My Next Big Win—Right On Time

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My experience is that in the stock market, wealth is built in steps.

My portfolio is flat for 12-18 months, and then a Big Win comes.  Flat again, then Big Win.  Repeat.

(The hard part of investing is keeping that money, during the flat times.)

Big Wins actually come along regularly; every 2-3 years in my experience.

It has been just over two years since my last Big Win—Pacific Ethanol, which I bought in November 2013 at $3/share.

Nine months later it was $23/share and my wife was half a million dollars richer.

And right on cue, my next Big Win has showed up, just over two years later.

That’s right now.  I think I’m staring my next Big Win right in the face, right now.

I’ve followed the business for just over a year.  Revenue is soaring.

That’s because there are very few businesses the world actually needs—but this is one of them.

This stock is my next step up.  If you miss this, it could be another two years.  Don’t wait.

Step up to new riches, RIGHT HERE.

What Went Wrong at Ultra Petroleum?

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By Bill Powers

Which natural gas producers will make it through this winter of low prices?  I’ll tell you one that I think will survive….but first I’ll tell you one today that probably will not.

Natural gas prices on the NYMEX dipped below $2/mmBTU in December 2015 for just the second time in eight years.  At other natgas hubs—like in the Marcellus in the US Northeast—prices went below $1.

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With a warm winter and high , prices could stay low—which hurts all producers.  But it could be the final gasp for ones who have debt-soaked balance sheets.

Ultra Petroleum (NYSE:UPL), a company that transformed itself from a penny stock (under $1!) 15 years ago to a peak valuation of  over $100/share, (this is one of very few 100-baggers ever) or $14.8 billion in 2012, is one of many natural gas-focused fallen angels.

While the company still has the same management and operates in largely the same areas it has for most of its existence, things have changed drastically at the company over the past six years.  And because of that, I don’t see the company surviving this time of low prices.

I’ll walk you through how this train-wreck went off the rails.  Really, it’s a story of  the company continued to drill uneconomic or marginal gas wells while overpaying for entry into new areas (acreage in the Marcellus and Uinta) while financing these activities with debt.

Even though UPL is still a low-cost operator, the company now has a debt-soaked balance sheet and interest costs that are rapidly destroying shareholder value.

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By no means is Ultra the only company that has lost its way in recent years.  Nearly the entire industry chose to lever up to chase new oil plays while outspending cash flow to simultaneously grow natural gas production.

By examining the details of the transformation of Ultra Petroleum from Wall Street darling to a company fighting for its life will we will get a better understanding of the precarious position the entire industry finds itself in.

The strategy of UPL stands in stark contrast to that of Rice Energy which has spent far less money, drilled far fewer wells and taken on much less debt wells to achieve a comparable level of production and larger cash flow.

Ultra Petroleum has three concentrated areas of operation: the Pinedale/Jonah area of Wyoming where it produces tight, dry gas; northern Pennsylvania where the company produces from the Marcellus and the Uinta Basin where UPL is pursuing a secondary recovery project in a medium gravity oil field.

UPL has operated for more than a decade in Wyoming and currently holds 67,000 net acres in the Pinedale and Jonah fields that produce approximately 750 mmcf/d for the company.  Below is a graphic containing a snapshot of its acreage:

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Source: Company Presentation

In 2015 the company spent approximately $435 million to drill 137 net  vertical wells in Pinedale, or spent about $3.2 million per well.   Due to the long production history of wells in Pinedale and Jonah, where there have been more than 4,000 wells drilled over the past 25 years, it is reasonable to expect the average well to produce approximately 4 bcf over its lifetime.

As might be expected given UPL’s long-term presence in Wyoming, the majority of the company’s value rests here.  Assuming 75% of Ultra’s acreage is drilled over the long-term, and using 40-acre well spacing, the company has a total of 1,256 net locations that would yield it approximately 6 tcf over the lifetime of the wells.

However, due to the extensive drilling that has already occurred on UPL’s acreage, it has a working interest in 2,500 wells, and the high initial decline rate of its wells, it is reasonable to assume that approximately 3 tcf of future production remains on Ultra’s Pinedale and Jonah acreage.  Assigning a value of $1.50 per mcf for the remaining reserves in Wyoming values UPL’s Pinedale/Jonah property at $4.5 billion.

