Report: Let's start with a recent takeover
deal that's been getting a lot of criticism in recent weeks. Freeport-McMoRan Copper & Gold
Inc. (FCX:NYSE) made a $9
billion takeover offer for the oil and gas explorer McMoRan Exploration Co. (MMR:NYSE) and
Houston-based Plains Exploration &
Production (PXP:NYSE). Are you happy with this deal?
King: It came as a surprise. I've held
McMoRan Exploration in Energy & Scarcity for about two years. I
like what McMoRan is working to do with deep gas in the Gulf of Mexico.
Still, I recommended that readers take their money off the table with this
deal. Sell the shares, take the cash and we'll find other opportunities.
Exploration nearly doubled after the Freeport announcement, going from $8 to
$15 per share. You can't walk away from that kind of potential gain. Take
your money, pay your taxes at the lower 2012 rates and do something else with
the money next year.
another angle to this takeover. Freeport and Plains together already own
about 36% of McMoRan. There are a lot of ties here, between key individuals.
I think this deal was driven by the impending tax changes next year.
Freeport, the copper play, is borrowing a lot of money to fund this whole
process. Fortunately, interest rates are very low, so it's borrowing cheap to
do a big takeover, which will give a lot of people a really sweet payday, and
they'll get to pay capital gains taxes at much lower rates this year than if
they wait until January 2013.
"Jim Bob" Moffett, who founded McMoRan, is also paying himself. He
was a significant shareholder in McMoRan Exploration. He's taking from his
left pocket to put it in his right pocket.
Street hated this deal. Freeport's share price dropped by about $6/share
within a few minutes of the deal being announced.
whole deal really hinges on the Davy Jones well offshore of Louisiana and
whether or not it can make that play. Can it turn this around? Can it make it
a viable, producing well?
Jones is all about using new, deep-drilling and production technology to make
this type of well work in the Gulf of Mexico, albeit in shallow
water—20 feet or so. Sad to say, the Davy Jones well isn't quite where
it needs to be. But it's coming, and likely sooner
than most people believe.
forecasting that oil prices are going to rise."
components of the technology are all there, I'd say. I've seen super-strong
well casing. I've seen advanced valve systems. I've seen blowout preventers
that can handle the stresses. It's just that I have seen these things in
vendors' offices and warehouses in Houston. Now the trick is to systematize
it all, and make the Davy Jones concept work as a deep gas producer with
economics that won't break the bank.
question is what's going to happen with natural gas prices in the U.S.?
Whether it's Davy Jones or a new well, companies are drilling wells that need
$6, $8 and $10 per thousand cubic feet (Mcf) gas. Yet, on a good day, gas is
selling at $3–3.50/Mcf. Are the economics going to work? That's a whole
TER: How does
this change the landscape among the hard asset players? Are we returning to
the 1970s, when mining companies and oil and gas companies were one and the
BK: Back in
the 1970s, when oil prices went up and the economy realized that energy was a
key component of everything, a lot of oil companies started to get into other
resources. They did these types of rollups in the 1970s, and then they spent
a big part of the 1980s divesting and spinning these things back out. Right
now, in this era, McMoRan may be a one-off idea. It's a unique play. It's not
quite time to break out your old 1970s leisure suits and hang the disco balls
TER: Let's get
to what you're calling "taxageddon." How will this affect
BK: When the
tax code changes dramatically on Jan. 1, a lot of people are going to feel
the sting. We'll get hit by that 2% increase in the FICA Social Security in
every paycheck. The capital gains tax rates will effectively double on Jan.
1, including the Obamacare increase. The personal rates will go from 15% to
the 30–35% range. It's a big hit.
TER: Are you
managing the Outstanding Investments portfolio differently than you
were a year ago? Are there more yield-bearing stocks in that portfolio?
