"experts" had been talking about oil prices going to $130 per
barrel. Now there's talk of $50–60 per barrel oil. Either end of that
spectrum is not sustainable in the long run, says Byron King. In this
exclusive interview with The
Energy Report, he explains why he believes
prices will settle in the $80–100 range. In the meantime, the recent
pullback offers some interesting buying opportunities for investors ready to
pounce when the market finds a bottom, as well as some names investors can
nibble on right now.
The Energy Report: Things
have been pretty hectic on the global economic and financial fronts lately
and the energy markets seem to be defying the expectations and predictions of
many analysts. What's your take on where we are and where things are headed?
Byron King: We're living
with volatility, most of which is due to international currency and exchange
rates. The dramatic decline in the euro has caused a capital flight to the
U.S. and a strengthening of the dollar, which results in lower oil prices. The
other big macro-type issues include the looming economic slowdown in China.
More news stories are coming out about negative demand indicators in China,
which will definitely be bad for Chinese consumption growth. The country may
use less oil than people forecast. The Saudis are producing at least 1
million barrels per day (MMbbl/d) in excess of what
they normally would. So, between the rising dollar, slowing growth and excess
production in Saudi Arabia, we're seeing these gyrating low prices.
TER: One hundred
and thirty dollar per barrel oil and $5 a gallon (gal) gasoline failed to
materialize as predicted, and now there's talk of $60/bbl
or even $50/bbl oil in the shorter term. Some oil
analysts are now predicting $3/gal gasoline by early November. What's your
BK: Extremely high
or low prices aren't realistic for the long haul. The world economy will
hardly function with $130/bbl oil. The airline
industry shuts down right away and much of the rest of the world will suffer
accordingly. A $5/gal gasoline price makes for an instant U.S. recession.
Whatever economic strength we saw in late winter and early spring got stuck
in the mud when gasoline prices went over $4/gal on the East Coast and toward
$5/gal in California. All of a sudden, the U.S. economy lost traction, and
we're sliding back into recession.
And while the world economy can't deal with high oil
prices, Credit Suisse's $50/bbl oil prediction,
though it may happen, would not last long. For one thing, the seven sisters
of oil exporting—Saudi, Iran, Nigeria, Kuwait, United Arab Emirates,
Russia and Venezuela—simply cannot afford under $85/bbl
oil because they have their own bills to pay. Those lowball prices could be
reached because of events, but they won't remain because of supply-and-demand
TER: Is the
$80–90/bbl range reasonable?
BK: This morning,
West Texas Intermediate (WTI) oil was trading in the $78/bbl
range. That's rather low by recent standards. A WTI price of $80/bbl is enough to keep the North American oil industry
working. A $90/bbl level for Brent, the
international standard, will keep the international oil industry alive. It
will tighten things up for the big oil exporting countries, but they'll be
able to avoid bread lines and riots. The number that oil has to find is
$80–85 in North America and between $90–100 internationally.
TER: Have upside
speculators been chased out of this market at this point?
BK: This is still
a trader's market, with rising prices and falling prices. For people with a
really strong stomach and money to play the short term, have at it, boys.
This is your market. The last thing the traders want is for oil to stay
static at $85/bbl, though the rest of the world
might like that for budgeting and projecting purposes. For traders, the last
couple of months have been terrific. The people who understand the market and
are successful over the long term know that you sell on the way up and buy on
the way down. It's a question of understanding the market dynamics. As Mark
Twain said, "If you're going to throw your eggs in one basket, you have
to watch that basket." When you're trading at the margins and a move one
way or the other could wipe out your capital, you have to keep your eye on
things. But the big oil thinkers don't worry about today's headlines. They
need to think about the very long term.
TER: Big companies
are usually able to absorb oil price fluctuations, but what happens with the
smaller companies during periods of low prices and volatility?
BK: It's been a
tough world out there for small companies without deep pockets. The energy
business, in general, is for companies with money. A small gold miner versus
a small oil company carries a difference of at least one or two orders of
magnitude. The equivalent of a $20 million ($20M) gold company would be a
$200M oil company. With the small guys, the big concerns right now are
geographic and economic.
