In the midst of a global market lull, many companies are sitting on their hands, argues Mark Lackey of CHF Investor Relations. That's why he's scoping out smart management that's keeping busy and making great progress—whether or not the markets are quick to notice. Learn who's getting a running start in the uranium, oil and natural gas spaces in this Energy Report interview.
The Energy Report: It's been a busy five months since your last interview in August. What's your macro view on energy markets?
Mark Lackey: The problems in Europe were somewhat worse than most people anticipated regarding Greece and long-term bond rates in Portugal and Spain. Slower world economic growth wasn't a disaster, but it was enough to knock the price of oil back down under $90 per barrel ($90/bbl). Natural gas had been climbing closer to $3.70–3.80/thousand cubic feet (Mcf), then retreated as well. And, of course, uranium got all the way down to $41.25 per pound ($41.25/lb). Part of the reason for that was that only two out of 56 reactors in Japan were actually operating, but I'm still bullish on uranium. The oil weakness experienced wasn't terrible, but oil certainly went a little lower than I anticipated. Now that it's back in that $88–89/bbl range, I'm anticipating somewhat stronger prices next year for oil, as well as for natural gas and uranium.
TER: Are you still expecting West Texas Intermediate (WTI) to average between $100 and $105/bbl next year, or has the supply/demand picture changed?
ML: I've lowered my expectation to more like $95–105, partly because the shale oil supply has been a little bit better than I expected with more Bakken production on-line. On the other hand, China, India, Indonesia, Japan and Brazil have all announced significant infrastructure spending programs for 2013, which will certainly increase the demand for energy.
TER: You talk with many people in the analyst community. What's the current mood and outlook there?
ML: There's a bit of a divergence. People on the street who agree with me believe that world growth will be fairly decent and that the five countries with the big infrastructure spending will, in fact, move the world forward. There are some who believe that both Europe and the U.S. will do better, and they're seeing oil up in the $110–115/bbl range. Then, there's a smaller group looking at an $85–90/bbl range because they think the U.S. economy will stagnate and the situation in Europe will continue to deteriorate. I would say that more analysts agree with where I am, but there's more divergence in opinions out there than I have seen in the last few years.
TER: Natural gas prices have staged a strong comeback from last spring and now the main concern in the North American markets relates to winter weather usage. Any thoughts on that?
ML: Last spring, natural gas hit close to a 10-year low, under $2/Mcf. It bounced off of that to $3.90/Mcf largely due to increased industrial demand and gas substitution for coal in the electricity market. It's since retracted a bit of that. In the very short run, if you're looking solely at the winter, a cold winter could move the price higher.
Looking at fundamentals over the next year, I expect a better year for both the auto and chemical sectors. On the supply side, drilling activity for gas was down in November to a 16-year low in the U.S. but partially offset by horizontal drilling advancements. On balance I expect we're going to see somewhat less gas than some people are anticipating, and I expect it to get back up to $4/Mcf by the end of 2013.
TER: Can you update us on some of the oil and gas plays you discussed in your last interview?
ML: We had mentioned Greenfields Petroleum Corp. (GNF:TSX.V), which operates in Azerbaijan. This is not wildcat drilling. Greenfields has been very successful reworking old wells and fields and finding oil and gas in established areas with past production. We see its production going up significantly this year. Being close to Europe, it gets a much higher price for natural gas as well—anywhere from $5–9/Mcf and also $15–20/bbl more for oil because it's based on the Brent price, not the WTI price. Azerbaijan has had a lot of expertise in drilling and a good labor force going back to the Soviet Union days. It's a very pro-oil and gas jurisdiction and clearly one of the best areas for that business.
TER: How's the stock done since we last talked?
ML: It's thinly traded and has gone down some, even though it beat expectations. With oil prices coming down somewhat, people were selling small- and mid-cap oil and gas stocks in the last three to six months of 2012. But I would suggest that people should now be looking at companies like this because of the lower entry point and better cash flow numbers in 2013.
TER: What about Primeline Energy Holdings Inc. (PEH:TSX.V)?
