Investor Opportunities in the SmartGrid

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The SmartGrid is here to redefine how we generate, deliver, and pay for electricity—and that will be a big opportunity for energy investors in 2016.

The SmartGrid will help utilities reduce demand among their customer base during the very expensive peak periods, and cost-effectively increase their use of renewable energy.

The good news for investors is that there are a lot of small to medium sized public companies creating the innovations that these utilities will have to spend billions of dollars on to modernize the US grid, and keep rates low for customers in a market that’s getting more de-regulated and competitive all the time. (The EIA reported today that wholesale US electricity prices dropped 25-35% in 2015–that’s huge!)

To better focus my research on which stocks to buy, I’m attending the Grid Modernization Forum at the Chicago Conference Centre Jan 19-20 (http://www.grid-modernization-forum.com/).

I’ll be meeting with key technology innovators and executives who are attending to share perspectives on how best to leverage their investments, and take the SmartGrid to the next level.

One of those executives is Tom Hulsebosch, Managing Director of West Monroe Partners, a consulting firm with a division specializing in utilities and the electrical grid. Hulsebosch leads the firm’s efforts in developing smart grid and sustainability programs for utilities.

The SmartGrid is barely out of the womb—new standards, new products, new services are just being developed and fighting for market share—and Hulsebosch is helping this baby grow.

In a 45 minute phone interview last week, he shared some great insights into the investment opportunities happening, and some of the smaller public companies moving to take advantage of them.

What’s exciting to me is that most of this innovation is on the edge of the grid and is happening outside of the utilities’ control—the Market is deciding which new technologies and companies will be King (i.e. the Amazon or Microsoft of their niche) and Hulsebosch says utilities will have to adapt and interface with the New Winners.

Hulsebosch says the innovation is happening at the very far end of the power grid, nearest the customer.

“If you think about the electrical network there are 3 key parts – generation, transmission and distribution. Smart grid innovation is happening around that distribution and distributed energy generation and soon battery power.”

He points to solar and battery storage as an exciting new area, especially in areas where the price for power varies dramatically between night and day.  With a home battery, residential and commercial accounts could charge at night—and in some places in the US, night power only costs 20% of daytime power—and then use that energy during the day, saving a lot of money.

“These advanced rates can enable new innovative products to take advantage of this pricing differential and make the business case for things like home energy storage and solar.” says Hulsebosch.

As an example of home innovation that rewarded investors, Hulsebosch point to Nest, which was bought out by Google in 2014 for $3.2 billion—likely the market cap of the entire thermostat market!

Of course Google wants all the home usage data.  They’re going to learn all about when people are home and away and habits and figure out new ways to monetize that data and insights to customer behavior. So it was a strategic play by Google.

“They created a very cool interface to the thermostat. It’s a learning device that tries to figure out when you’re home or away, automatically saving energy when you’re away.  Nest has integrated motion sensors on their devices all over. which include carbon monoxide and smoke detectors.

“Not only does it provide a great customer experience, but it helps people save money.  They’ve taken a lot of complex concepts and made them easy to use.

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Hulsebosch says utilities are incentivizing customers to buy a Nest thermostat. The utility doesn’t have to install or manage the thermostat; it’s being done between Nest, the contractor, and the homeowner.  The utility can send Nest a price or “curtailment” signal into their Cloud application to reduce or increase temperature during peak periods–and Nest makes the adjustment to the thermostat. The customer feels good about being green and in many programs receives a credit on their bill for being part of the program.

This is called ‘Demand Response’ and Hulsebosch says this is a great example of a win-win between an innovative company like Nest, the homeowner, and the utility.

There is an entire public company dedicated to demand response—Enernoc (ENOC-NASD).

Hulsebosch says there are lots of other potential Smart devices for your home that could save you money when a utility deploys smart grid which enables advanced rates.

“You may also have other smart switches so you could remotely control your outlets, your pool pump.  And appliance companies like Whirlpool are providing ways to control when the refrigerator goes into the defrost cycle when energy is cheaper. To really take off these technologies will need to be ‘set and forget’ because most people don’t really care alot about saving on their electricity bill.

“This is where innovation is in the customer interface, like what we see in the Nest products.  This could help make these smart devices in our homes and building more ubiquitous. How do you create ‘set and forget’ solution and take advantage of the new energy paradigm?”

I asked Hulsebosch to voice the new energy paradigm in his own words:

“I would say we’re doing a couple things here that are pretty exciting around the smart grids that are enabling this new energy paradigm.  One is we’re providing customers with near real-time feedback–or a speedometer–on how much energy they are using through the smart meters.  The smart meters enable this feedback to the customer and all the utility to bill customers not only based on how much energy they use, but when they use it.”

“We are seeing more compelling applications that use this smart meter data. And example is where  the utility allows the customer set a budget for how much they don’t want their bill to exceed.  If the application anticipates that the customer’s bill will exceed their desired budget it will flag the customer that at the current consumption level and they will not hit their budgeted amount.

“For larger energy users like commercial and industrial users this could be very helpful on a couple of fronts since excessive energy use could also indicate they have a maintenance issue on a piece of equipment.”

“The second key area that is very exciting is around the integration of Distributed Energy Resources including battery storage and solar into the electric grid at higher levels of penetration.  Customer owned DER is an exciting shift in the new energy paradigm and when we combine this with the new advanced rates I expect to see new innovative solutions and customer business models.”

DER means anybody else besides the utility generating electricity–like homeowners with rooftop solar who sell excess electriticity to the Grid. “Advanced rates” means a highly variable rate structure for electricity during the day, where peak time usage is SEVERAL times more expensive than night time.

Hulsebosch says he never would have guessed that one of the coolest things coming out of the smart grid would be a thermostat.  But he says that’s a sign investors should be looking close to the home for innovation and therefore, capital gains.

