HOARDING
How to buy one of the world's biggest, cheapest energy hoards... and get paid to wait on the boom
How to buy one of the world's biggest, cheapest energy hoards... and get paid to wait on the boom
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Satellite radio, which provides hundreds of static-free radio stations anywhere in the country, is standard. You can "sync" the car with your iPhone, which allows remote controlling of the car's heating and cooling system. The Leaf makes almost the same amount of noise while running as while not running. You might also notice the Leaf has no tailpipe. That's because there's no engine exhaust to pipe out.
Last month, Olivier Chalouhi of Redwood City, California became the first person in America to own a Leaf... the first mass-produced electric car priced for broad appeal.
The Leaf recently won the European Car of the Year award, making it the first electric car to win a major "car of the year" award... an important milestone for "green" enthusiasts.
However, with a range of just 100 miles per charge in low-speed city driving – and just 50%-75% of that for highway driving, the Leaf is a joke in the eyes of your average red-blooded, meat-eating American driver.
"Go ahead and laugh," the Leaf driver might say... "The joke is on the American taxpayer."
You see, the sticker price of the Leaf is around $33,000. However, buyers receive a subsidy from the U.S. government (aka you, the taxpayer) of $7,500 on a Leaf purchase. Whether you like electric cars or not, the government is forcing you to pay for them. The government wants 1 million new electric cars on the road by 2015. That works out to $7.5 billion in incentives... or an average of $87 per taxpayer.
We're discussing the Leaf because it's a part of one of the world's biggest resource trends you're not hearing about: The impending boom of global natural gas consumption.
What folks who go wild over boondoggles like the Leaf don't realize is we don't generate electricity from the flapping of butterfly wings or rainbow generators...
We burn coal to generate electricity. We run nuclear plants to generate electricity. These two sources are responsible for around 70% of the electricity produced in the U.S.
The Leaf doesn't burn gas... It burns coal.
And natural gas? It's responsible for 24% of our electrical generation capacity. But that's going to rise. As you can see from the Leaf story, the U.S. government wants the nation to go green. And one of the ultimate green plays is natural gas. It's cheap… It's clean… We have abundant supplies of the stuff. It's practically un-American not to burn the heck out it… And that's exactly what's going to happen over the next several decades.
Fortunately, we can buy the ultimate blue chip of this sector on the cheap right now… and collect a substantial dividend. Here's the story…
The Pickens Plan... The Shale Boom... The Nissan Leaf ...
The Obama Tax Craze... The Rise of Asia:
All Roads Lead to Higher Natural Gas Consumption
As one of the smartest, loudest, richest oilmen in America, T. Boone Pickens commands an audience. Since graduating college with a geology degree in 1951, Pickens has spent the last 60 years building a billion-dollar fortune by finding oil, putting together giant deals, and managing energy investment funds. He's the "rock star" of the U.S. hydrocarbon industry.The Obama Tax Craze... The Rise of Asia:
All Roads Lead to Higher Natural Gas Consumption
Pickens is now 82 years old. He doesn't need to focus on money anymore. These days, he's focused on the "Pickens Plan"... a giant push to convert a portion of the American truck-and-car fleet to burning natural gas instead of oil.
If you've read my research in this letter and my publisher's free daily e-letter DailyWealth in the past few years, you know new drilling technologies have recently unlocked vast natural gas supplies in the United States. From 2003 to 2008, natural gas spent most of the time trading in between $6 and $8 per million BTUs (British thermal units)... and occasionally spiking past $13. The new drilling technologies have unleashed so much new supply that natural gas prices have plunged into the $3-$4 range.
From a security standpoint, we have to get on our own resources in the United States. If you didn't have resources, that would be a real problem but we have resources. You have 4,000 trillion cubic feet of natural gas, it is 30% cleaner than gasoline and diesel, it is cheaper, and it is an unbelievable opportunity for us to move to our own resources again. If we don't use natural gas for serious transportation fuel, we are going to go down as the dumbest crowd that ever came to town. Why wouldn't you replace dirty-foreign-expensive with cheaper-cleaner-domestic?Pickens, who has a flair for the dramatic, also notes...
... we have more natural gas than any other country in the world. You are sitting here with 4,000 trillion [cubic feet of] natural gas, which is equivalent to 700 billion barrels of oil, which is three times what the Saudis have. You are honestly going to look like a fool if you sit here and ignore what you have available to you and you don't use it.The Pickens Plan has problems. It calls for massive federal subsidies, just like Leaf drivers get. In addition, natural gas engines do work... But they aren't as powerful as traditional diesel engines. We'd have to build a lot of new fueling infrastructure.
Regardless, Pickens' main point is a good one: We have a tremendous amount of natural gas we aren't using right now.
