Energy & Commodities

Iran cuts oil exports to Europe

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The move comes days after Iran’s Oil Minister Rostam Qassemi said Tehran could cut off oil exports to “hostile” European nations as tensions rose over suggestions that military strikes are an increasing possibility if sanctions fail to rein in the Islamic Republic’s nuclear ambitions.

Iran argues that the EU oil embargo will not cripple its economy, claiming that the country already has identified new customers to replace the loss in European sales that account for about 18% of Iran’s exports. 

Members of Iran’s parliament have been discussing a draft bill, although not finalised, which would cut off the flow to the European Union before the latest EU sanctions on Iran go into effect this summer.

Iran has said it is forced to manufacture nuclear fuel rods, which provide fuel for reactors, on its own since international sanctions ban it from buying them on foreign markets. In January, Iran said it had produced its first such fuel rod.

Iran’s unchecked pursuit of the nuclear programme scuttled negotiations a year ago but Iranian officials last month proposed a return to the talks with the five permanent UN Security Council members plus Germany.

 

TSX flat amid rising commodities, Greek assurances that it can get bailout

Oil Patch & The Multi-Billion Dollar Water Services Industry

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There is a multi-billion dollar water industry forming before investors’ eyes in the oil patch.

It’s a huge opportunity for some great capital gains — but changing regulations, and a very attentive mainstream audience questioning business practises which have been in effect for decades, will will make it choppy water for investors.

“In 2008 there were 25 billion barrels of water handled (by the oil and gas industry) in the US—even at 60 cents a barrel it’s a multibillion dollar business,” says Jonathan Hoopes, President of GreenHunter Energy Inc. (GRH-AMEX). “With the big growth in unconventional since then, it’s likely another 5-6 billion barrels.”

 

…..read more HERE

China’s Oil Imports From Iran Reduced Again

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China has stepped up the pressure on Iran in the face of Europe’s oil embargo. China will reduce its crude oil imports from Iran for a third month, sources said today, as the two remain divided over payment and price terms, although they plan to meet again for talks as early as this week.

 

China is the top buyer of Iranian oil and also the fastest expanding major oil importer, putting it in a strong position to negotiate for better terms after it more than halved imports for both January and February.

The reductions for March-loading supplies will be largely the same, if not deeper, than the previous two months, industry officials with direct knowledge of the supply situation told Reuters.

 

China, which buys around 20 percent of Iran’s total crude exports, cut its January and February purchases by about 285,000 bpd, just over one half of the total average daily amount it imported in 2011.

 

Spotlight China: Electricity Consumption Drops Sharply; Central Bank Vows Housing Support; Asia Real-Estate Bull Turns Bearish HERE

 

Potash’s Current Calm Promises an Exciting Future

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Last year marked the third-largest growth in the potash industry, but hesitancy from India and China may put things on hold in 2012. However, MGI Securities Analyst Corey Dias still expects to see a lot of positive news coming out of the junior potash space. In an exclusive interview with The Energy Report, Dias specifies which companies he’ll be following for progress.

COMPANIES MENTIONED: AGRIUM INC. –ALLANA POTASH CORP. – KARNALYTE RESOURCES INC. – PASSPORT POTASH INC. – POTASH CORP. – RIO TINTO – RIO VERDE MINERALS DEVELOPMENT CORP. – THE MOSAIC COMPANY –VERDE POTASH

The Energy Report: Total potash demand in 2011 was estimated at 56 million tons (Mt), and the market has traditionally grown at a rate of about 3.5%/year. Do you believe we’ll see a similar increase in 2012?


Corey Dias: I think 3.5% could be at the high end of growth for 2012. I would expect slightly lower growth this year given that India is delaying its potash purchases until the end of Q112. China is also determining its exact needs, and there are rumors that it may reduce its imports this year versus 2011. Everything tends to depend on price. Canpotex (the marketing company for Saskatchewan potash producers) and its Belarusian counterpart are holding out for higher prices than India and the China currently seems willing to pay. With those delays, demand will probably be slightly below the historical 3.5% growth rate.

