Interest rates may be near zero, but financing big projects is still tough for most mining companies. That's why James West has switched his focus to energy investments, where the payoff is often much faster. In this interview with The Energy Report, West explains why intermediate-term energy opportunities have become his sweet spot.
The Energy Report: In the three months since your last interview, the sailing certainly hasn't been clear. What's your view of the global economic picture and the next focal point for investors?
James West: The competition for shrinking resources is indicative of an advanced civilization that has reached its zenith in terms of its ability to expand on the planet and is now in a state of decline. All of these macroeconomic situations that are engulfing the world—sovereign debt crises, currency debasement, resource nationalization and protectionism, declining employment opportunities, rising violence and rising competition for food resources—are part and parcel of that decline. From a macroeconomic focus, the possibility for growth is limited by these overriding factors. There are just too many people competing for increasingly scarce resources and opportunities. I don't have a lot of hope for the economy, barring a massive decline in the global population.
TER: Last November, you talked about interest rates. Are they ever going to go up or can the U.S. economy and debt structure even stand the consequences of "normal" interest rates at this point?
JW: Interest rates can't stay too low for too long and still have a positive economic impact. At this point, the purpose of low interest rates has been maximized. Despite the fact that interest rates are at all-time lows, lending is almost nonexistent and is mostly limited to the highest-quality corporate borrowers. The whole purpose of low interest rates is to spur economic activity and investment, but nobody is lending for startups. Nobody is lending for exploration. Nobody is lending even for resource development. They're only lending when it's safe. The only reason that we must maintain low interest rates now is so that the G7 sovereign group can continue to borrow at ridiculously low rates.
TER: In your last interview, you stated that you favor energy stocks over mining stocks because of the difficulty in getting financing. Has your opinion changed?
JW: It hasn't changed. The mining market has become very company and management team specific rather than metal specific. In every deal, you have to look at management, where it is in its development and whether it can access capital. The best real-world example is what's happening with Northland Resources Inc. (NAU:TSX; NPK:FSE). It has basically had to halt construction of its iron ore project in Sweden because it could not access the roughly $400 million ($400M) it needed in combined debt and equity. Shareholders are stranded in the deal, which is now frozen. Its management team cannot convince bankers to lend or invest in equities in the project because it doesn't have the track record. There's a large resistance out there to financing high-capex mining projects.
On the energy side, that's not so much the case because the time from drilling a hole to bringing a well onstream is much shorter than the usual production timeline for mining projects. In a risk-averse universe, energy is far more attractive, especially conventional oil and gas.
TER: Where were you able to get your best returns last year?
JW: My best performer in 2012 was Abakan Inc. (ABKI:OTCQB), which should soon be listed on the NASDAQ. Abakan has developed a technology that extends the life of metal assets used in oil and gas drilling between six and 20 times. Most of the world's remaining oil and gas reserves are high in sulfur or other corrosive materials, so the lifetime of these metal assets used to explore, extract and transport can determine whether some projects are viable or not.
The Natuna Island project, which is owned by CNOOC Ltd. (CEO:NYSE), is one case in point. Here's a $20 billion ($20B) gas deal that cannot viably move ahead using pipeline infrastructure that only has a life of five to seven years, which is what happens to pipes in a high-use environment. CNOOC has been waiting for this project to proceed, and Abakan has the solution through its MesoCoat product for cladding pipe and its Powdermet product for coating metals assets.
Abakan has agreements in place with Petrobras (PBR:NYSE; PETR3:BOVESPA) and other major oil companies that can't be disclosed because they're subject to confidentiality. That's been my biggest win of 2012.
TER: Where did that go during the year?
JW: I bought it at $1.02 in September 2011. I sold a large portion of my position at $2.70 from September to mid-October. I essentially got a 160% return there. I'm negotiating to reload on that company because it will start producing commercial quantities of its pipe products in 2013, and majors will be ordering them. That's when it changes from a speculative story to a growth story. I think it's going to be a multibillion-dollar company. In Obama's State of the Union address, he mentioned that he was recommending an immediate $50B program to replace corroded infrastructure in the U.S. Abakan happens to be sitting in the sweet spot to be the recipient of some of that.
TER: What's your strategy for 2013 and 2014?
JW: I'm going to be looking for intermediate-term opportunities where there's a profound shift in the company's prospects that should drive value. I'm looking for 12- to 24-month plays. That's my sweet spot. That timeframe makes conventional energy plays very attractive.
TER: Do you want to give an update on some of those companies you've discussed in the past or new ones that look interesting?