In October 2013 UPL entered the Uinta Basin through the purchase of the 9,000 acre Three Rivers field that was producing 4,000 barrels of oil per day (bopd) at the time of purchase.   Ultra financed this $650 million purchase entirely through debt.  Below is a snapshot of the company’s acreage:

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Source: Company Presentation

Though the Three Rivers field was considered a mature field at the time of purchase due to its extensive development, UPL management justified its purchase price due to the potential for additional recoveries through an infill drilling and waterflood program.  During 2014 the company drilled 74 new vertical wells into Three Rivers at a cost of $1.7 million each (about $150 million total) and ramped production up nearly 3-fold over the course of the year.    According to the company, the Three Rivers field exited 2014 at over 11,000 bopd.  (Source: Company 2014 10K)

Unfortunately for shareholders, the timing of a massive ramp up in production from Three Rivers could not have been worse.  Due to the waxiness of the crude oil in the Uinta Basin (it is priced off a benchmark called “Black Wax Crude”), Ultra and others receive a discount to NYMEX WTI of between 10 and 20% and sometimes even higher.  Receiving large discounts and falling NYMEX prices has made much of the recently added production rather unprofitable.

Due to the weakness in Uinta pricing over the past year UPL drilled only 19 wells in 2015 and did not complete any of them.  However, in the first half of 2015 Ultra initiated a waterflood on Three Rivers that it hopes will greatly improve recoveries.

While it is still early days with regards to the success of the waterflood, I am somewhat skeptical a material increase in recoveries can be achieved in a field with 18 to 20 API gravity oil.  Time will tell.

The lack of new wells coming online in 2015 and the early stage nature of the waterflood caused production at Three Rivers to collapse 60% in the first 9 months of 2015 to only 4,750 bopd according to a September 2015 presentation.  I expect further declines in production in 2016 as minimal activity is likely to occur due to today’s weak prices and the heavy discount on Uinta crude.

After spending over $800 million on the acquisition and development of Three Rivers over the past two years, UPL has little to show for its efforts.  With production from the field falling and it producing negative cash flow in today’s price environment, Ultra has destroyed nearly $600 million of shareholder capital in a very short period of time.

A fair value for UPL’s Three Rivers field, assigning a value to its proved developed producing reserves of $14 per barrel, would be approximately $200 million.

UPL’s foray into the Marcellus at a time of skyrocketing land costs has only slightly outperformed its investment in the Uinta Basin.   Ultra’s first entry into the Marcellus occurred in 2008 when it formed a 50/50 joint venture agreement with privately held East Resource to test both the Marcellus and the Oriskany formations in northeast Pennsylvania.  (The Oriskany is a prolific sand formation directly beneath the Marcellus that has been produced in Pennsylvania for decades.)

Due to the success of early drilling in the Marcellus, UPL increased its acreage positions in and around Tioga and Potter counties to 320,000 gross or 170,000 net acres shortly after entering the Marcellus.  In 2009, the company purchased 80,000 net acres in northeastern Pennsylvania for $400 million or $5,000 per acre that brought the company’s total net acreage position to approximately 250,000 acres.   Similar to the purchase of Three Rivers, this acquisition was funded entirely with debt.   During 2012 the company drilled 27 net wells on its Marcellus acreage at a cost of over $200 million and in 2013 drilled another 20 net wells costing approximately $150 million.

By 2014, unable to produce consistent results on its acreage in northeast Pennsylvania and a very weak pricing natural gas in the Appalachian Basin, UPL significantly reduced its exposure to the Marcellus by swapping 155,000 net acres and $925 million in cash with Shell for Shell’s acreage in the Pinedale.  Once again, the cash portion of this transaction was funded entirely with debt.

Today, the company’s footprint in the Marcellus is a fraction of what it once was.  Below is a snapshot of UPL’s remaining acreage position in the Marcellus:

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Source: Company Presentation

Due to continued weak wellhead prices in the Marcellus, gas for delivery into the Leidy, PA hub on January 8th averaged $1.30 per MMBTU, and acreage that lies outside of the most prolific part of the play, a fair value for UPL’s remaining 130 bcf of proved reserves in the Marcellus would be approximately $.75 per mcf or $100 million.

