The Energy Report: When we talked last October, you predicted that low oil and gas prices would
fuel an economic resurgence in the U.S. and impact everything from politics
to job creation. Is the economy living up to its potential?
Matt Badiali: I think so. Companies moving here and building new
factories are citing low energy costs. The average family is saving
$1,200–2,500 per year, which is a pretty big savings. But they don't seem to
be spending, so it hasn't impacted the overall economy as much as I thought
it would. On a bigger scale, low energy prices beat low-cost wages and
low-cost materials: In today's economy, low energy costs will bring the
economy to you.
TER: It has had an uneven effect on jobs, however, particularly in
oil-producing areas. You recently wrote that Saudi Arabia is playing chicken
with oil prices. What impact is the continued flow of oil into the market
from the Middle East having on companies in places like the Eagle Ford?
MB: It's having massive impacts, particularly in the Eagle Ford and
the Permian Basin. Harold Hamm, CEO of Continental Resources Inc. (CLR:NYSE),
calls the three big shale plays—the Bakken in North Dakota, Permian Basin in
West Texas and Eagle Ford in southeast Texas—Cowboyistan.
This extended period of lower oil prices is causing companies to become
more efficient. They're not drilling willy-nilly. In fact, 60% of the rigs,
some 1,000 of them, aren't working right now, and as many as 60% of wells
that are being drilled are not being completed—about 4,000 of them. The expensive
part of shale wells is cracking the rocks, cleaning the well bore and
plumbing it. That's called completion. It's actually inexpensive to drill the
well right now. When the price goes up, a lot of inventory is primed and just
has to be fracked to start flowing.
However, there is a lot of oil that won't be drilled at all at the current
price. The experimental shales are where the going is tough. The Tuscaloosa
Marine Shale in Louisiana is dead, and will probably be dead for a while.
Some of the peripheral shales in Colorado and Canada aren't going to work
with oil at $60/bbl. Russian, Nigerian and Venezuelan oil cost far more than
$60/bbl to produce.
Saudi Arabia continues to produce lots of oil in order to put marginal
producers out of business. Saudi Arabia has a sovereign wealth fund worth
more than half a trillion dollars; it can continue producing at $60/bbl oil
for a long time.
TER: How long can the U.S. frackers keep this up?
MB: It depends on the company. If you're making a profit, you can
keep it up indefinitely. If you're not making a profit, you're in trouble.
We're seeing mergers and divestitures, particularly when it comes to
companies that took on massive debt. Take Magnum
Hunter Resources Corp. (MHR:NYSE.MKT), for example. The $316 million
market cap company has over $950 million in debt. It isn't making any money
right now. It recently announced the sale of a major asset—the Eureka Hunter
Pipeline in the Marcellus and Utica shales.
I think there will be more of that, both in the shale and the Canadian tar
sands. Companies are being forced to get leaner. The current lack of
investment in development will have a global impact down the road. All Saudi
Arabia did was maintain market share and refuse to cut production.
Maintaining oil production was important to the Kingdom, particularly in the
battle with Russia for Chinese market share. However, there will be fewer new
sources of oil down the road. . .which could lead to higher prices.
TER: From both a short-term and long-term investment approach, what
oil and gas explorers and producers are doing well and can survive?
MB: Right now, I am waiting. I'm not buying producers today. I need
to see which companies are doing well at lower oil prices. We just completed
the first quarter, where hedging probably didn't play a role in the bottom
lines of producers. I am waiting to see the results.
I do like companies that supply fracking equipment and material. I think
there is an opportunity now to buy assets that are going to be useful forever
at very low prices. For instance, I like the frack sand producers. Engineers
have discovered that more sand per well is more economical. I was just at the
Energy Information Administration (EIA) conference and heard that, in the
Permian Basin alone, from 2012 to 2014, the average initial production rate
rose from 400 barrels a day (400 bpd) to 800 bpd. In two years, engineers
doubled the volume of oil produced, mostly through changing the way they were
fracking rocks, and a big part of that change was the volume of sand added.
Now, instead of 500,000 pounds, companies are using 2 million pounds of sand
per well, and producing a lot more oil. They are, in a sense, trading the
sand cost for better oil production. That is an easy trade to make.
