Matt Badiali: Why Bill Powers Is Dead Wrong

The Energy Report: Are we truly facing peak cheap oil with all the easy stuff already out of the ground? Why is oil still at $95 per barrel ($95/bbl)?

Matt Badiali: The main reason we're still at $95/bbl, with demand falling and production rising is exports. It's been illegal to export crude oil from the U.S. since the '70s. However, refiners have gotten around this rule by exporting "finished products" like gasoline diesel fuel, for example.

Remember, Europe and Asia are paying a lot more per barrel than we are. Our refined goods can be economically put on a ship and sold competitively in those markets for a lot more money than they can get here. One of the reasons that this is big business is that we've dramatically increased the amount of oil that we're producing at home. The secret is about half of that oil isn't what we consider crude oil—it's natural gas liquids. It can legally be sent out to other markets because it's not crude oil.

Let me give you an example. Mexico has consistently been one of the U.S.' major sources of oil and gas imports. In 2005, we were getting about 1.4 million barrels per day (1.4MMb/d). However, as our demand has fallen off, exports have been growing. Now the U.S. only takes about 400,000 b/d from Mexico. Imports fell off 41%, but our exports to Mexico grew by 200%. The U.S. is now the world leader in exporting finished product, which I don't think many people understand. That, in a nutshell, is why we're still paying $90–100/bbl.

TER: Does exporting these resources help or hinder our energy independence? Do you think that unconventional drilling will turn us into "Saudi America" or are we overestimating well lives and underestimating the cost of fracking?

MB: On the one hand, there are the "Saudi America" folks who are really optimistic about both the technology and the ultimate supply of oil and gas in the U.S. On the other hand, you have energy investor Bill Powers, who has got his arms folded across his chest and his chin out, just saying "No." That's his answer to everything.

I don't know if we'll ever be energy independent. Honestly, to me, that's a non-argument. It's going to be market forces that drive whether we're importing oil from somewhere else or if we're using our own and exporting. That's not as big a concern to me as the argument that Powers made, which is we don't have enough. I think he's wrong. I don't think that he understands the context of our success.

The peak oil theory never ever considered the idea that we would ignore the conventional rocks and just go straight to the source. Our oil field went from the size of a group of oil tankers in the Gulf of Mexico to the Gulf of Mexico. That's the size of these systems. They're enormous. I'm sure Bill is a nice guy, but he's dead wrong.

TER: What about the theory that these new sources are expensive to access?

MB: That was going to be my next point. Bill has said even Chesapeake Energy Corp. (CHK:NYSE) was forced to write-down 20% of its reserves in 2012. That was 4.6 trillion cubic feet of natural gas reserves gone, right? Clearly this is unsustainable. Well, the reason that they wrote those reserves down isn't because the gas disappeared. It's because we found so much that the gas price went to $1.80 per thousand cubic feet ($1.80/Mcf) in 2012. A company can't produce natural gas for $1.80/Mcf in these unconventional fields. We have shut down drilling in huge shale plays because of the economic component.

TER: What price does it have to be in order to make these fields economical?

MB: It's not a point; it's a continuum. Some stuff works really well at $3/Mcf. The Marcellus in Pennsylvania works great at $3/Mcf. The Barnett Shale in Texas, on the other hand, wouldn't be economic at that level. And the enormous Bakken Shale in North Dakota doesn't work if oil prices fall too low. They have to put oil on trains, which is at least twice as expensive as what it would cost to put it in a pipeline.

TER: Do you think that will be the impetus to get pipelines built?

MB: I hope so, but that's a slow process. As we develop these fields, natural gas prices are going to have to inch higher if we run out of cheap plays. The industry has been remarkably flexible at finding cheap sources or making things cheaper to meet the price of natural gas.

"Bill Powers doesn't understand the context of our success."

Low prices are going to stimulate demand. I've seen it happening in my own town. We have a couple of pulp mills on the island where I live. Several months ago, one of the mills switched from fuel oil to natural gas. They're saving millions of dollars per month on fuel costs. The company that owns the mill is doing this at all its mills. We've seen a lot of power plants that have switched to natural gas because it's cheap.

TER: Of course, it would be a game-changer if truck fleets switch to natural gas. But is that practical?

MB: I do think it's practical. Americans are ingenious at ways of making use of cheap things. I see enormous demand for natural gas. Demand will increase, pushing the price of natural gas incrementally higher and driving down the price of oil.

TER: What about Bill Powers' theory that the decline rates in fracked wells are much higher than anticipated? What are you seeing out at these wells?

MB: You finally found something that Bill and I agree on. The decline rates are enormous. But Bill is applying conventional oil field metrics to unconventional fields. In a normal field, these kinds of decline rates would mean that the field stinks. We're drilling so many more wells in the shale that the decline rates don't matter. Think about the scale. They're so big people can't get their heads around it. They simply refuse to understand it. Every day, every month, every year, we get better at using our technology and improving our ability to get at this stuff. The only barrier I see right now is political.

TER: How long will the price deferential between Brent and WTI stay as wide as it is now and what's keeping it there? Is that political?

MB: That's structural. Refineries in Europe were built and geared toward one kind of oil that comes out of the North Sea: Brent. It's very hard and it's expensive to change around the system to accommodate new oil. All these refineries are geared to Brent—the amount of Brent fell, the volume fell, the demand rose and prices soared.

It created a market for our finished fuels. We were sending ship after ship to Europe with diesel fuel. Our refiners made a huge profit because, at $90/bbl, we could stick it on a ship, send it to Europe and stay below $120/bbl to convert into diesel.

I'm sure there are some savvy entrepreneurs over there who will invest the money in changing around their refineries to accommodate different crude stocks.