BK: In the
last year, I've focused more on identifying yield-bearing stocks. I added one
this fall called Linn Energy
TER: In recent
editions of Energy & Scarcity, you have discussed declining rates
at fracking wells across the U.S. Do you believe this is an across-the-board
problem or is it limited to certain plays or geology?
pretty much all of the shale gas wells. A fracked well that does not decline
quickly is truly the exception. Last week, at a conference at the University
of Texas, the overall decline rates that were tossed around were absolutely
shocking. The decline rates on wells in their first year are in the range of
35–40%, and it is a similar number in the second year. By year two, a
company will have produced perhaps 75% of the ultimate recoverable
hydrocarbon out of a well.
wrecks the economics of a gas well to produce most of its output up front,
during a low-price environment. These frack plays are astonishing wells, in a
technical sense, but the economics are very problematic.
TER: If the
production rates are rapidly declining and there is not as much natural gas
as first thought, won't that ultimately lead to higher natural gas prices?
gas prices are already starting to climb back up. About a year ago, the
number of rigs devoted to drilling for gas fell off a cliff. I am bullish on
natural gas in general. The natural gas price could double to the $7 range
within the year.
TER: One of
the companies in your Outstanding Investments portfolio is Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE), which is
moving heavily into natural gas. Is that a smart move?
Dutch Shell is moving to gas. Exxon Mobil
Corp. (XOM:NYSE) is moving
to gas. Chevron Corp. (CVX:NYSE) bought Chief Oil and Gas LLC
in western Pennsylvania to establish itself as a major player in the
Marcellus region. However, the executives from these companies will tell you
about the very tight economics of these projects. Actually, Rex Tillerson of
Exxon said that up until now, Exxon has been losing its shirt on these
bullish on natural gas in general."
going to say that Royal Dutch Shell has done the wrong thing. It bears
watching. These big companies have deep pockets, and will have to work their
way through this storm the same as everyone else. The good news is that the
big guys can afford to take risks that small companies, or even large
independents, can't take to drill gas plays and test new technology that
might change those decline rates from being so steep.
TER: What are
some other senior oil and gas producers in the Outstanding Investments
BK: Over the
years, I've focused more on international names. Statoil ASA (STO:NYSE;
STL:OSE) of Norway is a large, well-run
company. I like that the Norwegian government has a large stake because it
seems to be mature enough to let Statoil operate as an oil company, collect
the dividends and benefits, but not interfere in the day-to-day operations.
Statoil has wonderful technical capabilities. It's a nice dividend payer.
company Total S.A. (TOT:NYSE) is also a
large, global company that operates in a lot of jurisdictions that France has
close ties with. It pays a nice dividend. Total has been good.
BP Plc (BP:NYSE; BP:LSE) has been
in the portfolio for a while. I kept it through the Gulf of Mexico blowout.
BP's shares dropped terribly right after the blowout, although I told people
to buy back in at $28/share, and it wound up going up to the $40s.
Yet BP has
been a very frustrating company for a lot of reasons. Of course, there is the
Gulf of Mexico disaster, but it has other issues related to people's
perception of its safety culture. Fair or not, people write books about it,
like Drowning in Oil: BP and the Reckless Pursuit of Profit, by Loren
Steffy of the Houston Chronicle. That hurts BP's share value.
hasn't done itself any favors with the confusion over its partnership with
TNK-BP. I'm still thinking through what to do with BP. On the one hand, it
has a lot of great people and assets. It has an aggressive aspect to its
exploration and production in the future. On the other hand, there is
informed speculation that BP could be worth more in a broken-up state. It's
going to be interesting to see how BP evolves over time.
natural gas is used to heat homes and to create electricity at large
utilities. Could declining output from fracked natural gas wells ultimately
be a boon to green energy sectors like solar, geothermal or wind?
natural gas has completely altered the economics of the electric utility
system in North America. Natural gas base rates are now considered the number
to beat, even when people are proposing nuclear power. That's a very odd
dichotomy because a natural gas well can be set up and generating electricity
in a few years. With nuclear, it can be a 25-year process to acquire a site,
get the permitting and navigate the maze of regulation and public acceptance
for a reactor. What may be a temporary glut of natural gas is truly altering
the long-term investment climate for nuclear power.
TER: Are you
less bullish on uranium plays as a result?
bullish on uranium because there's not going to be enough new uranium mined
and milled to meet demand. China has an aggressive plant-building program.
