This Is Your Energy Entry Point
Oil prices are starting to creep back up while gas, coal and uranium are poised for moves this fall, according to Mark Lackey, long-time energy analyst now representing resource companies with the IR firm of CHF Investor Relations. In this exclusive interview with The Energy Report, Mark shares his current insights on energy markets and talks about a number of companies he thinks are sleepers, ready to move quickly when the energy commodities take off.
The Energy Report: Since your last interview, you've made a jump from the research side of the business to the investor relations (IR) side. How has the view changed?
Mark Lackey: When I worked in the brokerage industry, I relied on IR people to bring me clients and stories, updates on companies I was following or promising companies of which I was never aware. There are over 3,000 companies listed on the TSX and TSX Venture exchanges and you can't know all the stories, so analysts often need introductions. Here at CHF, I'm involved in taking clients, largely in the resource sector, to meet with research and corporate finance people and brokers as well as retail and institutional investors. We also help with companies' press releases, presentations and even market-making.
But regardless of whether I'm doing research or IR, it's still a function of whether you believe in commodity cycles and how certain sectors, companies, locations and managements will benefit and profit.
TER: Talking to other brokerage firms and people in the investment business, what's the general mood at this point?
ML: In the small- and mid-cap market, the mood has been mixed. Some people are negative about the commodities sector in the short run, and some even think the whole commodity cycle is over. Others are more neutral. Then you have a smaller group of people who tend to support my view and are much more positive in the very short run.
TER: How does this affect your view of the oil and gas markets?
ML: I'm actually quite positive. After getting down below $80/barrel (bbl), West Texas Intermediate (WTI) is now back up over $96/bbl. The Brent price is at $115/bbl. Recent inventory numbers, particularly in the U.S., are down, so there's no overhang in the near term. Demand has hung in reasonably well, considering all the European problems, and there's still decent demand coming from the emerging markets. WTI will likely trade between $100/bbl and $105/bbl next year, with Brent between $115/bbl and $120/bbl.
Natural gas has been somewhat weaker, but it bounced off the $2/thousand cubic feet (Mcf) price a few months ago up to the $2.85–3/Mcf range in North America. With more industrial demand coming back, particularly in the auto sector, and stronger demand from electric utilities, gas should move back up closer to $3.25–3.30/Mcf in the next year. By way of comparison, prices in Europe can be anywhere from $4–8/Mcf, and in China they're as high as $15/Mcf.
TER: What interesting oil and gas situations have you recently come across that deserve some investor attention?
ML: The first company I'd like to talk about is Greenfields Petroleum Corp. (GNF:TSX.V), which has production in Azerbaijan, a country that used to produce about 70% of the old Soviet Union's oil and gas. Azerbaijan probably has the best history and the best understanding of oil and natural gas relative to most of the other countries in that area. Another advantage there is getting the Brent price for oil.
Azerbaijan still has some pretty good land positions available that would be more difficult to get in North America these days. Greenfields has gone back into some of the previously developed areas and is doing more delineation work, rather than wildcat exploration. It also has some greenfields projects. It's going to get some pretty good returns given the prices over there for both natural gas and oil. I think you'll see growing production from this company over the next few years in an area where there's potential to see some real improvement in cash flow. The stock has had pretty nice moves off its lows. With higher expected oil prices in the next year, we would anticipate that the share price should move higher.
TER: Is Azerbaijan stable?
ML: Yes. Azerbaijan has had an oil and gas industry for over 50 years and recognizes that this is its biggest source of income. It understands the oil and gas industry and this is a relatively good place to do business compared to all the potential places that you could look for oil in the world.
TER: Who else is on your radar?
ML: We like Primeline Energy Holdings Inc. (PEH:TSX.V) and its prospects in the South China Sea. Its partner is the China National Offshore Oil Co. (CNOOC), which is a huge company. Primeline just put out an updated resource report and should be producing by the middle of next year. With the extremely high natural gas prices in China, the company should have good cash flows and earnings within the next year or two, as well as some pretty good capital appreciation potential.
The stock started to gain momentum after the company filed its Overall Development Plan for the Lishui gas project in June and it's now pushing its 52-week high of $0.60. We think it offers investors a really attractive opportunity over the next few years.
TER: Oil services have been getting some positive press lately. Are you following any companies in that sector?
ML: The oil services side is often overlooked by investors. But drilling activity and rising prices create rising demand for oil services. We represent Bri-Chem Corp. (BRY:TSX), which is a North American wholesale distributor of oil and gas drilling fluids and piping products to the energy business. Bri-Chem is well integrated in the oil and gas service industry and expanded from Canada to the U.S. last year. It has earnings and cash flow and it is one that investors should be looking at.