“I think the space where we will see new innovative energy technologies and companies is around the smart home/office.  These companies will be creating  a compelling customer interface around their solutions that enable energy savings and the integration of distributed generation.

He says he’s not seeing many new companies come innovating close to the utility. “It is at the edges where I expect to see innovative new companies with investment opportunities,” he says

The edges of the energy market are where I’ve made all my money in the last few years.  In Part II of this interview, Hulsebosch and I discuss other areas of the SmartGrid and mention a couple small caps succeeding in their niche.

PS—You can join me at the conference—register today.

Where Americans Should be Investing Right Now

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The Canadian dollar has dropped 25% against the US dollar in the last 18 months, going from 94 cents to 71 cents.  That’s horrible news for Canadian drivers, as the lower loonie (as Canada’s dollar is affectionately nicknamed) has almost completely eliminated any savings at the pump, while oil prices dropped from $110 – $37.

But for Canadian light oil producers–and their investors–it has shielded them from even more pain.  For those lucky few producers, this chart is their favourite one in the world right now:

CAD boostSource of Data: Bank of Canada

That is the “boost” to cash flow that Canadian light oil producers are getting—and heavy oil producers to a degree—thanks to a loonie that has gotten weaker and weaker since the oil price started to falter 18 months ago.

In early July 2014, you could only get CAD$1.065 from a USD, or “greenback”.  On December 21, 2015 you could get $1.40!

Here is how Canadian producers—with Canadian properties—benefit from a weak loonie:

Canadian producers sell their oil in US dollars but account for revenue in Canadian dollars.  So as the US dollar rises—so does the amount a Canadian producer receives per barrel of oil.

More revenue, but no difference in expenses–as Canadian light oil producers with Canadian properties have expenses that are paid in Canadian dollars.  Those would include salaries, royalties, drilling costs, interest and everything else.

A strong U.S. dollar therefore helps revenue, but has no impact on expense.  That means more profit!

Back in July 2014, these Canadian producers were getting a 5-7% boost to revenue because of the exchange rate differential.  Today that boost is close to 40%.

The chart below tracks the WTI oil price in both US and Canadian dollars.  The spread between the two has widened as the loonie has weakened over 2015.

spreadSource of data: EIA and Bank of Canada

The graph shows how significant this exchange rate boost has been.  With WTI  sitting at $35 per barrel right before Christmas—and the exchange rate nearly 1.40—WTI in Canadian terms is nearly $50 per barrel.

The chart above is simplified of course, as it just takes the WTI price and multiplies it by the exchange rate on each day.

In the real world the Canadian light oil producers must also deal with a differential price from WTI.  That differential over time should generally equal the cost of transporting the oil from Canada to the WTI pricing hub in Cushing Oklahoma.

On Dec 21 that differential was only $3.50/barrel, which means that Canadian light oil producers were receiving WTI price $35.80 – $3.50 = $32.30 in U.S. dollars.  Once converted to Canadian at a 1.395 exchange rate the price in Canadian dollars is $45.05.

$45.05 is certainly NOT an attractive price for oil—but it is certainly better than $32.30.

The cash inflow difference for a 40,000 barrel per day Canadian producer of light oil at the current USD WTI prices because of this exchange boost would look like this:

  • 365 days x 40,000 barrels per day x $32.30 = $472 million
  • 365 days x 40,000 barrels per day x $45.05 = $657 million

If the loonie was trading at parity with the U.S. dollar today a 40,000 barrel per day light oil producer would be generating revenue of $472 million.

With the loonie at 1.395 that same producer is generating $657 million.

That is a $185 million difference in revenue almost all of which will flow through to cash flow since costs are based in Canadian dollars.

For a producer in that situation the weak loonie has been an enormous benefit.  I’ve focused on light oil producers for this story as the big heavy oil producers have to buy a lot of their equipment and capex in American dollars.

But it’s still bad–the rate of bankruptcies in Calgary is now occurring at a depressing rate.  A large percentage of the companies in this industry were built for $90 per barrel oil, not $30 per barrel.  Very low natural gas prices has only worsened the issue.

But without the help from the weak Canadian dollar it would be even worse.

An Interesting Proposition For American Investors

Just as the price of oil and the U.S. dollar have a very direct inverse relationship the Canadian dollar and oil are joined at the hip.

Since February of 2015 the correlation between the loonie and oil has been 94%.

correlation

Canadian light oil producers have seen their stocks crushed, despite the loonie collapse and better balance sheets than their American counterparts.

That might create an appealing opportunity for American investors who want long term exposure to oil.  Here’s why:

  • Investing culture in Canada rarely allows producers to load up on debt and as a result Canadian companies went into this oil price rout with much better balance sheets than the Americans
  • The weak loonie has helped deflect some of the oil price blow that U.S. producers have taken on the chin
  • When oil prices reverse and stock prices turn higher so too will the Canadian dollar—giving American holders of Canadian light oil equities both stock and currency gains
  • The best in class Canadian producers are still paying a dividend even after a year of depressed prices

Let me walk through the leverage that exists here for American investors.  I’ll use Whitecap Resources (WCP-TSX) as an example (I am not long).  It’s a high quality Canadian light oil producer with a balance sheet that is built to last. It produces roughly 40,000 boepd and 77% is oil and other liquids.

On Dec. 21 Whitecap shares traded on the TSX for roughly $8.87 CAD per share ($6.35 USD).   If oil heads higher in 2016 and Whitecap shares rally to $13.30 CAD Canadian investors are going enjoy a 50% return.

The return or American investors in US dollar terms is likely to be considerably better.  If oil heads higher almost assuredly so too will the Canadian dollar.

