Oil and Gas–in the Bahamas?

By
Keith Schaefer
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The Biggest Wins in the Market either come from

a) buying the leaders in an industry and staying with them
b) turn-around stocks–typically broken companies on the mend – and unique, high-growth small-cap stocks.

There’s another newsletter that specializes in this—very successfully.  It’s Fabrice Taylor’s President’s Club.  For the last five years, he has developed a remarkable track record in finding forgotten or undiscovered companies whose revenue and cash flow are soaring.

He’s going to share that knowledge at his very first conference, November 6-8 in Nassau, Bahamas.  I’m going–to hear and meet with Fabrice directly–and also listen to a few of Canada’s top small cap fund managers explain their expertise, and hear their top junior stock picks.

I suspect many of the CEOs of those stock picks will be attending as well–Fabrice has organized 35 CEOs from the best micro-and small cap companies on the Toronto Stock Exchange.

You will hear presentations from some of the best money managers in the country, including Jason Donville, Bruce Campbell and JF Tardif.

I will also be presenting, and I will be available to you Nov 6-7 for one-on-one questions and talks. (That’s the only oil and gas you’ll ever see in The Bahamas ;-))

I want you to join me.

It will be an invaluable 3 days of learning and networking with some of the brightest and most diligent minds on The Street—mixing with the top management teams.

Make no mistake, this is a very exclusive conference.  Yet the conference is FREE to attend for investors and most meals are covered by the sponsors.  This conference turns investing work into fun.

These destination conferences are where investors make the best contacts.  And I can tell you from experience, you get a lot more colour and detail on your investments–meeting management in person–than you do reading press releases or conference call transcripts.

Fabrice has a great niche.  He’s a CFA, and get ahead of sell-side analysts if he believes in a story.

Canada’s national newspaper, The Globe and Mail, co-sponsors this conference.  That’s a great endorsement of Fabrice’s talent.

Over these three days you will meet 35 of the best small, high-growth companies in Canada, including a few private companies with go-public plans (a link to the list of companies is below).

Exclusive, yet FREE.

Just sitting next to one of our speakers at dinner or lunch would be an invaluable education in investing. And you’ll learn timeless business lessons in general by rubbing shoulders with our entrepreneurs in a relaxed setting.

The event will be covered by The Globe & Mail and other media.

Also, if you’re an entrepreneur looking to raise your company’s profile, we still have a few spots available.

Who should attend:

1) individual investors and institutions interested in the small-cap space, brokers, portfolio managers, financial media and family office representatives.
2) companies who feel now is the time to put their securities (shares, debt instruments) on the map. We will put 2 million eyeballs on your story.

Space is limited and filling up fast.  Exclusive yet FREE.

You can book online at:  www.presidentsclubconference.com  OR  contact Nadine at: nadine@thepresidentsclub.ca or call her at  1-647-202-5292.

I hope to see you there!

Why I’ve Started Buying Oil Stocks Again

By
1940bkg
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I’m off to Dubai for a week of meetings, but I want to leave you with some ideas that should leave you…questioning…The Bear Case on oil.

I want to be clear…I’m not a perma-bull on oil.  Far from it.  I’m an investor, and a trader, looking for a trend.  Energy is my chosen field right now.

So I don’t care which direction oil moves–as long as it moves; show me a trend.  The oil price staying flat is a trend.

So where is oil going?  While the reality is–nobody knows–there is some evidence emerging that suggests the global oil market is a lot tighter than most people believe.

Here’s three points to consider:

1. Charlie Brown and The IEA (International Energy Agency)

Remember poor oil Charlie Brown trying to kick that football?  Lucy tricked him every time.

1

The International Energy Agency trick investors every year. Because the IEA makes the same error each and every year: they chronically underestimate global oil demand by a wide margin.

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.

Bolding and underling of their conclusion intentional!

That is the size of the error in an average year.  What then happens in a year where oil prices have been cut in half?

This year there is good reason to believe that the IEA has underestimated demand by a lot more than 700,000 barrels per day.  The IEA’s initial second quarter report included a 1.7 million barrel per day “plug” which was required to balance their numbers.

A “plug” is accountant lingo for “I can’t figure this out”.  It’s like a contingency fund.

The IEA had to include this plug because inventory levels didn’t rise as much as the IEA’s estimates of supply and demand said they would.

The IEA thought that the oil market was oversupplied by 3 million barrels per day, but they could only account for 1.3 million of those barrels.

I know it’s a crazy thought….but could the plug relate to the IEA underestimating demand?  I know I’m thinking outside the box, I mean after all they have only done exactly that for the past 15 years in much less volatile markets.

With oil prices under $50 per barrel, it would make a lot of sense that they have underestimated demand this year by much more than they usually do.

Remember, the IEA data is a primary source of inputs for oil market analysts.  That means that this underestimation by the IEA has filtered through oil analysis everywhere–potentially making almost every analyst’s estimates of demand significantly too low.