If you're in the natural gas business in North
America, you have to be deeply concerned. Natural gas prices are at
historical lows and the cash flow just isn't there to support much
development. A small company may have tens or hundreds of millions of dollars
tied up in leases. If you don't somehow drill or exploit these leases in one
way or another, you're going to lose them. So not only would you not be
drilling or extracting, but you'd lose your leases, too. That's a terrible
So what will we see in North America? There will be
some cutbacks in drilling. It's already happening, but we're going to see
more of it. It will affect the smaller drillers and service companies first.
The big guys—Halliburton (HAL:NYSE),
Schlumberger Ltd. (SLB:NYSE) and Baker Hughes Inc. (BHI:NYSE)—will also
feel it but, they have much deeper pockets and they're large and
international. So we'll see some rigs get stacked, but I don't think we'll
see as many as some of the gloom-and-doomers are
forecasting. A lot of these smaller companies have to keep their geologists
and engineers working and drilling or all of that money that they spent on
leases in the last five to ten years goes down the drain.
Overseas is another story. You almost have to take
each country as you find it. Argentina is a disaster with what's going on
with Repsol YPF SA (REP:BMAD).
A couple of weeks ago, a company called Pan American Energy LLC saw its
operations literally overrun by rioting workers—one of the largest and
oldest fields in Argentina was almost shut down because of political issues
and labor unrest.
Look at Poland. A lot of people were thinking Poland
was going to have its own shale gas revolution, but a couple of weeks ago,
Exxon Mobil Corp. (XOM:NYSE) decided to pull out of Poland after a couple of
bad wells. Now, the cynics are saying that Exxon is getting better deals from
Russia. Russia is the big fish that Exxon wants to land, so it's going to
walk away from Poland.
One more country I'd throw in is Libya, which was a
big oil producer. With the recent shale revolution, its exports almost
ceased. Now, it has put a lot of things back into shape, but what I hear is
that many of those repairs were jerry-rigged and could start breaking down.
Secondly, the security situation is not nearly as good as the operators would
like to see.
TER: Do you think
that there will be enough cutbacks in domestic natural gas production to
trigger a price rise in the foreseeable future?
BK: Prices have to
rise, and they probably will rise sooner than conventional wisdom suggests.
I'm sort of a contrarian by nature, but the fact is they're giving gas away
as it is, so I don't see much downside from here. I do see upside potential,
as well as more demand from more places. We're already seeing a complete
upheaval in the electric-generating industry with coal-fired plants. There
are no new ones being built and they're scaling back on upgrading the old
ones because they may not operate long enough to pay back.
That has impacts elsewhere in U.S. industry, such as
with companies that do the engineering and supply the parts, engineering and
such for upgrading pollution controls on coal plants. They're about to enter
their own mini-recession because of lack of business. Natural gas is also
playing havoc with the renewable energy space. Natural gas-fired energy is so
cheap that the windmill guys and the solar guys are losing the battle of
economics on that alone. I expect to see slightly less gas supply and likely
more demand than what people have anticipated.
TER: What are some
of the oil and gas majors that would be good shots to weather the ups and
BK: In the
international realm, Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE) is
in very good shape. It is a wonderful, technology-based company that has deep
pockets and a very aggressive plan to grow its resources and reserves over
the coming years.
Another one that I think is just a spectacularly
well-run company is Statoil ASA (STO:NYSE;
STL:OSE), of Norway. It is truly one of the world leaders in
offshore work and has made a major commitment in North America. People in
North America should know there's a new kid on the block. I think we're going
to see great things from Statoil.
Further down in North American domestic plays, I'm
keeping my eye on a company called Denbury Resources Inc. (DNR:NYSE). Denbury
is a very advanced independent as independents go—and is making a lot
of good moves in the tertiary recovery area using carbon dioxide to get the
last drops of oil out of reservoirs.
