|
AN
INTERVIEW WITH BILL POWERS
by David Shvartsman
Finance Trends Matter
August 4, 2006
Today we’ll be
talking with energy analyst and hedge fund manager Bill Powers, of
Powers Asset Management. Bill has published two successful energy
investment newsletters, Canadian Energy Viewpoint and US
Energy Investor, and has been a contributor and guest to Financial
Sense Online and the Financial Sense Newshour.
In 2005, he decided to focus his full attention and energy to running
his investment fund, Powers Asset Management.
Mr. Powers originally came from a background in technology, and had
thoughts of becoming a tech analyst. After working in the securities
business and technology related work, he set his sights on finding a
field that was inversely correlated to the overcrowded tech sector of
the late 1990s. His growing involvement in the energy sector showed him
that oil and gas fit that description.
A magazine cover supplied the contrary indicator that signaled an end to
the downtrend in oil prices. The appearance of The Economist’s
now famous “Drowning in Oil” issue was something that told him the
timing was “absolutely right”. During our discussion, Powers
compared The Economist’s March ’99 cover story to BusinessWeek's
infamous “Death of Equities” cover which preceded the bull market in
stocks beginning in 1982.
Powers saw the need for an energy-focused investment newsletter and
decided to press forth with the idea, unpopular though it may have
seemed at the time. He began writing articles on Canadian oil and gas
companies and launched his own publication, Canadian Energy
Viewpoint, in 2002. His hedge fund, Powers Asset Management, was
launched in early 2005.
Bill, let’s begin by talking about some of the supply and
demand fundamentals that are shaping your overall view of the oil and
gas story that’s unfolding. Give us an overview, if you will.
Basically, supply and demand continues to tighten for both world oil and
North America natural gas. We’re at a time of no spare capacity for
either. This is unprecedented. Not only are we at a tight spot for
supply & demand, very few large projects are going to come online to
replace maturing production from existing fields. This is unlike the
1970s where we had two oil shocks, but yet we had Samotlar in Russia
coming online - which is a very large field, the North Sea, Gulf of
Mexico, all were in their infancy at that time, as well as Prudhoe Bay.
We’ve heard references to the last oil crisis of the 70s
as being political in nature, a political shock due to Opec cutting off
supplies to the West. Does the information we have suggest that the next
shock will be driven by a lack of supply?
This is going to be a geological shock. By that I mean sure there will
be production that will come in from offshore Brazil and out of West
Africa. But the fact of the matter is that the largest producers in the
world, such as Saudi Arabia, has probably had peak production. I very
much agree with Matt Simmons’ book, Twilight in the Desert.
Venezuela is in decline, Mexico is about to go into a steep decline, and
Russia will decline. Indonesia, which is a member of Opec, last year
became a net oil importer. Not only that, we’re seeing largest oil
fields in China, Daqing, in decline.
While China has made monumental efforts to replace its production,
it’s struggling to do so. They have made some good discoveries in the
South China Sea, but that will barely keep production flat. As their
economy grows, there will be more demand for oil imports from the rest
of the world.
In India, their biggest field is Bombay High, which was developed by the
British before WWII. That field and the rest of their biggest oil fields
are in decline. That is a very rapidly growing country that will have
needs for additional imports. What we're really seeing at this time is
declining production from mature basins and increasing demand from
majority of developing and the developed world. Demand continues to
increase even here in the US, despite high prices. I think that what
will surprise people is that prices will stay high. Will prices move
higher in the immediate future? Maybe, maybe not, but I think the
long-term trend is very well established and it is up.
As far as North American natural gas goes, we do have somewhat of a
similar situation in that there is somewhat of a supply overhang right
now due to the very warm winter we have had. However, we are at 100
percent utilization for natural gas land drilling rigs, as well as rigs
in the Gulf of Mexico. We have a declining rig count in the Gulf of
Mexico because rigs are being shipped overseas which is somewhat of a
new phenomenon. The rig count has dropped from about 150 to 90 right now
in the Gulf of Mexico and this is because the rig companies are signing
higher day rates for overseas. That will affect shelf production for
natural gas on the continental shelf.
Is the "rig count" a metric used mostly to
describe natural gas production or is offshore oil included in that as
well?
Mostly natural gas. About 90 percent of the rigs drilling in the US are
directed towards drilling natural gas. That’s both onshore and
offshore, but the rig count deals largely with natural gas, especially
as it involves land rigs.