2. Chicken Little Says China’s Oil Demand Is Falling

An acorn dropped on Chicken Little’s head and she ran around telling everyone who would listen that the sky is falling.

That was an overreaction.

China’s economy is clearly slowing, and that has translated into the media repeating over and over and over again how weak China’s demand for oil is.

It is very easy explanation for weak oil prices, but I don’t think these Chicken Little’s have actually checked any data to support their claims.

The reality is that China’s oil demand is just fine thank you very much.

According to Platts Chinese oil demand was up 10% year on year in August of 2015.  It’s up about 8.8% on the year in total.  and wasn’t August the month that the weakness in China’s economy really rattled the markets?

Clearly China isn’t firing on all cylinders.  But it’s also clear oil consumption is not suffering.  That doesn’t seem to add up, but there is an explanation.

What has happened is that Chinese demand is changing.

Oil demand from industrial consumers (users of diesel) has levelled off as subsidies of infrastructure projects have dropped.    What has more than offset this is consumption growth of gasoline and kerosene from non-industrial consumers.

2

An even bigger surprise (certainly to me) might be what has happened to China’s oil inventories over the summer.

As Stephen Kopits of Princeton Energy Advisors points out, August commercial oil and refined products inventory levels relative to rates of consumption in China didn’t just not increase….they actually decreased.

That can’t happen if oil demand is plummeting.

3

Source: Prienga.com

As Kopits said….”Anyone looking for excess commercial oil inventories will not find them in China.”

That’s weird, because if the IEA’s 1.7 million missing barrels aren’t in China….where else could they be?

3. Where Is The Contango?

A few weeks ago Goldman Sachs rattled a few cages by suggesting that the oil glut had actually gotten worse in recent weeks and that $20 per barrel oil was a real possibility.

Since Goldman was likely using the 3 million barrel per day oversupply figure it took from the IEA for Q2, saying things had gotten worse was really saying something.

If the oil glut is as huge as Goldman suggests a question that has to be asked is “why aren’t we looking at a severe contango in the oil futures market”?

A contango structure in the futures market is when front month oil prices trade at a discount to future month oil futures prices.   The futures curve slopes upwards and to the right.

In an environment where there is a massive oversupply we would typically expect to see a severe contango situation where front month prices trade at a big discount to future months.  Too much near term supply would obviously put significant pressure on near term prices.

When oil demand collapsed in 2008/2009 and a serious oversupply situation clearly existed the difference between the front month and a year forward was over $23 per barrel for WTI. As of last week the year forward price for WTI was roughly $4 higher.

That doesn’t seem to scream “glut”.

The Market Does Seem To Be Saying That A Bottom Is In

There’s more. Did you see the market action following last week’s EIA report.  The report was decidedly bearish…..yet oil stocks performed well and oil held up too.

To me that says the Market believes–that while oil will not go up in a straight line…the bottom is in, and that psychology (for now) is all that’s needed to see a lot of money come back to the sector.

Of course, the Market could be wrong, but last week’s action was compelling.  (There will almost certainly be some consolidation/choppy price action in oil this week as the Market digests these gains).

It’s enough to get nibbling my favourite oil stocks in small chunks.  One is absolutely the lowest cost, most profitable producer I see in the whole world at US$50 oil.  The second is an old favourite who…did what the good management teams do in down markets.  They buy other assets cheap, and get themselves (and their shareholders) in a great position to profit.

Volume and price are both picking up on this stock as it gets off the mat.  The first move is always the biggest.  To get this stock, and why I like it, click HERE

Keith Schaefer
 

What Made Oil Move and Who Benefits the Most

By
Keith Schaefer
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0

I became a believer in this oil price move on Wednesday, when a bearish weekly report came out from the EIA—the US Energy Information Administration.

US production was up and inventories were up—everything about that report was bearish.  The oil price only dropped for an hour, maybe 90 minutes, then went back into positive territory.

In this 11 minute podcast, I go through what I think caused the oil price move, what stocks are benefiting the most and how I’m structuring my personal portfolio.

Click here to listen

PS—What if this Move up in the oil price is NOT real? That’s why I own this one stock—Click Here

Keith Schaefer
 

Pipeline MLPs Are In Trouble—Here’s Why

By
Keith Schaefer
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The Coming Energy Infrastructure Overcapacity Glut
October 1, 2015
By: Bill Powers

When free money is thrown at any part of the energy industry for a long enough length of time, the natural boom bust cycle can be taken to extremes and massive distortions can develop.

Due to unprecedented access to all forms of debt capital, especially the high-yield variety, the exploration and production (E&P) industry of North America drilled tens of thousands of uneconomic wells over the past six years.  Concurrently, an epic building boom for energy infrastructure to process all of this new oil and gas production was easily financed as investors reached for yield during a period of zero-percent interest rates.

The billions upon billions of dollars cheap capital that has been raised for infrastructure MLP (which includes pipeline gathering, compressor and processing MLPs) have resulted in a worsening overcapacity situation in many basins.  There is now too much capacity chasing declining production in nearly every once booming shale basin.  For example, midstream processors in the Haynesville shale are now scrambling for business due falling production and a glut of capacity.  More on the situation in the Haynesville below.

