Chen Lin Sees Buying Opportunity of a Lifetime in Energy Stocks

The Energy Report: Chen, last year you correctly predicted that oil could fall as low as $47/barrel ($47/bbl). What's your outlook for the rest of this year and what is that based on?

Chen Lin: I'm not a technician, but I looked at North American production increases of 1 million barrels a year and knew it would result in an oversupply situation, especially in light of the world economy softening. It was a perfect storm for the energy sector. The rapid increase in the fracking production in North America has been phenomenal, but it had to result in lower prices, so a year ago, I started planning on $47/bbl oil just to put a rough number there. At that price, fracking will be curbed, and then we can get back in balance again.

A year later, that is right about where we are. Looking ahead, I see oil bottoming in 2015. As the price drop occurs, a lot of companies will go under because they are not sustainable.

TER: Are you worried about conflict in Yemen, Saudi Arabia and Iraq?

CL: Yes. Those are geopolitical factors, and they will likely keep a bottom for Brent crude. Between Brent and West Texas Intermediate (WTI), I'm actually more bullish on Brent than WTI.

TER: Do you think that that gap will widen or stay about the same?

CL: Geopolitics are very hard to predict. The gap may widen sharply this summer if oil storage in North America continues to fill up. That will be a perfect buying opportunity, a once-in-a-lifetime buying opportunity for domestic energy stocks, because WTI will go back up. You see, this is not a global supply/demand imbalance. We have all this oil in storage because the United States forbids raw oil from being exported. That artificially depresses the prices. And it will have consequences. If oil goes to $30 or $20/bbl, that will basically bankrupt the U.S. domestic oil industry. And it will put pressure on the president and on Congress to lift the ban on oil exports.

You have to understand, the world doesn't actually have too much oil. The U.S. is importing some 9 million barrels per day from overseas, but that's a different type of oil. We're producing light oil, which doesn't work with our current refinery capacity. So we import what we need and store what we have. That is why the margin between Brent and WTI may continue to widen through the summer and fall.

At the same time, the refiners are working overtime. The stock prices have been increasing, but we might be nearing a top. Current margins are probably not sustainable because they will likely lead to the lifting of the export ban in the U.S. I've traded refiners with some very good profits, but I may have to start selling if we begin to peak.

TER: Is there an investing opportunity in building storage tanks?

CL: Yes, probably, but those opportunities are transient. This is not a long-term investment opportunity. It could shift to overbuilt with one swipe of the president's pen to lift the ban on oil exports. A lot of states are hurting badly from this oil crisis, so plan for a change at some point to this 40-year old law. Then, U.S. and Canadian oil producers become the performers of a lifetime.

TER: Are you still bullish on ethanol?

CL: I'm neutral on ethanol right now. I was very bullish on ethanol last year and made some pretty good profits in the sector. But right now inventory is too high, and the profit margin is very low. The positive is that the short interest is also very high. That is why I am in neutral territory. At this point I am more excited about some international plays, so I sold my ethanol stocks.

TER: What makes the international oil and gas plays a better bet right now?

CL: Many analysts are looking for a V type or U shape of recovery, but I see it as more of a reverse J pattern. Prices will recover some, maybe halfway, and then stay around $60 or $70/bbl for an extended period of time. If we go above that level, the North American fracking factory will start running too high again. That will keep the top of the oil price for a pretty long time unless some geopolitical event occurs like Saudi Arabia getting attacked. That is why I am looking for international oil plays that can make money at around $60/bbl oil.

TER: What are some examples of international oil companies you are buying?

CL: Canacol Energy Ltd. (CNE:TSX; CNNEF:OTCQX) is one I've been really buying. I started in January at around CA$2/share. I keep buying. Any time it dips below CA$3/share, I've been trying to pick up more because this company has a bright future in the environment I'm talking about.

Canacol management raised money at the top, raising $125 million ($125M) when the stock was $7.90/share at the end of last May. Then at the bottom, Canacol picked up two enormous Colombian assets, previously owned by now-bankrupt Brazilian tycoon Eike Batista at a fire sale price of $30M. These two contracts in the Lower Magdalena Basin potentially include trillions of cubic feet of natural gas worth billions of dollars. The company is using the money it raised wisely to pick up a very important asset at bargain basement prices.

TER: How long will it take for that to pay off for Canacol?

CL: The payoff will be enormous. Right now, there is a natural gas shortage in Colombia. Production there has been reduced by about 8%, or 90–100 million cubic feet (90–100 MMcf) each year, but demand is growing. Canacol could fill that shortfall by December. It is selling for about $5–8/thousand cubic feet ($5–8/Mcf), but the cost of production is about $0.50/Mcf, and the buyer pays the transportation costs because there's such a demand. That is a great situation to be in right now.

My calculation is Canacol's natural gas has $180M/year contracted in 2016. This is in addition to all the light oil it produces, about 10,000 barrels per day at end of 2014, as well as farm-in agreements that Exxon Mobil Corp. (XOM:NYSE), Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE) and ConocoPhillips (COP:NYSE) are spending money on to earn interest. In 2017, Canacol's natural gas contracts are likely to be $300M. Each subsequent year it can increase that by roughly $120–150M. Of course, that depends on a lot of different factors, including the decline of Colombia's natural gas production continuing, which is extremely likely because no one is doing exploration in Colombia right now. All Canacol needs is to close the previously announced bank loan, and it has the liquidity to execute hundreds of millions of annual cash flow. It's a most ideal situation.