 

TER: Potash Corp. (POT:TSX; POT:NYSE) of Canada has shut down two mines in that country, andThe Mosaic Company (MOS:NYSE) says potash buying is slow right now as buyers are taking a wait-and-see approach. What do you make of Potash Corp shutting down those two mines? 


CD: It is a prudent approach. The company doesn’t want to flood the market with product as it would like to sustain a reasonable potash price that could provide a reasonably profitable return. By shutting down these mines, it’s limiting the output and that should keep the price at a fairly stable level. It’s not a question of shutting down so much capacity that prices are going to spike; it’s simply a way to keep potash prices relatively stable until the moment when a larger buyer comes back into the market, whether it’s India or China.


TER: In 2011, potash had the third-largest price increase among the 32 commodities ranked by the Scotiabank Commodity Index and, over the span of 2011, potash rose about 32%. The leading indicator of potash prices is often the price for corn, which is down significantly after some bumper corn crops in Eastern Europe, Russia, and Australia. What do you believe will be the average price per ton (t) for potash in 2012?


CD: Potash prices seem to be ranging between $450 and $550/t at the moment, depending on the port of delivery. It will probably stabilize around the $500/t level in the short term. I don’t see any reason for a significant spike in the price at this point. Although the corn price has recently seen a dip, it still remains above its historical average. Moreover, given the fact that the U.S. Department of Agriculture said that its stocks-to-use ratio is still well below the historical average, it would take a significant amount of corn production to reach the normal level of 15–20% in terms of that ratio, and reaching that level of production to meet this ratio could be a real challenge, especially when corn demand continues to grow. Therefore, while corn is slightly down, I don’t think there is going to be a downward trend in the corn price, or a complementary downward trend in potash. 

TER: You don’t believe that potash will be in the top 10 performing commodities in 2012? 

CD: I think it will have a fairly average year. I don’t think it will repeat its price performance in 2012 as it had a relatively low price point from which to start in 2011. It will probably stay somewhere in the middle of the park vis-à-vis other commodities.


TER: In an interview with The Energy Report in May 2011, Dundee Securities’ senior analyst Richard Kelertas predicted that we would see $750/t potash at some point before May 2013. What’s your perspective? 


CD: As you said, that was in May 2011. The market looks a little different now than it did then. The fact that India is pushing back on pricing and delaying its purchases and China is reassessing are going to mitigate the potential upside of the potash pricing. Probably $600–650 is a reasonable price going to 2013, but there are a number of different factors that come into play in addition to India and China, whether it is production capacity being added to the market via brownfield or greenfield projects, whether or not there is a recovery in the European market, or whether or not the U.S. recovery continues. The fact that farmers seem to have a lot of money coming out of 2011 could, at worst, bode well for holding a pricing floor on potash at current levels and could potentially even support a higher price. I think that $600–650/t is reasonable. 


TER: Tell us about your coverage universe and the types of companies you cover.


CD: I’m now ramping up coverage in the potash space. My first report was about Passport Potash Inc. (PPI:TSX.V; PPRTF:OTCQX), a name that I’ve followed since early 2011 when I was working in an institutional equity sales capacity at MGI. I really like this story and the fact that it’s in a safe, mining-friendly jurisdiction. An opportunity to build a mine in a potash-rich region—the Holbrook Basin—with only two competitors in the Basin could provide an opportunity for consolidation. It is a story with a great deal of appeal. 

Generally, I’m looking at small-cap developers and am not restricted to North America. There are developers in Africa and South America that could be appealing in the same way. It will be up to clients to decide whether or not they have the risk tolerance for assets outside North America.


TER: Is that typically the type of company that MGI covers even in the other sectors?


CD: We tend to cover smaller-cap names. Large-cap names would be a bit more difficult for us to champion in a lot of ways because we wouldn’t necessarily get the mind space from clients for large-cap ideas because clients are well covered by banks and bulge bracket firms that are looking at the Potash Corps of the world, companies like Agrium Inc. (AGU:NYSE; AGU:TSX) and Mosaic.