I can't tell you if the government will get fully behind the Pickens Plan. But I can tell you the government is serious about burning less oil and coal. These two are the "dirty" fuels.
And as we've seen with the Leaf – and the Obama administration's pushing of various carbon taxes – the government is starting to push America in the direction of increased natural gas use over coal and oil. This will be a major tailwind for natural gas consumption.
Adding to the tailwind on a global scale is a familiar tale in the resource business: The growing consumption by the giant nations of China and India (or "Chindia"). As you can see from the below chart of Chindia's natural gas consumption over the past 25 years, it's a giant uptrend.
"Chindia" generates most of its electricity with coal... but it knows coal produces horrible pollution. It badly wants to increase its percentage of electricity generated from clean natural gas (and uranium). This is driving more gas consumption and more gas imports. It's a huge tailwind for natural gas prices over the long term.
As you can see, huge forces are escalating natural gas consumption: It's cheap... It's clean... It's abundant... "Chindia" is consuming more and more of the stuff.
While this demand tailwind won't cause a short-term explosion in natural gas prices, it's a no-brainer to start hoarding the stuff right now... in advance of the coming consumption boom, which will be driven by the U.S. government and "Chindia."
Fortunately, we can buy the ultimate safe, North American natural gas hoard on the cheap right now... and pick up a near 3% dividend while we wait on the boom...
The Greatest Hoard of Natural Gas in
North America Is Going Cheap
Commodities are cyclical. We can count on that.North America Is Going Cheap
Natural gas is no exception. Its price may be at historic lows today... but we can be sure it will rise again at some point. Many roads may lead to higher natural gas demand. But the simplest is this: Natural gas is the cheapest source of clean energy in North America today.
It costs about $2.91 to buy enough coal to generate 1 million BTUs of energy. A million BTUs of natural gas costs $4.58. The trade off comes from the soot and pollution generated by burning coal. Natural gas combustion produces one thing... carbon dioxide. That difference will matter in the future.
To quote legendary commodity investor Jim Rogers, "The best cure for low prices is low prices." Eventually, the utility of natural gas and its low cost will create demand. We simply have to be patient.
In investment terms, we want to own enormous reserves that can be produced when the natural gas rally cranks up. We want to buy companies the market has left for dead... but will have enormous natural gas production in the future. Essentially, we want a "call option" on natural gas.
We want to own "PUDs."
PUD stands for Proven Undeveloped Reserves. These are undrilled gas wells with zero exploration risk. Typically, PUDs are located between two producing wells or in the middle of proven fields just waiting to be drilled. We know the gas is there... The company that owns it just hasn't drilled it yet because prices are too low.
Right now, the stock market is giving away natural gas PUDs for free.
The price of natural gas is so low, investors aren't willing to pay much at all for future production of PUDs. Companies only get credit for current productions and cash flows... promising properties are selling for peanuts.
If the price of natural gas heads up from $4 to $6 or $8 in the coming years, these assets will skyrocket in value.
That will likely take years to happen. We're buying today because it's cheap and stands a great chance of doubling or tripling our money over the next three years.
That's why we're buying...
The King of PUDs
Encana Corporation (NYSE: ECA) is a $23 billion North American-focused natural gas producer and explorer. It is the undisputed king of undeveloped natural gas.As a landholder, Encana has more developed acreage than all but six companies in the world. Among only the firms with more are oil majors like ExxonMobil and ConocoPhillips – giants four times Encana's market cap.
The company can trace its roots back to the Canadian Pacific Railroad (CPR). In 1881, the Canadian government gave CPR land in exchange for building a transcontinental railroad. In 1958, the railway created an oil and gas subsidiary to exploit those resources. In 2002, it spun off that subsidiary, leading to EnCana's creation. Those original deeded acres make up part of Encana's 12.7 million acres. That's an area larger than Maryland and Connecticut combined.
The company's assets span North America. As you can see on the map, Encana has a foothold in nearly all the major natural gas discoveries on the continent.
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You can think of Encana's vast collection of PUDs like you would a portfolio of stock options. Options can be speculative investments. They may not have much value in the near term. But if you place a small sum of money into them, you could wake up one day to see that your investment soared in value.
In addition to the PUDs, Encana has an enormous amount of gas waiting for the drill...
According to SEC filings, it has 19.5 trillion cubic feet of natural gas reserves. But remember, the SEC uses a rigid set of guidelines to dictate how a company reports reserves... and its rules take into account if the asset can be produced economically. Much of Encana's gas isn't economic at today's price, so the company can't report it as reserves.