But more generally, this new reality for midstream MLPs is showing up in the marketplace in the form of big drops in the stock prices and corresponding rising yields.

While many MLPs now offer very high yields, most have payouts that are unsustainable over the medium-term (six to 24 months) and should be avoided.  One company that is likely to see downward pressure on its prices is Azure Midstream Partners (NYSE:AZUR) that operates primarily in the Haynesville.

The company recently reduced its 2015 adjusted EBITDA guidance 10% given that “producer drilling activity will remain below expected levels for the balance of 2015.” (Source: http://finance.yahoo.com/news/azure-midstream-partners-lp-reports-111500533.html )  Azure units are currently yielding 22%.   With falling production levels in both the Texas and Haynesville portions of the Haynesville and little hope of a rebound in activity at current commodity prices, I expect to see further downward guidance from Azure and many of its competitors.

In other words, we are at the beginning of what I expect to be a brutal bear market in infrastructure MLPs.

The biggest surprise to most investors in the midstream MLP space is the amount of commodity price risk embedded in these companies.  How can this be?  My broker told me that I should reach for that juicy yield since mid-streamers have fixed contracts with well-heeled producers in all the hottest basins…. Hmm…  Unfortunately, markets, in at least this case, still work.

While it is certainly true that midstream companies have contracts in place that will provide for a steady stream of revenues in the short and intermediate term, we are now seeing financially distressed E&P companies, who are desperate to cut costs, renegotiate existing contracts at far lower rates. 

Why would a midstream MLP that has invested potentially hundreds of millions in a gathering system—and is taking the standard 30% of a producer’s gas as a fee for processing and selling the gas into the interstate system—agree to reduction in fees?  The answer is two-fold.

First, in older shale gas basins such as the Haynesville in northern Louisiana, mid stream companies are scrambling for business.  This play already had a huge gathering infrastructure in place to service conventional production that was expanded to accommodate more than 8 bcf/d of new shale gas from the Haynesville formation.

After peaking at approximately 7 bcf/d in late 2011, Haynesville production is roughly 3.5 bcf/d and is falling fast. (Source: LA DNR and TX RRC)   Declining production from E&P’s in the Haynesville means a smaller pie for the midstream MLPs to divide up.

Second, financially distressed shale-focused companies will increasingly play the bankruptcy card.  Filing for restructuring would allow existing contracts to be renegotiated at potentially much lower rates.  For example, it is very likely that distressed companies such as Goodrich Petroleum (NYSE:GDP), Halcon Resources (NYSE:HK) and Sandridge Energy (NYSE:SD) and others are seeking major concessions from their midstream providers.

To get a better understanding of just how much negotiating leverage midstreamers have lost with E&P companies who were once desperate to get their products sold no matter the terms, let’s examine the first large renegotiation between an E&P and a midstreamer.

On September 8th Chesapeake Energy (NYSE:CHK) announced that it had renegotiated its gathering contracts for its Haynesville and Utica project areas with the Williams Companies (NYSE:WMB).   Below are a few of the highlights of the Haynesville deal:

–In exchange for extending the length of the agreement between the two companies and CHK providing higher volumes in future years, the companies converted a variable rate agreement to a fixed rate agreement.

–CHK’s expected gathering fee for 2016 drops from ~$.88 per mcf to ~$.65 per mcf, a 26% reduction under the new agreement.  This reduced fee includes a minimum volume commitment penalty. (Source: http://www.chk.com/Documents/investors/20150908_Latest_IR_Presentation.pdf )

–CHK fee for gas gathering in 2018 drops to only ~$.53 per mcf in 2018 and escalates with CPI thereafter.

It is quite clear that WMB would not have converted its very lucrative existing gathering contracts with CHK to fixed rate agreements at greatly reduced rates if it believed it could have replaced CHK volumes with volumes from other operators.  Given that there were only 26 rigs running in the play as of the end of September and not enough wells are being drilled to keep production at current levels, it seems Williams had little choice but to lock in fixed fees for guaranteed future volumes at a time of very low natural gas prices.

What other companies will be impacted by gathering system renegotiations?
Another midstream MLP that is likely to face a distribution cut due to the fierce competition and dropping activity levels is Southcross Energy Partners, LP  (NYSE:SXE) that operates in the Eagle Ford shale area of Texas.  Similar to other shale plays, the Eagle Ford has seen a large drop in activity, a plateau in production and a massive build out in processing capacity.  Not a good combination for a smallish processor of hydrocarbons.

As a believer in the cyclical nature of markets and in mean reversion—even in markets that have been grossly distorted by the free money bonanza of the past six years—there will come a time when the midstream sector will offer an outstanding risk/reward ratio and juicy, sustainable yields.  However, that time is still a long way off.   I believe a fantastic buying opportunity for midstreamers lies on the horizon but there will be many, many distribution cuts and millions of frustrated investors before this time arrives.