TER: Passport Potash’s share price took a beating in 2011. It’s currently developing the Holbrook Basin potash project in Nevada. Why do you believe that junior is going to rebound this year?


CD: Part of Passport’s problem this past year was based on the market itself being quite volatile, especially toward the end of the year. In general, small-cap names tend to suffer the most in those circumstances. But management made a few promises to the market that it was unable to keep and probably didn’t realize the extent to which it would be punished by the market by having missed deadlines. However, I believe that the company is starting to right itself. It is in the process of putting together an NI 43-101-compliant resource estimate, which we expect to be released by the end of Q112. Following that, we should see a preliminary economic assessment or scoping study and, further, a prefeasibility study from Passport in order to show the economic viability of its project. In addition, there was an announcement on January 18th that Passport has brought on a new chairman who has significant operational experience gained during his time with Rio Tinto (RIO:NYSE; RIO:ASX). It also has added Ali Rahimtula, who has experience in India, which is key in this type of business because there is the potential for an offtake agreement with an Indian partner. Passport has acknowledged the fact that it needs more relevant experience on the board, and has clearly begun to address this shortfall.

 

Like most of the names in the junior developer space, there tends to be a rerating—in terms of valuation—of these types of businesses once milestones are met along the road to production. As Passport meets its milestones, the market will likely provide the company with a more positive valuation via a re-rating of its stock. The company’s stock price hit bottom at $0.17 toward the end of last year. Since then, it has been able to at least project to the market that it does have some deadlines, which it intends to meet. Passport has engaged the engineering firm ERCOSPLAN to complete its NI 43-101. ERCOSPLAN has a really good reputation in the marketplace and has done a lot of work for developers in the potash space worldwide. The market now understands that the company is working very hard to meet its current deadline and, once met, Passport will have a potash resource estimate to put to the market. The market at that point will respond favorably, in my opinion.


TER: A competitor operating in the same basin that Passport is operating in, the Holbrook Basin, already has an NI 43-101 resource of 125 Mt potassium chloride (KCl). How large do you expect Passport’s resource to be once it’s published? 


CD: The competitor has about 94,000 acres of land, while Passport has about 81,000 acres. If we were to use a ratio of acres to contained tons of KCl for the competitor and apply it to what Passport has, Passport would probably come in somewhere about 100–101Mt of contained KCl. Remember, this is in no way a forecast that I am making as to the size of Passport’s resource. Even if Passport has something like 80% of that number, I think it’s still a decent-sized resource. In my report, I am forecasting that Passport will produce about 1Mt/year over 40 years. That implies about 40Mt of in situ KCl. If we’re talking somewhere between 80–100Mt of contained KCl, there is significant opportunity for Passport to increase the size of production on an annual basis, or it gives a bit more leeway in terms of what the potential resource size could be, on a contained-ton basis. 


TER: You have a Speculative Buy on that particular equity. What is your 12-month target?


CD: My 12-month target for Passport is $0.75.


TER: Another junior in that space, Allana Potash Corp. (AAA:TSX; ALLRF:OTCQX), jumped out of the gate in 2011 and slipped above $2 in June 2011 before spending the rest of the year retreating from that benchmark. It now sits well below $1. Will that junior rebound this year? If so, what are the catalysts that are going to make that happen?


CD: I think so. Allana probably jumped up based on speculation more than anything else, but as the actual resource-related numbers come in, then it tends to start trading at some kind of multiple based on its enterprise value (EV), whether it’s EV:resource or EV:ton KCl, et cetera. When the market sees that it’s getting closer and closer to production, that’s when the valuation will start to improve. I think that is something that could happen this year. When one has an asset that doesn’t have any economic information tied to it, it’s very easy to speculate as to what you think the value should be. Obviously, the closer one gets to production, then there are hard and fast numbers that one can start applying some kind of multiple to in order to value a company like Allana Potash. That’s probably why it’s now down below $1. It’s probably more reasonably priced here and as more news comes out that’s favorable to the company, then you should start seeing the stock move back up.