Due to UPL’s propensity to fund property acquisitions with debt during a period very low natural gas prices, the company’s debt load has grown significantly in the past 7 years.  The below table display’s the company’s growth in year-end debt:

Year Total Debt on 12/31
2009 $795 million
2010 $1.6 billion
2011 $1.9 billion
2012 $1.8 billion
2013 $2.5 billion
2014 $3.4 billion
2015(est.) $3.4 billion

Source: Company 10K reports

UPL Valuation

While Ultra Petroleum has assets that can be valued at approximately $4.8 billion and debt of $3.4 billion, one could posit that the company’s shares should trade closer to their estimated net asset value of $8.50 per share ($1.3 billion in assets/153 million shares) rather than their current going rate of under $2.00 per share.

However, today’s commodity price bear market, dropping revenues, high decline rate project areas and Ultra’s large interest expense is choking the life out of the company.

For example, in Q3 2015 the company generated $222.5 million in revenue but had cash operating costs (which excludes depletion costs) of $102.5 million and interest expense of $43.1 million.  UPL’s interest expense alone consumed a whopping 19.3% of the company revenues for the quarter.

But it gets worse.  During Q3 2015, Ultra realized a gain of $45.3 million on its gas hedges which improved its average realized price to $3.33 per mcf from the otherwise $2.68 per mcf had the hedges not been in place.  However, Ultra’s natural gas hedges expired in October 2015.  Without a hedge book in place the company is likely to see its realized price for gas fall approximately 20% in Q4 2015 compared to Q3 2015.   Even weaker realizations can be expected Q1 2016.

Though UPL’s 2016 capex guidance will not be available until Q4 results come out next month, the company is likely to spend only enough to keep production flat in Wyoming.  According to the Q3 2015 company conference call, this would indicate about $300 million in spending in Wyoming this year.  Also, UPL is likely to spend only minimal amounts on its Uinta and Marcellus projects areas in 2016 due to the very poor current economics of both project areas.

It is quite clear that the strategy of UPL over the past six years of:

  1. continuing to drill hundreds of uneconomic/marginally economic gas wells
  2. overpaying for access to an oil project in Utah and
  3. for fringe acreage in the Marcellus

has severely damaged the company’s ability to weather today’s storm.

The outlook for Ultra Petroleum stands in stark contrast to that of Rice Energy.  Rice has a manageable debt load and concentrated, high-quality asset base that was acquired at reasonable prices which allows the company to grow production without grossly outspending cash flow.

Lastly, and most importantly, the inability of gas-focused companies such as UPL (Chesapeake Energy would be another) to survive the current market difficulties and increase drilling as prices improve, will make the next upturn in prices one for the ages. 

The searing downturn that is now in its final stages has so severely damaged the risk taking appetite and risk taking ability of the E&P industry that US natural gas production has now entered a decline that will last for years.  This situation will be great for the industry survivors such as Rice Energy (RICE-NYSE) and but may be of little value to companies like Ultra Petroleum.

Editors Note—This is a story about survivors.  This stock is a THRIVER—and it put my portfolio in 2015 into the black.  I now make $3500 a month in dividends from this stock.  Click HERE to get it working for you.

How to Connect With Success

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Meet the Energy CEO’s—for FREE—in Toronto on Saturday, March 5
One of the most difficult jobs of the year is selecting the companies to present at the Subscriber Investment Summit (SIS).  It’s because we want the best companies possible there.

Companies like Canamax, which was bought out for a near double in December 2015.  And companies like Granite Oil, which increased dividends twice last year, and is likely the only junior producer trading at the same price now as it was in October at the Vancouver conference.  NexGen just announced one of the biggest uranium drill holes in history, and that stock has analyst targets at 3-5x its current price (and a great chart to boot!).

Meeting the CEOs, and other experienced investors, is how you Connect with Success at our Subscriber Investment Summit.

This year’s Toronto conference is Saturday, March 5th at the Toronto Hilton, downtown at the corner of Richmond and University. Click here to register today!