If the share price above in Whitecap takes place and the Canadian dollar also strengthens from $1.40 to $1.20 (a fairly reasonable assumption if oil goes to US$60WTI) an American investor holding Whitecap is going see his shares increase from $6.35 USD to $11.08 USD (the $13.30 CAD share price at a 1.20 exchange) which is 75% gain.
That would be a powerful double reward.

The cherry on top of a company like Whitecap is that is pays a monthly dividend in Canadian dollars of $0.0625 which on the current share price represents an 8.5% yield.  A yield which would also increase for U.S. investors if the loonie strengthens.

This investing thesis is fine for foreign investors—but only for a select group of light oil producers in Canada.  Heavy oil producers and particularly oilsands producers do have a lot of costs in US dollars; oilsands has very high upfront costs.  And heavy oil gets a much lower price than light oil; Canadian heavy oil touched US$22/barrel right before Christmas.

Since only 20 percent of Canadian oil production is light oil there are really only a handful of companies with solely light oil in their production mix.

What I Did Wrong; What I Did Right in 2015

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Trading mistakes.  Looking back on 2015, I made the same ones! (Visual—bang head against wall repeatedly).  I’m going to tell you what I did wrong and what I did right in 2015, and where I see The Big Money being made in energy in 2016.

The key to investing of course is knowing who you are, and who you’re not.  I’m not patient.  I don’t like to buy deep value.  I like expensive stocks—they stay expensive because of good management teams.  One of my gifts is sensing when a trend or a stock is about to have critical mass, and finding the best stock to play that.  So that’s a bit of momentum trading.  I want to hold my positions for 9-15 months and make 50%.  That’s who I am.

(Generally, if subscribers sell my picks 6 months to the day after I initially bought it, they do the best—I’ve let a couple triples and doubles get away from me by not following that self-knowledge.)

My One Big Trading Mistake of 2015?—no stop losses on the stocks I love.  I had two big positions this year, one in energy services, and one junior producer, that went down about 2/3rds from their high 15-16 months ago.

(The producer was Canamax, which just got bought out for a next-day-double in early December.)

Why did I hold them, if I’m trying to make money in the market?  It’s such a litany of the regular excuses—but basically I fell in love with the company.  Traders need to be heartless b!W#$%, and there are times I’m not.

The services company in particular adds value to its customers like no other pubco I have ever seen. They’re innovative, creative, disciplined…and hey, they’ve raised the dividend over a dozen times since I bought the stock 5 years ago.  I’m actually getting paid over 20% yield on some of my stock…

OMG, just listen to me there. What I didn’t listen to was the price action—and now the stock is down 66% from its high.

Normally, when a winning stock comes off 20% from setting a new all time high, I really look at the stock again.  A 20% drop generally means the stock has to recycle (shareholder turnover) for awhile. It’s a great time to re-look at the business and the stock.

And despite my appreciation and affection for the company, the simple answer is always—sell half.  Then you’re always right.  And this stock had split 9:1 (nine new for every one old!) on me—so I had lots.

I tell other people—if you look at a stock more than twice a month, sell enough that you don’t look at it more than that.   That’s what I should have done with all my energy stocks as they were collapsing.

Some stocks were so junior they were illiquid and had no bids.   I still own them but don’t pay much attention to my zombies.

I traded  myself out of my Valero position for a small loss in the summer at $58, after calling it The Trade of the Year in January. I got nervous about the stock pattern.  I bought it starting at $53, all the way up to $65…so my average cost was about $58.  The stock never pierced through support, but it sat at its support line for a month, and I felt I was watching the stock too closely…always a sign I own too much.  Instead of prudently selling half, I sold it all, only to watch it run to $71 within 4 months!

I did a few things right this year:

  1. I believed that nobody knew a thing about where oil prices were going.  I didn’t pay any attention to Big Company CEOs, or highly respected global consultants.  Fundamentals were changing SO fast, nobody had accurate enough data to really understand what’s happening.  And that is still the case.  One of my lines is—I don’t care what I think; listen to Mr. Market.

This was the year the Market really understood that the EIA and IEA truly didn’t know anything more than private industry—and in fact generally they knew less.  (Yet the Market still trades off of the weekly numbers for oil and gas).

2. What that meant for my trading was–that I was very flexible; willing to take a 10% loss quickly on any trades.  Stop losses were some of my best trades.

  1. Diversify into downstream investments.  The global energy complex has
    1. Upstream–where the energy is in the ground; i.e. producers and service companies
    2. Midstream—Pipelines; getting the energy closer to the consumer
    3. Downstream—refiners, energy retailers, power companies

Upstream and Midstream companies have taken a beating this year, but sub-sectors like refineries and energy retailers have actually done very well—and that’s where I put most of my money this year.

If investors wanted exposure to producers in 2015, it was a year of only owning the leaders, which by definition trade at a premium.  Generally, I like expensive stocks.  They are expensive because they have the best management teams who can survive in down times and thrive in good times.  These stocks get A Big Bounce first, before the lesser lights move up.

  1. Buy Big on your conviction picks.  2015 will still be my first year with a loss in my completed trades account since I started in 2009.  But overall, my OGIB portfolio—my real money, not a ‘paper’ or ‘model’ portfolio—is likely only going to be down 5-6%.  The main reason for that performance is—and this is true almost every year—my One Big Stock; my Fat Pitch (a downstream stock)—worked out.  History says I find one high conviction pick a year, and God Bless me they have all worked except one; Poseidon in 2012 (even that was a triple for a year).

Looking forward into 2016, I confess I’m not focused on catching The Big Rallies in oil.  Big moves are almost ALWAYS counter-trend.