TER: What are your thoughts on the Danakil potash project in Ethiopia?


CD: The Danakil project is interesting because it’s a near-surface project, which means the capex should be low. I think that it will have a fast track to production, which is another positive. And the fact that it’s probably selling to India, and perhaps China, is another positive because there is a quicker trade route to those countries when compared to North American or South American potash producers. 

 

That said, there is no domestic demand for the product in Ethiopia. The companies that I believe have an advantage are those that have domestic demand or significant domestic demand, whether it’s a place like the U.S., which imports most of its potash needs, or South America—Brazil in particular—where 90% of its potash needs are imported. Ethiopia is also landlocked, that is, it has to go through another country in order to reach the port. Moreover, there is a greater possibility of political risk in Africa than in the U.S. or in Brazil. However, if everything remains stable, I think there could be a big opportunity for Allana, especially given its low operational cost base. 


TER: What are some other small-cap potash plays that you expect will outperform in 2012?


CD: Verde Potash (NPK:TSX.V) is planning to produce a unique product called Thermopotash. Thermopotash, derived from the combination of glauconite and limestone, is a slow-release potash product with no chloride, which is great for crops like tobacco, coffee and oranges. In addition, the company is exploring the use of a new technology—the Cambridge process—which could potentially convert Verde’s potassium-rich rock to regular KCl. This would be a massive opportunity in Brazil. In terms of available infrastructure, Brazil falls behind North America but is certainly ahead of Africa. 

Rio Verde Minerals Development Corp. (RVD:TSX) is another small company operating in Brazil that recently confirmed that it has potash on its property. The stock has moved up a little bit on the back of that news. Once an NI 43-101 resource estimate is released for Rio Verde Potash’s potash asset, we should see another re-rating of the stock.

Karnalyte Resources Inc. (KRN:TSX) is another one. Once again, I tend to favor the junior potash developers that have a bit of a unique element or bring something a little bit different to the table. Karnalyte is focusing on extracting potash from the potash-bearing carnallite layer, which is unusual for Saskatchewan because other producers and developers target the sylvinite layer that is usually closest to the surface. Karnalyte’s deposit is based on an anomaly where there is a significant carnallite layer that is relatively near-surface vis-à-vis the sylvinite layer. The technology that it is planning to use also could provide a magnesium byproduct and sodium chloride byproduct, both of which the Company could potentially market and sell in the future. Karnalyte has a number of things going for it; I think management is very strong. The fact that it has four patents pending for its technology could mean that what it ends up with is going to be very unique. It has a massive land holding and has only conducted advanced exploration on 20% of it. Fnially, it plans to expand its plant by using cash flow generated from its initial buildout. 


TER: It has done a nice job of managing its share flow, too, with only about 21M shares outstanding vs. something far greater for a company like Allana. 


CD: Yes.


TER: Or do you prefer a larger share count, such as Allana, with its 193M shares verus 20M for Karnalyte?


CD: When you’re in the small-cap space—and especially if your float is small—it becomes a bit riskier for clients to hold when the markets are a bit more volatile. It’s one thing to get into a stock, but when the market is volatile and a client is looking to exit a position, it’s very difficult to do if the trade volumes aren’t there. That’s the risk with Karnalyte. The average trade volume is 34,000 shares a day. So if you have a position that’s 100,000 shares, it’s going to take you roughly three days to get out of that position, and that assumes that you can be 100% of the trading volume over those days. And you could end up driving its price down significantly while you’re trying to exit your position. Having a more liquid position in a stock like Allana that you can get in and out of a lot more easily would likely appeal to portfolio managers.


TER: Could you give our readers an outline of what to look for in the small-cap potash space over the next year or so?