We have an incredible line up of energy CEOs attending. Here’s the list:

Michael Fallquist has grown Crius Energy Trust (KWH.UN-TSX; CRIUF-PINK) to almost 1 million customers from scratch in the last few years.  The company has NO DEBT, and pays a dividend. With only 17 million shares out, even a small increase in revenue can mean a big dividend increase.  All their revenue is in US dollars.  This energy retailer ticks all the boxes.

Ask Michael about his long-lasting residual payments on his solar sales, or how he benefits from declining energy prices.

Pat Ward’s Painted Pony Petroleum (PPY-TSX; PDPYF-PINK) will be the #1, fastest growing junior gas producer in Canada in the next two years, going from 16,000 boepd to 40,000 boepd in that time.  They’re well hedged, have no real development risk and give investors an incredible call on higher gas prices. Painted Pony has partnered with Altagas (ALA-TSX), whom I expect to be the first LNG project shipping natgas off Canada’s west coast.

Ask Pat and Jason about LNG and pricing, and breakeven levels.

Ian Telfer and Craig Steinke’s Renaissance Oil (ROE: TSX-V) was the only Canadian company to win any properties in the December 2015 Mexican auction.  They beat out the second place bids by only 2%!  They partnered with oil services giant Halliburton who does a lot of business in Mexico.

Ask Craig what he will be spending his $25 million in available capital on, and at what oil price he thinks he can get 1 year payback on wells.

Marc Murnaghan’s Polaris Infrastructure (PIF-TSX; RAMPF-PINK) is a most unusual energy producer because it knows exactly what price it will be paid for its energy for the next 10 years. The other interesting thing? They only have to drill a well every 2-3 years to keep production steady. Lowest decline rate in the world? Maybe. They produce 50 Megawatts of power from geothermal energy in Nicaragua.  PIF is having a big growth curve in 2016 with three new wells, and will be starting a dividend in Q3 this year.

Ask Marc and CFO Shane Downey how much they think they can increase their Free Cash Flow this year if these wells are successful.

You have many reasons to speak with Tamarack Valley (TVE-TSX; TNEYF-PINK) CEO, Brian Schmidt. You probably want to ask him how he gets such top performing wells out of Alberta’s giant Cardium play.  What does he do different?  How does he get such fast payback on wells with such a high percentage of natural gas?  Brian has been very active at CAPP—the Canadian Association of Petroleum Producers—for years.  He is very well connected, incredibly knowledgeable and willing to share.   He’s also one of the most disciplined operators in the patch.

There is a simple question for Richard Thompson, CEO of Marquee Energy (MQL-TSXv; MQLXF-PINK)—how did you assemble such a large, contiguous package of low-cost, highly productive oil production just outside of Calgary in a hyper-competitive environment? It’s a great story, and tells you about the patience, diligence and deal maker in whom you are investing.  His Michichi play is already one of the top payback plays in Canada, but you should ask him how he’s reducing costs even more.

We keep the presentations brief, and the one-on-one time long—at the coffee breaks and during lunch so you can ask them questions directly, face-to-face.

You get to ask them anything you want—and get a sense of them as people.  Being around winners helps you find winners.

Come meet them NOW—right here:

TORONTO SUBSCRIBER INVESTMENT SUMMIT 2016
Hilton Hotel – Downtown Toronto – 145 Richmond Street West
Saturday, March 5th, 2016 9 AM – 5 PM

Cocktail Reception to follow at the close

Connect with Success. Register today. Click here

(You have to pay $200 to enter the CAPP show in April to meet them, and here you get to do it for free.)

The Only Business Model That Works in Energy Now

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There are very few business models that work in the energy patch right now—especially upstream, where the producers are.  The industry produces too much oil globally and too much natural gas in North America—that oversupply has driven prices into the ground.

Even in the downstream  markets—where the refineries are—they have produced too much gasoline and distillates and sent pricing through the floor.  Their business model still works, but crack spreads—the difference in price between 3 barrels of oil and the products they produce—are rapidly getting thin.  Crack spreads = profitability.