In Canada, I've been following a company called Cenovus Energy Inc. (CVE:TSX; CVE:NYSE) for two years
now. It is a very rapidly growing player within the Alberta oil sands play.
It has lots of acreage and lots of investment to grow things with very good
economics. The one major issue for Cenovus and for
all of the Canadian oil sands operators is access to markets. The Keystone
Pipeline debacle was not good for the oil sands players. At the same time,
the Canadians are moving very firmly toward finding another way of doing it.
We may or may not see that northern pipeline get built to the upper Pacific
Coast, but there is certainly a plan in place to take some of that Alberta
oil sands product down to Vancouver for export, which will be to the
long-term, strategic detriment of the U.S. Regardless of who is president
next January, we will see some sort of a Keystone Pipeline expansion to move
more oil sands product out of Alberta and down into the U.S.
TER: Can you give
us a little more detail on the revenues and market caps of Denbury and Cenovus and where
you think they might be going?
BK: Cenovus is a $32 billion ($32B) market cap company. The price:earnings (P/E) is around
12. It is making money, and it pays a nice dividend—2.8%. It's been a
bit of a sleeper for many investors, but I think Cenovus
is a great choice for investors looking for exposure to the Canadian oil
sands plays. It is a good, strong idea with a lot of upside and a lot of
growth potential, and it pays a nice dividend while you're waiting.
a $5B market cap. The P/E is about seven, with no dividend. This is a stock
where I'm looking for internal growth to bring the capital gains back to
investors over the long haul.
TER: What other
companies are interesting at these levels?
BK: I'm a big fan
of the oil service sector. Right now, Schlumberger is trading down around
$60. Schlumberger is one of those companies that almost never gets cheap because too many people know how good it is.
When it trades in that low-$50–60 range, I always consider it a buying
opportunity. When oil prices recover, that $60 Schlumberger stock is going to
be an $80–90 stock. If you can just bear with the market gyrations,
it's almost a guaranteed 40–50% gain.
Right now, with things as volatile as they are,
investors want to be very careful about going too deep into these very
turbulent waters. To the extent that you do go in, it would be with companies
that have a really strong upside such as Cenovus or
TER: Do you have
any thoughts on Encana Corp. (ECA:TSX;
BK: Encana is also a very strong Canadian firm. It has almost
a $14B market cap and a relatively high P/E of 27. But the dividend yield is
a nice 4%. If you're looking for yield, Encana
would do it for you, but with a P/E of 27, I think it's priced more like a growth
stock than others. In this oil market, I don't know if management can really
live up to those kinds of expectations. I'm not negative on it; I'm just
saying, be careful.
TER: To summarize,
what do you think the average investor should be doing these days if they
want to play the energy markets?
BK: I would be
very wary of most gas plays just because of the economics. I would also be
wary of the oil service sector, with the exception of Schlumberger, which
happens to be cheap but won't be cheap for long. In terms of the larger oil
plays, I'd suggest Statoil for international and technical competence with a
good growth profile in front of it and, in the oil sands, Cenovus.
I don't want to give too long of a list to the investors out there because
this is not the time to be too bold.
This market could confound people greatly. We're at
the beginning of a presidential election cycle where government statistics
and government announcements will become completely meaningless because
everything will become politicized. There are many beaten-down ideas out
there. The market is filled with underpriced value, but you want to find the
best of the best of those underpriced values. I think I've given a few names
in this discussion. I'll be able to sleep well at night if investors act on
TER: Should we wait
a little bit for the oil market to bottom out before it's an ideal time to
get in or should people be averaging in?
BK: I think people
should view the market as trying to find a bottom. Right now, it's OK to
nibble, but it's better to watch and wait.
TER: You've given
us a good overview of where you think the market might be headed and some
good names to look at. Thanks again for your time.
BK: Thanks for
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
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1) Zig Lambo 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: Royal
Dutch Shell Plc. Streetwise Reports does not accept stock in exchange for
services. This interview was 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