TER: Do you think Canacol will continue in acquisition mode, or is management going to work on the projects it already has?

CL: Right now, Canacol's top priority is to drill additional appraisal wells to prove trillions of cubic feet potential in reserve. Its Proven and Probable reserves just came out at 345 MMcf. But it needs to drill a few more wells, then it can dramatically increase its reserves. Once you have a reserve, you can sign contracts with the utilities, which are desperate for natural gas. Even at $5/Mcf—almost double the U.S. natural gas price—natural gas is still is a bargain because it is the equivalent of $30/bbl in oil. Diesel would be even more expensive with the refining charge and coal is not an option. There is no alternative. All this points to a very bright future for Canacol, but no one is looking at it because everyone is so depressed about oil prices in the U.S. I'm excited. It's a perfect time to buy bargains, and I think Canacol coming out of this correction will be a great winner.

TER: You've talked to us before about Pan Orient Energy Corp. (POE:TSX.V). It just announced a share buyback, it's in the midst of drilling, and it announced a deal with Talisman Energy Inc. (TLM:TSX). Why is the market not recognizing these advances?

CL: Pan Orient has not been recognized by the market for quite some time. Frankly, I've been holding it for the past three years. Even after the $0.75 dividend, I'm not making any money, but I'm still extremely excited about the East Jabung project with Talisman, which is in the process of being acquired. It's a very good project because it is land-based and shallow. The capital expenditure is only $4–5M/well with something like a billion barrels of oil equivalent. It could be one of the largest oil discoveries in the world. Also, the fiscal terms of that concession are favorable for Pan Orient—about 35% oil, 35%/65%. Usually Indonesia requires 15%, 15%/85%. Talisman awarded the contract to Pan Orient because of its good connections with the government, but there were a lot of suitors for that property.

When Pan Orient closes the deal with Talisman, which could be any time now, we should have an update on the drilling schedule. The previous update looked like the end of 2015 or early 2016. That will be the lottery of my lifetime because the upside is so enormous. The downside is limited because Pan Orient is trading at cash or below cash if you calculate the money Talisman is going to pay it to option 50% of this concession. So the downside is very limited. The upside is enormous. That's why I'm very excited.

For Pan Orient, these are very good fiscal terms; it has a very good location, is land-based and is cheap to drill. None of that is priced into the stock, which has held pretty firm while the rest of the sector dropped 80% or 90% or more, so I'm patiently waiting. I hope that the day will come when I get my reward. But, again, this is high-risk exploration. You don't know if a well will hit or not. But if you hit, the upside is enormous. It's different than Canacol. With Canacol, everything is lined up pretty well. I know that the cash flow is coming in, so the certainty is high. But with Pan Orient, nobody knows. I've been holding that for a pretty long time, and I will continue to hope.

TER: You were also a very patient Mart Resources Inc. (MMT:TSX.V) investor. What do you think of the buyout offer of $0.80?

CL: I have to say frankly I'm quite disappointed in myself in that I should have sold in early September. That was when I told my subscribers to sell energy stocks because I saw the energy crash coming. That was an excellent call, but I recommended that they hang on to Mart Resources. I wish I had told subscribers and myself to trim that down too. At that time, I was clinging to the hope that the new pipeline would start flowing any day, but it didn't happen until December 2014. By that time, oil had already crashed. In the meantime, management took on debt to bid for the Shell Petroleum Development Company's OML 18 lease at exactly the wrong time, despite my repeated pleas to management to not take on more leverage until the pipeline was flowing. I was disappointed. But I bought Mart mostly from $0.15 to $0.40/share. I already received more than $0.40 in dividends, so it's still a winner for me, but not as big as I'd hoped.

I think the $0.80 offer will stand. The buyer is a Mart partner in Nigeria, Midwestern. It knows the project very well. I heard the owner of Midwestern is very wealthy, so I think it will go through. I'm holding my share for the $0.80. It probably will happen in late summer or fall, but still it's unfortunate because Mart could be worth much more.

TER: Looking forward, what advice do you have for energy investors who want to survive in a $47/bbl oil world?

CL: Personally, I think this is not survival time; this is an exciting bargain-hunting time. On the investing shows like CNBC, they are talking about $20–30/bbl oil, but they aren't distinguishing between WTI and Brent. When everyone is scared, it's the perfect time to buy. Right now, I think it's the best time to buy international plays like Canacol and Pan Orient. If you hold Mart, it should go up 30% in a few months. If WTI really crashes over the summer, that will be a buying opportunity of a lifetime for the domestic oil producers. I'm extremely excited about that. I think 2015 will be the year we remember as the year of energy bargain hunting, so I'm quite excited about it.

TER: Thanks for your insights, Chen.

Chen Lin writes the popular stock newsletter What Is Chen Buying? What Is Chen Selling?, published and distributed by Taylor Hard Money Advisors, Inc. While a doctoral candidate in aeronautical engineering at Princeton, Chen found his investment strategies were so profitable that he put his Ph.D. on the back burner. He employs a value-oriented approach and often demonstrates excellent market timing due to his exceptional technical analysis.