I want to own a company whose business model works at these energy prices.  I found one, and I’ve made it my largest position.  I expect record revenues and record cash flow this year—and next.  Over the last ten years they have built up the business from scratch—and are so profitable, they have  NO debt and pay a dividend.  I think 2017 revenue will be over $1 billion—and management grew it from the ground floor.

That’s clearly a business model that works.  I mortgaged my house to buy this stock.  I put it in my son’s tax free savings account.

And every month, I get to pull out a big chunk of change—just over $3500 of passive income.  It’s like free  money!

Read my research on The Business Model That Works—risk free.

Keith Schaefer
Editor/Publisher
Oil and Gas Investments Bulletin

The Oil Data That Made No Sense

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Something Doesn’t Add Up In North Dakota’s November Production Report

If you want to find buried treasure, you have to dig.

And even then you may find the treasure chest is empty.

That’s what happened to me this last two weeks as I realized one bit of oil data made NO sense to me at all—and spent several hours chasing down what the real numbers were.

The Market bids up and sells down oil and oil stocks each week based on a lot of data points—much of it from international (IEA), national (EIA) and state (North Dakota) governments.

And when I read this month’s North Dakota Director’s Cut (published by North Dakota Department of Mineral Resources) something didn’t seem quite right.

In fact it seemed very wrong.

So I started digging, and found a mistake.

North Dakota’s Director’s Cuts can be found here

Common Sense Would Suggest Otherwise

Like all of the oil market data that investors rely on, the North Dakota’s Director’s Cuts is released long after the actual production took place.  The November edition of the report was released last week on January 15.

It did not contain good news for oil bulls.

The report showed daily North Dakota production of:

  • 1,171,119 barrels/day in October
  • 1,176,314 barrels/day in November

That’s only a 5200 bopd increase, but seeing oil production going up anywhere at this point is bad news for the price of oil.  Seeing oil production going up in one of the major shale plays is even more dismaying.

It is more than a little bit surprising that oil production in North Dakota (the Bakken) is holding up, given high decline rates and plummeting rigs counts.

The news in the comments section of the November Director’s report gets even worse.

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What’s disturbing is the number of completions.   A “completion” refers to the horizontal well being fracked and actually put on production.

To predict where production is going you must follow the number of completions, not the number of wells being drilled.  

The November report is telling us is it only took 26 well completions to grow North Dakota production by 5,200 barrels per day.

Now I know that the industry has been maximizing efficiencies…but given the rate that we know shale production declines…this seems hard to believe.

What A Little Digging Reveals

It is amazing what you can accomplish squirreled away in your basement office thanks to the internet.  There is a lot of good data out there for anyone willing to spend the time to find it.

The North Dakota Department of Mineral Resources, Oil and Gas Division provides a Daily Activity Report database.  Here you can find all of the oil and gas activity that happens in the state of North Dakota on a daily basis.

Included in the Daily Activity Reports are the number of completions.

I went through each of those daily reports for the month of November, and this is what I found:

Date Number of Wells Completed
2-Nov-15 4
3-Nov-15 2
4-Nov-15 1
5-Nov-15 3
6-Nov-15 2
9-Nov-15 5
10-Nov-15 3
12-Nov-15 1
17-Nov-15 1
18-Nov-15 4
19-Nov-15 1
23-Nov-15 7
24-Nov-15 3
25-Nov-15 2
30-Nov-15 2
   
Total 41

The daily reports show 41 wells being completed in November.  The Director’s Cut for November showed only 26.

That’s a 50% difference.  Why?  There is more to the story.

To determine the true number of well completions you also must factor in wells that are on the North Dakota Confidential Well List.

What is a confidential well?  Here is the North Dakota Department of Mineral Resources explaining:
When an operator requests and is granted confidential (tight hole) status for a well, it restricts our ability to release information about the well. Section 43-02-03-31 of the North Dakota Administrative Code states in part:

All information furnished to the director on new permits, except the operator name, well name, location, spacing or drilling unit description, spud date, rig contractor, and any production runs, shall be kept confidential for not more than six months if requested by the operator in writing. The six-month period shall commence on the date the well is completed or the date the written request is received, whichever is earlier.
Any confidential well that was completed during the month of November would not be included in the number of completions (26) quoted by the Director’s Cut.

