Casey Research Summit Special Report Part II: Drilling Down into Oil & Gas Prices
The private panel that began with three key speakers at the April 27-29 Casey Research Recovery Reality Check Summit continues with a second installment in today's Energy Report. This exclusive features Casey Energy Opportunities Senior Editor Marin Katusa, Global Resource Investments Founder and Chairman Rick Rule and Casey Research Senior Editor Louis James, turning their attention to oil and natural gas prices and opportunities in equities.
Companies Mentioned: Africa Oil Corp. - ConocoPhillips - Exxon Mobil Corp. - Kinder Morgan Energy Partners L.P. - Poseidon Concepts Corp. - Royal Dutch Shell Plc - Suncor Energy Inc.
The Energy Report: Since we last talked in November, oil went from $90–110 per barrel (bbl). Has it established a floor that will stick? Or, as Porter Stansberry predicted during the summit, is it getting ready to crash? He said that the same sort of technology that brought on the glut of natural gas will lead to an abundance of oil that will depress prices.
Marin Katusa: Porter was basing his comments on the success of shale gas in North America, and with that you have natural gas liquids and some oil. In North America, gas became a victim of its own success, worsened by a warmer-than-expected winter. But understand that gas, in general, has very localized markets.
When it comes to the oil sector, people think Exxon Mobil Corp. (XOM:NYSE), Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE) and ConocoPhillips (COP:NYSE) are the biggest players. The big players are actually the national oil companies (NOCs)—Saudi Aramco, Petróleos Mexicanos (Pemex) and Petróleos de Venezuela, which are not reinvesting in operations and exploration. Their production is decreasing as a result. Cantarell, in Mexico, is one of the greatest oilfields in the world, but it's decreasing by 3.5% every year. The NOCs are distributing profits to fund massive social programs. For instance, more than 55% of Venezuela profits from oil-funded social programs.
"The reasons North American natural gas dipped under $2/Mcf don't apply globally. India and Japan are signing $14–15+/Mcf. It's twice that in Europe. North America is a unique case." –Marin Katusa
By the way, America imports more than a million barrels of Venezuelan oil each day and pays a premium over what it pays for domestic oil. But that's another story.
I don't necessarily agree that the same reasons North American natural gas went under $2 per thousand cubic feet ($2/Mcf) would apply globally. India and Japan are signing $14–15+/Mcf. It's twice that in Europe. North America is a unique case; the rest of the world is nowhere near that when it comes to shale exploration.
TER: Will that change when the U.S. starts exporting in 2015 or so?
MK: I think 2015 is a very aggressive timeline. Eventually, the market will fix itself. But to say that oil will go to $40/bbl by Christmas? I wouldn't take that bet. That said, for two years we've been using $60/bbl oil for our equations. We publish the best netbacks in the business every quarter. So if a company can make money at $65/bbl oil, it will make a lot of money at $105/bbl oil. But if you invest in companies that need $90/bbl oil to break even, you're not going to do so well.
TER: You said the market will fix itself. Will oil go down to, say, that $60/bbl you've been using?
MK: Buyers are not paying producers $103–105/bbl. Because of the massive differential for selling less, the Canadian oil sands producers are selling as low as $63/bbl. In the Bakken, they're selling for $72/bbl. So it finds its equilibrium. In the Canadian oil sands, existing production can be profitable at $60/bbl, which we've been saying for a couple of years. New production, if it's open pit, it needs $90/bbl oil to be economic due to the massive inflation in equipment, trucks, tires and skilled workers.
TER: Why do we quote oil at $105/bbl if it costs $63–72/bbl?
MK: A lot of people think that Suncor Energy Inc. (SU:TSX; SU:NYSE) or any given oil producer is making $105/bbl for oil, but companies are selling their product for $63/bbl. It depends on the differential and Suncor's selling price versus the West Texas Intermediate (WTI) crude oil price, which is the posted price. Gas producers in Edmonton are getting much lower prices than what's quoted in the Henry Hub. The oil price in North America or the Brent price isn't necessarily the same price a company is selling its oil for.
Rick Rule: It's pretty complex. What people think of as the posted crude oil price comes from either WTI or Brent. That used to be the way the world worked, but we have localized differentials now. One of the differentials that Marin was speaking about is the differential between light sweet crude and heavy crude. And the differentials widen and tighten depending on a variety of factors.
