Energy & Commodities

Markets still have big downside risk – be careful!

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Posted by Josef Schachter: Schachter Asset Mgmt.

on Thursday, 27 September 2012 12:16

Hold large cash reserves. Buy late October through mid-December during upcoming tax loss selling season.



Energy & Commodities

Oil is Not Looking So Hot

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Posted by The Mad Hedge Fund Trader

on Thursday, 27 September 2012 07:47


I received another one of those scratchy cell phone calls from my friend in the West Texas oil patch. You could almost feel the dust coming through the ether. He said that while Ben Bernanke his committed to buying $40 billion a month of mortgage-backed securities as part of QE3, he has not promised to buy a single barrel of oil. This is bad for oil.

That means Texas Tea has to take the full brunt of collapsing demand caused by economies in free-fall like Europe, China, and Japan. There are no bailouts here. On top of that, Saudi Arabia wants to whip some discipline into its fellow OPEC members.

Saudi Arabia does this by permitting its own production to surge, dropping prices, and inflicting pain on recalcitrant cartel members, especially Iran. Around $80 a barrel is thought to be a price they would be happy with, some $15 a barrel lower than today’s price.

Last week rumors were rife of a “fat finger” trade that drew in high frequency traders and triggered an almost instantaneous $4 plunge in the price of oil. But notice how it has failed to bounce back. This generated chart sell alerts more than you can count.

The break of the 50-day moving average on the charts is thought to be particularly significant, reversing an uptrend that has been in place since June. Notice that the “fat fingers” always seem to hit the “Sell” button and are oblivious to the location of the “Buy” button … maybe they don’t have one.

On top of all this is the never ending threat of a Strategic Petroleum Reserve release by the administration that would cause prices to immediately gap down. It is safe to say that energy is not Obama’s favorite industry. He is essentially sailing “Buy those $100 calls on oil at your peril, because I will render them worthless.” That is what he did with his jawboning campaign in the spring when crude threatened $107. Substantially tougher margin trading requirements for many commodities by the main exchanges quickly followed.

RELATED: Exxon & Rosneft Plan to Drill for Oil in Old Soviet Nuclear Dumping Ground

One factor that no one appears to be watching is the dramatic ramp up in Iraqi oil production. In recent years, we have gone from zero to 3 million barrels a day, and appear to be headed toward 5 million barrels a day by 2015. That is half of Saudi Arabia’s total annual output. Norway and Canada are also increasing production.

Back in the US, conservation is making a dent on the consumption side in a thousand different ways that are impossible to quantify in the aggregate. Every time someone trades in a gas guzzler for a hybrid or electric vehicle they are cutting US consumption by 24 barrels of oil a year. Toyota will sell 2 million hybrids in the US this year, about half in California. That works out to a total oil savings of 48 million barrels a year, 132,000 barrels a day, or 1.3% of our total imports.

Energy savings are going on every day in a myriad of ways, from better building design, to industrial recycling of heat, and conversion of light bulbs from incandescent to fluorescent. It has become a major cost-cutting issue for US corporations. I just checked the specs on my new 80 inch 3D flat screen TV and it uses a quarter of the power of its cathode ray tube predecessor now headed towards the recycling center (notice how all the actors have suddenly aged 10 years). I have always said that this will be the big sleeper on the American energy front.

RELATED: Big Oil Funding U.S. Politics

The final argument is that in the wake of QE3, there is a sudden death of “Risk Off” positions to trade against. Oil is almost one of the only ones out there. So an oil short will partially hedge out downside risk in the substantial “Risk On” positions we have built up in (GLD), (AAPL), and (GOOG).

The extra turbocharger on this trade is that the hedge fund community is still hugely long oil, betting an attack on Iran by Israel that never came. As we move into yearend, the pressure on them to dump their losers will be overwhelming. So I am quite happy to buy the United States Oil Fund (USO) December $32.50-$35 put spread at $1.07 or best.

The (USO) in particular is a great instrument to play from the short side because it has one of the worst tracking errors to the underlying in the entire (ETF) universe. (Only the natural gas ETF (UNG) is worse). Notice how it always goes down faster that it goes up. This is because of the enormous contango in the oil futures market, whereby far month futures trade at gigantic premiums to the front months. The (USO) has to take the hit on the rollovers; hence, its terrible track record.