Given that the confidential list that currently includes 1,836 wells that could mean a significant number of wells are excluded.

For more perspective on the size of the confidential well list—consider  that there were 13,077 producing wells in total in North Dakota in November.

It wasn’t easy, but I found a way to find out how many confidential wells were completed.  Most of the information about these wells is kept private for 6 months.  But not all of the information.

Any production runs (oil sales) from these wells are reported.  If a well is selling oil, clearly it has been completed.

There is no single spreadsheet or database of those oil sales.

However if you are willing to look up each individual well and record when oil sales started you can estimate the completion date.

It is a painful process, but I decided to do it.  Then I stopped doing it when I found another piece of info in the daily reports that summarizes confidential wells that have commenced producing or have been plugged.  I guessed that would be the number (assumed that no wells would need to be plugged) and NDIC Director Lynn Helms confirmed it.

When I counted confidential wells that started selling oil in November I found 26 of them:

Date Confidential Selling Oil
2-Nov-15 1
3-Nov-15 0
4-Nov-15 0
5-Nov-15 2
6-Nov-15 1
9-Nov-15 3
10-Nov-15 0
12-Nov-15 0
13-Nov-15 1
16-Nov-15 3
17-Nov-15 3
18-Nov-15 4
19-Nov-15 0
20-Nov-15 4
23-Nov-15 1
24-Nov-15 0
25-Nov-15 2
30-Nov-15 1
   
Total 26

That would suggest that the true number of completions in the month of November was 67 (41 in the daily activity reports and 26 confidential wells) and not 26 as reported in the Director’s Cut.

Oil Market Data Quality Issues Isn’t Unique To North Dakota

The oil production data that comes out of North Dakota is arguably important for investors, and mistakes like this really shouldn’t happen.

A quick common sense review of the numbers suggests that 26 completions has to be wrong.

But don’t be too hard on these guys.  The oil reporting agencies with much, much bigger budgets make much bigger mistakes.

All the time.

John Kemp from Reuters last week had a great article on the questionable quality of oil market data.  In particular Kemp detailed the

International Energy Agency’s historical difficulties in forecasting global oil demand.

This is an issue I also touched on earlier this year when I referred to the following findings from Raymond James:

US brokerage firm Raymond James took the IEA’s initial reporting of global oil supply and demand over a 15 year period and compared it to what the IEA’s final figures were for the same period several years later.
They found that on average the IEA had to revise its demand estimates higher by 700,000 barrels per day.

It is one thing to make a mistake.  But the IEA underestimates demand over and over and over again!

Considering these data challenges you can see why predicting where oil prices are headed is so difficult.

Remember my analogy of digging to find buried treasure—and sometimes coming up empty? That’s what this exercise was, in the sense that it did NOT change how I would invest in the energy sector right now.

But it does prove that nobody really knows what is happening in the oil market unless they’re looking at history, and not trying to foretell the future.

EDITORS NOTE—I don’t wait for oil to go up in my portfolio.  I go out and find energy stocks that have good looking stock charts and even better looking financials.  Like my solar “royalty” stock that has already increased its dividend in 2016.  You just have to know where to look. LOOK HERE to get the symbol of this 2016 winner.

How Many Energy Related Companies Have Upped Their Dividend in 2016 Already

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Do you know what a royalty is?

I don’t mean the Queen of England.  In business, it’s where one party gets a small slice of revenue—with no costs.

It’s a free ride.

In oil and gas, it’s often called a GORR—Gross OverRiding Royalty. In mining, it’s often called an NSR—Net Smelter Return, or NPI—Net Profits Interest.

But I like to keep things simple.  I call it a free ride.

It’s the most lucrative kind of revenue.  And I’ve found a company that is like a royalty company for solar in the USA.

Their business model gives them a call on solar growth in America.  If solar doesn’t grow, it costs them almost nothing.

But if it does grow—and the recent 3 year extension of solar tax credits says it will—this company stands to grow at an incredible rate for the next three years.

I’ve never seen anything like it.  The business model is so profitable, they already increased their dividend once in 2016.

No debt. Growing dividend. And they make their money in US dollars.