For example, production efficiency in Venezuela, the traditional source of Gulf Coast sour crudes, is a factor. Transportation and infrastructure bottlenecks are factors. We're now to the point where a critical pipeline that once transported crude from the Gulf Coast to the U.S. Midwest has been reversed because of production declines in Mexico and Venezuela, which in turn encourages U.S. Gulf Coast refiners to take heavy crude out of Canada.
All of this is what creates localized markets in oil. The international light sweet crude markets are very stout. Nigerian bonny crude and Brent crude's international trade is marked by tightness as a consequence of declining supplies in traditional frontier market exporters, such as Nigeria as well as Venezuela and Mexico.
The North American domestic market is ironically awash in oil as a consequence of three factors: The high price of gasoline has begun to destroy demand along with the weak economy. The incredible de-bottlenecking that's gone on in the Athabasca tar sands has doubled tar sands production in four years. And the conjunction of technologies that Marin was talking about has produced a flood of shale oil, particularly in the Bakken.
TER: But when the gas at the pump is up, the excuse retailers give is that WTI is at $105/bbl. That's the logic presented to consumers.
RR: I can't speak to other parts of the country, but being an oil producer myself and a gasoline consumer, I'm certainly familiar with the California gasoline market. California municipalities constrain the construction of gas stations, so there are fewer and fewer outlets. Some communities that were really tough on how many gas stations they would permit have prices $0.25–0.30 per gallon higher than nearby communities that were more generous.
"What people think of as the posted crude oil price comes from either WTI or Brent. That used to be the way the world worked, but we have localized differentials now. . .that widen and tighten depending on a variety of factors." –Rick Rule
On top of that, all the margins for producers, refiners and distributors that are built into the price of gasoline go to the government in the form of taxes. California is a high-cost refining environment, with high taxes and constrained competition. Gasoline demand in the U.S. has grown 1.2–1.3%, compounded for 29 years, and the United States hasn't permitted a new refinery for 29 years. Of course, it's possible that new refineries would not have been built regardless, because refinery and marketing margins are so lousy. But that's the picture.
MK: Also, the older refineries need more downtime for maintenance. All these things factor into the equation, and that's why you have high prices at the pump. In Canada, more than 50% of the price is taxes. Major global production is coming from these NOCs, which I call the New Seven Sisters.*
Look at the coming nationalization of resources. Look at what's happened in Argentina. The private companies, the Exxons of the world, risk their capital and their shareholders' capital. When they have success, the country nationalizes these resources. So there's another factor to take into account if you want to understand how tight the oil markets really are.
*[Before the rise of the OPEC cartel and NOCs, the original Seven Sisters included Anglo-Persian Oil Company (now BP), Gulf Oil, Standard Oil of California (Socal), Texaco (now Chevron), Royal Dutch Shell, Standard Oil of New Jersey (Esso) and Standard Oil Company of New York (Socony) (now ExxonMobil). The Seven Sisters dominated the global petroleum industry from the mid-1940s to the 1970s, and up until the oil crisis of 1973, they controlled about 85% of the world's petroleum reserves – Editor.]
TER: A number of analysts we've interviewed lately say the best bet now is to invest in the service companies—the drillers, pipeline builders and so forth. What's your take?
MK: Part of our portfolio in The Energy Letter is geared toward service companies, and certainly Kinder Morgan Energy Partners, L.P. (KMP:NYSE), which is one of North America's largest pipeline transportation and energy storage companies, has been very generous to our portfolio. In five months, there's been over a 30% gain.
But if you're going to go into the service sector, you have to be confident in a company's ability to cover its debt, because a lot of these service companies took on massive debt during the bull market and will blow up on it.
TER: Looking for other potential investments, Louis, you said that the secret is to figure out what "real stuff" people need, because it will retain value. When prices on valuable stuff go down ridiculously, it's a godsend, because you can buy when it's cheap and sell when it's expensive. Is the stuff people need cheap now?
Louis James: "Stuff" is not really cheaper. There is deflation in some asset classes and some equities, but life for the average Joe is not cheaper and commodities in general are not cheaper. Oil is still above $100/bbl. When commodities have not lost ground but the equities have, that's an alligator-jaw pattern. I'm not speaking as a technical analyst—that's just a metaphor. But it's actually fantastic if you have high, driving prices in the commodities, and you find good, cheap companies with good management, money in the bank and the wherewithal to weather the storms.