JW: I would like to mention, first and foremost, Aroway Energy Inc. (ARW:TSX.V; ARWJF:OTCQX). I love Aroway because it is developing oil and gas assets in central Alberta as well as in Saskatchewan. It has a program in place whereby in mid-2013, it plans to be producing over 2,000 barrels per day (bpd), and 90% is oil. It is building its production infrastructure more or less internally from cash flow, and it is in a position where it is going to be growing that domestic production in a safe jurisdiction, Canada. I think Aroway is probably one of the best-case examples of lower-risk exposure, with an experienced management team that can access the capital and that has a record of successful drilling.
It recently announced its year-end production. It exited 2012 with over a thousand barrels of oil equivalent per day (1 Mboe/d), of which 90% is oil. It also has another 100 boe/d behind pipe. That's up from the 2011 exit of around 650–700 boe/d. It is also getting ready to drill a lot of wells in Saskatchewan on its West Hazel property, and is expecting to double its current production of about 300 bpd oil from there. It is well on track for reaching its target.
TER: What else do you like?
JW: Terra Nova Energy (TGC.V:TSXV; TNVMF:PINK; GLTN:FRA). We have that in our Midas Letter Opportunity Fund. Terra Nova is working on its petroleum exploration licenses with Hunt Energy & Mineral Co. Australia Pty Ltd. (private) in the Cooper basin of Australia. It expects to be drilling by March of this year. That's one that I'm quite excited about because it has a strong management team. It has Jim Hutton, who has been a very successful investor in various energy projects and mining projects, as a director. It also has Henry Aldorf, who was a co-founder of Interoil Corp (IOC:NYSE), now the CEO. That really improves the company's prospects, so I'm more excited about it than I was previously.
TER: You talked about Prophecy Coal Corp. (PCY:TSX; PRPCF:OTCQX; 1P2:FSE) and its situation in Mongolia. What's going on there?
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JW: Prophecy Coal is suffering from an unfortunate misconception. The mining world is now focused on Mongolia's struggle with Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK), which has stopped development work at its Oyu Tolgoi project. The global perception is that Mongolia is rattling the resource nationalization saber a little bit too loudly for the comfort of foreign investors.
But the company that owns Prophecy Coal's power plant and coal mine assets in Mongolia is actually a Mongolian company. People think it's a foreign company operating in Mongolia, but it's not; it's a Mongolian company that's listed on the Toronto Stock Exchange. That misconception, combined with the bad impression from observing the discord between Rio Tinto and the Mongolian government, is why Prophecy Coal is getting beaten up so badly in the market. But I think as it evolves with participation by the Mongolian government, people will start to understand the situation more clearly.
TER: What's it going to take for people to understand it better, or to see the light? Or is it all pretty much up to what the Mongolian government decides to do?
JW: It's very much a case now of "show me." Investors want to see the company plan a power plant, raise the money for it, build it and bring it on-stream without the Mongolian government taking 90% of the revenue. It certainly has its power offtake agreement in place and at least soft financing commitments from various entities. Now it needs to firm those up and start building, and maybe we'll see some upside come into the stock.
TER: What other companies are on your radar?
JW: One of the long-term plays that our fund has a big position in is EFL Overseas Inc. (EFLO:OTCQB). EFL has a great executive team with a record of founding major projects and taking them from start to finish, through the end zone into success. EFL is up in the Liard basin of southeastern Yukon, where it has doubled its land position, and it also has a largely unused gas processing facility there. This is a company that's all about positioning itself now for the ultimate rise in natural gas prices, which will come about at some point. I think there will be a stampede into that stock because people will look around for the best contenders for large-scale natural gas production and EFL is certainly one. There are several projects under development for liquefied natural gas export facilities in British Columbia, and the company is a takeout target now that CNOOC has successfully taken out Nexen Inc. (NXY:TSX; NXY:NYSE) for its natural gas asset.
TER: To sum things up, what's your recommended investment strategy at this point?
JW: The strategy is looking for high-impact, low-risk, short-term plays where there's a management team with a track record of success and the ability to raise capital as well as take projects from start to finish.
TER: We appreciate your time and the opportunity to talk to you again.
JW: My pleasure.
James West is publisher and editor of The Midas Letter, an independent capital markets entrepreneur and investor. He has spent more than 20 years working as a corporate finance advisor, corporate development officer, investor relations officer, media relations and business development officer for companies involved in mining, oil and gas, alternative fuels, healthcare, Internet technology, transportation, manufacturing and housing construction.
By. Zig Lambo of The Energy Report