CD: You’ll see a number of companies starting to reach the prefeasibility and feasibility stages. At that point, these companies will start to look for strategic partners, whether it’s to fund the buildout of the products or secure an offtake agreement for the product that’s going to be produced a few years out. At that point, we’ll start to see which projects are going to be viewed as more viable. There probably won’t be enough demand to drive a need for every single junior potash developer that is currently out there to actually move into production. That said, there is also the possibility that some of these companies will be absorbed by larger entities that are looking to enter the potash space given the future, positive fundamentals for potash or those that are currently in the market and are looking to increase potential capacity moving forward. I expect to see a lot of positive news coming out of the junior potash space, especially as a few of these companies meet milestones in order to get a little bit closer to production and production becomes more of a reality. 

Corey Dias has worked in the capital markets industry since 2003 and has spent eight years in institutional equity research and institutional equity sales. In addition, he has worked for a U.S. hedge fund, where he shared responsibility for the running of a $400M portfolio and sought out assets for private equity investment on behalf of the fund. Mr. Dias holds a Master of Business Administration from the Richard Ivey School of Business at the University of Western Ontario.

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Copper Continues to Confound the Commodities Crowd

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Loyal subscribers know I often opine that world markets are in the midst of a secular bull market for commodities, or “stuff”, as my recently passed friend Clyde Harrison was so fond of saying. Despite his traitorous penchant for Coors Light (instead of the classic St. Louis-brewed lagers), Clyde was one of those fellow Missourians who always had to be shown, and we all miss his wry wit, sense of humor, and insight into the speculative commodities markets. 

 

You may also be aware of my many writings and interviews on the supply-demand fundamentals of copper, the metal with a “Ph.D. in Economics”. Copper is the one commodity that most directly reflects the near- and mid-term health of the world’s economy.

 

The modern copper industry started in the early 1900s with advent of large, mechanized open pit mines that could mine lower grades thru economies of scale. Development of these mines was coincident with the demand for and delivery of electricity to the industrialized world. Copper cable and wire is necessary for efficient transmission of electrical power and remains the main use of the metal.

 

Powers Energy Investor Editor Bill Powers doesn’t shy away from microcaps; he embraces them. In this exclusive interview with The Energy Report, he explains why triple-digit oil is here to stay and how the best-positioned companies will be sitting pretty when natural gas prices rise—as will investors who time the rebound right.

COMPANIES MENTIONED: ADVANTAGE OIL AND GAS LTD. – ARSENAL ENERGY INC. – CHESAPEAKE ENERGY CORP. – CONNACHER OIL & GAS – DENBURY RESOURCES INC. – ENERGY XXI – EVOLUTION PETROLEUM CORPORATION – FAIRBORNE ENERGY LTD. – PETROBAKKEN ENERGY LTD. – PETROBANK ENERGY & RESOURCES LTD. – PETROMINERALES LTD. – QUICKSILVER RESOURCES INC – SM ENERGY CO. – SOUTHWESTERN ENERGY CO. – TOTAL ENERGY SERVICES – ULTRA PETROLEUM CORP.

 

The Energy Report: Is it fair to say that you are a value investor?

Bill Powers: Absolutely. I’m very much a value investor focused on fundamentals and finding companies that can grow reserves, production and cash flow without taking on too much debt and/or diluting shares. Those are the companies that can have very strong long-term outperformance. That is my theme, and I think it is really powerful right now. The companies I’ve identified do not currently reflect future prices that their stocks will be receiving.

TER: Clean balance sheets, steady cash flow and a depressed market price: would that sum it up?

BP: Yes. The Canadian junior market has changed in the last 10 years markedly. It’s matured greatly. Many companies have proven management teams and very good cash flow but are trading below their net asset value. 

TER: Do you try to stay away from micro-cap stocks?

BP: Absolutely not; I very much embrace micro-cap stocks. As a newsletter writer, my commentary is largely directed at investors who want information on companies that are below Wall Street or Bay Street’s radar screen. I try to find the company that I feel is best positioned in a certain play and that have the chance for the best share price appreciation. Usually, it’s not the large-cap producers who have acreage in the play. 

