Rick Rule: Silver Linings
Source: The Energy Report (3/24/11)
If the clouds of crisis enveloping Japan, the Middle East and North Africa hold any silver linings, they may be in the form of opportunity for resource investors, particularly in the uranium, oil, natural gas and alternative energy sectors—at least that's how Rick Rule sees it. The widely known and well-respected founder of Global Resource Investments returned to cyberspace this week for a webcast wherein he explored some of the investment implications of these recent crises. In this Energy Report exclusive, Rick shares his insights and investment ideas.
Riding the wave of growing fear, investors have been pulling out of uranium stocks, as some in the markets are calling for an end of the nuclear renaissance and the demise of the uranium bull market. With Japan's tragedy marring perceptions of nuclear power as a safe and clean alternative to fossil fuels, the uranium spot price fell right along with valuations of companies in the uranium sector.
Reaction to the crisis is not over, Rick says, noting that this adds volatility to an already volatile market. He expects nuclear-power opponents to seize on the crisis to whip up as much political and social hysteria as they can, raising—and perhaps exaggerating—questions about the state of readiness for potential disasters, not just in Japan but also around the world.
"We're going to have the opportunity to take advantage of fear and terror in the uranium industry in a way that we haven't had," says Rick. He calls attention to the fact that two uranium companies subject to current takeover bids are already trading at 25%–30% discounts to the value of the bids. This is "indicative of the wonderful opportunities that we'll see over the next year," he adds.
In no way does Rick consider the current crisis the end of the line for nuclear energy for Japan or even the U.S., which seems to "erroneously believe it can afford to ignore physical challenges in the face of emotional challenges." Why? The U.S. derives 19% of its electricity from uranium, according to Rick, who adds, "the idea of shutting down 19% of U.S. generating capacity and throwing the country into the dark is an absolute non-starter."
He fully expects Japan to return to its reliance on nuclear energy, as well. "Despite the challenges Japan faces," says Rick, "nuclear power is the inescapable cornerstone of its electrical supply going forward, for the simple reason that nuclear power is so dense." He explains that Japan can buy and store enough uranium to sustain its power grid for five or six years, adding that in no way could Japan—or Korea, Singapore or Taiwan—store enough oil, liquefied natural gas (LNG) or coal to guard against geopolitical supply constraints that will affect other energy sources. Around the globe, Rick states, nuclear power is an inescapable part of the energy mix going forward—not just because it's a major component today but also because energy demand will grow so much in the future. According to some estimates, demand could be up to 35% higher than 2005 levels by the year 2030.
To Be Rich Is Glorious
Much of that growth will come from developing nations, as what Rick calls "emerging-markets liberalization" takes hold in fits and starts. China is probably the best, and certainly the most-prominent, example. The country started down the capitalist road in 1979, and the post-Mao mantra introduced by Deng Xiaoping, the paramount leader of the People's Republic of China then and throughout the 1980s, set off what he describes as "the greatest boom I've seen in my lifetime."
Rick believes Deng wasn't seeking to diminish his power when he said, "To be rich is glorious"—words that sent a signal to the senior bureaucracy that the Chinese people should be a little more free and a little more self reliant. Since the shift in sentiment, China's economy has grown to 10 times the size it was then—300% just in the last decade—and per-capita incomes are rising every year. It may be "just a little more free," Rick says, but as China, India and Brazil have shown, "when societies become a little more free, they become a lot more rich; a little less constraint and a little more self reliance generate absolutely incredible economic growth."
This phenomenon is a boon to the resource sector, in particular, he says and he explains why.
In the Western world, wealthy people tend to spend their money on services, according to Rick, adding, "prosperity at the bottom of the economic pyramid is enormously beneficial for energy prices." The ability of these billions of people to enjoy a better lifestyle is increasing rapidly, he says, noting the lifestyle to which they aspire is energy intensive. India and China are building national highway grids, selling large numbers of vehicles and building electrical infrastructure similar to what the U.S. did in the '30s, '40s and '50s. We don't hear as much about Indonesia as we do China and India, he adds, but its 230 million people also will make that country a formidable energy consumer.
At this time, Rick says, the average Chinese citizen consumes just a fraction (3%) of the petroleum energy on which the average American relies. Considering the size of its population, if Chinese per-capita consumption rose to the level rivaling that of even South Korea (17% of U.S. consumption), China's economy "would consume every drop of oil produced in the world," Rick says.
As per-capita consumption increases in China and other developing economies, he continues, the impact on global petroleum prices will be dramatic. The fact is, billions of people not only want the standard of living that the Western world enjoys but also, increasingly, have the means to compete for it. Thus, inexorably, the price of commodities will increase. This includes prices for all energy sources—at a time, Rick notes, when energy supply has plateaued.
In terms of oil, while acknowledging that new technology will facilitate recovery of additional reserves from existing sources and help locate new deposits, he doesn't believe these endeavors will prolong the life of oil at prices in the neighborhood of $100–$150 per barrel. "We're running out of $100 oil," he explains, citing a variety of reasons. To an alarming degree, he says, the national oil companies that are responsible for the lion's share of production have diverted cash flow from reinvestment in energy security to domestically popular spending programs, including―ironically―subsidizing the price of energy or "increasing demand while reducing supply."
Further, he expects national oil companies that represent about 30% of the world's export crude (from countries like Mexico, Venezuela, Peru, Ecuador, Indonesia and Iran) to cease being oil exporters within five years. "Taking 30% of the world's export supply out of the equation when export demand is increasing at 2% per annum," he says, "is a recipe for incredible oil price rises."
