The Energy Report: Bob, in January you published an article saying that the drop in oil prices could be the "straw that pops the $7-trillion derivative bubble." Can you explain the influence of oil prices on derivatives?
Bob Moriarty: It's not the oil prices that are significant; it's the change in oil prices. If you own an oil field and it costs you $75 to produce a barrel, at $110 a barrel ($110/bbl), you're OK. If oil drops to $45/bbl, you're in serious trouble.
In the shale oil sector, producers were taking out hundreds of billions of dollars in loans to finance shale oil that was costing them about $110/bbl to produce. It looked good on paper, but was a disaster waiting to happen. A lot of people in the shale oil business will soon be going out of business.
"Pan Orient Energy Corp. just closed on the Thailand sale, and will be drilling a game-changing well in the next couple of weeks."
This could start World War III. The United States is the biggest oil producer in the world today, and Russia is number two. Russia's economy is based on oil priced at $110/bbl. They are very angry at the U.S. and Saudi Arabia for the games that have been played in oil. Oil at $45/bbl is not sustainable. It could bring down the world's financial system all by itself.
The real cost of energy today is $60 to $70/bbl. In the last piece I did with The Energy Report, I said $75 to $100/bbl oil was the new normal. That's still true. Oil is way below the cost of production, and that's going to hurt a lot of people.
TER: There is speculation the Saudis are doing this to wipe out some of the Russian and deepwater production. Could that be true?
BM: It's an economic act of war. The Saudis did it to get at the Russians and to get at Iran and the U.S. The Saudis have the cheapest cost of oil in the world. They could put everybody else out of business. The Saudis think that's a good thing. It's an extremely dangerous thing. It's like pulling the pin off a hand grenade and playing hot potato with it. At the end of the day the potato blows up.
TER: Will King Salman change the Saudi oil production strategy?
BM: I'm not sure that anybody could answer that question. I can't.
TER: To what extent do you think the violence and disarray in the Middle East is affecting oil prices? Are just the Saudis behind it?
BM: Everybody is overproducing to beat demand. The volume of oil in storage is as high as it has ever been. Oil is selling at about $50/bbl today, but if you store it for three months you can get $60/bbl for it. That gives everybody a big incentive to buy oil and store it.
I would guess that 98% of a producer's sunk costs have been spent before he produces his first barrel. There's no economic incentive for shutting the well off.
"The longer low oil prices continue, the more destructive it will be to both the financial and political systems."
Shale wells, on the other hand, deplete very rapidly. Once you've spent the money, you have to produce like crazy to pay for production, no matter what the oil price is.
I'm not sure we've seen the bottom. Oil could drop to $30/bbl, according to some. The longer low prices continue, the more destructive it will be to both the financial and political systems.
TER: You've written that an oil price below $40/bbl could mean a shooting war. Where would that shooting war occur, and what would be the catalyst?
BM: The catalyst was the U.S. spending $5 billion interfering in Ukraine over the last 10 years. We paid for a coup d'état. We overthrew Ukraine's legitimate government, and we're supplying arms and ammunition to the thugs now running Ukraine. Our government is demonizing Vladimir Putin, but Ukraine was part of Russia for 500 years. We are supporting the terrorism, and Putin is actually being quite rational. When he says this could start a shooting war, I believe him. And we will lose again, just as we have all the other insane wars of the last 15 years.
President Obama has threatened to kick Russia out of the SWIFT (Society for Worldwide Interbank Financial Telecommunication) system, which would mean Russians could no longer receive or send money abroad. That's an act of war.
TER: What does all that have to do with oil?
BM: We are trying to affect regime change in Russia. It's not going to work any more than it did in Afghanistan, Iraq, Iran or Libya. We are fooling with things that we just simply shouldn't be fooling with.
"A CEO's salary should reflect the real condition of the market."
We've been fighting with Russia for 10 years. Now Russia may decide that it wants to fight with us. Actually, I was wrong about the price of oil when it came to a shooting war: It wasn't $40/bbl oil. It was sub-$50/bbl oil. There is a shooting war going on in the Ukraine right now.
TER: Will that shooting war expand beyond Ukraine?
BM: When a war begins, people start off stupid and they only get dumber. So the answer is yeah, absolutely.
TER: Will the European Union (EU) get involved?
BM: The EU is already involved. If the EU had any sense, it would step back and stop the sanctions. When the Russians countered the sanctions, it hurt the EU tremendously.
TER: Russia has an advantage over the EU since it's acquired the vast majority of the EU's natural gas.
BM: Correct. Russia has some pretty powerful weapons.
TER: How are oil companies surviving at $40-50/bbl oil? What will be the fallout of that price point?
BM: The fallout will be $200/bbl oil, eventually.
Companies will survive because they don't spend money extracting oil. They spend money drilling for oil. When the price goes down, they stop drilling. The number of rigs in service is getting slashed.
That has an equal and opposite reaction. If you go for six or 12 months without drilling wells, you end up with a shortage as the older wells deplete. And that's when you end up with $200/bbl oil.
TER: Basically, companies are surviving because they're on the tail of the investment. How long will the tail last before we see depletion in oil production?
BM: Six months to a year, which is a long time in the oil business.
