Saturday, September 12, 2009

Capital & Crisis Hotline -- The Oil Sands Are Back!

Agora Financial
Agora Financial's Capital & Crisis

Capital & Crisis Hotline -- The Oil Sands Are Back!
September 11, 2009

"Opportunities are always there, but the opportunist is lacking."
-- Dickson Watts, Speculation as a Fine Art and Thoughts on Life

Dear Capital & Crisis Reader,

Some interesting rumblings in the energy market this week. Listen carefully, because these sounds are going to put money in your pocket if you own some oil stocks. Put your ear to the ground like a Sioux hunter of old and you can hear the large animals moving in the distance.

One of those large animals is dying. The Cantarell oil field in Mexico was once the world's second largest, bringing billions to Mexico. For years, oilmen have been saying that the Mexican government has been starving this beast. Oil fields, like the bison of the plains, need a lot of chow to keep going.

The Mexican government, though, seems to have a gift for public suffering. Unable to control its spending, it kept trying to plug the growing hole in its budget by cutting its spending on Cantarell. It was only a matter of time before the inevitable happened. And so it has come to pass.

This week comes news that the big old oil well is dying even faster than expected. Oil production has slowed to 500,000 barrels a day, from over 2 million barrels a day in 2005. Mexico's public deficit grows alarming wide, as oil exports make up 40% of its budget.

What this means to Americans is that we are going to lose a close and friendly source of oil. We'll have to plug that hole by buying more oil from the Middle East, or Canada.

As for Canada, this gets us to the second large animal thundering about in the oil world. China made a big splash recently. PetroChina paid $1.9 billion for a 60% stake in Athabasca Oil Sands Corp. China just bought itself 3 billion barrels of Alberta oil.

We've covered China's hunt for oil and resources in these pages. As The Globe and Mail reports: "Chinese companies have engaged in a months-long buying spree of global petroleum assets, snapping up a refinery and oil and gas properties in Asia, Russia, South America and Africa."

We've long known that China has eyed the oil sands in Canada with desire. So the transaction is not a surprise, but it does signal that the oil sands are back. The price China paid just for the oil sand assets comes to about 60 cents a barrel. That is a price that brings us back to the level of some deals in 2007 and 2008.

China's oil sand investment comes after Imperial Oil decided to begin construction of its $8 billion Kearl oil sands mine. This was in May, and was the first major oil sands project revived after last year's crash.

As I say, the oil sands are back.

Then there is Brazil, which has made headlines routinely thanks to its large offshore oil finds. However, this oil is years away from seeing daylight. It will be extremely costly, as well. The government is already trying to figure out how to divvy up the spoils, which is a cause of worry for investors. My gut tells me the bulk of the profits from Brazilian oil will end up in a big government slush fund.

As an investor, these episodes highlight the supply challenges in the oil market. Cantarell is, in a nutshell, the story of many of big oil fields. They are getting old and are sputtering. China's oil sand investment reinforces the idea. You don't go paying up for oil sands projects if you can find better sources of oil. The oil sands are very long-term investments and expensive to produce. Ditto the Brazilian oil.

So here we sit in what is supposed to be the greatest recession since the 1930s and oil prices are hanging in there at around $70 a barrel. Isn't demand supposed to collapse?

Well, it has. Oil demand fell by 2 million barrels per day, and most of that decline came from the developed countries, the U.S. in particular.

As Morgan Downey, author of Oil 101, writes, the U.S. uses oil inefficiently. About 76% of Americans get to and from work by driving alone. Plus, the U.S. vehicle fleet efficiency is less than half that of available technology. Therefore, Downey argues, "Relatively inefficient consumption allows for swift efficiency gains compared with other parts of the world, which are already at or close to maximum technically available oil-consumption efficiency."

Yet at the same time, OPEC members have cut about 3 million barrels per day from supply. Then the developing countries such as China and India, which Downey writes "only saw a temporary stagnation and are now exhibiting growing demand again."

The new demand for oil is from these developing countries. And it is a demand that has a very long runway to go yet.