Middle East Turmoil
And, of course, there is the increasing volume and intensity of social unrest in the Middle East and North Africa. International crude prices reached a 30-month high of $120 per barrel in February following earlier turmoil in Egypt and Tunisia. Overlaying systemic shortages with agitation for regime changes—not unlike the situations that also have erupted in Yemen and Libya—suggests the enormous potential for disruption in supply as a consequence of political turmoil, revolution and even higher prices. "And the balance between supply and demand is too tight to take the supply shocks that could come with regime changes," Rick points out.
For a glimpse into the potential of such supply shocks, consider the recent reductions in Libya's oil production. Libya pumped approximately 1.6 million barrels per day (Mbpd) of crude before heavy fighting between Muammar Gaddafi's forces and rebel troops, followed by U.N.-approved air strikes, slashed production to less than 400,000 bpd. This cut off exports and possibly damaged Libya's oil infrastructure. While the country's exports likely account for less than 1% of the world oil supply, Rick explains, the loss of 500,000–1 Mbpd of Libyan oil drove the price of oil up 10%–15% worldwide.
Black Swan on Steroids
"And what would happen," Rick muses, if serious agitation for social change were to occur in the United Arab Emirates, Kuwait or Saudi Arabia? "That's a black swan on steroids."
Though attracting far less media attention than its reactor crisis, the devastating earthquake and tsunami that hit Japan has purportedly wiped out 29% of its domestic refining capacity. As the world's second-largest net importer of oil, Japan relied on imports to meet 45% of its energy needs as recently as 2009. "The nuclear capacity was threatened," Rick says. "In northeastern Japan, the oil- and petrochemical-refining capacity was not threatened―it was obliterated. But this isn't what you read about in emotion-driven headlines."
While the oil market might be the most noteworthy bellwether because oil is the most-ubiquitous and most-useful form of energy, tensions in the Middle East and the crisis in Japan are focusing more attention on alternatives.
LNG: Fuel of the Future
Since 2008, Japan has been the world's third-largest nuclear power user, with 55 reactors providing more than one-third of the nation's electricity. Rick believes that additional nuclear capacity will replace what has been lost at Fukushima, eventually; but in the interim, he expects one consequence of Japan's need for power to create more reliance on hydrocarbons and that's likely to be LNG. He considers LNG the "fuel of the future at any rate, as it can be stored well, is energy dense and can be used for peaking production, which is cheaper to establish although more expensive to operate than baseload production."
Indeed, speculation that the damaged Japanese reactors will divert LNG resources there has already driven up the prices of natural gas futures and promises to incrementally tighten LNG supplies. Even before the March 11 tragedy, Japan ranked first among the world's LNG importers. With or without Japanese demand, Rick believes that upward momentum in oil prices will lead North American, and probably European, markets to investigate and initiate use of LNG or compressed natural gas as transportation fuel, at least to supplement diesel and gasoline for over-the-road trucking. He foresees a dramatic effect on natural gas prices and the creation of a global market that connects what currently are distinctly local markets.
Despite concerns about loading carbons into earth's atmosphere, Rick expects parts of the world—particularly countries that don't think they can afford clean air—to keep coal as an important component in the world energy mix. "Despite being vilified," he says, "coal will continue to be an important part of the energy matrix. The demand for energy will supersede the demand for clean air, especially in countries that are marching from 10%–15% electrification toward 100% electrification." And like it or not, he adds, this isn't hard—metallurgical coal for steelmaking isn't hard, except for "the dirty, old, thermal, steam coal that China, India, Pakistan and others will burn."
On the other side of the coin, he expects countries that believe they can afford to use more energy—Australia, New Zealand, the U.S., Canada and Western Europe—and fortified by fears about nuclear power, to intensify focus on alternative energies that are more politically correct. In fact, he anticipates "the unaffordable subsidies doled out to solar, wind and run-of-river power generation to increase whether we can afford them or not."
Rick personally considers only geothermal and hydro as the viable alternative power sources that work. While he submits that both of these sectors "are deeply out of favor," that makes them all the more appealing to Rick, who reveals that we can expect to see him increase his already-considerable stake in those sectors substantially.
Not that current headlines offer any rationale for panic, in terms of hydro and geothermal energy—at least not in the sense that uranium is suffering from the flared-up fear factor—but throughout his illustrious career, Rick has encouraged investors to summon the courage to buy whatever the masses of investors are snubbing. "It's the panic markets that offer the best opportunities to buy good assets and solvent companies at extraordinary discounts," he professes, adding, "More often than not, the huge gains come with having the courage to buy when others won't."
Rick Rule, founder and CEO of Global Resource Investments (GRI), began his career in the securities business in 1974 and has been principally involved in natural resource security investments ever since. He is a leading American retail broker specializing in mining, energy, water utilities, forest products and agriculture. Rick's company has built a national reputation for its specialist expertise in taking advantage of global opportunities in the oil and gas, mining, alternative energy, agriculture, forestry and water industries. Last month, Rick closed a landmark deal with Eric Sprott, another famous powerhouse in the natural resources arena. With GRI now a wholly owned subsidiary, Sprott, Inc. manages a portfolio of small-cap resource investments worth more than $8 billion and boasts a workforce of more than 130 professionals in Canada and the U.S. This article is based on Rick's Global Resource Investments webcast, Monday, March 21.
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