EDITORS NOTE—There is one company who benefits from all the ongoing US production—a services company with the secret sauce to improve profits for producers.  If E&Ps keep producing, they win with more business.  If they stop producing, the oil price goes up and their valuation goes up with it. Get this win-win stock NOW.

Where is the Market Going?

By
Keith Schaefer
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To me, the Market (Dow/S&P 500) is a bit of a binary trade right now. It’s pretty clear to me that the Market is determined to retest its late August lows. If it bounces, I think I can safely buy stocks and likely add to my biggest position again at a good price.

If the Market cuts through the August lows, I would suggest investors are in for a rough ride for a few months.  Tax loss selling will be coming quickly.

Investors haven’t had a real bear market for a long time; many have forgotten how ugly and demoralizing they can be.  I may look at my portfolio and think—wow, I’m actually pretty well positioned as I have low valuation stocks with good and growing cash flow….but bear markets don’t work that way. NOTHING gets spared.  (So I’m not putting much faith in the up-move in the Dow today).

So as you all watch your portfolios over the coming 3 weeks—put it in the context of this macro situation.

I suspect most stocks will move lower in the near term as the Market determines what it wants to do.  The crux will come sometime in October and I’ll decide how to invest once the Market makes up its mind.

Income stocks will certainly be less crushed, but in a bear market they go down too.  I would likely move to a larger cash position should the Market break below the August lows—and just wait for my opportunities.

And there are a couple VERY intriguing stocks out there right now that I’m researching.

Of course, the question is—when will this all play out?  Well, I think you can pencil in October 14-15 on your calendar.  I’m flying to Dubai late on the 14th on business, and will likely be completely out of internet for the entire 24 hour odyssey.  It makes perfect sense to me that will be when the Market pushes for a decision. ;-)

I will be back at my post on October 21; but I will likely try to write one colourful update on life in Dubai while I am there.

OIL—I just want to repeat here—NOBODY KNOWS.  There is NO SMART money in the oil trade right now.  I do not waste much of my time reading what Morgan Stanley or Goldman Sachs or PIRA or IHS CERA or the CEO of Exxon or Chevron thinks—or anybody else thinks–about the oil market right now.

I’m happy to be an agnostic and opportunistic investor.  I’ve shown I can make money in any market with some out-of-the-box investment ideas.

The last bit of real news in the oil market, IMHO, was when I became aware there is a HUGE “plug” number in the EIA data right now of well over 1 million barrels a day, which leads to a big possibility that demand is very under-reported and therefore the market is much tighter than the Market gives credit for.

But that will only matter when it matters, and not before.

It’s like my good friend and colleague Bill Powers’ thoughts on the natgas market going into undersupply—he has great data that creates a compelling argument—but he’ll be right when he’s right and not a moment before.

I’m certainly not going out investing on any of these “dark” theories. There is no point in trying to guess anything.

I think it’s fair to say US production is declining, but again Canadian oilsands production is making that up so far almost barrel for barrel.  US declines should outpace that growth soon however—but when you see projections of US production going down to 8.8 M bopd from a peak of 9.6 M—everybody conveniently leaves out 500K bopd of Canadian production coming back online this year after wildfires and maintenance shut it in, and then ANOTHER 300K-500K bopd over the coming 5 years.

Outside of that, there are just too many fast moving factors in the global oil market for anyone to have a strong handle on what’s happening.

I do believe the Market is mispricing the risk in the 2 M bopd of alleged spare capacity right now—i.e. oil prices should be higher—but that and $3.49 gets you a latte at Starbucks.

SUBSCRIBER SUMMIT UPDATE

Two things—one is we are now full with a waiting list for Thursday October 8 in Vancouver.  If you signed up to come but now realize you cannot make it, please email nichola@oilandgas-investments.com and let her know she can release tickets to others.

Second—I am very, very sad to say Scott Ratushny at Cardinal Energy has bowed out of the conference.  He shot me an email yesterday explaining that his legal team doesn’t want him marketing during this financing.

THE GOOD NEWS is that Richard Thompson, CEO of Marquee Energy, (MQL-TSX) is coming now.  I do have a full report on Marquee in the Members Centre for subscribers.  But their Michichi asset just NE of Calgary is a prime example of a high quality conventional asset that helps a producer get through these lean years and be set up perfectly for any oil price rebound.  Low cost wells, low decline wells that pay out in just 14-16 months at US$50WTI.

I caught up with Richard in Vancouver last week and got a full update.  I’ll incorporate that into the report in the coming days.

In conclusion–a) I have a couple new ideas I’ll be sharing with you in the coming weeks as the Market sorts itself out.

b) SIS next Thursday, October 8.  Granite Oil CEO Mike Kabanuk is bringing the best stock chart of any energy producer in North America to the conference–if you want to attend or if you want to cancel, email nichola@oilandgas-investments.com

Looking forward to meeting you next week!