And not a single solar analyst covers it—probably because they don’t need to raise money.

Finding such a strong growth stock like this—ahead of the analysts—happens once in a generation.

I expect this company to raise dividends AGAIN in 2016.  That will get the Market’s attention—and likely cause a big jump in valuation.

Get the name and symbol of this stock before the rest of the Market.

Keith Schaefer
Editor/Publisher
Oil and Gas Investments Bulletin

The Only Commodity Going Up In Price in 2016

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Commodity’ is now a four letter word.

Metal prices have collapsed.  Oil is plummeting.  Natural gas and coal are struggling, and iron ore is on death’s door.

But right now, there is one commodity that everyone agrees will rise in price this year.

The Big Banks are piling into the idea. Analyst reports are appearing left and right touting the opportunity.

And it’s a real opportunity: demand is rising steadily and suppliers are racing to keep up, creating a very tight market that should keep prices strong.

The commodity is lithium, and its future is in energy.

There is likely a lithium-ion battery sitting beside you right now – perhaps several—because lithium-ion is the battery of choice for cell phones, laptops, tablets, cameras, and power tools. Lithium demand from these consumer electronics represents just under 30% of the current market, or about 53,000 tonnes of lithium carbonate annually.

Consumer electronics will need 4 to 5% more lithium each year for the rest of the decade. That means the world’s phones, tablets, and power drills will eat up 67,000 tonnes of LCE a year by 2020.

So even if demand for lithium stayed limited to industrial applications and consumer electronics, it would still ramp up 20% in just four years.

But it will not stay so limited. There’s a bigger side to the story.

Electric cars.

There are not a lot of electric vehicles on the road today, but that will change. Goldman Sachs expects electric vehicles will make up 22% of the auto market by 2025, up from just 3% now.

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For every 1% increase in electric vehicle market share, Goldman Sachs expects lithium demand to rise by 70,000 tonnes per year.

The lithium market today is only 160,000 tonnes. That means demand from electric vehicles alone could triple the size of the entire lithium market by 2025, taking it from 160,000 tonnes today to 470,000 tonnes.

Investors are looking at a dramatic lithium market expansion.

Electric Vehicles (EV) – How Certain?

With oil getting cheaper every day—even in the long-dated futures curve—how can we investors be sure EVs will succeed?

Because governments are serious about supporting electric transportation.

Worldwide, they are spending US$16 billion to develop charging infrastructure, pay for EV incentives, and support research and development. As a result 14% of the cars bought in Norway in 2014 were electric.

And then there’s China. EVs are only 1% of the Chinese car market right now, but sales increased almost 300% in 2015.  China subsidizes almost half the purchase price of a new EV. There’s no sales tax.  They don’t need to win a lottery to buy one, and can drive it every day, not on odd or even days.

Even as lithium prices are now moving up, they only account for 2% of the total battery cost of an EV—so a big increase in price won’t impact the market much if at all.

Demand is rising. What about supply? 

Lithium is produced from two places – liquid solutions called brines, from salt flats or salars, and traditional hard rock mining.

Four companies dominate the global lithium space:

  • Albemarle (NYSE: ABL): Operates the Salar de Atacama brine mine in Chile and the Silver Peak brine mine in the US. Owns 49% of the huge Greenbushes hard rock mine in Western Australia.
  • SQM (NYSE: SQM): Operates another mine, also called the Salar de Atacama mine, in Chile.
  • FMC (NYSE: FMC): Operates the Salar de Hombre Meurto brine mine in Argentina.
  • Sichuan Tianqi: China’s lithium giant. Produces from brines in China; operates numerous conversion facilities to process spodumene concentrates. Owns 51% of the Greenbushes mine in Australia

Together, these four produce almost all of the world’s lithium. All are diversified companies that enjoy making money from their lithium units, and to that all would like to expand operations.

But it’s not that simple.

SQM would love to boost its output, but instead its operations are running at only 50% of capacity. It is being stymied by a host of environmental and government issues that do not look to be resolved any time soon.

FMC is similarly running at only 60% of capacity, constrained by technical issues with its evaporation ponds and stressed relations with the local government. Relations are so strained that water was cut off to the mine at one point last year.

