teapots will pick up more of it.  The teapot sector will consolidate and the most profitable companies will thrive, albeit with tighter margins.

Maybe some refineries outside of China will pick up some of the slack — I don’t know for sure.

What I do know is that demand for oil in China and the rest of Asia hasn’t changed much.

Andurand is right about the fact that the reduction in Chinese imports is not sustainable and will rebound.

Because China is such a big part of the global oil market, this is a big deal.  What would another two million barrels a day of oil demand for 7 months—to restock the Chinese oil cupboard—due to oil prices?  I think a lot.

The Market just doesn’t know when that will happen.

EDITORS NOTE:  I think The Bakken is once again one of the most profitable oil plays in North America—you only have to look at the stock runs of Whiting (WLL-NYSE) and Continental (CLR-NYSE) to see that.  But the Market is completely missing this $2 stock as it almost doubles production this year and will almost double it again next year.  I’m convinced shareholders will enjoy an incredible autumn season with this company… I give you the full report, risk-free, by clicking HERE.