Marin Katusa, Casey Research: The Future of Energy - Diversify Supply
Source: The Energy Report (1/22/09)
Uncovering early stage opportunities in the junior resource sector is no problem for Marin Katusa, senior editor of Casey Research’s Energy Division. Using a combination of boots on the ground and a diagnostic resource market tool that he created, Marin can easily analyze and compare hundreds of investment variables to determine the best investments and most promising private placement offerings. In this exclusive interview with The Energy Report, Marin shares his macro view on the energy sector, trends he anticipates in 2009 and major market forces that will drive energy in 2009 and 2010.
The Energy Report: Marin, can you give us your macro view on what’s happening in the energy sector and what trends we’ll see for 2009?
Marin Katusa: I definitely think a continuation from 2008 will happen, where we'll have downward economic pressure on the prices on stocks and energy commodities. We'll have the double negative effect for oil and gas with lower demand and global economic recession.
The problem with the OPEC countries is the compliance factor. A lot of them are cheating—like Venezuela, for example. They’ve increased their budget for 2009 by 22%, so they need $60 oil to break even. Now you have to ask yourself, are they going to be compliant? Probably not. They’re going to have to make up the decrease in oil price with volume. The one interesting fact is that they are increasing the supply to the large offshore tankers. They’re filling them up and they’re waiting. So there’s a lot of supply just sitting there and the market is aware of this.
It’s different than what Putin is claiming in Europe right now, where he can control compliance because he shuts off the taps for the pipeline. So there will be a difference; you will see large differentials in the European energy markets with the natural gas and Brent Crude prices—it’s never been this high of a differential. Even the natural gas in Europe is much more expensive than in North America. So that’s going to be a continuation of 2008, where we’re going to see downward pressure on the energy commodity prices.
TER: France is 95% nuclear. Will the rest of Europe do that?
MK: Not soon. Because of the cap ex and regulatory approvals, nuclear power plants take a long time. The French were very forward thinking. But if you look at even the U.K. and Germany, both are under 20% nuclear. You still have the Jane-Fonda “not-in-my-back-yard” effect. Where are you going to build a nuclear reactor with that type of psychology? So I think what they’re going to have to do is an unconventional type of shales—gas shales—and go towards new technology that makes gas recoveries economic in the short term (five years).
That’s going to be the key—and definitely they’re going to have to diversify. I hope to see a lot more of the countries building the nuclear power plants; but, remember, during the last cycle of all the planned and permitted sites, only 7% of the nuclear reactors were actually built. Which countries can afford the big capital costs?
TER: If we’re looking forward, and the government’s now saying we need to start getting off reliance on Russian energy sources and they’re willing to print money to build subsidies, why wouldn’t they just start building nuclear and coal facilities?
MK: It also depends on the voters because, even here in Canada, where we’re pretty liberal on the energy side (especially the gas, and Alberta’s completely oil and gas industries), people still don’t want the nuclear and coal power plants. For example, In B.C. you cannot build a coal power plant because of the pollution. Once people suffer such high prices, however, they’ll be forced to take the lesser of two evils. It’s the psychological aspect that will hold a lot of these projects back.
We’re big fans of run of river and geothermal energy. These are great projects that can compete with $50 to $60 oil, but the problem is it takes a lot of money to build these projects and only a few people can deliver them on time and on budget. So we’ve been spending a lot of time looking in Europe and at run of river projects and geothermal projects in North America. The key is diversifying your energy supply.
TER: Diversifying or tapping into energy supplies that may actually be on your own soil.
MK: Let’s take, for example, the U.K. or even Spain. They’ve got a lot of sources of gas in shales that can be tapped into, but how much is economic and at what prices? More importantly, which companies are exploring in those areas that will return profits to their investors? Let’s take a look at the Canadian oil sands. Only 10% of the resource is recoverable. At $30 oil, I would even question if it’s maybe 3% or 4% recoverable. Definitely no new production will come on at $30 or even $40 or $50 oil. For new production to come on, they need $65 to $70 oil, so that raises a good question: at what price can they tap into their own reserves?
TER: So because oil is projected to remain low, what is the prognosis for these various alternative energy projects to move along at any pace in the next year?