It all goes back to derivatives and central banks going into quantitative easing. When you can borrow an unlimited amount of money to drill for shale oil, you don't care about viability. If the price of oil goes up, you make money. If the price of oil goes down, you declare bankruptcy and stiff the bank. That's a foolish way to conduct business, but it's what we've gotten into with these enormous sums of money sloshing around. It's a scary time. We're going to look back and say, why didn't somebody warn us?
TER: If we're going to end up with an oil shortage, does that make this a good time to play the general oil market? Or do you think investors need to be more selective?
BM: I think investors have to be more selective.
For example, I spent an hour on the phone recently with Allen Wilson, the fellow who runs Jericho Oil Corp. (JCO:TSX.V). That company has signed a letter of intent to acquire acreage with shallow wells in Oklahoma, and makes money at $45/bbl oil. This is an incredible opportunity for well-managed, well-financed junior oil companies. The people who are financing at $110/bbl are giving those projects away.
TER: Are there other juniors that you consider no-brainer investment opportunities?
BM: Pan Orient Energy Corp. (POE:TSX.V) has done really well. The company has projects in Thailand and Indonesia, and a heavy oil project in Canada.
"Russia is very angry at the U.S. and Saudi Arabia for the games that have been played in oil."
Pan Orient entered into an agreement to sell a project in Thailand, selling half the project for $42 million ($42M). It is going to have $140M in tangible assets, with real value selling for $96M. That's a pretty good deal. Pan Orient's a well-managed company.
TER: Pan Orient's market cap is about $97M. What will take that market cap up? Would Pan Orient be able to produce with oil at $45/bbl and make money?
BM: Here's where it gets better. At the lowest oil prices we've had since the 2008 crisis, after the sale Pan Orient will have $91M in cash. You want to have a lot of cash on hand when people are giving assets away just because they are uneconomic. A company with $91M in cash can double, triple, quadruple its total assets. This is a wonderful time to have cash and be in the oil business. Pan Orient just closed on the sale and will be drilling a game-changing well in the next couple of weeks.
TER: In effect, companies are shopping.
TER: Will Pan Orient begin to diversify?
BM: It could, or the company could pick up more assets where it is already working. For example, it started drilling a particular well last month. There's a giant well just 4.5 kilometers to the north that has produced 4.5 million barrels of oil. If Pan Orient drills a well like that, it could increase the company's reserves by 600%.
TER: Moving away from oil, let's talk electricity, specifically lighting and the relatively new light-emitting diode, or LED, lights.
BM: LED lights are significant because they're so cheap. They offer an enormous savings in electricity. I suspect every incandescent light bulb in the world will be replaced in the next five years, because LEDs cost a fraction of what incandescent bulbs cost over the life of the bulb.
I recently talked with a California company called ForceField Energy Inc. (FNRG:NASDAQ). The company's competitive advantage is its marketing potential. It is going to big corporations all over the world-Mexico, South America, the U.S., Canada-with its innovative ways of selling the bulbs. ForceField will give customers the bulbs and install them. In return, the customer pays ForceField, say, half of what the customer saves on its electricity bill. It's a brilliant move. I really like the people, and I think the company will do well.
TER: Will ForceField need to acquire local companies outside the U.S. to facilitate financing and collection? Will it grow on its own or by acquisition?
BM: Management started by buying old electrical companies that already had good local reputations for cash and shares, to give them a piece of the action. This gave ForceField a book of customers.
It used to be that if you needed light bulbs, you went to General Electric Co. (GE:NYSE), because GE made light bulbs. Now, thousands of companies in China are making LED bulbs. The size, quality and price of those bulbs changes day by day, but overall, the quality is going up and the price is going down.
Likewise, to sell LED bulbs, you have to make the case to the customer: You can keep your incandescent bulb and use 20 times the electricity and produce five times the heat, or you can use this LED bulb that costs one-twentieth of what you've been paying and we'll give you the LED bulb if you split the electricity savings with us. It's a good move.
TER: Does ForceField have competitors doing something similar in terms of strategy in financing and market penetration?
BM: No, and that's why management is so important. Anybody can go into the light bulb business. You have to find a competitive advantage. Alternative financing is one example.
Here's another. Costco uses giant, high-wattage bulbs on the ceilings of its warehouses. Those bulbs are changed on a schedule, not when one burns out. The biggest cost is getting to the bulb. When you put in LEDs that last 10 times longer and cost a fraction of what you're used to, that is an enormous savings. ForceField provides the bulbs for free and even installs them, in return for half the savings on the electric bill.
TER: What other ways of investing in energy do you love right now?
BM: I'm looking at well-managed juniors. I want companies that have lots of cash, good management, and that are not overpaying when they pick up the assets that are being given away.
Oil is the biggest industry in the world. It affects everybody on earth. It affects the price of food and water. It has the biggest impact on our economy.
TGR: Any last tips on how to find the company of your dreams to invest in?
BM: There's no indicator more valuable than the salary of the CEO. The CEO's salary should reflect the real condition of the market. If it's out of line, don't invest in the company. If the CEO of 123 Oil R Us is making $700,000, his only interest is keeping enough money in the treasury to pay his salary. His interest is not the shareholder's welfare.
TGR: Thank you, Bob.
Read Bob Moriarty's thoughts on the fallout from currency swings and what gold companies he loves right now here.
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