EDITORS NOTE–I bought my largest position EVER during the dark energy days of summer 2015.  Even though the stock is up 30% and paying me a 10% yield, analysts say the stock is still cheap because cash flow is increasing so quickly.  It’s the Out-of-the-Box Trade for 2015–and paying off.  It will save a lot of energy portfolios this year.  Get the symbol right HERE.

 

Where the Market is Going and What the Perfect Investment Looks Like

By
Keith Schaefer
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RICK RULE INTERVIEW PART II

Keith:    Rick, in the first part of our interview we talked about the state of the energy market now, and what some of the opportunities are.

But let’s talk details for a second—you’re aiming to come in somewhat as a lender of last resort in a tough market; willing to take the Big Risks.

But I wouldn’t think that comes cheap to these companies.  What’s the art of getting a deal done in that environment?  Why wouldn’t they just stop drilling?

Rick:    Remember Keith, the decline curves on most people’s new production is steep enough that if they don’t drill their production credit facility cannibalizes all their existing cash flows anyway; any remaining value they have is in their PUD’s. A lot of these revolving credit facilities were set up in anticipation of the fact that the companies could become self funding in 2019.

Keith:    Right.

Rick:    If you’re drilling the types of plays that have driven the Canadian oil and gas industry for the last 10 years your hope is refracturing that is secondary stimulation and additional drilling. And for some of these companies not drilling given the level of revolving credit facility debt they have–it’s not an option.

Keith:    So really they have a choice of doing nothing and being caught in a slow death spiral or…

Rick:    Probably a fast death spiral Keith.

Keith:    Yeah a fast death spiral or they basically take your terms and…

Rick:    Yes, live to fight again!

Keith:    So now is there a sweet spot for you in terms of either size of producer, commodity, location…is there any trend there at all?

Rick:    We would want to go to companies that are in the best quartile in terms of fully loaded production costs. What we’ve noticed is the good companies and I’m talking about a sub $500 million market cap space, the good companies have been thrown out with the bad companies.

If you look at companies like Delphi that is an extraordinarily efficient little company and they’ve been savaged.

Keith:    Yeah.

Rick:    So we would look at companies to be completely frank that wouldn’t have talked to us 3 years ago because they wouldn’t have had to. We would look to show love to what I like to call the “bruised super stars.”

Keith:    Right it makes perfect sense. Now do these guys see you coming? Is there a difference between experienced teams and relatively new teams or by definition these are fairly experienced teams cause they are the low cost producers?

Rick:    We would look to both. We think this is going to be a wonderful period for recaps. We’re in discussion with a couple of groups in Calgary looking to put up $50 to $60 million of their own money and have $30 to $35 million in what are in effect revolving acquisition lines, bridge lines available from us. So we’d certainly look to back new teams that were comprised of people we’ve done business with successfully in the past.

Keith:    Right.

Rick:    Preferably you find a group that’s be intact for 8 or 10 years that has an asset they’ve been working on for 3 to 5 years that they’ve been successful with but have been set back by low energy prices and aggressive capital expenditure.Keith:    How do you structure a deal that works?

Rick:     What I see probably working differently in this market is a chance to do hybrid debt equity. An example would be where an issuer has 80 or 100 proved under developed locations and has the producing infrastructure in place and has some of the money but not sufficient money.

What Sprott proposes to do with those people is to say take 30% working interest in a well, drill the well, get a priority payout on the well and then drop back to royalty positions so the rest of the reserves in the well subject to the royalty accrue to the issuer and the issuer’s bank. We see a lot of potential for that.

So we see potential in 2 ways, one our working interest in the well would not, in that case, be subordinated to the issuer’s bank. Importantly for the issuer, at payout the issuer goes back up to 100% working interest and so he or she books the vast majority of the reserves.

For us, we get a relatively quick payout but we get a lower overall rate of return. It’s important to note, however, that after the hyperbolic declines the tails, the producing profile of the well after payout can be very, very long. And having, from Sprott’s viewpoint, a clear title overriding royalty position on a package of wells could be a very good thing for the Sprott shareholders simultaneously with it being a very good thing for the issuer’s shareholders, and the lenders .

So we see the ability to do more of these hybrid debt equity deals.

Keith:    For these companies that are a preferred payout and I don’t know if you consider that 100% or 80% of cash flow to payout or what but for most wells now; whereas you were talking before pay backs bounced so quickly, pay backs were sitting around for the really good plays 8 to 12 months and now the really good plays are 18 to 24 months.

Rick:    Yes we’re looking at 18 to 24 months and we’re looking at pay out with a return on capital employed, so we’re talking about 110% pay outs and then we’re backing off to a GORR (Gross OverRiding Royalty).

What we’re giving them is the ability to buy us back out the GORR. We want to be able to do a lot of these transactions, so we want to provide the issuers very attractive solutions.

Keith:    Right.