Up until a couple of years ago, U.S. production had been on the decline for 40 years. But in the last few years, production has increased with improved technology accessing unconventional hydrocarbons, particularly in the shale formations. This has been a boon for many of the oil service companies like Bri-Chem, which is likely to grow its cash flow and earnings even more over the next few years. It's trading around $2.65 and provides a pretty good opportunity for capital appreciation at these levels.
TER: Let's talk about the uranium market. Prices have been fairly flat and they've shown a little weakness in the past month. What do you think is happening there?
ML: Uranium was $70/pound (lb) back in March 2011 and then drifted down after the Fukushima incident. Japan took steps to close all 56 of its reactors and the Germans have taken out about seven or eight. There are about 445 operating worldwide.
The price has been sitting around the $50–$51/lb range for a number of months and recently has gone down to $49/lb on the short-term market. The lower demand in the short run is the reason for the $20 hit. The Japanese have probably gone through three-quarters of their reactors, testing them to make sure they can withstand certain high-strength earthquakes. They are also putting up larger retaining walls and doing other things to prevent future problems from flooding. Our guess is that at least half of those reactors will be back in operation in the next six months and maybe as many as 75–80% of them within the next year, period. Nuclear power accounts for 15% of Japan's needs. Japan's economy really can't function without some nuclear power in order to meet demand; its manufacturing sector requires an ongoing, inexpensive, stable power supply.
There are 60 other reactors around the world under construction and about another 240 planned over the next 5–10 years. Another factor is that next year, the phaseout of the Russian exports to the U.S. of highly enriched uranium from its nuclear warheads will end. Thus, demand is coming back and some supply is constrained, which should cause prices to move up in the next couple of years.
TER: What stocks do you like in the uranium industry at this point?
ML: We have followed Strathmore Minerals Corp. (STM:TSX; STHJF:OTCQX) for a while. It has large positions in both New Mexico and Wyoming, which has produced 90% of past U.S. uranium production. In 1980, the U.S. was the biggest producer of uranium in the world. Today it only produces about 4 million pounds (Mlb) a year, making up about 8% of its needs. Strathmore is sitting on large reserves and has the potential to be a significant producer down the road. It expects to be producing in 2016 out of Wyoming and in 2017 out of New Mexico. The stock price has probably been hurt by the weaker uranium price and the fact that it is three years from production. We expect uranium prices to rise to $65/lb by the end of next year and to $75/lb by the end of 2014. This could be a perfect storm for Strathmore, and the market will start to recognize this stock. I think you'll see quite a bit of capital appreciation over the next two to four years.
TER: What else are you looking at in the uranium sector?
ML: We like Fission Energy Corp. (FIS:TSX.V; FSSIF:OTCQX). It recently took over another uranium company, Pitchstone, which had some very good properties, also in the Athabasca Basin of Saskatchewan. What makes Fission very attractive is its proximity to Hathor, which was taken over by Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK) last year in a battle with Cameco Corp. (CCO:TSX; CCJ:NYSE), the world's largest uranium company. It's obvious that Rio Tinto wants to get bigger in North America and Cameco would also be interested in making acquisitions.
One of the potential takeover candidates would have to be Fission. It does need to do more drilling and prove up its resource over time. But, it's well positioned, has the money and is certainly in the right address near some of the biggest and highest-grade uranium mines in the world. It has good management and the company is well funded. We think this is a stock that people should also be looking to invest in. As this company moves forward and proves up more reserves, it will become a much more likely takeover candidate, perhaps in the next couple of years.
The other company that I like in this sector is Forum Uranium Corp. (FDC:TSX.V), which is really more of a microcap company, of which I only follow maybe three or four. My interest in Forum is based on its very good project location in the Athabasca Basin and its very experienced management team. Its partner is Rio Tinto, which just took over Hathor and wants to expand in the area. Other than maybe Cameco, you couldn't ask for a better partner. It's done some drilling and needs to do more to move this stock to a point where somebody would consider taking it over. For a micro-cap uranium play, Forum is a good one to look at considering its project and its partner.
TER: The other part of the energy market is thermal and metallurgical coal used in steel production. What have those two markets been doing?
ML: We tend to follow more of the met coal market. The weakness in the natural gas price, particularly in the U.S., has hurt thermal coal producers, especially in Appalachia, where there are somewhat higher costs. We think the thermal coal market will see some recovery over the next couple of years because it's not just the U.S. that uses thermal coal. Far more thermal coal is used in China than in the U.S.