I still own small positions in Best of Breed upstream companies to catch upside to a rising oil price…and I will be watching for a big supply response in the US—where oil production drops another 500,000 bopd or more.  This would be a catalyst for the oil price and stocks…BUT…oil has to jump a full $20-$25/barrel from today’s $34 for most juniors and intermediates to grow meaningfully within cash flow, and warrant a 6-9x cash flow.  Every other move is a trading rally, and I don’t want to stare at my screen all day trying to outguess the Market.

I would rather look for The Big Uptrends. That has been the oil price for the last few years.  But into 2016, I think the next bubble in energy could easily be downstream–The Smart Grid, as the US (and really all the world) moves to include wind and solar  into their power mix.  It means massive new capex spending, and is creating new opportunities with new technologies for energy savings for both utilities and customers.

As an example, cities all over the world—in Asia too—are putting small computer chips in their streetlights as they move to LEDs, creating a new network that can host all kinds of new apps.  The power and flexibility of this network is will jump 5-fold in 2016.

The cell phone went from being dumb 10 years ago to now being so smart it’s the #1 economic generator for the entire Third World.  The new networks that cities are putting up will reshape how energy is produced and consumed—in the US first, but all around the world.

Investors really can’t even imagine the features and benefits of this new network 10 years from now—just as we couldn’t have envisioned what the IPhone would do 10 years ago.

That’s where I think The Big Money is for 2016.

EDITORS NOTE:  This kind of stock rarely comes along.  Debt free, highly profitable—and THREE growth catalysts that are just starting to hit their stride.  It’s going to make my 2016 one of the most profitable ever.  The Street is just warming up to  the company now—so get the symbol and all the details before this goes mainstream—RIGHT NOW

This is What Happens When You Hit the Panic Button

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Tanker stocks around the globe were crushed on Thursday as the TeeKay group–with six US listed equities and bonds–reduced their dividend to shore up their balance sheet.

That was my oppotunity–and for OGIB subscribers. I’ve been following another tanker group–Golar (GLNG-NASD) and Golar Partners (GMLP-NASD) for years.  I knew the companies, I had spoken to management for years and I knew how the stocks traded.

And I knew they were in much better financial shape than TeeKay: Golar has lower payout ratios and less debt.  So when Golar dropped a massive 35% in a matter of hours due to the TeeKay scare, I alerted subscribers at a price of US$8.26.  My yield at that price on a US$2.31 dividend is 28% even.  This is on a stock that is regularly paying down its debtload, covering its dividend payments and just beat the Street in Q3 financials.

Now, TeeKay has a bigger fleet and has ships for both oil and gas, whereas Golar is exclusively a natural gas shipper–LNG.  And the decline in LNG prices has actually increased the trade traffic.  Golar also owns several floating LNG import terminals, called FSRUs–Floating Storage and Regasification Units.  This is the hottest subsector of the global energy complex, with 5 new FSRUs ordered in the last 12 months.  FSRUs are less than half the cost and can be delivered in  half the time of a massive land based terminal.  And of course, they can be moved if economics in the region change–it’s a ship after all!

Friday, the stock gapped open higher to over $12–and OGIB subscribers took great and fast profits. Here are some emails from my inbox this morning:

Thanks for the GMLP suggestion.  I took my 28% one day gain.  My wife and I will toast you tonight when we go out to dinner.- John C

Keith.  Followed you on gmlp yesterday and made $18,000 US in less than 24 hrs!  As a snowbird this is sweet!
Thanks and Merry Christmas  
Jack in Calgary

Thank you for GMLP Have you ever thought about expanding your service to include one more industry other than OIL-  Happy subscriber!!!  A  Lynch, Maryland

Great call. Thanks for bringing that one to our attention.   Jason P

Great Trade on the GMLP. I was out of the office and therefore missed it – but it is a great call anyway. Have a wonderful Holiday Season. Brian in B.C.

Thank you for the instant reply, you are the best, have to get more of my friends to join OGIB, got two poker buddies for you last year. Very much appreciate your spin on what you are doing, just going to follow your lead. No pressure Keith, keep up the good work. – Steve R, Saskatchewan

I’ve been sitting on lots of cash this year.  So I had lots of dry powder for this trade. Be patient and wait for your time with your stocks.

This is the second quick money for OGIB subscribers in December.  On December 4, my largest junior oil position, Canamax Energy (CAC-TSXv) was taken private at a 90% premium to market–giving me personally over $100,000 in liquidity (at a profit!) and cashing up many OGIB subscribers–just in time for Christmas.

Note: Text of bulletin that was sent out to paid subscribers is attached below:

PORTFOLIO PURCHASE

GOLAR LNG PARTNERS
GMLP-NASD

TeeKay, one of the largest tanker groups in the world, eliminated ALL their distributions today across all their publicly listed companies.

That is causing every tanker stock on earth to collapse today.

So I bought xxxx shares of GMLP at $8.26. GMLP is Golar LNG Partners–part of the Golar group. I have bought and sold these stocks a lot over the years.  They are now managed by Tor Olav Troim, and the infamous John Fredriksen (a genius in his own right, but a cowboy) is no longer involved.

GLNG is a C-Corp (regular corporation) and GMLP is ALSO C-Corp as well–it is NOT an MLP. (They don’t file K1s)

At the current $8.02 price, GMLP now has an 28.8% yield (US$0.5775 per quarter or $2.31/yr).  It has a contract backlog of 5.2 years on its fleet of ships (5 LNG carriers and 6 FSRUs) and over $2 billion in revenue.  It does have 3.4x debt to cash flow at $1.275 billion, and an EV/EBITDA of 5.2 ($1.8 billion/$346 million)

The Street has been trading down all the MLP stocks all year (GMLP has debt and distributions like an MLP, and has the symbol GMLP, but it’s not an MLP), but today is ultimate fear day, and I’m buying stock.

The MLP game is built on the idea that high distributions that are ALLEGEDLY not impacted by commodity prices will exact a big premium from the Market.  And for a few years that was true.