MK: The number one factor for many of these projects to be completed will have to be government intervention through subsidies. Number two is long-term thinking investors. There’s a company we like a lot in Europe, Reservoir Capital Corp. (TSX.V:REO), which is working on a run of river project that will have government subsidies, and the government on its side in seeing the project is completed. It also has long-term investors who are not looking for the one- or two- or three-year return on investment. Yes, oil is $30 right now, but let’s not forget that peak oil is real and when peak oil does come, we’re looking at $200+ per barrel. And now all those green energies that were able to survive this current crisis are definitely economic. If you are going to invest in the alternate energy sector, make sure the company you invest in can weather this current economic storm by having the financing in place to survive for 36 months; that is one of our criteria.
TER: So you have to get to the point where people are suffering from such high prices that they’re either going to start investing in these alternative energies or have the plant in their back yard. Which is going to push it? At this point, we’re looking at 2009 cheap oil. If you have less than a three-year perspective, is investing in alternative energy a viable investment strategy?
MK: Well, a lot of green energy does have investment and is near term production, but it hasn’t hit the media mania phase yet because of the low oil and gas prices. It’s not the buzz that uranium was in 2007, but there are a lot of companies that are financed that will be there to provide some of the energy requirements. See, that is the key. Green energy will not provide 100% of America’s energy needs in our lifetime. Even if you triple the amount of green energy production in the U.S., it won’t even make a dent in the energy spectrum because it’s so small today. So what you have to do is diversify your sources. And there will always be Russian gas coming into Europe, but hopefully not at 40% of Europe’s needs (certain countries in Europe have 100% of their gas supply come from Russian sources). Even if Europe goes down to 20% natural gas, they’re going to have to quadruple (or even 10 times, in certain countries) the amount of green energy power production.
TER: I want to go back to uranium. Uranium went wild through 2007; it was one of the first ones to crash in 2008. Do you think it has hit a bottom and what are the fundamentals that will cause it to rise up again?
MK: The first fundamental that everyone’s well aware of is the HEU (U.S.–Russian Highly Enriched Uranium) agreement coming to an end. Now the question is: are the Russians going to renegotiate the HEU agreements on the old terms? Definitely not. We’ve done all our calculations and it’s not economically viable for the Russians to continue the contract as it was. So, if America is able to get the HEU agreement, it’s going to be on some new terms, probably around $60 per pound uranium.
Additionally, there is the supply crunch coming in the States. In the early ‘80s, there were about 30 mills in the U.S. Today, there’s only one conventional mill that is able to operate, which is owned by Denison Mines Inc. (TSX:DML).
Now Putin may want to start signing these contracts with the nuclear reactors in China, and the Chinese are going to be building “pebble bed reactors,” which are much smaller and much lower cost. They’re like little modular components, and they’re actually built in a factory. And as the supply, or demand, increases, you can add other modules to this reactor.
The Russians will be supplying a lot of the Chinese uranium demand, and that will compete with American needs for uranium. Uranium only makes up about 4% of the cost of the nuclear reactor operating costs, so there’s a lot of room for the price of uranium to go up.
So, where are the Americans going to get their uranium? We wrote about this in detail in the Casey Energy Opportunities newsletter. The Australians also signed a deal with the Chinese. Now the Canadians have the high-grade Athabasca uranium projects, and they provide the U.S with uranium. However, operational problems—flooding, reaching lower grades than expected and very difficult mining conditions—are delaying projects and reducing the amount of uranium produced. Economic uranium deposits are very difficult to find. There are some very, very experienced geologists who have been in the uranium business for 40 years, who are extensively drilling in the Athabasca and they’re not finding the deposits.
Negatives for the supply of uranium to the U.S. include: only one conventional operational mill in the U.S.; lower production coming out of the Athabasca; Australia selling some of its production to the Chinese; and Russia selling uranium to Chinese reactors.
In addition, the nuclear warheads in America will not be able to provide the low-grade requirements for the nuclear reactors as the down-blending capacity required to meet the demand isn’t available.
TER: Are we looking at this in the next 12 to 18 months, or is it going to take a while as these pebble bed reactors get built and the agreement doesn’t get renewed?
MK: Well, they have started building the pebble bed reactors in China. I think the timelines of many projects have been delayed due to economic pressures, but you will see these reactors in China operating by 2013.