TER: How do you define a micro-cap?

BP: I consider a micro-cap as $250 million (M) on down.

TER: You recently wrote in the Powers Energy Investor that foreign investors are paying too much for joint venture (JV) agreements with large North American companies. If foreign companies are overpaying, why is that depressing the price of gas?

BP: I’ll give an example: Chesapeake Energy Corp. (CHK:NYSE) made a deal with Total Energy Services (TOT:TSX) to farm out its Utica shale acreage in Ohio. To put this into perspective, there have only been a handful of wells drilled in Ohio into the Utica shale, primarily within one county. This is a speculative play and I am very skeptical of how productive the Utica shale could really be.

That being said, the way these deals are structured is that Total, the foreign company in this case, pays $600M up front to Chesapeake, which will be drilling wells funded completely by Total. So between now and the end of 2014, it will be spending $1.5B on drilling. There are other companies that have done similar deals totaling maybe $20B from largely foreign companies farming into U.S. acreage. This is important because the foreign company will fund drilling for usually two years irrespective of gas price, and when companies drill with somebody else’s money, they are not sensitive to the fact that gas right now is under $2.50/thousand cubic feet (Mcf). It’s a good deal for the American companies, but it’s usually a very, very poor deal for the foreign firms.

TER: Classic economic theory says that if you keep producing like this and prices get very low, people will quit producing. Then, eventually, prices will go back up. When does that happen?

BP: I think it’s going to be happening fairly soon. Right now we have a glut of gas. Part of this is due to Haynesville and Marcellus operators’ drilling acreage to keep leases from expiring. The rig count is really starting to fall, especially in the Haynesville, which is producing 6 billion cubic feet (Bcf)/day right now and is the largest-producing field in the U.S. But that rate has already flattened out, and production will probably start to fall as rigs continue to get dropped. These are very high-decline wells. Texas production is beginning to decrease because the Eagle Ford is not offsetting production declines elsewhere in Texas. Gulf of Mexico production continues to go down. Basically, with gas under $3/Mcf, virtually every field in North America is uneconomic, and we will see a big slowdown in drilling. Very few companies have attractive hedges in place because we’ve had low gas prices for a couple of years. We will see a rebound in gas prices, and it will be quite violent. The challenge is finding the right timing of it. It is not so much a function of when the economics make sense as it is about when other people’s money runs out. We’re seeing that happen right now.

TER: Have we reached the point of maximum pessimism yet?

BP: That’s hard to say. I do think there is a lot of pessimism, but that doesn’t mean a reversal is imminent. I do think that at some time in 2012 we will see that reverse itself, and when that happens we will see gas prices increase substantially.

TER: It sounds like you are playing a very bullish scenario for natural gas. One of the first things I noted in your model portfolio from your Powers Energy Investor is that you have significant personal exposure to natural gas.

BP: Yes, absolutely. From an investor’s standpoint, being a contrarian is easy when your stocks are going up or when your ideas are being recognized by other market participants. What I’m doing in my newsletter is finding gas producers that have been beaten bloody by the marketplace but are low-cost producers that will make it to the other side to see the rebound in gas prices. I’ve identified about five companies that are leaders in certain plays or that have very good leverage to what I think are some of the best North American unconventional resource plays. Those are all places that will continue to produce into the future because they have the better acreage that will become economic once gas prices go back to $4/Mcf. Right now, you’re getting a lot of upside for free because the marketplace doesn’t believe that gas prices will eventually rebound.

TER: Could you talk about those companies you just referenced?

BP: Sure. One of the companies is Ultra Petroleum Corp. (UPL:NYSE), which is a slightly bigger company than I usually cover. It is very active in Wyoming on the Pinedale Anticline, and it’s also very active in the Marcellus. It is a very low-cost producer. This company was a penny stock about a decade ago. 