Companies like Hi-Crush Partners L.P. (HCLP:NYSE) and U.S. Silica
Holdings Inc. (SLCA:NYSE) are the beneficiaries of this new demand. We
bought these stocks in May, and they have been down a bit, but I'm happy to
buy these companies at these prices because fracking is here to stay. It is
the technology that's going to drive U.S. oil production in the future. Good,
clean, Wisconsin sand is going to continue to be valuable even though share
prices are a fraction of what they were six months ago.
TER: Both of these companies jumped up last summer and then went
right back down again. Was that an anomaly?
MB: The move was from May to August, and it was the result of the
news coming out about how much sand was being used. There were dedicated rail
trains, 30 cars a day, carrying nothing but sand. The demand for sand was
enormous.
TER: What will make that price jump back up again? What is the
catalyst?
MB: Remember the 4,000 wells being drilled today aren't being
fracked? They will be. When they are, the sand demand is going to skyrocket.
Once oil hits $70–80/bbl, there is going to be a massive demand for fracking
equipment and sand. For people looking for oblique investments in the oil
industry, sand companies offer the best opportunity right now.
TER: You recently wrote about the challenges of moving all the new
production that fracking is making possible. Are we any closer to a solution
for getting oil from Canada to U.S. refineries or to consumers in Asia?
MB: Yes. The problems we've had moving Canadian oil have been
solved or are in the process of being solved. The last leg of a main artery that brings Canadian crude
straight to Houston is almost complete. Run by pipeline companies Enterprise
Products Partners L.P. (EPD:NYSE) and Enbridge
Inc. (ENB:NYSE), the new route runs from Alberta, Canada, to Houston,
Texas.
TER: Are there still opportunities to invest in infrastructure
solutions—master limited partnerships (MLPs), in particular?
MB: Yes. MLPs have also gotten pretty beaten up of late. There are
companies that I like in the space. We bought TC
Pipelines L.P. (TCP:NYSE), the MLP that TransCanada Corp. (TRP:TSX) owns,
specifically for that reason. It pays a nice dividend. We've held it for
eight months now. Our return is basically flat. Share prices eased lower, but
we've been collecting dividends.
I think Plains All American Pipeline L.P. (PAA:NYSE) is a great
deal right now. This is another oil and gas infrastructure pipeline MLP. It's
come down about 30% since its peak in September. For investors looking for a
dividend from a pipeline company, I like this a lot. It pays about 6% today.
One of the reasons Plains All American is down is one of its pipes in
California burst, resulting in a pretty big oil spill. That's the kind of
news that's going to go away fairly quickly, but it propelled the shares
down, and the shares might be an opportunity for investors today.
Some of the MLPs have gone up in price. We looked at Scorpio
Tankers Inc. (STNG:NYSE) as one of the potentials. It's up about 40% over
the last eight months. This is an attractive company.
TER: You're going to be speaking at the Sprott/Stansberry
Vancouver Natural Resource Symposium at the end of July. What is one
thing that natural resource investors need to understand about where we are
in the energy investing cycle, and how to preserve or even grow their wealth?
MB: Bear markets in commodities are opportunities. You have to
think against the grain in the natural resource sector. You have to put in
the hard work to investigate the sector on the way down and then buy stocks
when things start to perk up again.
In the oil and gas space, we're in the investigations mode. We're looking
at companies that we'd like to buy and are high-grading our list. We're
looking for companies with low debt and fair to decent operating margins at
low oil prices. Those are the ones we're going to buy. But we're not going to
buy them until we see an uptrend. Oil has had a small uptrend. It has bounced
off its bottom. We are getting a lot closer today to buying these companies
than we were even a month ago.
TER: Thanks for speaking with us, Matt.
Read Matt Badiali's Guide to Avoiding
Pitfalls in Resource Investing
Matt Badiali is the editor of the S&A Resource
Report, a monthly investment advisory that focuses on natural resources,
including silver, uranium, copper, natural gas, oil, water and gold. He is a
regular contributor to Growth Stock Wire, a free premarket briefing on
the day's most profitable trading opportunities. Badiali has experience as a
hydrologist, geologist and consultant to the oil industry. He holds a
master's degree in geology from Florida Atlantic University.