....view charts and page 2 HERE


Energy & Commodities

British Columbia's Golden Triangle

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Posted by Lawrence Roulston's Resource Opportunities

on Wednesday, 26 September 2012 11:54

A corner of Canada's western-most province hosts one of the richest mineral belts in the world.
Few investors yet appreciate the enormous value of that region.



Energy & Commodities

Cutting-Edge Technologies Will 'Green' Fracking

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Posted by Keith Schaefer: Oil & Gas Investments Bulletin

on Tuesday, 25 September 2012 16:25

Fracking in the U.S. is here to stay, affirms Keith Schaefer, editor of the Oil & Gas Investments Bulletin. North American business is dependent on cheap energy, and even energy utilities are switching from coal to natural gas. Although environmental concerns remain, the industry has incentive to do the right thing, says Schaefer. In this exclusive interview with The Energy Report, Schaefer profiles service companies that are using cutting-edge technology to make fracking safer, greener and cheaper.


The Energy Report: Keith, considering that natural gas prices are still near all-time lows, can you still argue that fracking has improved North American energy markets?

Keith Schaefer: In just a few short years, fracking grew the supply of natural gas way ahead of demand. The price of natural gas fell from $8–9/thousand cubic feet (Mcf) to $2/Mcf! Natural gas is the low-hanging fruit for the energy sector and for consumers. Cheapened feedstock provides a huge boom for American business.

TER: Have fracked oil prices kept pace with falling natural gas prices?

KS: It has not declined by the same degree, but it has lowered the cost of North American oil. West Texas Intermediate (WTI) used to be the major benchmark for oil around the world. Now, WTI is only a benchmark for a small area of the United States and Canada. In addition, the flood of supply coming out of new shale oil wells in North Dakota and Texas is overwhelming the refinery complex in the Gulf Coast, which is about 50% of North America's refinery capacity.

TER: Is there a glut of gasoline? Prices for consumers are certainly high.

KS: That's a great question. The short answer is no. But the long-term answer is yes. People are saying, OK, how come gas prices at the pump are so high when we've got all this oil? What's going on? Here is how the game works: the refineries are moving their production flows to produce the least amount of driving gasoline possible, and the most amount of other refined products, like home heating oil fuel, diesel, kerosene and jet fuel. These are products they can export, in which case they get to use the Brent prices, which are 15% higher than WTI prices. These refineries generally operate on skinny-to-average margins, so 15 points is huge for them. That is why the price of retail gasoline for driving is 50% higher than it was in 2008.

Let me give you an example. I'm in Vancouver. We sell gas by the liter, not the gallon. Back in 2008, we had an uncanny relationship where if oil was $100 a barrel (bbl), gasoline was $1 a liter (L) at the pump. If it was $110/bbl, it was $1.10/L. If it was $1.35/L in Vancouver, oil was $135/bbl. Now, gasoline is $1.35/L, but oil is only $96/bbl. Why? Because the refineries are producing the least amount of gasoline, and the most amount of other refined products.

TER: Does fracking lower oil production costs?

KS: As a rule of thumb, the cost of production for most shale plays in North America is $40–45/bbl, which is not that much different from costs using conventional methods. It is above-ground logistics that cause lower prices for fracked oil. We don't have enough pipelines to efficiently transport the fracked oil to the refineries. Consequently, supply backs up at the hubs, creating big discounts. For example, in late June, Canadian oil and Bakken oil were at huge discounts, almost $20/bbl to WTI. Because of pipeline disruptions and refinery downtime, Canadian producers were receiving under $70/bbl for their oil. But only 2½ months later, the logistics are running smoothly and Bakken oil is now selling at only a $3/bbl discount to WTI.

TER: Why do we see regional price differentials at the pump?

KS: Logistics. Here is an example. Recently, BP Plc's (BP:NYSE; BP:LSE) Cherry Point refinery, which is just south of the Canadian border, went down. The next day, gas prices jumped $0.30 per gallon from Seattle to San Diego.

It's not like we have no new refining capacity. Even though no new refineries have been built since '76 in the U.S., refineries have been expanding. Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE)and Saudi Aramco have spent $10 billion during the last few years, doubling the size of their Motiva refinery in Texas from 300,000/bbl per day (bblpd) to 600,000/bblpd. It immediately ran at full capacity. But, then, an industrial accident took the new expansion offline for nearly a year, which boosted the retail price.

TER: Why is fracking politically controversial?