Another I really like, a smaller company, is Advantage Oil and Gas Ltd. (AAV:NYSE; AAV:TSX). It has a great project in the Montney in Canada. It is an extremely well-run company that I think is doing very good work up there.

There are other companies that offer a lot of value and have seen their share prices decline, such asFairborne Energy Ltd. (FEL:TSX) in the Willrich. It’s a very exciting play in Alberta’s Deep Basin.

This is just a preview of companies that I think have good acreage and that are very leveraged to rising gas prices. 

TER: Those were three of your five favored gas companies. What were the other two?

BP: One is Quicksilver Resources Inc. (KWK:NYSE). It’s a U.S.-based company that has a fair amount of debt on its balance sheet. However, for a small-cap company, it has fantastic acreage in the Horn River Basin, where it is very early stage, but this may turn out to be the best shale gas play in North America. Time will tell. This company has been around for more than 50 years, and it has a very good management team. It has been a leader in a number of shale plays. It had the Antrim shale in Michigan and the Barnett shale in Texas. It was one of the early players in those plays.

The other one I like is a bigger company that continues to produce very good results, and that isSouthwestern Energy Co. (SWN:NYSE) in the Fayetteville shale as well as in the Marcellus. The company has a dominant acreage position in the Fayetteville and has really been able to grow its production quickly in the Marcellus. It is a very well-run company by Steve Mueller. 

So those are just some companies that I try to find. Each is unique. Each of them has different catalysts that will help its share prices more than double once gas prices start to move up. I think these stocks could go up three- or four-fold from here without any problem.

TER: Ok, you love natural gas. What about oil?

BP: I’m very bullish on oil. I think there are some very good factors that will keep the price of oil over $100/barrel (bbl) almost irrespective of how the economy does. With the natural declines from the Gulf of Mexico and the North Sea as well as Venezuela and Mexico, a lot of countries are struggling to keep up production. I think the U.S. has been able to increase its production materially over the last five or six years due to breakthroughs in technology, but that does not change the long-term trajectory of oil production in the U.S. We will see declines from California and the Gulf of Mexico, and we will see further production declines in Alaska, which will largely offset some of the very exciting production growth in unconventional plays, such as the Bakken in North Dakota or the Permian Basin in Texas. I do think triple-digit oil prices are here to stay, and I think we could see $150/bbl before too long, especially if there is a disruption in the Middle East. I think the leverage available to investors with small-cap companies is really mindboggling when you look at what oil prices mean to these companies.

TER: What oil-based companies are we looking at?

BP: Arsenal Energy Inc. (AEI:TSX), a very exciting play in the Bakken. It also has acreage in the Willrich and a very good management team. It is growing its production, and it just did an acquisition that grew its production to around 4 thousand barrels (Mbbl)/day. It has a very strong future as far as production growth that’s high net back, high cash flow and reasonable balance sheets. That’s one company that I am very high on. It has a market cap of only about $109M. It is one of my favorites.

As far as other companies that have great leverage that will go up, I’m becoming very keen on oil sands companies. I think companies like Connacher Oil & Gas (CLL:TSX) are going to rebound and continue to rebound. PetroBakken Energy Ltd. (PBN:TSX)Petrobank Energy & Resources Ltd. (PBG:TSX) and Petrominerales Ltd. (PMG:TSE) are all very oil-weighted companies that will be able to really ramp up cash flow in 2012 as oil prices maintain the $100-level.

Then we do see some U.S.-based companies like SM Energy Co. (SM:NYSE) in the Eagle Ford. This is along my theme of trying to find companies with the best leverage to a certain play. I think SM Energy has the best acreage in the Eagle Ford. 

A couple of companies are involved in secondary oil recovery are Evolution Petroleum Corporation (EPM:NYSE) and Denbury Resources Inc. (DNR:NYSE). I think both of those companies are very well-leveraged to oil prices.

So those are some ideas that I think will provide shareholders great returns in the next two years.