This year it has been well documented by both stock prices and scribes like analysts and newsletter writers–that is not the case.  Hence the Great MLP collapse of 2015.

Now let me tell you where I think GMLP might be different.  One is that as natgas and LNG (Liquid Natural Gas) prices around the world have collapsed, interest and demand in FSRUs–Floating Storage and Regasification Units (floating import terminals for LNG) has gone way up.

FSRUs are now the preferred source for LNG–they are less than half the cost of a larger land based terminal and can be delivered in under half the time.  Operating costs are surprisingly similar.  AND, of course, they can be moved around the world because they are ships!  Tough to move a 200 acre land parcel, no matter how many barges you have ;-)

FSRUs are also contracted on longer terms–usually 5-10 years.  So their cash flows get a bit bigger multiple.  GMLP now has six FSRUs operating, and a 7th, the Tundra, that was recently contracted out for just 5 years.

Worldwide, 5 FSRUs have been contracted in the last 12 months, the most ever.

There is lots of LNG liquefaction coming onstream in both Australia and the US right now, so that should tighten up the LNG carrier market as well.  I think that’s about bottoming right now.

GMLP has 3 LNG carriers coming off contract in two years, at the end of 2017.  The Street is nervous those contracts will get re-done at much lower levels.  That’s probably true, but GMLP only owns 60% of one of them, and with all this new liquefaction, rates may not go as low as the Market thinks–or certainly as low as is pricing in now.

There is still a good chance that as we near the end of 2017, the dividend takes a 10-20% hit.  At 28.5% yield, that’s priced in.  The current coverage ratio is 1.34, and has averaged 1.23 since 2013.

Contrast that to the main Teekay companies, TGP and TOO, which have coverage ratios under 1–0.96 and 0.86.

GLNG only owns 30% of GMLP now; they don’t control it but obviously have some say in it.  It totally makes sense for GLNG to buy it back now, it’s so cheap.

Notably GMLP has no future capital requirements–it can choose to accept new ships from GLNG as it wants now.

With 62.87 million shares out, the stock at $8.50 has a market cap of $534.4 million, and an EV of $1.8 billion.

Thomson Reuters shows consensus estimate of $346 million for 2015 EBITDA, and $364 million for 2016.

EPS estimates are $2.58 for 2015 and $2.82 for 2016.  8.5/2.58=PE ratio of 3x.

I WILL DO A MORE THOROUGH UPDATE ON GMLP LATER THIS MONTH

You know what the key has been to me making money in oil and gas in 2015? NOT investing in oil and gas, but in tanker stocks, refineries, energy retailers and SmartGrid stocks.

SmartGrid stocks especially are an incredible opportunity and I am looking at one company especially that looks to be my favourite for 2016.  This US-listed company has over $100 million cash, no debt, and is growing at an incredible rate–not  just in the US, but in Canada, Australia and Europe.  It’s a global story. And the Market is just starting to recognize it. Early in the New Year, you’ll get an exclusive look at it, right here.

The Entire OilPatch is Watching This Court Case on Wednesday

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Here is an energy issue I thought would have been resolved years ago–but it’s going to court this week in Alberta.  The central question is simple–what takes priority if a producer goes bankrupt–environmental liabilities to plug & abandon (P&A) wells, or creditors.

What’s happening is that the Alberta Energy Regulator (AER) is asking receiver Grant Thornton to set aside enough money in the receivership of bankrupt Redwater Energy Corp. to pay for the abandonment costs of any wells they have.

If the AER wins, creditors will get less.  If Grant Thornton wins, either the taxpayer will pay or the government will possibly get the energy industry to pay more into a general liability fund–at a time when the energy industry is scraping for every penny.

Nobody wanted to speak with me as this issue is before the courts.  My understanding is that the case is Dec 16-17. The best website to review is http://www.grantthornton.ca/services/reorg/creditor_updates/redwaterenergy. Here’s an excerpt that appears to be the core issue for the AER

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I’m not an expert on P&A costs and laws.  But as a bit of background, the province of Alberta operates a “Licensee Liability Rating Program” (“LLR”). The program is designed to ensure that energy companies or the Province has funds to pay for abandoned wells. Under the program, each company is required to pay a security deposit to the AER, if their Liability Management Rating (“LMR”) is below 1.

This LMR is calculated as the ratio of a company’s “eligible deemed” assets under certain programs (i.e. LRR, facilities, oilfield waste) to the “deemed liabilities” in these programs.  Assets over liabilities.

In the Redwater case, the AER is claiming that the Receiver (Grant Thornton) must pay the province to ensure the LMR of Redwaters assets is above 1.  On the other side the Alberta Treasury Branch (ATB) and Grant Thornton is saying the money has to stay put to fulfill the Receivership fees and debts of the Company–just like it says in the Bankruptcy and Insolvency Act.

This could be a big issue in Canada if energy prices stay really low.  The precedent set in this case will decide whether the province can claim priority for closure/abandonment orders in receivership situations.

Alberta has had an “orphan well fund” for some time. The LLR program was set up so the province wouldn’t have to rely completely on the orphan well fund, and make sure oil and gas companies were paying their liabilities.

P&A liability is becoming more of an issue in a couple other areas of the oil patch.  As the junior market moved to sustainability and away from growth in 2014, many companies started buying older, more mature assets (properties with A LOT of wells with very small production, but with very low decline rates).  But now with low energy prices, many of these wells may no longer be economic at such small production rates.

I was speaking with one CEO last week who enjoys a premium-valuation, i.e. he still has a rich enough value in his stock he can do accretive acquisitions.  But they are only completing one acquisition a year because most of the others have too big a P&A liability.

Because the bottom line is–somebody has to pay to properly P&A a well.  And if the AER loses, more of this liability will be put on either taxpayers or an industry already reeling from low prices and a pending royalty review.