I also think we'll see more volatility, and the chances of seeing much lower prices are pretty good. When a bear sentiment grabs the market, it takes everybody down, both the best and the worst players. If you have the courage to face it, that's very good news.
"There is deflation in some asset classes and equities, but life for the average Joe is not cheaper. Commodities in general are not cheaper." – Louis James
If you're new to the game, you can get fantastic buys on things that others have identified as great plays, already worked on and de-risked. If you're already long, it's a matter of self-discipline, which few investors have. Most of them get burned again and again. They buy high when everybody else is buying. They feel confident. They jump in. Things turn against them. The tide goes the other way. They get scared. Everybody else gets scared at the same time and they get creamed. Investors need self-discipline, belief in what they're doing and they need to know why they're buying something to be able to happily take those shares off weaker hands.
I think there's a good chance we'll see much more of that over this summer and I'm looking forward to it. After the sector bounced back from 2008, I wrote that we should be so lucky as to have another one.
TER: Speaking of lower equity prices, Marin, last fall you told us that quantitative easing was deflating equity valuations. "He who has cash will be king," you said, "because he can afford to buy discounted stocks." Is that still the case? Or are we too late?
MK: I still believe we're in deflating equity prices. By mitigating risk, being strategic and always taking Casey free rides, the portfolios for 2011 for both the Casey Energy Report (CER) and Casey Energy Confidential (CEC) gained over 20%. And Q1/12 was over 20% for both newsletters, too.
Throughout the year, a few of our buys had massive gains—like Poseidon Concepts Corp. (PSN:TSX), Tag Oil Ltd. (TAO:TSX.V) and Africa Oil Corp. (AOI:TSX.V). Did we sell too early? Yes. But so what? We reduced our risk. We made money. We lived to see another day. And with one of them, we now have a dividend for free and the company's growing.
So if you do your homework and buy good companies, you can do well. I don't think you're too late at all.
To read part one of the Casey Panel on The Gold Report, click here.
Founder and chairman of Global Resource Investments and president of Sprott Asset Management USA, Rick Rule began his career in the securities business in 1974 and has been principally involved in natural resource security investments ever since. He is a leading American retail broker and asset manager specializing in mining, energy, water utilities, forest products and agriculture. Rule's company has built a sterling reputation for its specialist expertise in taking advantage of global opportunities in the resources industries. In 2011, Rule closed a landmark deal with Eric Sprott, founder of Sprott Inc., another famous powerhouse in the arena. Sprott Inc. offers resource-oriented investors opportunities in segregated managed accounts, mutual funds, hedge funds and private partnerships. The collective organization offers unparalleled expertise and access to investment opportunities in all resource sectors. Sprott Inc. manages a portfolio of small-cap resource investments worth more than $8 billion and boasts a workforce of more than 130 professionals in Canada and the U.S.
Louis James is chief metals and mining investment strategist at Casey Research, where he is also the senior editor of Casey International Speculator, Casey Investment Alert and Conversations with Casey. When not in meetings with mining company executives in Vancouver, British Columbia, James regularly travels the world evaluating highly prospective geological targets and visiting explorers and producers, getting to know their management teams. For more than 25 years, Casey Research, headed by investor and best-selling author Doug Casey, has been helping self-directed investors to earn returns through innovative investment research designed to take advantage of market dislocations.
Investment Analyst Marin Katusa is the senior editor of Casey Energy Report, Casey Energy Opportunities and Casey Energy Confidential. He left a successful teaching career to pursue what has proven an equally successful—and far more lucrative—career analyzing and investing in junior resource companies. With a stock pick record of 19 winners in a row—a 100% success rate last year—Katusa's insightful research has made his subscribers a great deal of money. Using his advanced mathematical skills, he created a diagnostic resource market tool that analyzes and compares hundreds of investment variables. Through his own investments and his work with the Casey team, Katusa has established a network of relationships with many of the key players in the junior resource sector in Vancouver. In addition, he is a member of the Vancouver Angel Forum, where he and his colleagues evaluate early seed investment opportunities. Katusa also manages a portfolio of international real estate projects.
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DISCLOSURE: 1) Karen Roche and JT Long of The Energy Report facilitated this panel discussion. They personally and/or their families own shares of the following companies mentioned in this interview: None.
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March 5th, 2021
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