KS: Scientific studies have shown that fracking is not an environmental issue. It does not contaminate the ground water. There is usually more than a mile of granite between where the fracking takes place and the water table. On the other hand, the government of British Columbia has released a study finding that fracking causes earthquakes. And there is seismic activity associated with fracking and saltwater disposal wells, but that takes place in the formation where the fracking is occurring. The quakes are no different than any of the millions of micro seismic events that happen around the world every day. Of course, there is an impact. Blasting for mining creates seismic events. Building a dam creates seismic events. Filling a large manmade lake creates seismic events, because water is heavy. Fracking is no different.

It is the fierceness of emotion that is the big issue here. People get nervous about the safety of their water supplies and say, "Hey, prove to me that fracking is really safe!" Industry has responded by saying, "Look, here's the science. We've been doing this for 50 years. No need to worry, it's all good." But that's not what people need to hear. People need to hear, "Hey, we hear that you're really concerned about this, that it's a big issue for you. Let us come together at a community hall and talk about it." That would be more effective than just taking out ads that say, (a) we bring so many jobs to the area, why are you bugging us? and (b) we've done this for decades, why are you bugging us? That kind of attitude is not going to win any arguments.

TER: Are drought conditions in the Southwest and Midwest affecting the availability of water for fracking?

KS: Due to drought, the price of water for oil and gas companies has more than doubled in the Midwest and Texas. Some of the oil and gas companies are not drilling as much as they said they would this year because they need to figure out where to get the water and how much they want to pay for it. Even though the amount of water used by the industry isn't huge compared to irrigation, there are areas where the oil industry is bidding for water rights against farmers. The industry needs to be very careful about public relations. Otherwise it becomes a case of the big guy against the little guy.

TER: Are there any technological fixes to that issue?

KS: Yes. Firms involved in the fracking supply chain are figuring out how to source, treat, recycle and dispose of water efficiently. One company that comes to mind is Ridgeline Energy Services Inc. (RLE:TSX.V). It has a proprietary water recycling technology. EOG Resources Inc. (NYSE: EOG) is a Ridgeline client, as is Pure Energy Services Ltd. (TSX:PSV). These companies are starting to recycle their fracking water, which is great.

Other companies doing water management include GreenHunter Energy (GRH:NYSE:MKT). That's Mark Evans' deal from Magnum Hunter (MHR: NYSE.A). This company is determined to use saltwater disposal wells as its entrée into the water management sector. Another company is Poseidon Concepts Corp. (PSN:TSX). It has a water storage product and is branching out into more vertically integrated work in the water sector. There are lots of companies experimenting with this, and for good reason—there are very big margins, 50–85% gross margin. That's fantastic. It beats the pants off any other service in the oil patch. Investors should be taking a strong look at fluid and water service companies.

TER: Aside from the Bakken shale, what are the most exciting international sources of shale oil and gas?

KS: The only other notable proven deposit of size is the Vaca Muerta shale in Argentina. There are a few Canadian juniors down there, but the Argentine government has started to nationalize part of YPF SA (NYSE: YPF). Plus, some permits were pulled from juniors by provincial regulators. That put a huge chill in the market for these stocks. They are well funded and cashed up, but the market's just not going to care about them until there's real production growth.

European shales have been fairly slow to take off. Poland's been on the hot list for a while, but nothing's happened. During the next two to three quarters, we could see a few wells get plunked down in New Zealand. That looks like a fairly thick formation. If it gets going, it could be a big win for investors next year.

TER: What about the oil and gas shale near Paris, France?

KS: Fracking is still banned in France. ZaZa Energy Corp. (ZAZA:NASDAQ) dropped its French play and is now focused on the Eagle Ford shale and the Eaglebine in Texas.

TER: Could fracking be banned in the U.S., either in certain areas or in its entirety?

KS: Fracking will never be banned in the U.S. But if it did happen, businesses would go bankrupt left, right and center. Many companies are hooked on cheap gas. There would be widespread bankruptcies and unemployment. Power companies are using cheap gas instead of coal. The U.S. reduced its greenhouse gas emissions more than any other country in the world over the last two to three years because of shale gas.

TER: What technological changes will keep fracking profitable, while reducing its environmental footprint?

KS: A company called GasFrac Energy Services Inc. (GFS:TSX) has been trying to get the industry to start using liquid petroleum gas (LPG) for fracking, instead of injecting water into the ground. LPG is propane, which is a naturally occurring substance in the formation, so it doesn't damage the formation, as water can. Unfortunately, the company is not having very much success. But the industry is doing a lot of research into food-grade fracking fluid. The idea is to make fracking fluid as green and environmentally friendly as possible. That's a couple of years away, but it's only a matter of time.