Rick:    We see a situation where the Market takes care of itself in 3 or 4 years. And a company that has a great land base–and a lot of the small Canadian companies have monstrously large and wonderful land bases—where the companies have an existing portfolio of proved producing reserves and if we can help them monetize enough of the PUD’s to service the underlying credit revolving facility they still have enormous optionality in the rest of their PUD’s and land base.

Keith:    Right.

Rick:    We see this as a classic bridging opportunity. We see this as an opportunity to help someone get through the next three years.

Certainly we’re not the Red Cross; we’re going to do extraordinarily well helping them through the next three years. But we see in the case of many companies with $300 million market cap that we’re the only players in the market trying to help them survive.

Keith:    OK. Go on.

Rick:    If my suspicions are correct about the 1st and 2nd quarter of next year and particularly the 2nd quarter where the annual reports come out and the new reserve evaluations come out and the analysts are able to look at the reserve evaluations relative to the revolving credit facility, I think by that point in time we might evolve back into the equity business because we may be the only players in the equity markets.

We basically try and compete with other players in the market by competing where they aren’t. Right now we don’t see a lot of people in hybrid debt equity or in subordinated bridge and mezzanine facilities and so we’re competing here. My suspicion is we may have a 2 or 3 year window in debt but we may only have a 1 year window in debt. It may be the window next year is in equity.

Keith:    OK…now in the last cycle, after the 2008 crash, oil prices rebounded more quickly than people thought they would.

Rick:    Yes!!

Keith:    Today I would suggest you’re looking or consensus anyway is that we’re looking at a much longer timeframe to get back to those levels. How does that impact your thinking this cycle vs. last cycle?

Rick:    I think it’s correct and we have more to fall in the oil and gas space. We had that little move in the oil price from 50 to 62 or 63 that gave people a lot of hope and a lot of guys came to market. The issuers probably had less hope than the investors because the issuers “monetized” that demand as fast as they could. I think that hope has been dashed and I think we’re in a position in the very, very near term and now I’m talking between now and the end of October where there’s no hope.

We see equities collapsing, oil and gas stocks are equities; and we see the energy price off, we see emerging and frontier markets collapsing, we see all peripheral equity markets (and the junior markets are certainly peripherals) collapsing and then we have the specter of the psychology of that great boogey bear month of October coming up. Bad things seem to happen in October and when you have a market that’s emotionally driven, things like “October” become relevant.

So my suspicion is between now and the end of October there’s no particular reason to take much equity risk because most of the visible factors that could move a market one way or the other seem to be there to move it negatively.

Keith:    Right okay. Again, like the fact that this is going to be a flatter market opposed to a stronger rebounding market how do you see that impacting strategy?

Rick:    For me, in the near term what I’m going to be is a lender and not an equity player.

Keith:    Right.

Rick:    I think we have lower to go on the equity side. The issuer suggests that they’re starved for capital but for some reason they can’t spell warrant. In other words, they aren’t willing to make equity deals that suggest they are actually starving for capital. I suspect that will take care of itself and there will come a time when the best equity players out there raise capital on terms that reflect it’s scarcity.

Keith:    Rick we are running out of time. You’re painting a bearish picture here…what hope is there for energy producers and their shareholders?

Rick:    I do feel hopeful although I don’t feel hopeful about the next 8 weeks. But the truth is that the natural resource business has been extraordinarily good to me over time.

But it has been good to me because I’ve maintained the cash and courage through the last down cycles. The money you have invested in bull markets that you don’t scrape off the table and put in the bank or somewhere sensible declines by 50% in the bear market. This particular bear market, of course, has been more vicious than that.

But in the ensuing bull market if you apply the time at the market bottom to rationalize the mistakes you made, kick out the terminal losers and re-deploy the money into things that will survive and thrive in the bull market, in the ensuing bull market you make 10 times your money.

And trough to peak is sort of a 10 year cycle, so if you think about something where every 10 years you lose half your money and then you take the half you have left and it increases in value 10 times, the aggregate arithmetic is pretty damn good.

Keith:    Yeah.

Rick:    I believe the aggregate arithmetic coming out of this market is not going to be pretty damn good, it’s going to be spectacular because the market as expressed by the TSXV hasn’t fallen by 50% it’s fallen by more like 80% or closer to 90%. And my own experience has been the bear markets are truly the authors of bull markets and while I can’t tell your listeners when—I definitely can tell you that it will occur.

Keith Schaefer

 

My Top Out-of-the-Box Trade Idea for 2015

By
Keith Schaefer
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Oil and gas producers are among the least profitable sectors in the energy world—yet they gain the most attention.

And they’re cyclical—you have to trade them.  They had a great two year run from 2009-2011, then were the wrong place to be for two years, but the Polar Vortex of 2014 gave them great legs through the rest of last year.  Now…well, you know.  It’s not pretty.

That’s why I’m constantly looking at other sub-sectors in the global energy world.

In December 2010, I had great success with an LNG shipper, Golar LNG, (GLNG-NASD) which ran from $15-$48.