But really what we’re seeing are smaller reservoirs of natural gas
being discovered. Due to technology, we've had a very steep decline
curve in natural gas. We’re seeing what Matt Simmons has referred to
as the natural gas treadmill, which means it requires more and more
wells to be drilled every year to keep production flat. So any let up in
drilling will have a major decline in production.
So we are seeing despite the high prices we’ve had over the past few
years, production has declined in North America, and I believe it will
continue to do so. While there are fields in Wyoming and the Barnett
Shale, that will probably continue to increase but the rate of increase
will not make up for the maturing fields elsewhere. We will see a much
bigger move towards unconventional natural gas, but I don’t think it
will compensate for the decline in conventional production from mature
fields.
And then the big question mark for North American natural gas is LNG,
Liquefied Natural Gas which gets talked about a lot.
Does that fall under the category of unconventional gas?
It would be considered an unconventional source in the sense that it
comes from overseas. Places such as Algeria, Trinidad, Egypt, Qatar.
Those are major exporters, especially Algeria and Trinidad.
It has to be shipped by tanker, then reliquefied…
They have to ship it and reliquefy, yes. They are building new import
facilities to take in natural gas. However, the big problem with that is
there are other countries that are doing the same thing. Asia is the
largest consumer of natural gas, Japan has long been the largest
consumer of natural gas and they have already tied up supply for quite
some time. So what we’re seeing is while there is potential to import
it, that lack of aggressiveness by import facility operators is going to
severely limit the amount of gas that comes into this country for the
next decade.
They can’t get permits to build enough facilities?
Well, the facilities are actually underutilized right now, so it’s not
a problem of facilities. What it is, it’s tying up long-term
contracts. That is very, very competitive.
So the Japanese and the other countries of Asia are giving
them longer-term contracts and more fruitful terms so the supply is
going to Asia?
Yes, correct. And so is Great Britian, who is now becoming an importer
of natural gas, Spain has built LNG. A lot of Europe is now looking for
alternatives to gas coming out of Russia. So Europe is becoming very
dependant on Middle Eastern natural gas and they are becoming a force in
the LNG trade.
Does it seem to you that all the infrastructure that’s
been built up around natural gas (power plants, industrial use) is a
very big bet on the reliance of natural gas supply?
Yes, well that’s a good point. Actually there was a law that was
passed in 1978 or 1979 that limited what natural gas could be used for,
and it outlawed using natural gas for power plants, as there was a big
natural gas crisis back then. Then that law eventually was repealed in
the 1990s, and what happened was, from about 2000-2005 there were a huge
amount of gas fired power plants built. That was because the National
Petroleum Council, which is the research division of the US Department
of Energy, predicted that natural gas would stay at $3 for the first two
decades of this century. Almost immediately after they wrote that, gas
started its climb up to where it is now.
So there have really been some errors in judgement as far as building a
lot of power plants that may have difficulty in getting supply in the
future. There has been a lot of industrial demand that has been
destroyed along the Gulf coast. The fertilizer industry, the chemical
industry: a lot of those plants have moved overseas. The smelting
industry in the Pacific Northwest for aluminum and other industries, a
lot of major heavy industrial users of natural gas have had to move
overseas in order to secure cheap supplies.
Do you have any thoughts on Uranium and nuclear energy?
Well I’m a big believer in nuclear energy. I believe there will be
more plants built here in the states. Overseas, there’s a big
commitment to nuclear – France gets almost 78% of its electricity from
nuclear energy. Over in the developing world, such as India and China,
there’s a number of plants built or being built. They are going to
have no other choice than to commit to that. So I think that nuclear
energy has, until renewables become more competitive, the advantage.
There’s no real choice but for nuclear energy, because I think
hydrocarbons will become prohibitively expensive to generate electricity
from in the very near future.
Do you see that happening in the next 15-20 years?
I think it’s a process that’s already started happening. If oil
continues to rise, natural gas will probably go up along with it, so the
time frame is unclear but I think it’s in the process of already
happening.
Do you think we’ll be able to use less uranium because of
newer plant designs?
As far as that goes, I know there’s been an increase in demand for
uranium because they’ve done up rates for existing power plants. I
think there will probably be more efficient use of uranium due to new
reactor types, but there’s still going to be, I think, a net overall
increase in uranium demand due to the reemergence of the nuclear power
industry in the United States and its continued prominence overseas.