TER: So if we’re looking at uranium and it’s a longer timeline until we finally hit the lack of supply, what’s the investment play here?
MK: Number one, you have to ask yourself: what’s my risk tolerance? But let’s break it down further. There’s definitely going to be an upsurge and huge demand in the U.S. because it has existing power plants, and it needs the uranium there. So a lot of the price went up due to the speculation of funds buying the actual uranium. It’s a very niche market. You want to diversify your uranium holdings. In the U.S., I would like to have a producer, such as Denison Mines, which we recommended in our newsletter in Nov. 2008 and on BNN in early December as a buy under C$1.00 (that has an operating, existing permitted mill). It also has mines in the area that are economic to deliver and produce, so it produces uranium but it also produces vanadium.
Then, for your higher risk, I would go for ISL (in situ leaching) operating companies—except ISL projects are not profitable under US$40 uranium to $45 uranium. Ur-Energy Inc. (TSX:URE), a company we recommended in our November 2008 issue, also as a buy under C$0.40, is fully financed to go into production, and its only hurdle is the permitting of the project. We believe they will get the permits. It was trading at 50% of its cash position when we recommended UR-Energy. That’s simple mathematics—how much cash do they have in the till and what’s their market cap? We’ve pulled over 100% a couple of times investing in, and taking profits from, that company. So Ur-Energy will be a good investment if you’re looking for a near-term ISL producer.
A higher risk ISL near-term producer would be Uranium Energy Corp. (AMEX:UEC) in Texas. It has the ISL Goliad project. The only reason I would say it is higher risk is because it’s not fully financed yet, so it has the risk of not being able to raise the funds required to put the project into production. That said, Amir Adani (president of UEC) is someone you want to pay attention to. Amir has a bright future, and I wouldn’t bet against him on either selling the company at a significantly higher price or raising the funds required to put the Goliad project into production. That’s a big issue moving forward for any energy company exploring or trying to go into production—do they have the money to do what they intend on doing? So those three are great plays and the lowest risk one, I would say, is Denison. Then I would go with Ur-Energy, and then Uranium Energy would be my high-risk play in the space.
TER: Is geothermal a large enough market to be an investment opportunity?
MK: It is, but you have to have a long-term perspective. Geothermal is an unexciting but real sector. It’s true and real play—it will deliver investors profits—but it’s not like a uranium junior, such as Hathor Exploration Ltd. (TSX.V:HAT), where the drill results can triple the price of a stock. Hathor is a company that, early on, we had recommended under C$0.50 cents. It went to just under C$5, and we have since taken profits. In the U.S., there are some great companies that have the potential to deliver significant profits to investors and they’re looking pretty cheap right now. Again, the risk for a lot of the geothermals is will they be able to raise the money to put their projects into production? So that’s a major risk going forward.
TER: I live in California, and it appears that the state is going to start giving tax rebates; I think this will also be true in Nevada, but I don’t know that for sure. Does that offset this financing issue?
MK: It’ll help, but there will have to be big financings because these projects are not cheap to put into production. Drilling geothermal holes are very high risk and they’re deep. Some can go down 3,000 meters, that’s just under two miles; so it’s difficult as many things can go wrong when you’re drilling that deep. Improvements have been made in drilling but it’s still risky and difficult. We did a full geothermal report in August that you can get on our website. We looked at every single publicly traded geothermal company—the ones operating in the U.S, Nicaragua, Iceland and Australia.
TER: Now the one in Nicaragua is being financed by the government, isn’t it? And that’s Polaris Geothermal Inc. (TSX:GEO)?
MK: Well, no, it’s a partnership—Polaris Energy Nicaragua S.A. ("PENSA")—and not 100% financed by the government. You need the private factor and also the expertise. So it has just under $12 million cash right now, but it does have some debt.