Albemarle wants to expand its Salar de Atacama operation but is struggling to earn permission from the Chilean government, which is concerned that depleting brines could impact nearby freshwater aquifers.
In other words, increasing output is not simple.

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Existing operations are not enough. If supply is to keep up with the coming tsunami of demand, new capacity from new players needs to emerge in the next few years.

Brines only exist in select spots. In several of those places – read Argentina and Chile – brine mining is fraught. We’re talking about some of the driest places on earth, so water is carefully guarded and tapping underground brines raises concern that nearby aquifers will be drained or contaminated. Then there are the massive evaporation ponds, which no one much likes.

Hard rock deposits are more common, but they have to carry enough grade and sit in a way that mining is economic.

Looking across the list, there are 16 projects that could potentially reach production by 2020. Only three stand a chance of producing by the end of 2017.

More generally, it would be wildly optimistic to think all 16 will make it. But many are trapped in companies with broken balance sheets and inflated share structures.  They may or may not be able to raise money.

Here’s Citi’s take on the situation.

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Compare that with the demand curve:

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The market is very tight.

The more conservative forecasts have supply just keeping up with demand. As long as a mine or two manages to come on line each year until 2020, the world would have between 4,000 and 10,000 tonnes of LCE surplus each year.

Compared to a market of 200,000 to 300,000 tonnes, that is basically nothing.

Existing producers are struggling to use their existing capacity let alone expand, because of technical and permitting challenges.

Their struggles mean new supply growth will be up to new market players. Many will try. Some will succeed. Others will undoubtedly fail.

That means two things:
1) a very tight lithium market will support strong prices
2) to profit off those prices, investors will have to bet on the best in the business – the ones that will make it.

Lithium doesn’t have an open price like oil or copper; rather it’s negotiated directly between buyers and sellers.  On the official side, FMC (FMC-NYSE) announced a 15% price increase across the board on October 1st.

On the rumor side, there has been lots of chatter about lithium carbonate selling for US$6,500 per tonne of late. Many say prices have been even higher in parts of China where supplies are already tight.

“Lithium is a very opaque market, making accurate pricing data hard to come by. What I can tell you is that…the “Big 3” have signed a few full year 2016 contracts in the low $6,000 range, however most customers around the world will pay substantially more than $6,000 per tonne for lithium carbonate this year.” Joe Lowry, independent lithium expert.

Indeed, recent stories tell of spot transactions at $10,000 per tonne. And analysts resoundingly agree that prices will remain strong until the end of the decade – even if the precise price remains veiled.

“Lithium is the new gasoline.” Goldman Sachs, December 2015.

Lithium will power the world’s ballooning fleet of electric vehicles. It energizes your smartphone, your power drill, and your camera. It is needed to manufacture ceramics and glass.

Demand is rising rapidly. The four companies that have controlled supply for years cannot respond. New players need to bring new mines on line.

It’s the kind of very real supply-demand equation that bankers and brokers love – and haven’t seen in years. They are piling in. Junior companies are jumping aboard as well, snagging potentially prospective lithium properties.

It has all the makings of a multi-year bull run, driven by the world’s ‘new gasoline’. And this is just the first inning of this run.

Investing in the right company, or really the right management team, can make you rich.  In my next story, I’ll tell you the name and symbol of the company I’ve invested in, because the Chairman has done it before—creating a 10 bagger, a 15 bagger and a 20 bagger in his last three companies.  That’s life-changing wealth. And each time it only took him 2 ½ years.

Stay tuned.

Keith Schaefer

There’s Green on the Screen with these Stocks

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You know the kind of stocks I like?

1)    Stocks that have lots of upside, and almost no downside.
2)    Stocks with high profit margins
3)    Stocks that increase their dividend
4)    Stocks that are riding the Global Wave of an Unstoppable Force.

I’ve found the stock that fits all these criteria.  In fact this company is doing so well they increased their dividend once already in 2016.

This industry’s growth rate is not only incredible, it’s increasing.  Nations around the world are jumping on board, and this company is reaping the rewards; I’m reaping the rewards.

Get the full story now, before the institutions do.