As a geologist, I believe the company can actually produce about 58 trillion cubic feet of gas. We call those assets "contingent resources." Here's a table that shows the difference between the SEC-blessed reserves and contingent resources.Here's a table that shows the difference between the SEC blessed reserves and contigent resources.
Encana has 23,100 producing wells. It also has an inventory of 35,000 drilling locations (PUDs plus contingent resources). That's enough inventory to drill 1,500 wells a year for more than 20 years... without doing any exploration at all.
Another key piece of information is the cost range. This is the expected cost per MCF. Many of Encana's plays aren't economic when gas trades for less than $3.50 per MCF – so they're tenuous at best today.
But when the natural gas price hits $4.50 per MCF, it clears even the upper range of costs. That means profits will soar once natural gas clears about $4.50 per MCF.
Even better, those production costs should decline over time as Encana works each property. Here's why...
Encana operates in nearly all the best shale gas plays in North America. As we've discussed before, shale gas – or unconventional gas – comes from thin-layered rocks. These rocks require horizontal drilling and hydraulic fracturing (fraccing) to open them up and let the gas out. This can be an expensive proposition at first. The key to shale gas is, the longer you are in a region, the better the economics become.
For example, Encana spent four years working the Montney shale. In 2006, it cost $1.5 million per frac stage (frac jobs are typically priced in standard "stages." A well can have multiple frac stages, depending on complexity and size). Those wells produced 2.1 million cubic feet of gas per day. By 2010, the company had its cost down to $600,000 per frac stage. Its production rose to 5.3 million cubic feet per day.
Or consider Encana's early-stage shale play Horn River, in British Columbia, Canada. In just two years, it cut its costs from $2 million per frac stage to $600,000 per frac stage. It increased production from 4.6 million cubic feet per day to 11.7 million cubic feet per day.
The costs fall thanks to economies of scale. At the same time, its engineers tailor the process to the immediate geography. That increases production.
The company employs what it calls the "gas factory" technique to maximize its gas production. It can drill six horizontal wells from a single drilling location. That's the equivalent of 48 vertical wells. In some places, the company can drill as many as 16 to 20 wells per location. As you can imagine, that reduces drilling costs. It also reduces the amount of roads and pipes needed to get that gas to market.
Encana plans to use those techniques to double production in the next five years – regardless of whether gas prices rise. That means our base case scenario is a double on our investment over that period. However, that assumes natural gas prices don't recover in that period... If they do, we could make much, much larger gains in Encana thanks to that growth plan.
Should natural gas climb into the $7-$8 range – like it was back in 2007 – Encana's PUDs will soar in value, as well as its cash flows and dividends.
It's Time to Buy the Cheapest
Independent Energy Company on the Market
Encana's books show the company's fundamentals are solid...Independent Energy Company on the Market
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Conservatively, we should double our money over the next thee years on production alone. If we double production and the market decides to pay six times our cash flow – a reasonable assumption over the next three to four years – that's a 300% gain.
And as added incentive, this company is shareholder-friendly...
Today, Encana pays a 2.7% dividend. The company began paying a dividend in 2003 and has grown it 682% since then. It has never decreased its payouts.
And consider... it paid 86¢ per share in 2009 and 2010 – two terrible years for natural gas producers. The company's production fell, its cash flow fell, and its earnings fell. But management remained conservative through the good years. It was prepared to pay its dividends even in the worst of times. That makes Encana's dividend one of the safest out there.
Plus, the company is actively buying its own shares. In 2010, the company bought 2% of its shares at an average price of $32.42 per share. Clearly, management believes its shares are worth at least 10% more than today's share price... and they're buying more. In 2011, management agreed to buy back 36.8 million shares. That's 5% of its 736 million outstanding shares. If you add that to the dividend yield, we could earn 7.7% this year... even if nothing else happens.
From 2003 to 2008, Encana grew production 165%. The company's success and rising energy prices drove a spectacular rise.
Then came late 2008... Like most every stock, the boom turned to a bust during the credit crisis. Oil and gas prices collapsed. And Encana shares cratered from near $50 to less than $20.
As you can see from the chart below, EnCana has recovered a bit... but is still inside a long sideways trading range. Low natural gas prices have kept the stock from exploding in the past few months like most resource stocks did. This gives us a great entry point.
Unlike many of our resource plays, I encourage you to see Encana as a long-term dividend paying investment. We're buying a giant, cheap hoard of natural gas... and looking to hold it for a long time. Investors experienced with options can consider using this stock to build a long-term covered call program to juice the yield. But we will only follow the stock for portfolio tracking.
However, we do have some risk here.
Our greatest risk is commodity risk. Things could get worse before they get better. Natural gas prices averaged $4.38 in 2010 and $3.95 in 2009. We could see a repeat of those prices if the world's economic picture clouds over again.