Every one of those plants needs to lock down a 20- to 30-year supply early in
the development cycle. There are not enough new mining plays coming on to
level of uranium supply is also going to go away in a year. Russia is not
renewing its agreement with the Megatons to Megawatts program, which
purchased nuclear reactor fuel that had been converted from enriched uranium
in old nuclear weapons.
TER: Are there
any particular uranium plays that you're bullish on?
BK: Uranium Energy Corp.
(UEC:NYSE.MKT) extracts uranium via
in situ recovery, by washing the uranium out of sandstone using hydrogen
peroxide in Texas. It is producing uranium yellowcake at an internal loaded
cost of about $18–20/pound (lb), which sells into a spot market at
frack plays are astonishing wells, in a technical sense, but the economics
are very problematic."
numbers are going up. It just had a brand new permitting approval at Goliad,
Texas. It will be using a fairly simple technology, drilling wells that are
less than 1,000 feet deep. It's pumping the fairly benign substance hydrogen
peroxide, along with a few other odds and ends, into the sandstones. It is
pulling it out with resins and taking it to a fully licensed plant at Hobson,
outside of San Antonio.
visited the facility. It's all good: The people are good. The technology is
good. The economics seem good. I like Uranium Energy as a long-term play. It
will be very sensitive to rising uranium prices that I forecast in the next
year or two.
TER: Any others?
BK: Over a
longer time frame, there is a Canadian company operating in South America
called U3O8 Corp. (UWE:TSX;
OTCQX:UWEFF). U3O8 has very early-stage uranium
deposits in Colombia, Guyana and Argentina. I've visited the Colombian play.
It is polymetallic, which means that in the process of recovering the
uranium, it is going to be able to pull out phosphate, silver and some
intriguing quantities of rare earths. It's very early stage. It is still
doing the drilling out in the jungle. It is a speculative play for long-term
investors who know how to ride these junior resource markets.
TER: The green
energy sector is in the midst of hard times. It's had more downs than ups
during the past few years. How would you characterize alternative energies
renewable energy space has been very frustrating for most investors. It's not
to say that you can't produce energy using solar, wind or geothermal. Of
course you can. But it gets back to that well-known critique about how, when
the wind doesn't blow, you have no power. When the sun doesn't shine, you
have no power. What's the answer?
a lot of wind and solar power. It creates so much power during windy and
sunny times that it actually disrupts the fossil fuel baseload within Europe.
Yet, for every windmill and solar field, Europe still needs fossil fuel
backups to kick on if the alternative source goes down. This kind of
overdevelopment of so-called renewables may feel good to the green side, but
it has completely disrupted the economics of a lot of utilities across
Europe. Many European utilities have ceased being investment-grade assets.
may be a temporary glut of natural gas is truly altering the long-term
investment climate for nuclear power."
built renewables to that scale in the U.S. If we do, we would have a similar
problem. Rapid overbuilding of green power will degrade the investment
quality of many public utilities, which are among the few things that pension
funds and institutions can still count on. It's something that investors need
to keep an eye on. We blew up the stock market in 2008 with a housing
meltdown. Do we want to risk blowing up the market again with a utility
meltdown? We're not there yet, but we could be on that track.
Grail for renewable energy is backup battery storage that charges up
batteries for continued use after the wind or sun dies down. I've been
focusing on American Vanadium Corp. (AVC:TSX.V), which is
developing a vanadium redox battery that's very intriguing and scalable. It's
capable of storing immense amounts of electricity.
only being used right now in Japan, right?
Japanese are leading the charge of commercializing it. The Chinese are close
behind. In the U.S., it's the typical story of caution and underinvestment,
relating to the problem of industry working with public utility commissions
(PUCs). Will the PUCs of America build this new tech into the rate base?
wants to be the first one to approve a vanadium redox battery system for a
public utility. People don't want to put their necks on the block. But I
suspect that a lot of people would love to be the second players at bat.