I have not read all of the materials of the ATB-Grant Thornton/Redwater case, but you can bet a lot of eyes will be on this case this Wednesday and Thursday.

And this is law, so while the Application is being heard December 16 and 17, several different things could happen those days. There could be a decision, a decision could come shortly after, there could be procedural issues that delays the application or the hearing could be adjourned.

EDITORS’ NOTE–As oil prices and oil stocks get crushed, my #1 pick for 2015 has been comfortingly steady.  That’s because of its high dividend, which comes from a very low payout ratio. The dividend is Big and Secure.  That’s why I expect the Market to make this stock move up in the New Year. Click Here for the Big Story.

Keith Schaefer
 

Kinder Morgan–Money for Nothing, Dividend Growth for Free No More

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Pipeline behemoth Kinder Morgan (KMI-NYSE) cut its dividend last night by 75%–ending a three year string of getting their money for nothing and your dividends for free (with apologies to the band Dire Straits).

This issue is causing investors to give all North American pipeline stocks a higher discount rate–and therefore a lower Net Present Value–on their dividends for years to come.  That has been showing up in lower stock prices for midstream (pipeline) stocks for most of the year.

As you will read below, my NPV calculation gives Kinder Morgan a price of $13.82.  And that’s with dividends growing 15% a year from the new level of 50 cents a share annually.  But the Market will like a lower payout ratio–now 22% vs. 90% previously–and will likely bid the stock higher now.

What do I mean by free dividends? The free dividends came courtesy of the U.S. Federal Reserve’s Zero Interest Rate Policy (ZIRP) of the past few years (free money!).  It allowed capital intensive businesses like pipelines to rapidly expand their asset base using low-cost debt financing.  The low-cost debt provided lots of excess cash flows–above debt service costs–that were paid out as dividends to investors, make them (and company management!) rich in the process.

All this debt-driven dividend growth led to the current income/dividend stock craze, with no sector benefitting more than the MLP sector–Master Limited Partnerships. (Canadians: think income trusts…)  One of the most beloved MLPs at the time, Kinder Morgan (now a regular C-Corp), grew revenue by more than 100% from 2011 to 2014 (from $7.9 billion in 2011 to $16.2 billion in 2014).

They did it by increasing their total asset base from $16.8 billion to $38.5 billion.  They are in the asset leasing business (owning very expensive pipelines and charging tolling fees to customers), so more assets = more income!

The $21.7 billion increase in assets was financed via a $26.6 billion increase in debt (to just over $42.7 billion) over the same period.  That allowed distributions to grow from a CAD$1.20 per unit annually rate in early 2011 to CAD$2.04 per year today.

That’s a lot of numbers, but the punch line is this:  KMI borrowed $26 billion from 2011 to 2014 to buy $22 billion of pipeline assets and nearly doubled their distributions to equity holders in the process.

In 2014, Kinder grew distributions 9% and investors believed North American oil production could grow forever and cheap credit would allow Kinder, and many others, to expand their assets into perpetuity – locking customers (oil producers) into take-or-pay contracts often spanning 20 years that would guarantee the stable cash flows.

OPEC thought differently, however, and Kinder has seen their share price decline by more than 2/3 in just one year!  With that kind of decline, it must be cheap, right?

Maybe…

Investors view MLPs (and income stocks) as cash flow streams rather than equities or operating companies, which is why they tend to be valued more richly than most companies.  Everyone loves cash.  Until last year, investors rarely questioned if MLP distributions would grow – they only asked how quickly the growth would occur and what dividends would be a few years from now.  As a result, investors simply HAD to own MLPs!

Using a simple Net Present Value model (NPV) to show that despite the surge in MLP valuations, I can show investors were actually acting quite rationally.  Kinder’s stock was $43 prior to the energy market crash.  Apply a simple 6% discount rate (roughly their cost of capital) to 9% distribution growth for 20 years, and the Net Present Value of Kinder’s dividends from 2015 onward were roughly $47 per unit, as this chart shows:

1

But as oil prices collapsed, investors saw increased risk in MLP cash flow streams – something few thought was possible just months prior.  After all, aren’t they fixed price, 20 year contacts?!?!?  In the case of Kinder, as oil prices collapsed, revenue declined from $4.266 billion in Q3 2014 to $3.57 billion in Q3 2015.

This scared investors as they realized there actually WAS risk to cash flows, and thus future dividend growth.  Using the same NPV model above, but lower the expected dividend growth rate to 4.50%–then KMI units are now worth just $30.14:

2

As you can see, a relatively small change in dividend growth expectations has a HUGE impact on the value of the cash flow stream – and thus the company.

Notice, however, the discount rate didn’t change.  The discount rate is effectively the hurdle rate – or minimum rate – investors believe they need to earn in order to justify risking their hard-earned money in an investment.  When interest rates are low and times are good, discount rates can be very low (sub 5%).  When interest rates increase, investors have alternatives–some of you may remember the days when savings accounts offered 5% interest rates!

When a sector is believed to be risky, as the entire energy sector is today, investors want higher returns to compensate for the risk.  Would you buy an interest in an oil well today promising a 5% return?  Probably not!  10%?  Nope…  Start talking 30% to 50% and I’ll sit down and listen to the pitch.

While sub-5% rates of return were previously the norm back in the good old days  of 2014 (when KMI yielded 4.6%), in today’s market investors want MUCH higher returns…  I could make a pretty long list of companies offering 10%+ yields that I would not buy today.  In the case of KMI, prior to yesterday’s distribution cut the yield was 12.97%!

And what happens if we increase the discount rate from 6% to 10%?  The Net Present Value of expected Kinder distributions – still growing at 4.5% per year – declines to $21.10.