TER: Speaking of oil sands, the Obama Administration nixed, at least temporarily, the Keystone XL Pipeline from Canada down to the Gulf Coast. Are the concerns valid? Aside from the developer TransCanada Corp. (TRP:TSX), who does this hurt?

BP: I think this really hurts American consumers. I don’t believe the concerns over the environmental aspects of the XL Pipeline were valid whatsoever. I think this was almost entirely a political maneuver. Right now, the U.S. still imports a substantial amount of production from overseas, and I don’t think some of these overseas suppliers are nearly as reliable as Canada. We import a lot from countries such as Venezuela and Mexico, which are struggling to maintain their production levels and are increasing internal consumption. So I think it is unlikely we will see material imports from either of those countries 10 years from now. Given the growth profiles of many Canadian oil sands producers such as Imperial Oil (IMO:TSX; IMO:NYSE.A) and Cenovus Energy Inc. (CVE:TSX; CVE:NYSE), I think we will see material growth in the Canadian oil sands from about 1.2 million barrels (MMbbl)/day to maybe 4 MMbbl by 2022, obviously depending on permitting issues and the price of oil. I think the Keystone would have been a very good supply. Eventually, I think the Canadians will get fed up and build a pipeline to Port Rupert and send the oil sands production to Asia if the U.S. cannot find some solution to get the XL Pipeline moving forward.

TER: The differential in price for what Asians are paying could pay for shipping that oil to Asia.

BP: Yes, absolutely. And one of the things we’re seeing in Asia is that some of the biggest producers such as Indonesia are seeing flat to declining production. And China has really struggled to keep its production flat. There have been some very good offshore finds in Malaysia and Vietnam that will replace some of the declines from places like Indonesia, but on an overall basis, those are not keeping up with the growing regional demand. Numerous Asian countries, especially China, would love to tap into the Canadian oil sands. A pipeline will get built. It’s just a matter of whether it leads to the U.S. or to the west coast of Canada. 

TER: You have reviewed Energy XXI (EXXI:NASDAQ) recently.

BP: It’s not in my model portfolio right now, but I was very impressed that it has been able to grow production and that the company has a material oil weighting. It has a very good mix of exploration prospects as well as development prospects. Right now, the market has really turned its back on the Gulf of Mexico producers such as Energy XXI, and it is trading at lower valuations than its onshore peers, but it is able to generate material cash flow. In the case of Energy XXI’s balance sheet, I think some investors were a little scared off by its debt levels, which I see as very manageable given the cash flows it will be receiving over the next two years and its significant material reserves that it can borrow against. I think Energy XXI has a pretty bright future. I’m going to continue to monitor the company and see how it continues to execute over the next six months or so. It has a very good mix of high-impact exploration and lower-risk development.

TER: Bill, you are writing a book now?

BP: I’m currently working on a book that looks at shale gas and what I consider to be the myth of a 100-year supply. While there is a significant amount of shale gas that will be recovered in the next decade, it is nowhere close to a 100-year supply. Shale gas is not the game changer that a lot of people think it is.

TER: What thought would you leave us with?

BP: I think the perceived risks in energy investing have been somewhat overblown given where oil prices are. The space is very volatile, but for investors who can take a longer-term approach and who can identify companies that are well-run and that have legitimate projects, there are fantastic returns available. The energy sector has been out of favor, but the fundamentals are very strong. I think investors who can position themselves in gas-weighted firms ahead of the coming rebound will be richly rewarded, but there are also fantastic returns in oil-weighted companies that will benefit mightily from triple-digit oil prices.

TER: Bill, I’ve enjoyed speaking with you.

BP: Thank you for having me.

Bill Powers is the editor of Powers Energy Investor and previously the editor of the Canadian Energy Viewpoint and US Energy Investor. He is a former money manager and has been an active investor for over 25 years. Powers has devoted the last 15 years to studying and analyzing the energy sector, driven by his desire to uncover unrecognized trends in the industry and identify outstanding opportunities for retail and institutional investors.

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