Unfortunately, we are very risk averse in the U.S., whereas Japan and China
are charging ahead—if you'll excuse the pun. Looking ahead, if we crack
the code on reliable, large-scale storage, it could truly alter the economics
of alternative energies.
TER: If you
were to speculate on which one of those renewable energy sectors will be the
first one to be commercially viable, where would your money be?
panels are becoming less costly, which is improving the economics for use on
a much larger scale. It will be geography dependent. The sunny Southwest and
West regions ought to see solar penetration the soonest and in the greatest
degree. The idea that there could be a solar-powered Boston or Minneapolis is
probably not as realistic.
TER: One issue
with solar is the lack of baseload power. That's a big advantage of
geothermal over solar. However, if you want to talk about frustrated
investors, look at geothermal energy.
BK: I started
out Energy & Scarcity Investor with a number of geothermal ideas.
I truly believed that these things were on the way up, but the technical
problems and capital requirements have been absolutely overwhelming. The fact
is that the largest geothermal power producer in the world is Chevron. It
picked all that up when it bought Unocal. In 2005, Unocal had developed a lot
of geothermal in Indonesia. A lot of green-power people hate it when I say
that Chevron is the biggest geothermal player.
Geothermal is working in Central America. Why isn't it happening in the U.S.?
started to happen here in certain areas, such as Nevada. I drove by a
geothermal facility on Interstate 80 when I was in Reno recently. Where it
works, it works well. But it's getting it to work that's the hard
part. The foremost reason is that there are few geologists and engineers who
understand this space. It's tough to build a technical team and keep the
lights on long enough to make it all work. It's been very frustrating.
bullish on uranium because there's not going to be enough new uranium mined
and milled to meet demand."
frustrating is that geothermal is struggling to spread in an environment that
is supportive of renewable energy. California and Nevada state legislatures
are telling the public utilities to have a certain percent of power coming
from renewables by certain dates. The Obama administration and the
Environmental Protection Agency are supportive at the regulatory level. There
are tax benefits and low interest rates. Still, the geothermal space has not
TER: Have you
stopped following geothermal companies?
BK: I haven't
stopped. I just don't spend a lot of time on them. There are too many other
ideas that offer a better return on investment.
conclude, what investable themes in energy should investors look for in 2013?
BK: In terms
of oil and gas, people should look for surprises. I'm forecasting that oil
prices are going to rise. There are conventional oil plays that still offer
excellent returns to investors.
gas prices are also going to drift up as the year goes on. The rapid
depletion rates on fracked wells from the past two and three years are going
to kick in, and probably with a vengeance.
could be interesting breakthroughs in the alternative space. 2013 could be
the year when investors start to better understand energy storage. This could
be the year that the investing community is going to begin to realize it's
out there and that could lead to the beginning of a rebound in the solar and
energy storage spaces.
TER: Will we
see a dramatic rise in uranium prices in 2013?
BK: I think
the spot price will start to drift up late in the year. People are going to
have a lot more on their plates to worry about in the first six months of the
year. For some strange reason, a lot of investors have allowed their investment
horizons to shorten up. What people ought to be worried about now is that at
the end of 2013, there is going to be a big uranium shortage worldwide. It
will happen. I don't think that it cannot happen.
Byron King writes
for Agora Financial's Daily Resource Hunter. He
edits two newsletters: Energy & Scarcity Investor and Outstanding
Investments. He studied geology and graduated with honors from Harvard
University, and holds advanced degrees from the University of Pittsburgh
School of Law and the U.S. Naval War College. He has advised the U.S. Department
of Defense on national energy policy.
Click here for a
free copy of Bryon King's award-winning Outstanding Investments.
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1) Brian Sylvester of The Energy Report conducted this interview. He
personally and/or his family own shares of the following companies mentioned
in this interview: None.
2) The following companies mentioned in the interview are sponsors of The
Energy Report: Uranium Energy Corp., U3O8 Corp. and Royal Dutch Shell
Plc. Streetwise Reports does not accept stock in exchange
for services. Interviews are edited for clarity.
3) Byron King: I personally and/or my family own shares of the following
companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this
interview: None. I was not paid by Streetwise Reports for participating in