3

It could be argued the sector is oversold.  It may be, but discount rates don’t recover overnight.  If oil went to $100 tomorrow, investors would still remember the pain of 2015 and require a higher rate than they did a year ago.  The very same cash flow stream investors valued at $43 a year ago ($1.85 in 2015 dividends growing 9% per year for 20 years at a 6% discount rate) is only worth $31.08 if investors believe the sector is more risky today and thus require a 10% discount rate rather than 6%.

Bottom Line:  Don’t expect MLPs to come roaring back to new highs, even if oil prices do!

4

So how did Kinder units fall under $16.00?  They did something most (honest) MLP CEO’s are doing:  They admitted they could cut their dividend.  In fact, on Monday the WSJ reported Kinder held an emergency Board meeting to discuss cutting their dividend and late last night they announced the 75% cut – to $.50 per share annually.

Often times perfectly honest management teams that swore they would never cut their dividend end up doing so when investors expect them to – the shares continue to slide until they do and at some point, companies realize they are no longer getting credit for maintaining their dividend but rather being punished for not cutting it!

Besides keeping investors from worrying, there are some benefits to cutting your dividend – even when you could afford to continue paying it.  Quite obviously you can build up some cash to pay back debt, make acquisitions or just keep for a rainy day (like today).  As perverse as it sounds, dividend cuts also allow companies to offer much higher growth rates in the future, which as we now know investors value (higher growth rate = higher unit price).

Three years from now I guarantee you will hear more than one company say something like “three consecutive years of double-digit dividend growth” in their PowerPoint presentations, leaving out the bullet that mentions they cut their dividend in half in 2015.

But what happens if we cut KMI’s 2016 dividend by 75% in our NPV analysis, to their announced $.50 per unit, but then increase the growth rate going forward to 15%? in half in our NPV analysis, to $.93 per unit, but then go back to a 9% growth rate?

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You get a stock price that finds a home somewhere near $13.82–pretty much what just happened to the stock in the last week.  Despite the ‘higher growth rate’, the units get slaughtered…  Cash in 2016 is worth much more than cash several year in the future – hence the ‘Present Value’ in Net Present Value…

It’s a big and humbling setback for both KMI and the industry that investors thought were immune to big commodity price swings.  The stock will certainly be down in the first couple hours of trading Wednesday, but I’m very curious to see what happens to the pipeline stocks that have a much lower payout ratio on their dividends (KMI was near 90%; others are closer to 50% and should therefore be safer).

If the old song for KMI was based on Dire Straits 1986 hit Money For Nothing (and Your Chicks for Free), maybe the new one should be Don Henley’s 1989 hit–End of the Innocence.

EDITORS NOTE: I invest in companies with low payout ratios—so their dividend is safe.  I found a 10% yield on an energy company with almost NO DEBT, and one of the lowest payout ratios in the entire energy complex. The market is discovering the stock, as it’s now an 8.5% yield.  The business is growing so fast I expect even more yield compression.  Profit Big—and Safely.  CLICK HERE NOW.

Keith Schaefer

Why This Oil Producer is Going Private

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Yes Virginia there is a Santa Claus.  Private equity fund Edge Natural Resources LLC is taking Canamax Energy private–at 67 cents, or a hair shy of a double over Thursday’s share price.

It has been my largest position for a junior for two years, and gives me–and the subscribers who bought it at the same time—just over a double of my 30 cent cost.

The price works out to 2x PDP (Produced, Developing Properties) or about 10x 2016 cash flow on strip pricing (which is obviously really low right now.)

So it’s wonderful news for retail shareholders who get a big payday right before Christmas.

But to me, here’s the news on this deal—management had to take the company private because they couldn’t get any M&A work done with such a low valuation in the public markets.  They had previously done 5 deals in 2 years.

Part of that very low valuation is that Canamax is very small—about 1500 boe/d.  But they have very little debt (about $1-1.5 million) and their latest well results showed—according to brokerage firm Richardson GMP—that their new horizontals would pay out in only 7 months at US$50 WTI.

That’s amazing; that is the best payout on well costs I see anywhere in North America, including the Permian.

I spoke to CEO Brad Gabel Friday morning after the Edge buyout of Canamax was announced. He said they couldn’t even get a single meeting in Toronto or Montreal with those amazing results.  So it was clear their low valuation wasn’t going to change.

Gabel had told me previously that there were some great micro-cap sized deals to be done in Western Canada–but with a 38-40 cent stock, they had no currency to do any transactions.  Nothing was accretive unless the stock was a lot higher.

Enter private equity firm Edge.  Principal Roy Aneed was Canadian head of NGP—Natural Gas Partners, another PE firm.  He was well known  to Canamax Chairman Kevin Adair, being a shareholder at Adair’s Spry Energy that was sold to Whitecap Resources (WCP-TSX).

It’s a case of smart PE money doing what they’re supposed to—buy good assets and good teams at the bottom of the Market.  Retail investors—including me—are so giddy about getting the liquidity; they’re just happy to be out at a decent profit in a bad market.  That tells me this deal will do well for the PE team.

I had an email from one of my institutional subscribers complaining this deal is a “take-under” vs. a take-over.  He’s right–if and when oil goes back to US$60WTI.

Canamax has a talented technical and M&A team with very low cost production and almost no debt—that stock would soar to more than twice what it’s being bought for now.  But nobody knows what’s going to happen.

I know some other large shareholders who would have waited.  Canamax was in the Top Tier of Juniors that would have run up hard and fast…whenever oil turns around.  But management wanted to sell into this bid so they could go do more deals and grow the company.  The banks are starting to get a bit more mean right now with producers.  And retail was happy to take the money and run.