The dollar also has something to do with the oil price, as we've discussed before. When the dollar is weak, the price of oil rises. In this way, oil is a great inflation hedge. If you like gold, you ought to also like oil for this reason.

I think the biggest opportunities in oil are in the smaller mammals of the oil world. The big oil companies are going to have to run extra hard and long to replace their existing oil reserves. The giants are getting harder to find and cost a mint to develop.

However, there are smaller oil fields with compelling economics and companies for which such fields make a huge difference on their stock prices. These smaller oil companies will grow faster. They are also targets for those higher up the food chain.

We own Gulfport Energy (GPOR:nasdaq), a good old-fashioned America producer. I wrote about this stock recently (see the September C&C, No. 67) and its Algar Lake Project. The company has producing oil fields in Louisiana and Texas. It also has this oil sands project at Algar Lake. It has 11.9 billion barrels of oil in place, of which about 3 billion are net to Gulfport (via its 25% ownership).

As a fun "what if" exercise, take the 60 cents a barrel the Chinese just paid and apply it to Gulport's 25% stake in Algar Lake. You get a value of $1.8 billion. The market values GPOR at $350 million in its entirety. Now, I'm not saying Algar Lake is worth that. But it does show you in a very rough way the potential value creation behind Gulfport's Algar Lake project.

We also own Canadian Natural Resources (CNQ:nyse), which has come way back from its lows -- up 145%. We're up about 30% from our initial entry point. Its huge Horizon oil sands project is only now starting to produce cash. It's a tremendously valuable asset, which I think the market still does not appreciate. It will, though, after we get several quarters of solid production.

The price of oil will bounce around all over the place, but the long-term thesis behind these ideas is very strong.

*** Titanium Metals

Our Titanium Metals (TIE:nyse) idea is off to a good start. It's over $10 per share as I write, showing us a 20% gain. One interesting note to pass on about competitor RTI International Metals. It fell 6% on Wednesday and another 3% yesterday after announcing it would sell 5 million shares to reduce its debt load.

It just brings home once again how important the balance sheet is in this environment. We've done a good job this year picking up companies with excellent financial conditions. Investing is, in some ways, an exercise in controlled pickiness. We will stay picky.

*** Gold Notes

Our shares of IAMGOLD (IAG:nyse) are up 94% since we picked up shares in February. The company continues to deliver good news -- most recently, accelerating its development of its Essakane gold project. And the gold price has come to life. Hang onto IAMGOLD, as I think we've got lots of upside left.

Also, shares of New Gold (NGD:amex) have also done very well, up about 44% since we bought shares in July. I was very tight in my buy-up-to price on New Gold. I'm raising my buy price to $4.50 per share, reflecting a higher gold price in my valuation. Lots of good upside here, too. If you don't own any gold stocks, this one is still a value.

*** Natural Gas Soars

I can't end without noting that natural gas jumped 15% yesterday after inventory data showed some lower storage levels. This was the biggest jump in five years. And Old Man Winter is banging on the door, often good for natural gas.

Buy your natural gas stocks now, while the price is still very low. Pick up shares of Contango Oil & Gas (MCF:amex) if you don't own it already. I know I've pounded the table on it for a while now, but it is only a matter of time before the shares trade much higher. In the meantime, you own a debt-free producer with a talented hand at the wheel in Ken Peak.

That's all for this week. Enjoy your weekend, and I'll write you again soon!


Chris Mayer

P.S. I have a notecard taped to my wall just above my desk with a quote from St. Augustine: "The world is a book and those who do not travel read only a page."

When I think about the impact my own travels have had on me, I tend to agree with St. Augustine. In October, I'll be traveling to Dubai and Mumbai. I won't be taking readers with me on the trip, but my friend Karim Rahemtulla is taking a group to India -- and Mount Everest –Feb. 20-March 8.

Karim and I were in India together in 2007, and I can tell you he is a good guide to have. He's travelled throughout the country and is well versed in Indian history. Plus, he's just a good guy to hang around with.

I can't make this trip, but I thought I'd let you know about it. If you've never been to India, these trips are a great way to get a taste. For details, call (800) 926 6575 or e-mail Michelle at

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