TER: Any other names on the cutting edge of fracking technology?

KS: Raging River Exploration Inc. (RRX:TSX) has a big play in the Viking formation in Saskatchewan that is very profitable. Its water flood technique is returning incredibly cheap oil. It got the first half million barrels of oil out at about $30–35/bbl, and the last half million barrels at $5–10/bbl. It is at the forefront of recovery technology. Normally, a firm is lucky if fracking returns 10–15% oil. But with the water floods, the recovery factor can go way up. That is great news for Raging River stockholders.

Renegade Petroleum Ltd. (RPL:TSX.V) is also working in the Viking formation, and it has two other upcoming plays worth watching. One is the Slave Point play in Red Earth, which is north of Edmonton. Pinecrest Energy Inc. (PRY:TSX.V) has been involved. Renegade will drill the first well later this year. If it can prove up one or two wells, it has a big enough land package to allow a lot of new locations to open up. Renegade also has a really interesting conventional play in southern Saskatchewan called Souris Valley. It's turning out to be a lot more profitable than the company had originally thought it would be.

TER: What is your bottom-line message on the future of fracking?

KS: Mainstream public attention on water management isn't a bad thing. It makes the industry do things that should get done. Fracking water should be food grade. The market rewards stocks for doing the right thing. There's nothing that the market hates more than uncertainty. If the industry starts to lose what I call its "social license" in the United States, that loss will have a very big impact on valuations. Companies are incentivized to do the right thing, to do it well—and to do it fast. That's why we will soon see a resolution to the fracking issue.

TER: Thank you for chatting with us today.

KS: A pleasure as always.

Keith Schaefer of the Oil & Gas Investments Bulletin writes on oil and natural gas markets. His newsletter outlines which TSX-listed energy companies have the ability to grow and bring shareholders prosperity. Keith has a degree in journalism and has worked for several dailies in Canada but has spent the last 15 years assisting public resource companies in raising exploration and expansion capital.

Want to read more exclusive Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Exclusive Interviews page.

1) Peter Byrne of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Royal Dutch Shell Plc.
3) Keith Schaefer: I personally and/or my family own shares of the following companies mentioned in this interview: GasFrac Energy Services Inc., Poseidon Concepts Corp., Raging River Exploration Inc., Renegade Petroleum Ltd., Ridgeline Energy Services Inc. and ZaZa Energy Corp. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this story.


Energy & Commodities

Profit-Makers in the Oil and Gas Service Sector

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Posted by The Energy Report

on Monday, 24 September 2012 12:21

Everyone agrees that high energy prices are here to stay, so most companies should perform well in the long run. But what about near-term opportunities? Taylor MacDonald, associate portfolio manager at Pathfinder Asset Management, is looking to service companies for industry outperformance. In this exclusive interview withThe Energy Report, he describes why proprietary niche service companies virtually own the markets they are establishing


The Energy Report: It's been almost a year and a half since your last interview. We've had lots of ups and downs in the market. What is your current outlook for oil and gas? Are prices going to be stable or do you expect significant movement one way or the other?

Taylor MacDonald: Eric Sprott put it best when he said something along the lines of "Tell me how many greenbacks the Federal Reserve is going to print and I'll tell you where oil prices are going" Greater easing is bad for the U.S. dollar and good for things priced in dollars. In a supply-constrained environment, the potential for shocks exists, but demand will continue to grow as long as oil prices don't run too quickly or so far as to cause too much of a drag on global economic activity.

If there's an incident in the Middle East that shuts down oil infrastructure in Saudi Arabia or the Strait of Hormuz, we could easily see oil at $150/barrel (bbl) or even $200/bbl. Hopefully that would be temporary. But irrespective of that possibility, we are quite bullish on the energy space. Until someone develops something to supplant it, we are still going to need a lot of oil and gas to fuel global economic activity.

TER: Would additional easing make much difference?

TM: I don't think there's any end in sight to easing, which will only continue to devalue the dollar—and that is good for commodities priced in dollars. Realistically, we are looking at steadily higher oil prices going forward.

TER: It seems that most of the easy oil has been found, at least onshore. A lot of activity is taking place offshore in places people didn't consider potential oil-producing areas. Is this the future of oil and gas production?