So the intent in going private is to be able to use technical talents of the very gifted VP Operations Jeremy Krukowski in the field to grow organically, and use the crafty team of Gabel and Harry Knutsen to complete more “steals” like they did with the Flood asset in Alberta.  They bought the Flood asset for $500,000 net, after it had more than $20 million spent on it by previous operators.

Now they are going to have the chance to go to work, with a big PE fund behind them and no public shareholders (we can be such a pain sometimes!).

I’m happy for the CAC management team, and happy for the OGIB subscribers who are making some money here.  This was my biggest ground floor position in late 2013, and many subscribers jumped on the stock with me at 30-50 cents (back then it was 5-10 cents, pre rollback).

I hope most got their cost out at higher prices—the stock was as high as $1.94; a six-bagger in one year.  Much to my wife’s chagrin, I did not—I was a believer here.

Earlier this year, Canamax purchased Powder Mountain Energy, who had minor production but $21 million in cash.  At this price the Powder Mountain shareholders are making money (essentially a 58 cent buyout), and the fact that the main backer of that company, a fund called 32 Degrees, stayed with Canamax–that would have been a big deal making sure nobody got lowballed with an offer.

It’s a bit ironic that Canamax Chairman Kevin Adair is now involved in TWO very out-of- the-box transactions.  Kevin’s main job for the last 3-4 years has been Petrus Resources, and he’s actually taking that public right now–the IPO funding was just announced a few days ago.

Who goes public into an energy tape like this?  But he has taken the same integrity and character and discipline into Petrus-they will be one of the lowest cost producers in Canada–as he has at Canamax.

Kevin was the #1 reason I bought Canamax when it was a shell and had less than half a section in Alberta’s Belly River play (made famous by DeeThree/Boulder Energy).  Kevin was actually paid by minority shareholders to remove their liability and the first well hit over 200 bopd.  So my bet was proven right very quickly.  And then came Flood.

Being as I have few capital gains this year, I sold the stock Friday at 64 as opposed to waiting into January for the deal to close.  I will give the arbitrage funds their 3 cents, or 5%.  Because of a few losses I’ve already taken, this transaction is close to tax free for me.

With 64 cents, that puts the 2015 OGIB portfolio at a loss of just $48,000 as of Friday morning, or 1.8% for the year.  If I add in my $38,000 in dividends this year, I’m only down $10,000 on a $2.4 million portfolio.  FLAT.

That’s a minor miracle for an energy focused portfolio in this market.

So Santa Claus came early to me and Canamax shareholders.  But if oil prices have an unexpected sharp turn up in January (a pause in the US dollar after the rate hike?) it could feel more like the Grinch Who Stole Christmas.

EDITORS NOTE—what am I doing with my $60,000 in fresh cash from Canamax? My favourite stock is paying me 10% dividends right now, on a low payout ratio from a company with almost NO debt.  It’s a rare combination.  Oh, and um…it doesn’t produce oil or gas, it just produces cash. Buckets of it. The name and symbol are right HERE.

 

 

Why Canada? Why LNG?—A Summary of a Presentation by LNG Canada

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Canadian LNG–Liquefied Natural Gas–exports aren’t getting a lot of respect these days, partly due to low LNG prices, and partly because of the high profile environmental opposition to Petronas’ proposed terminal location at Lelu Island near Prince Rupert.

But behind the headlines, LNG Canada, a joint venture led by Shell Canada has been working quietly on their LNG project in Kitimat.  I invited David Stanford, Legal Director for LNG Canada, to update subscribers at my recent Vancouver conference.  He packed so much good information into his presentation that I thought I would summarize some of the highlights for you.

According to David, if the LNG Canada project goes ahead, it will take approximately five years to build, and if the upstream, pipeline and liquefaction plant are considered together, it will employ 16,000 people during construction. The safety record of the industry – more than 50 years with no accidents of any significance, and a product that evaporates rather than spills – makes LNG as a product more acceptable to most communities when compared to oil.

LNG is the cleanest burning fossil fuel and Canada has a plentiful supply of natural gas. Canada, a G7 country with rule of law, public land tenure, fiscal stability and a robust regulatory system are all things that are very attractive to investors. These are large projects that require tens of billions of dollars of upfront capital investment, so investors want certainty.

Canada is also even more attractive since the National Energy Board recently announced that legislation has been amended to extend export licenses from 25 years to up to 40 years, which significantly enhances the viability of projects in Canada.

Canada has its challenges as well. Taxes are higher, the distance between the upstream resource and the facility requires a 670km-long pipeline, and the pipeline needs to go across difficult terrain. There are also a variety of stakeholder interests at play. That said, LNG Canada has been able to address these challenges in a positive way.

marine terminal

SW view of site

LNG Canada reviewed 570 sites up and down the coast before settling on the site in Kitimat. LNG Canada has also been able to negotiate Impact Benefits Agreements with First Nations within whose traditional territory the project is located or who are along the shipping route. And while the pipeline route is long, it is shorter than some of the other projects being proposed in British Columbia, and less technically challenging to construct.

The location of the site means shipping times to key overseas markets are reduced.  It has already been zoned for industrial use, and has an existing deep water wharf.  The site is mainly brown field, as green fields are more expensive and can be more controversial from a local stakeholder perspective.

Another advantage the project has is best-in-class technology and emissions. Twenty percent of its power needs will come from BC Hydro, which when combined with the use of LMS 100 turbines means that the plant will emit approximately 50 percent fewer greenhouse gas emissions than the average LNG plant currently in operations today.

There are also lots of good materials and videos on their website – lngcanada.ca if you want to know more.

 

Editor’s note:

My largest single investment I’ve ever made in the history of my OGIB service is a stock that doesn’t rely on the price of oil.  If anything, lower oil prices help it.  This company is also paying me an 8% yield with a rock solid balance sheet. Read my full report on the company before its next quarterly comes out–Follow this link right now for the full story.