TER: Where are you investing in to take advantage of this?

MB: The problem with these unsettled periods is that they're hard to figure out. I invested in Italian oil company Eni S.p.A. (E:NYSE) because I want to take advantage of high prices. I'm still mildly concerned about the domestic oil price falling or being subject to down pressure. Why not buy a company with oil that is sold on the Brent crude price? It's a major oil company that's been around forever. It operates in all the places that U.S. companies won't go. It pays a nice dividend.

I also have to give credit to Porter Stansberry. He's done a remarkable job at seeing the big picture and knowing where the plays are. Stansberry recommended Burlington Northern Santa Fe LLC (BNI:NYSE), the railroad that was getting a lot of the oil from the Bakken out to the market. That was a great oil and gas play. He also recommended Chicago Bridge & Iron Co. N.V. (CBI:NYSE) to take advantage of the expanding pipelines.

I think that there are some fantastic opportunities in the pipeline space, but I'm late. They've gotten expensive.

TER: Do you like MLPs?

"It's a good time to be an energy investor. It's exciting, it's fun and you can make a lot of money."

MB: I like MLPs, but I'm afraid that they're a little expensive right now. You want exposure to that climbing price, but right now you have a 50/50 chance of the oil price going up or going down. I want more certainty. I'm looking for yield that might be mispriced. I'm looking for yield with hedges. There are some opportunities out there, however.

The thing you don't want to do right now is buy natural gas royalty trusts that are pure natural gas. There's one in particular that I've really liked for years called San Juan Basin Royalty Trust (SJT:NYSE). In a good market, San Juan Basin just prints money because it's a royalty trust on a chunk of land in New Mexico and Colorado. The wells are being drilled and operated by ConocoPhillips (COP:NYSE). San Juan just shows up and gets a check and distributes the check to shareholders. It's a great business—except ConocoPhillips recently said that gas prices are too low to economically drill any more wells in the San Juan Basin. That was that.

TER: Another form of energy that's been in the headlines lately is uranium. When we talked in January, you pointed to a pushback on the nuclear moratorium in Japan because of increasing energy prices and brownouts. Japan's working on new safety guidelines that could lead to reopening reactors. China has 29 reactors under construction and another 51 planned. What impact could that have on uranium prices?

MB: Oh, man. I'm so excited about uranium. There's all this uncertainty in oil and gas, but there's very little uncertainty in uranium. It's just a matter of time. If you can be patient, you're going to make a lot of money in the uranium space. Right now, uranium is priced as if we will never produce electricity from nuclear power again and that's not true.

The Fukushima Daiichi event was such a horrible disaster and it just scared the heck out of all of us—nobody wanted to own uranium. There was a lot of overreaction. The fact is Fukushima was a dangerous plant to begin with. It was built in a colossally, geologically unstable location on a subduction zone. In comparison, the San Andreas Fault is a fender bender. The earthquakes that happen on subduction zones are 15-car pileups. That was exactly what happened at Fukushima.

There has been a timeline set out for the Japanese reactors to come back online. As Japan gets back to normal, it will be a catalyst. We still have construction happening in China. We have construction happening in India. We have construction happening in Saudi Arabia. There is new demand coming on in the next 12–18 months.

If you're a conservative investor, try Cameco Corp. (CCO:TSX; CCJ:NYSE), the ExxonMobil of uranium. It has major supply agreements with all of the major nuclear power producers.

Then you go down from there to some other little producers. Denison Mines Corp. (DML:TSX; DNN:NYSE.MKT) is a great one. Energy Fuels Inc. (EFR:TSX) has production. These companies are producing at $40 a pound ($40/lb) and breaking even, but once the price of the uranium goes up, their profits are going to grow because they've already covered their costs. These companies are going to start popping up on people's radar screens, and investors are going to wonder why they're trading at 3x earnings.

The uranium sector right now is a textbook opportunity. It was a hated commodity that was left for dead and we see the uptrend coming. If you're willing to wait 18–24 months, you can very easily double your money here.

TER: If it's going to take a little while for Japan and some of these facilities in China to come online, are you looking at companies that are producing now or companies that will be producing once that demand kicks in?

MB: The conservative bet is to go with companies that are in production and making money at the current price. That's Cameco. That's Uranium Energy Corp. (UEC:NYSE.MKT) in Texas. Then you have the explorers that are developing new stuff. That's UEX Corp. (UEX:TSX) in Athabasca in Canada. That's Kivalliq Energy Corp. (KIV:TSX.V) up in Nunavut. That's Fission Uranium Corp. (FCU:TSX.V) in Athabasca.

The explorers are the companies where you're going to take on more risk because they're not in production. However, I do think there's a lot of upside. I would buy them when the uptrend starts to take hold. Right now, I'm more conservative.

TER: Energy Fuels has four producing mines and a number of others that are still in development. Do you like that mixture?

MB: Absolutely. Mines are finite producers. A mine is like a loaf of bread. You get so many sandwiches out of it and then you've got to get another loaf of bread. I love to see companies that have mines in production, mines about to go into production and several exploration projects. That's the ideal mining company.

TER: Is this a good time to be an energy investor?

MB: Yes, without question. It's exciting, it's fun and you can make a lot of money, unless you're Bill Powers—then you're going to stand in the sidelines with your arms crossed and your chin up.

TER: Thank you for taking the time to talk to me.

MB: You're welcome.

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 pre-market 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.

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1) JT Long conducted this interview for The Energy Report and provides services to The Energy Report as an employee. She or her family own shares of the following companies mentioned in this interview: None.
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3) Matt Badiali: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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