TM: That is certainly going to be where we'll continue to see a lot of action. We look at both new exploration on old fields and new exploration on new fields. Pathfinder has done very well in the past with holdings in Tag Oil Ltd. (TAO:TSX.V) and New Zealand Energy Corp. (NZ:TSX.V; NZERF:OTCQX), two companies that are developing what was previously seen as an "exotic basin." We've also done very well with our holding of Africa Oil Corp. (AOI:TSX.V). We think that companies going into underdeveloped or unproven basins are ripe for the picking. The other place we've seen a lot of potential is in companies going into past-producing fields. One company in this arena, which we have a large position in and from which I recently got an update from management is PRD Energy Inc. (PRD:TSX.V). It's acquiring acres and acres of land in Germany, Lower Saxony, and going back into fields that produced until World War II—and some more recently. PRD is going to rework them by applying modern extraction techniques to fields that have produced a mere fraction of their potential. This could be one of the better plays we see over the next year.

TER: Would you classify these as unconventional oil plays or extensions of existing technology?

TM: These are about as conventional as things get. I think the money that's going to be made at the moment will be on normal oil and gas production. There is a lot of potential in unconventional reservoirs and new extraction techniques, and in applying conventional techniques to unconventional reservoirs. But right now, the simpler it is, the better.

TER: Have there been any major developments in some of the companies that you talked about last year?

TM: There's a saying in the mining business that the best way to make money in a mining boom is to be in the business of picks and shovels. We are looking beyond that to "Picks and Shovels 2.0."

In the oil and gas space, a handful of companies are applying new technologies to old industry problems. The first one is Ridgeline Energy Services Inc. (RLE:TSX.V), which we discussed at length in April 2011. It's a cutting-edge energy services and water treatment company applying a proprietary technology to treat water from the industrial and commercial wastewater markets. We feel that Ridgeline is likely to be the victor in the race to provide the best solution for the treatment of dirty water from fracking—and really for most kinds of industrial process flow-back water.

Ridgeline made the transition from a relatively short research and development (R&D) period (three years) to full commercial deployment, and boasts a formidable list of major clients, including ConocoPhillips (COP:NYSE), Devon Energy Corp. (DVN:NYSE), Enbridge Energy Partners L.P. (EEP:NYSE), EOG Resources Inc. (EOG:NYSE) and Progress Energy Resources Corp. (PRQ:TSX ), to name a few. When we discussed Ridgeline last year, the shares were trading in the $0.50 range. After a meteoric rise to a high of $1.41 last March, the price has come back down to earth and is now settling in the high $0.50s. We recently added a sizeable position to our Pathfinder Partner's Fund and it is now our single largest share holding. We believe investors would be wise to pick up a position in the company here.

After a number of significant developments, Ridgeline is far better positioned than it was last year. First, it acquired 100% of the global rights for its technology for just less than 35 million shares. This was expected, but still a milestone for the company. Second, the company added a strong new CFO and a new COO as well as a Fortune 500 director. Third, the company set up a fully operational commercial facility with EOG Resources in New Mexico, which we visited earlier this year.

Ridgeline also finalized an agreement to purchase an industrial wastewater pretreatment facility in Los Angeles, where it's currently treating industrial wastewater streams. Although this application doesn't get the same attention as the company's work in the oil and gas space, it has more profitable margins that are multiples of what is seen in oil and gas. And the near- and mid-term revenue growth from the facility should underpin Ridgeline stock at a higher price.

Lastly, the company started manufacturing its water storage units, which are bladder-and-manifold systems. The growth of competitor company Poseidon Concepts Corp. (PSN:TSX) has shown that the market for water storage in the oil and gas industry is massive. Ridgeline's storage system may not have the same growth, but we do expect it to be a significant contributor to sales and profits as it is rolled out.

This treats a huge and growing problem of water usage and disposal when fracking. It is cost competitive with down-hole disposal—if not cheaper—and also allows reuse of the water in the next frack. Not only does it save on the disposal cost but also on water acquisition cost. This is my favorite company and our largest holding.

TER: What are the growth prospects in terms of revenues?

TM: I expect the company will bring in $27 million (M) in the next year, and then $55–70M the following year. This will be a very high-margin business, especially as Ridgeline branches out into industrial wastewater treatment and into its water storage system. The water storage uses bags, as opposed to Poseidon's system, which uses giant "kiddie" pools full of water. Poseidon's system works much better in Alberta, where surface land area is a constraint. The bag system lays flat on the ground and is also fully contained. If land isn't an issue, as in Texas, and where evaporation is a huge issue, such as with the current drought, the bag system presents a very interesting solution to water storage needs.