We sent one of our analysts out to Nicaragua to meet the president of the country and to analyze the projects. The Central American economy is going to recover soon, and they will need more power generation. That’s good news for a company that’s able to prove it can produce the electric generation—a key issue—and the company’s on good terms with the government. There’s always the risk, but I would say that it’s been oversold just like a lot of good companies in this market because everybody went down. This is something that we’ve definitely been looking at and, at these prices, we’re attempting to put out a best buy on it—but we’re looking at what the forward cash requirements will be for the company. Both Polaris and Nevada Geothermal Power Inc. (TSX:NGP) (OTCBB:NGLPF) are good companies. Nevada has some very serious investors in it, such as Rick Rule, who is a very aggressive investor in the geothermal sector. When Rick talks, the smart money listens. Doug Casey and Rick are very close friends, so I get the benefit of picking Rick’s brain from time to time.
TER: Going back to Polaris, I thought it had financing lined up with the International Monetary Funds.
MK: Let’s hope so but, until the money is in the bank, don’t count on it. We have it in our portfolio and for Nevada, we took profits on it, so we made 100%. Then I introduced something called the “Casey Free Ride Formula,” which states that when you feel you want to take your money out, always take your initial investment out, and then the rest is playing with the house’s money, so it’s a bonus.
TER: Are there any other geothermal projects that look interesting at this point?
MK: One I think is very interesting—Ormat Technologies Inc. (NYSE:ORA), which is what I would call a central service provider for the geothermal sector, as it provides both construction and operations. Nevada has contracted Ormat to build its Blue Mountain project; so Ormat is something that we recommended. It was trading in the $50s, and we said wait ‘til the low $30s to get in. We did not see it coming down as fast as it did, but Ormat has positive earnings—and, if you’re a geothermal company, you will need the material from Ormat.
TER: What does the company make, specifically?
MK: They build the actual plants and even operate their own electric-producing plants. So it is like a one-stop shop for a lot of these geothermal projects.
TER: What about solar?
MK: I think solar’s interesting, though I think the solar sector needs to improve the technology further to make it more economic. I’ve read about all sorts of companies that are trying to do things like put solar in paint and make solar windows. I think it’s a story down the road; but to rely on the energy, I don’t think we’re there yet. Economically, without the subsidies, they don’t work. So, again, is it subsidized? If the government takes away the subsidies, will this be profitable? Right now, the answer is no.
There was a little bit of a surge going on in the solars when oil was hitting close to $150. A lot of demand was going on for solar companies, and we looked at everything. For any of our research reports, whenever we recommend a company, we make sure that we not only talk about that company but also talk about the whole sector—and we studied every single company in that sector. We looked at the manufacturing companies, installers and silicon providers—and our recommendation was Lonestar Capital Corp. (TSX.V:LON.P) at C$0.1 back in March of 2008, we have since put a sell on the stock and realized +400% gains.
We recommended it at 10 cents, and we took profits. We have since sold the company. It’s an interesting dilemma, but the key is you have to take profits if you want to make money. So would I buy Lonestar now at $1.00? No. But at 10 cents, it’s an interesting story and we saw the upside in oil. Oil doubled in a short period of time. And you’re going to see a lot of derivative markets that, like the solars, will also heat up when oil comes back up. The key is to take profits.
TER: Going back to oil, do you see investment opportunities there? You referred to peak oil before; the prices are low. Will they continue to be low through 2009?
MK: If you’re a speculator and you believe in the peak oil theory, let’s look at the oil sands companies like Suncor Energy (NYSE:SU), which we actually have a buy under $20 recommendation on (it was $28 when we put out the speculation). We are long-term believers in the oil sands, and at $30 oil it’s not that exciting of a story. But at $60, $70, $80 it’s a very exciting story. So during these recessionary times, when a company like Suncor has over $4 billion in cash and is already producing, it doesn’t need to go into the high costs of new production. It has other projects that it may bring on in four years, but it is currently producing and profitable under US$35. Now you can pick up these companies at significant discounts. Remember in the summer, this was a $50+ stock. So these are major companies that are getting corrected. If you’re a long-term believer, put in your stink bids and wait to be filled. That’s the way I am playing it.
If you’re a very high-risk speculator, we can look into the North Sea. The North Sea isn’t necessarily a $30 oil story; it’s more of a $75 per barrel story, but there are some big resources there. And there are companies that were trading at $15 to $20 just three months ago that are trading at 50 cents per share today. The reason they’ve gotten so reduced is, again, financing risk. Their credit lines were taken away from them because the banks had the problems, so they have a $700 million debt that’s going to be due. So this one company’s producing 20,000 barrels per day. It plans on going to 40,000, and then the stock went from $15 to 50 cents within two and a half months. That is the opportunity that we have identified if you’re high risk and you believe in future oil. The question is: will it be bought out? We think it will; we think that it’ll be bought out for significantly higher than the 50 cents it is trading at today. So there are definitely opportunities in the market today.