ML: Primeline Energy will have operations in the South China Sea and its partner is CNOOC Ltd. (CEO:NYSE), one of the largest oil and gas companies in the world. Production is expected late in 2013 and it has some significant upside in terms of cash flow and earnings, particularly into 2014. That's when one analyst has forecast earnings of $0.24 and cash flow of $0.28 per share, which I agree with. An important point to remember about why it can see such good earnings is that it gets $15–16/Mcf for selling gas into China, or approximately four to five times what natural gas gets here.
TER: That's definitely one to keep an eye on. You also talked about a company in the services business.
ML: Right. That's Bri-Chem Corp. (BRY:TSX), which announced the takeover of Kemik Inc., a chemical blending and packaging niche company that will add to Bri-Chem's cash flow and earnings. Bri-Chem has been very strong in the drilling fluids, cementing and steel pipe business sector, supplying the oil and natural gas service area. Now it will have even better earnings and cash flow in the next two years if U.S. gas drilling activity starts to turn up this year. And last week Bri-Chem closed another U.S. fluids wholesaler acquisition of General Supply Co. in Oklahoma. At this stock price level it's certainly one that people should be looking at and expecting appreciation in 2013.
TER: Do you have any new names in the oil and gas sector that look interesting?
ML: We've started to follow a company called Strategic Oil & Gas Ltd. (SOG:TSX), which is a very interesting play in the Steen River area of western Canada. It has primarily light oil, which sells at a premium to WTI or Edmonton light. It's done a great job of increasing production—more than doubling it in the last year. Another recent acquisition added approximately 10–12% to its production numbers. It's well capitalized and with such a good balance sheet, we see it going forward in 2013 with work that can further increase its light oil production.
TER: So, where's that one trading these days?
ML: It's trading around $1.20 per share. When we first looked at it three or four months ago, it was trading at $0.70. It's been a nice winner, given the performance of the rest of the TSX Venture market, which has gone from 2,450 in 2011 down to 1,200 at the end of 2012. Strategic Oil's big increase in production and the fact it produces light oil has caught the attention of the marketplace.
TER: The other energy sector that seems to be coming back is nuclear. Prices had been pretty weak for several months and then suddenly jumped up to over $46/lb. Did the Japanese election have something to do with that? What's the outlook from here?
ML: Yes, the Japanese election was the key factor in moving the price strongly in just a few days. Before that, people were only starting to wake up to the fact that the end of the Megatons to Megawatts program will take about 24 million pounds (Mlb) out of the marketplace by 2013 year-end. Clearly, the fact that the Japanese government won with a largely pro-nuclear position was a major catalyst. They need to stimulate the economy and will be facing potential electricity shortages if they don't begin restarting more of their nuclear plants over the next year; mind you restarts require new environmental assessments that the government has now said will be done in June.
TER: So that's expected to create enough demand to justify higher prices?
ML: That, and there are some other factors too. There are 66 reactors under construction worldwide as we speak. If the Japanese bring back even 20 of their 56 that are off-line in the next year and more new reactors built come onstream in the next one to two years, then you can see some significant demand increase for uranium. In addition to the Megatons to Megawatts program phaseout, Cameco Corp. (CCO:TSX; NYSE:CCJ) has deferred its Kintyre project in Australia and BHP Billiton Ltd. (NYSE:BHP; BHPLF:OTCPK) has deferred expansion of Olympic Dam. Then Uranium One Inc. (UUU:TSX) canceled its Zarechnoye project in Kazakhstan. Higher demand and lower supply lead us to expect significantly higher uranium prices in the next one to three years.
TER: Have there been any interesting developments with the uranium developers you talked about in August?
ML: Fission Energy Corp. (FIS:TSX.V; FSSIF:OTCQX) had some very good drill results in the Athabasca Basin, at Waterbury Lake and Patterson Lake South. This caused the stock price to almost double in about a week and remain close to that peak. One of its properties is very close to the Hathor property that was ultimately acquired by Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK), so we view Fission as a potential takeout candidate. It's going to do more drilling to define additional resources, but it's a company that has some pretty good potential.
TER: A lot of companies are working the Athabasca Basin, where most of the North American uranium development has taken place.