TER: And the company is going to make money regardless of what oil prices do because these are services that companies need to use one way or another.

TM: Definitely. Ridgeline also has two other businesses. One of them is treating hydrocarbon contaminated soils at its GreenFill sites; there are many throughout Alberta. The other is an underlying environmental consulting business, which was how the company started. These other business streams help to support the company and add to both the top and bottom lines.

TER: With regard to profit margins, how sensitive to oil prices are most companies at this point, relative to future exploration activities and the profits that they are making right now?

TM: Cost inflation is something that every single business space is currently experiencing, not just oil and gas. Companies must do whatever they can to become more efficient and save on exploration, development and production costs, etc. One company we are very keen on is Calgary-based NXT Energy Solutions (SFD:TSX.V; NSFDF:OTCBB), which has a disruptive, patented and patent-pending airborne survey technology for oil and gas exploration called Stress Field Detection (SFD).

SFD is a little difficult to explain, but it's essentially a jet with a passive sensor array on board that flies a grid over large swaths of land looking for drops in the gravity stress field. Surveys can be completed in one-tenth of the time and cost of 2-D and 3-D seismic surveys. This doesn't replace seismic, but rather pinpoints where to shoot the seismic. It allows companies to survey hard-to-reach areas with virtually zero environmental impact. The technology is fully proven and can be used onshore, offshore, and in mountainous terrain. It's been used and verified by Pacific Rubiales Energy Corp. (PRE:TSX; PREC:BVC), Pengrowth Corp (PGH:NYSE), Pemex (PEMEX:MSX), BP Colombia (NYSE:BP) and Ecopetrol (Colombia's national oil company).

To envision the process, imagine a river with a rock in the middle. As the river, an analogue for the stress field, reaches the rock, it will wrap around it. This means that the river, or again, the stress field, will have to change direction, which shows up in the gravity field, where the SFD can detect it. It's based on quantum physics. Flying a grid pattern, the SFD equipment measures and detects orientation changes in that stress. A trapped reservoir, for example, will affect the SFD, and allows delineation of prospective areas. The fluid could be oil, gas and/or water. The resulting data shows exactly where to shoot your 2-D and 3-D seismic.

This technology slashes permitting time, lessens environmental impact, and can literally save a company up to 90% on seismic acquisition costs. The technology only requires a flight plan, not exploration permits, which allows NXT to mobilize quickly instead of waiting up to three years just for the seismic permit. SFD also improves the success rate dramatically on wildcat exploration wells in frontier areas. NXT Energy has a growing revenue base and client list, with a rapidly increasing acceptance of the technology. It's also profitable on an earnings-per-share (EPS) basis over the last two quarters, and is a well-held and well-structured company. We think the company's future is very bright.

TER: Is this somewhat similar to airborne geophysical surveys for mineral deposits?

TM: Yes. But I would say this is much more precise in that it can tell you exactly where to find million-barrel fields. There's also the ability to locate water aquifers. Who knows where it could lead? This is one of the most interesting technologies I've seen in the business in my years in the industry.

TER: That's definitely a revolutionary technology. What else do you like in the services?

TM: This may not sound like the sexiest business on the planet, but in some ways it is. Cortex Business Solutions Inc. (CBX:TSX.V) provides an electronic procurement and invoicing system for the oil and gas business. It set up an electronic network to process invoices and convinced Husky Energy Inc. (HSE:TSX) to essentially come on as a beta test. Let's say Husky operates a hub with 10,000 (10K) different suppliers, ranging from modular assembly to pipe fabrication to wiring to meals and housing for employees, etc. A big rush of invoices come in at the end of the month and all are prone to human error. Using the Cortex system, every time a supplier initiates a document they'll pay a transaction fee of between $0.25–2.50 depending on the number of invoices sent in a month while the hubs pay a capped monthly fee in the thousands to tens of thousands of dollars. As you can imagine, the system started to take hold.