TER: Are you familiar with clean coal technology?
MK: Yes, we looked at the clean coals. The problem with the clean coal is the cost of the wash plants. Bringing in the wash plant can cost up to $1 billion, and that’s when it breaks the economics of the company. We’ve also looked at closed clean furnaces, which will be more viable.
TER: And what about the ongoing production? Is it just a capital one-time cost or are there ongoing costs?
MK: No, no, for a wash plant at a mine, it’s a one-time initial cost. Obama’s going to want to go towards independent energies, so there’s a lot of potential for wind, solar, geothermal and run of river; but coal is going to be the ugly duckling because, right now, 50% of America’s electricity is derived from coal. So they’re going to want to decrease that. Now they will go and move towards a lot of these green energies. There’s going to be a lot of support, a lot of money and a lot of incentives toward green solutions, but the reality is a lot of these companies will not be able to deliver on the purchasing agreements (basically they won’t deliver the expected amount of electricity). That’s very key here.
A lot of these coal companies are going to get taxed because of the carbon credits, and they’re going to get taxed heavily. You won’t see new coal power plants come on the line either. Then a lot of these coal companies are going to decrease in price as the green energies increase because of the demand, hype, psychology and incentives.
There’s going to be a point in the future, however, when a large percentage of these green energies will not be able to deliver the expected amount of electricity. At that point, the coal will be the unfavorable one but they will have to turn back to the old reliable dirty energy. But, you see, there are clean coal furnace technologies; so coal will come back in vogue at some point—four to six years from now.
TER: But we have this new energy director under Obama and he has more of a scientific and economic bent to him. Why wouldn’t he be looking at something like clean coal?
MK: I’m sure he will, but don’t fool yourself that science will have more weight than politics in Washington. Dr. Chu is very science-based. His main argument was against using food for fuel, so they’re going to look at alternatives. The problem is the politics behind it. So you have Obama’s head guy on the energy side against using corn for fuel, but what about the politics? There are a lot of political factors. And let’s not forget—from a geopolitical point of view—if Iran does something, oil could double in a week.
TER: But that would bode well for ramping up coal. Basically, aren’t we like the Saudi Arabia of coal in North America?
MK: Yes, that’s right. So the key is coming up with a very good economic clean coal technology, and we’re working towards that. Casey Energy’s chief geologist, Dr. Bustin, actually wrote a paper about that—how long it takes to put those into capital costs. It’s like the wash plants—they definitely work, but they’re very expensive and, right now, it’s not economic for a lot of the companies. It also requires looking at what type of coal. Is it metallurgical or thermal coal? So we’re looking at the different types.
TER: Going back to the geopolitical factors for oil, when you say the volatility of oil could be very high, what do you think will be the biggest surprise in energy in 2009?
MK: I think it’s going to be the differentials of Europe oil and gas prices from North America, and people haven’t yet fully discussed where the differentials between Europe and North America—or even between crude or gas—are significant. More so than OPEC, I think Putin is someone you really have to watch; what Russia is going to be doing. The disputes with Georgia were about pipelines. The disputes with Ukraine are about the pipeline. It is all about the pipeline with the former Russian states, so I think the story of 2009 and 2010 will be the differentials and the European struggle for energy independence.
TER: Very good. Marin, we really appreciate your time.
Investment Analyst Marin Katusa is the senior editor of Casey Energy Opportunities, Casey Energy Confidential, and the Casey 50. He left a successful teaching career to pursue analyzing and investing in junior resource companies. In addition, he is a member of the Vancouver Angel Forum where he and his colleagues evaluate early seed investment opportunities. Marin also manages a portfolio of international real estate projects. Using his advanced mathematical skills, he has created a diagnostic resource market tool that analyzes and compares hundreds of investment variables. Through his own investments, Marin has established a network of relationships with many of the key players in the junior resource sector in Vancouver.
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