ML: Right. The two other big areas are Wyoming and New Mexico, where another company we mentioned and have followed for a number of years, Strathmore Minerals Corp. (STM:TSX; STHJF:OTCQX) has projects. Its Gas Hills project is in Wyoming and the Roca Honda project is in New Mexico. I've liked Strathmore over the years because, whenever management told me they were setting certain milestones, they met them. I've spent a number of years in the uranium business and always thought the Gas Hills project area was one of the best in the U.S., and it's now owned by Strathmore. I also really like its New Mexico play, and the company has considerable depth in its property portfolio for a junior. Strathmore expects to see production in the next three or four years; that would make it a relatively low cost and fairly significant uranium producer in the U.S. If I'm right about uranium prices going a lot higher in the next three years, this stock will be trading at considerably higher than present levels.
TER: Do you have any new companies that look interesting?
ML: Forum Uranium Corp. (FDC:TSX.V) is one I've watched for a while. Its two main projects are in the Key Lake area of the eastern Athabasca Basin near Cameco's Key Lake Mill. It's also on-trend with Hathor's Roughrider discovery and Forum has two plays in the western Athabasca. Its management team of President, CEO and Director Richard Mazur; Vice President of Exploration Ken Wheatley and Chief Geologist Dr. Boen Tan are three of the best guys that I've known in the whole Athabasca area. These guys have actually discovered over 300 Mlb of uranium throughout their careers.
The company also has a very interesting play in the North Thelon, in Nunavut. I think there's some significant upside there, and it just announced some very good drill results. Many juniors aren't doing much these days, but these guys are out there drilling, raising money and moving their projects forward. That's important, because if we get the uranium prices I suggest, the markets are going to be looking at players who have been forging ahead.
TER: Does it have money in the till to be able to do more work?
ML: It has some money to do part of its next work program but will likely look to raise more. The company consolidated its shares Jan. 3. This is an interesting play also because of its partnerships with Rio Tinto and Cameco. I used to look at about 60 small uranium explorers and now I'm down to only about 10 that I think have a legitimate chance of doing something down the road. Forum is definitely one of them.
TER: Any other ones?
ML: There's Purepoint Uranium Group Inc. (PTU:TSX.V), which is also a player in the Athabasca Basin and has done a lot of work this year. It signed a joint venture agreement with Cameco and AREVA (AREVA:EPA) on its Hook Lake uranium project and completed an NI 43-101-complaint technical report there and on its Red Willow project. Purepoint just raised some money and Chris Frostad, Purepoint's president and CEO, is continuing to move it forward. He'll be doing a lot more drilling over the next year with some big people behind him. Again, it's a micro-cap company, but if you're going to buy some micro-cap companies, buy the ones with active management, good properties, some money in the bank and good joint venture partners. Then you at least have a good chance of success down the road.
TER: These didn't all start out being micro caps.
ML: No they didn't, and that's an interesting point. I can remember when it was trading at $1.60 back in the better uranium days. It's way more advanced now at $0.07, which shows you what happens when you have such a bad market environment. The market doesn't seem to differentiate, at this point, between uranium players that have stronger odds at being successful and those that don't. They're all in the same basket. Once we get better uranium prices, I think investors will start to focus on which companies actually have not been sitting on their hands.
TER: So what does the year ahead look like for energy stock investors and where do you feel they should be focusing their attention for maximum upside?
ML: I'm expecting a moderate upward movement in oil prices, but certainly not a boom. North American natural gas should move higher. Natural gas prices in Europe and China offer some pretty exceptional opportunities for companies selling into those markets. My three-year outlook on uranium is way above the consensus. I actually see uranium trading this time next year at $65/lb, compared to the current spot price of $44.75/lb. Then I see it at $80/lb at the end of 2014, and $90/lb in 2015, all based on the supply and demand factors I mentioned earlier.
TER: That would certainly bring life to a lot of these cheap uranium stocks. People are going to be all over uranium again if you get a double in the price.
ML: A lot of people may think I'm overly optimistic, but I would point out that when we first liked uranium at $10/lb in 2001, we thought there was some pretty good upside. I never expected it to go to $135, like it did in 2007. But, it does show you that when the uranium market starts to move, it usually moves fairly significantly and can create some definite investment opportunities.
TER: So there's something that people certainly should focus on in the next few months to a year. We greatly appreciate your time and input today, Mark.
ML: Thank you.
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.
By. Zig Lambo of the Energy Report