Husky streamlined invoice receipt and processing functions, saving millions of dollars per year. It even mandated that its suppliers all join the Cortex system. Cortex has now signed more than 40 major buying organizations in Canada and the U.S. onto the system, including such major names as Apache Corp. (APA:NYSE), Hilcorp (private), Energen (EGN:NYSE), Bonavista Energy Corp. (BNP.UN:TSX) and Murphy Oil Corp. (MUR:NYSE). I'd also point out that Cortex has also boarded over 8,000 suppliers to the system and that many of those suppliers are turning into hubs themselves, demonstrating accelerated acceptance. Every added hub creates a new network effect, because most suppliers don't work for just one company. As you add another hub, your average revenue per supplier, or ARPS, goes up. What I refer to as "manifest destiny" will likely enable Cortex to take over the oil and gas space.

The company's revenues will grow and multiply. I believe it's at the beginning of that hockey stick curve we all love to talk about. Cortex is about to turn the corner on profitability and cash flow, and the modeling I've done shows the numbers getting pretty heady a year or two out.

TER: Do you think Cortex will lock up the whole business, since there doesn't appear to be anybody else that's made significant inroads?

TM: It has signed up two utilities clients, and is also looking into the construction sector. Every major type of industry can probably make their systems better with Cortex. I think we are just starting to see Cortex's system take hold and it's one of the ways that oil and gas companies can fight rising costs in other areas of their businesses.

TER: What are your expectations for the company at this point?

TM: It did about $4.6M over the last year or so, and is trading at $0.18. From January 2013 and moving one year forward, I expect roughly $0.04 of free cash flow per share. Applying a 10 times multiple to that, which is justifiable given the growth curve, we can easily see a double from here. It went from signing one hub a month to four, then six, and now just announced that it signed a total of seven major buying organizations to the system in August. The worse things get for the oil and gas companies, the more they are going to need a service like this, because they are going to want to control costs and have a better handle on information. This is one of the best companies I've seen—and because it's so simple it is very difficult for it to go wrong. We are the company's second largest shareholder, after Fidelity.

TER: What else do you like?

TM: Another company we find very interesting is Synodon Inc. (SYD:TSX.V), which has developed and field-tested a remote gas-sensing technology called realSens, which it purchased from the Canadian Space Agency and has invested $47M in, to date. This promises to be a game-changer in the gas detection space. There are a range of applications, but the most near-term opportunity is in the gas transmission space, where the sensor is mounted on a helicopter that flies gas pipelines to detect any leaks in both industrial and commercial transmission. Two percent of all gas put into a pipeline doesn't make it to the other end. More than $300M is spent and more than 2M pipeline leaks are detected globally every year. Synodon's competitor dominates 80% of that $300M. That alternative method involves manually walking the lines with a "sniffer" device that detects gas. It's inefficient and extremely costly. There's also a large legislative environmental concern, which could really give Synodon a push.

This is a best-in-class technology and Synodon has some strategic partners already lined up, like TransCanada Corp. (TRP:TSX) and Enbridge Inc. (ENB:NYSE). The contracts are starting to roll in and the company has been finding massive leaks that previously went undetected.

The reason we got involved with this story is because Paul van Eeden, a preeminent resource newsletter writer, has come on as a director and owns over 20% of the company. That was the vote of confidence we needed to look deeper. This is, without a doubt, a best-in-show company in terms of cost, speed and efficiency, and we think it will become one of the go-to technologies oil and gas producers and distributors use to ensure efficiency and not leave any money on the table.

TER: Is this another revolutionary technology that could get a lock on a particular market?

TM: Absolutely. I think the legislative push could soon require companies to fly pipelines at pre-stated intervals.

TER: Do you like any more conventional plays?

TM: We continue to look for opportunities, and like companies that are applying either new technologies to old basins or old technologies to new basins. There are lots of different ways to make money in this business.

TER: These are interesting stories and we'll be watching to see how things develop. Thanks for joining us today, Taylor.

TM: My pleasure.

Taylor MacDonald is an associate portfolio manager at Pathfinder Asset Management Limited. He graduated from the Wharton School, University of Pennsylvania, with a bachelor's in economics in 2004. Prior to Pathfinder, he worked in equity research at Raymond James Ltd. in Vancouver, investment banking with Haywood Securities (UK) Ltd. in London, England, and institutional equity sales at RenCap Securities in New York. He has been a CFA Charterholder since 2009 and is a Level II CAIA candidate.

Want to read more exclusive Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Exclusive Interviews page.

1) Zig Lambo of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: New Zealand Energy Corp. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Taylor McDonald: I personally and/or my family own shares of the following companies mentioned in this interview: Ridgeline Energy Services and Cortex Business Solutions. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.

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