In 2012, I invested in a new refinery IPO called Northern Tier (NTI-NYSE) that ran from $18-$32.  In 2013, ethanol stocks turned around, and I caught the wave with Green Plains (GPRE-NASD) going from $9-$45, and in 2014 Pacific Ethanol (PEIX-NASD) going from $3-$23.

There is ALWAYS good money to be made in energy.  You just have to be willing to think outside the box.  Very few subscribers bought Green Plains because they didn’t know anything about ethanol.  Fair enough, but when conventional ideas like junior producers aren’t working, you have to research other areas.

That’s what I do.  In fact, my out-of-the-box ideas have been the best of my 6 year career at OGIB.

My Top out-of-the-box idea hit a new high this week, up over 20% since I bought it this summer.  Like the ethanol stocks, this company is a turn around that is now printing money like never before.  But it doesn’t rely on high commodity prices…and that’s just what the Market is figuring out.

The new high should tell you something.  Don’t miss out on The Out-of-the-Box Trade of The Year.  Click here and let the burgeoning cash flow of this company work for your portfolio.

Keith Schaefer

 

Why is Rick Rule so Happy? Interview Part 1

By
Keith Schaefer
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WHY DOES RICK SOUND SO HAPPY IN THIS ENERGY MARKET?

INTERVIEW WITH RICK RULE, SPROTT US HOLDINGS INC.

Rick Rule is a naturally happy guy, despite being immersed in one of the most depressed parts of the economy right now.  I’ve known Rick for almost two decades, and it was his comments as a lender to the energy patch—“This is the best time in the Market for us” that spurred my interview with him.

Now a Director of Sprott, Inc., a Toronto-based investment manager with over $7 billion in assets under management, and CEO and President of Sprott US Holdings, Inc., he brought a lot of experience and wisdom to our conversation.

Our one hour interview comes in two parts—look for Part II in the next day or three.

1

Keith:    Rick, in our pre-interview you said this energy market is not getting you down—in fact, just the opposite.  Tell me why that is

Rick:    One of the huge advantages to being 62 is that I’ve come to live my life in 5 year cycles. As a professional now I’ve been through eight 5 year cycles and 5 years seems a lot less daunting than it used to.

Keith:    Right.

Rick:    Particularly given the scale of the upside I’m looking at. I think if I asked any of your readers if they’d be prepared to live through a 35 or 40% down cycle so they could experience a 5 or 10 fold up cycle, everybody if they thought about it rationally, would say yes.

The problem is people’s perception of the future is set by their experience in the immediate past and the 35% down side seems much more probable then the 5 to 10 fold up side because it’s been so long since we’ve experienced an upside.

Keith:    Basically you’re saying that the risk-reward for you is on a time scale that actually gives you a bit of an advantage.

Rick:    Absolutley and it’s the time scale everyone will be on whether or not they care to admit it to themselves. People who don’t want to consider the 2 to 5 year timeframe are the natural normal victims of the market.

Keith:    Correct. So tell me what you’re doing now and maybe what you’ve been doing for the last two quarters to get ready.

Rick:    On the equity side in oil and gas almost nothing. My belief is both Calgary and Houston are in denial. And they are in denial from an intermittent position of strength, meaning that the oil and gas industry got enormously over capitalized in the 2002 to 2012 period.

Cutting through that over capitalization takes some time and so I’ve not been doing very much at all on the equity side. We have been attempting to be active on the lending side. I guess I can explain both of those and should go back to the equity side.

My suspicion is that a lot of the producers are getting notice of impairments with periods to cure from their banks.

And everybody from the banks to the brokers to the shareholders is hoping the market turns around, hope not being a very effective investment strategy. You are beginning to see a real flood to market of companies’ noncore assets; the problem is there are only sellers and no buyers.

Keith:    Right.

Rick:    Which means that’s a situation that is not going to work. They aren’t going to be able to sell enough of their noncore assets and that’s the problem. We need, of course, to see 2 or 3 quarterly operating statements to see the impact of $50 oil on a $90 Proforma and in particular, on a revolving credit facility.

Many of your readers may not know what a revolving credit facility is but it’s the dominant form of debt financing in the oil and gas business. They are reserve base loans that occur on an interest only basis and are renewed year to year based on a percentage of the net present value of the companies producing reserves.

Of course, the estimate of a net present value varies dramatically with the price quote.  The net present value calculations done by 3rd party evaluators this year were done with price estimates in the out years, the 2nd, 3rd, 4th and 5th years that had fairly aggressive escalating oil and gas prices.

These prices were about 25% in excess of the 3 year strip and futures markets, meaning companies reserve evaluations came through at premiums to what the market was expecting as a consequence of the pricing scenarios used by the evaluators.

If oil and gas markets don’t improve markedly soon, the next set of evaluations that will come out will be substantially lower, which means the impairments will be much more extreme. And they are going to be extreme after a 12 month period where companies have already been forced to cut their budgets. Which means in addition to the fact that the pricing assumptions are going to be reduced, deferring a year’s worth of capital investments means the company’s reserves pictures will be bleaker too.