During the worst period in 2009, Encana's shares fell to a low of $19.21. That's about 35% less than today's price. And even in 2009, the company still turned out a $1.9 billion profit.
While there is some commodity risk, Encana is a solid and relatively safe company. A big reason for that is our timing. The market hates natural gas. It only gives a company like Encana credit for its cash flow. Encana's gas assets are at fire-sale prices. Buying assets this cheap is about the safest thing to do with your money.
Also remember, with the threat of inflation making big headlines these days, the interest in getting cash into "real assets" like gold and energy these days is huge. If you're looking for such a long-term real asset play, Encana is a great one. It has the potential to soar hundreds of percent in value over the coming years should an inflationary trend take hold.
If crude oil continues to trot higher in response to rising Asian consumption and a lack of new supplies, it will pull natural gas prices higher with it. If you're bullish on oil over the long-term (I am), you're bullish on EnCana.
Portfolio Review
Now is the time for utmost caution...I could write five pages about my concerns that commodities have run up too far, too fast recently. But a picture says a thousands words, so let's just look at the chart below. It shows the past two year's trading of the benchmark commodity index (CRB).
The index has staged a spectacular move since September, up 23% in three months...
This huge move has sent many resource stocks up 50%-75%. Some of the smaller "junior" exploration firms are up more than 100% in the past few months. It has also brought a huge amount of speculative money into the commodity sector...
Speculative long positions held by fast-money hedge funds in vital markets crude oil, copper, and corn are near record levels. This move has brought us enormous gains. But it also leaves the sector vulnerable to a huge selloff that would shake out latecomers.
Now it's time to take some money off the table...
I know selling a position can feel like losing a family member for some folks. But it's the only way to make huge gains in the "boom and bust" resource sector. You can't fall in love with these stocks. (They won't love you back.)
When considering buying, selling, or holding a position, we have to ask the big question: Does the potential reward from here justify the potential risk?
If you can't make a good case for "yes, it does," then it's time to consider selling the position.
Right now, in the short term, some of our positions are at risk of big selloffs. We've made incredible gains... and I'm recommending you be conservative and take some gains off the table. But realize... if conditions change, I'm willing to jump right back into these names.
Originally, I planned to tighten our trailing stops on our higher-risk silver plays (especially in silver, as it has soared so much). However, this week, many of our stocks blew right down through the 10% stops I'd planned to use.
Instead, I urge you to:
• Sell, to close, Hathor Energy (TSX V: HAT) at $2.76 per share for a 58% gain.Again, I see our silver stocks as particularly vulnerable. In order to preserve some of our larger gains, we need to tighten up our trailing stops on several companies. Yes, this means selling our mega-winner Silver Wheaton. I know some folks will see this similar to shooting Old Yeller... but we have enormous gains here that could get rocked in a selloff. We need to protect them. And remember... there's no shame in banking a 300% winner.
• Sell, to close, Alexco Resources (AMEX: AXU) at $7.15 per share for a 57% gain.
• Sell, to close, China North East Petroleum (AMEX: NEP) at $5.81 per share for a 34% loss.
• Sell, to close, Silver Standard Resources (Nasdaq: SSRI) at $24.37 per share for a 89% gain.
• Sell, to close, Mag Silver (AMEX: MVG) at $11.50 per share for a 156% gain.
• Sell, to close, Silvercorp (NYSE: SVM) at $11.70 per share for a 270% gain.
• Sell, to close, Silver Wheaton (NYSE: SLW) at $34.19 per share for a 345% gain.
But keep these stocks on your watch list. Our silver plays are all great companies with great futures. We will almost surely jump back into them later.
Let's tighten our trailing stop on Northern Dynasty Minerals (AMEX: NAK) from 25% to 15%. That means we'll sell our shares if it closes at less than $12.34 per share.
Let's also tighten our trailing stops on Seabridge Gold (AMEX: SA), Fronteer Gold (AMEX: FRG), Magnum Hunter (NYSE: MHR), Vanguard Natural Resources (NYSE: VNR), and Imperial Metals (TSX: III) from 50% to 25%.
This will prevent us from giving back all our gains, in case a deep correction cuts across all the resource markets.
We've had a tremendous run together. Many of our stocks have skyrocketed in the past few months. Investors are wildly bullish right now, which should make any good contrarian nervous. Let's take some profits and keep our new buying to an unloved name like EnCana. I'll update you on how it all plays out.
Good investing,
Matt Badiali
January 7, 2011
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| * Total return includes dividends. This portfolio is not intended to represent the exact prices at which you could get in or out of a stock, rather, it represents the value of our insights at the time our material is published. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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