The high-cost producers have been affected the most as thermal prices have been hit as much as 20–30% in the last three to four months. That's made a difference to the bottom lines and investment analysts' view of that sector.
The same thing has happened in the met coal market. Because Chinese steel prices, particularly in China, have gone down 20% in the last three months, iron ore has gone down 20%, putting downward pressure on the met coal price because the biggest steel market in the world is China.
On the Australian market, the price has gone from $225/ton (t) down to $175/t. We think that this is probably the bottom of the market for steel, iron ore and met coal because construction activity usually picks up dramatically in China in October, November and December. We expect that all three areas will see recovery moving into the fall and through next year.
Weakness in the met coal market has affected the prices of all the companies we're going to talk about. I'd rather be buying when the met coal price is $175/t than when it was $225/t three months ago or when it was $300/t at one point last year. Now you can buy these companies at much lower prices and probably get much better value for your money.
TER: Let's talk about some of the companies you like.
ML: The first one I like is Corsa Coal Corp. (CSO:TSX), based in Ontario with production largely in Pennsylvania and some in Maryland. It's largely metallurgical, and a little bit thermal. Corsa has very high-quality coal that can be blended because of its low sulfur and ash levels. It's well-located in Pennsylvania near the major U.S. steel industry, which is still the third-largest producer in the world.
If you're one of the somewhat bigger neighboring producers in Pennsylvania whose quality of met coal is not as good, I think Corsa could be a good acquisition target. It expects to have some significant increases in production in the next two to three years. With the met price getting back up to the $225/t range over the next year or two, it should have some pretty good cash flow and potential earnings over that time.
The stock's trading right now at $0.17/share. I don't follow that many microcaps but Corsa is certainly one of the few I do and like.
TER: How about some other ones?
ML: Another one we follow is Cline Mining Corp. (CMK:TSX), a Toronto-based company with a significant met coal operation in Colorado that was about to start production within the last month. The decline in the price of met coal caused the company to postpone start-up and lay off people for 60 days. As a new producer, it could have been difficult to sell any of its coal. I think management did the wise thing by waiting to see if the market will come back in the fall and not build up too much inventory in a weak market.
Of course, this disappointed the market and it hit the stock price fairly hard. Cline has very good-quality coal with significant reserves and could be a pretty significant producer within the next two to three years, selling some in the U.S. and shipping some through Texas all the way over to China. With the expansion of the Panama Canal in 2014, bigger ships can go to China and a company like Cline would probably sell most of its coal abroad in the future.
TER: What other companies do you like?
ML: Colonial Coal International Corp. (CAD:TSX.V) is a western Canadian met coal company in the Peace River area in Alberta. It's in a good met coal-producing area with infrastructure, rail, experienced labor and decent power prices. Colonial is working on developing two very high-quality met coal properties, suitable for coking, with large reserves. There have been a number of takeovers in this area in the last year. And, looking at valuations, this company could certainly be trading at a much higher level if somebody was targeting them. If I had to pick someone in the met coal business in western Canada right now, Colonial would be my most likely acquisition target. Comparing it to the value of some of the other companies out there, its stock price should be considerably higher than where it's trading right now, at around $0.76/share.
TER: To wrap things up, give us your general thoughts on where you think things are headed and how the average man on the street should be looking at these energy investments.
ML: If you believe we're in a long-term commodities cycle, as we do here at CHF, then this is probably one of the best points to enter these markets.
We think oil is going higher, while some of the natural gas prices in the world are already extremely high. Coal and uranium markets appear near the bottom and we expect to see higher prices over the next two to three years.
In short, we think this is actually one of the better buying opportunities we've seen in the last decade for small and mid-cap companies in these sectors, and select micro-caps with sound fundamentals.
TER: Thanks for talking with us today. There are certainly lots of good opportunities out there.
Mark Lackey, executive vice president of CHF Investor Relations (Cavalcanti Hume Funfer Inc.), has 30 years of experience in the energy, mining, banking and investment research sectors. At CHF, Lackey involves himself with business development, client positioning, staff team coaching and education, market analysis and special projects to benefit client companies. He has worked as chief investment strategist at Pope & Company Ltd. and at the Bank of Canada, where he was responsible for U.S. economic forecasting. He was a senior manager of commodities at the Bank of Montreal. He also spent 10 years in the oil industry with Gulf Canada, Chevron Canada and Petro Canada.
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DISCLOSURE: 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.
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December 11th, 2018
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