Suffice it to say, I think the bomb goes off in Calgary and Houston in the 1st, 2nd and 3rd quarters of next year. So we don’t have a whole lot to look forward to on the equity side in the 12 month timeframe.

Keith:    What about the lending side?

On the lending side, there is about twice a decade when oil and gas players are forced to come into the high yield part of the lending market.  In other words, they are forced to come to Sprott. And we’re coming to just one of those periods.

There are 3 types of common opportunities available to a specialty energy lender like Sprott.

One of them is that companies will do sale and lease backs on their midstream assets; they will sell their gathering systems and processing plants, they’ll sell them to Sprott or they’ll sell them to players like Keyera, and Sprott would love to be part of the financing solution for providing financing to the market where financing is difficult to come by for midstream assets that had really nice reserve dedications to them.

Normally oil and gas companies want to control their producing infrastructure but in a very bad market where capital is short what the companies want to do isn’t particularly relevant. It’s what they can get away with. And this is the sort of circumstance that allows us to participate in markets like that.

The 2nd opportunity we have is that some players in this market who have substantially unimpaired balance sheets and have the ability to grow by acquisition. These are very rare but exist. They are people who normally have been in the business for 30 or 40 years and understand it’s a cyclical business. And providing financing for them to do expansion acquisitions is something that we’d love to do. Normally we’re not competitive in that space because normally people who are that prudent have access to all kinds of capital.

But again, about once in a decade the outlook for the oil and gas sector becomes bleak enough that competitors providing finance to the sector melt away and we have the opportunity to be there for the best of the best and we see that situation coming about.

The biggest opportunity of all, I think, will come from companies that have their revolving credit facility “termed” and don’t have the ability to access additional capital on the revolving credit facility, but they don’t have it pulled. (Ed Note—examples of this would be Manitok Energy and Spyglass Resources in Canada)

And if we have a situation where a company is beginning to get “termed” and have a lot of proved developed non-producing reserves, we will have the opportunity to go to the issuer and go to the senior lender and put in place a mezzanine tranche where we subordinate to the senior lender but the senior lender agrees to a 3 year stand still. In other words, they won’t do cash sweeps and  won’t foreclose and we put up the money to drill off the proved undeveloped even subordinating our interest in the production that we generate in return for pretty highly competitive rates of return on the capital we provide.

We aren’t taking very much technical risk but we are taking some financial risk. Again, this type of activity doesn’t happen in normalized markets when capital is cheaper, but where there’s only 4 or 5 capital sources available for hundreds of potential borrowers this sort of circumstance occurs. And we anticipate being able to do quite a lot of all 3 types of financing.

Keith:     Let’s talk about your first point—infrastructure. In this cycle it seems to me there has been so much infrastructure build out particularly in places like Alberta and B.C. with the huge Montney formation and the discovery there, but really across the whole WCSB (Western Canadian Sedimentary Basin) there has been, like you say, a big capitalization of different assets.

The industry was under huge pressure right up until 4 or 5 months ago to own, be in charge of your own destiny that way, you got rewarded in evaluation for that and then basically my recollection was a little bit of shareholder activism from the US side came in and suddenly it was like if you’re a producer under any stress at all, then you have to monetize that midstream because that’s worth whatever you paid for it you can sell it for 10 times cash flow now.

Is that a new part of the equation this cycle that wasn’t there last time because these assets…

Rick:    It wasn’t as enormously over capitalized last cycle as they are this time. A lot of them didn’t have occasion last time to own their own midstream assets. But it certainly happened last time around and people didn’t sell what they wanted to they sold what they could. They sold what they had to. The midstream assets are much more valuable now.

The perception in the 2000 bull market was that the Western Canadian Sedimentary Basin was a very mature basin and we had an acquire and exploit strategy that was dealing with a much more finite reserve life.

Keith:    Right.

Rick:    Now that we’re drilling off the Montney and the various shale plays we figure that in terms of production we have 20 or 25 years of running room left, which means with regards to midstream assets you’ll have higher throughput for a much longer period of time than we had anticipated. And we have a lot more assets to choose from and we have assets that were financed at low or negative real rates of return by the issuers. We also have a variety of issuers that have no choice other than to sell.

Keith:    Right.

Rick:    I think this is unique in my experience.

Keith:    I can see a very different landscape 9 months from now.

Rick:    I think that’s right. It is interesting and one of the things that sort of amuses me is that what happens every cycle is similar but never the same. One of the differences this time is this midstream opportunity simply because the midstream industry is so much larger.

PART II–What Does the Perfect Investments Look Like–and the art of doing a deal in a very tough business climate.

EDITORS NOTE–this doesn’t have to be a tough market.  My largest position–which I bought 3 months ago–is up 23% as of this morning, and is trading within 3% of its year high and paying me a 10% dividend.  You can profit in this market–find out this stock NOW–CLICK HERE.

Keith Schaefer

 

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