The idea that we have no real alternative outside of nuclear
energy may come as a shock for many of us. Environmentalists seem to be
split on the issue of nuclear or even whether or not to build windmills
offshore. But we will need energy from some source.
What do you think about alternative energy? How much electricity can we
get from solar and wind?
I think clearly, that solar and wind are the two that are furthest
along. I am not an expert on alternative energy, but I think that there
will be tremendous advantages in both solar and wind over the next
decade. They will become a larger portion of the power supply, both here
and overseas.
As far from an investment perspective, I think there are going to be
fortunes made in the alternative energy industry over the coming years,
because there are technologies that are making it competitive with
production of electricity from hydrocarbons. There are a lot of startup
companies out there that are going to do fantastically well.
Let’s talk about some of your previous energy price
forecasts. The case for $50 oil, which you made in February 2004, has
obviously been proved despite earlier skepticism. You then made a
forecast in November 2004 that called for $80 oil within 24 months.
We’ve come quite close to that mark and we still have a few months to
reach your target.
Well, when I predicted $50 oil in February ’04, I believe that oil was
near $35 and that was viewed as somewhat of an unsustainable price.
Really, the same reasons behind my thesis on $50 oil were true for $80
oil. Supply is becoming increasingly difficult to grow, demand is
continuing to increase, and also I think what the general public is now
starting to understand is that higher oil prices do not necessarily
destroy the economy.
There was a fantastic article that was written by Andrew McKillop,
“Price Signals or Cheap Oil Noise?”, that refers to this fact. In
1984, which was Reagan’s reelection year, the economy grew at 7.5%. In
2003 dollars, adjusted for inflation, the oil price range for daily
crude was $57 -$65. So high oil prices do not necessarily quash economic
growth.
I think that while there are definitely strains that are put on,
especially, lower-income members of society and certain industries feel
the pinch of higher oil prices more than others, but overall the economy
does adjust. And I believe that even higher oil prices, while they will
likely slow economic growth, there are other headwinds that will slow
economic growth such as the decline in housing. This will probably
damper demand for energy as much as high energy prices themselves.
So we are seeing that the economy is adjusting to higher oil prices. I
think that as long as prices do not spike, and they move up gradually,
we will see higher highs and higher lows as far as the price of oil
goes.
[As far as the forecasts go] I felt that it was somewhat of a stroke of
luck to have given the times and prices, but I think the trend that
started all the way back four years ago, we’re clearly seeing it play
out. And there’s going to be lots of ups and downs.
What do you make of the argument that higher oil prices will
bring on more supply?
Right now, that’s one of the big conundrums that a lot of economists
are struggling with.
Higher oil prices- what’s somewhat different from the traditional
economic thinking, as far as this bull market goes- no matter how high
prices go it’s not going to bring on a significant amount of
production. That’s because we are at, or very close to, peak oil. We
may have already passed it, or it may still be in front of us, but to
meaningfully grow oil supplies from here will be extremely difficult and
extremely expensive.
So we’re in a situation where, no matter how high prices go supply
will not be increased significantly. The same is somewhat true of
natural gas. When the industry worldwide is working flat out, there’s
not much more that can be done that’s not already being done.
I’m kind of amazed to see so many people applying this
textbook economic principle to something in the ground that is an
exhaustible resource. It’s almost as though they are thinking the
resource won’t run out or will quickly replenish itself.
But you also have to remember that for a period of 24 years, from ’78
–2002, when oil prices went up, supply did come on. Basically that
type of thinking is similar to the generals who are fighting the last
war. It really is. When Churchill went on the offensive in WWII, he
fired all of the generals and put young twenty-something lieutenants in
charge.
So who has the power to put these kind of influential
thinkers in policy positions?
Well, there are some people who are clearly out front on this issue.
Colin Campbell, Ken Deffayes, Jim Rogers has been out front on this
issue, Matt Simmons, Julian Darley.
People like these and many others who have been sounding the alarms that
this situation is happening and that it does deserve attention.
So basically we’re looking at private individuals and
industry veterans who have done their own thinking on the issue and are
able to come out and stir the pot.
Yes, and unfortunately that’s the way society works.
Matthew Simmons isn’t afraid that he’s going to get
fired from his job for speaking out…
Right, and he has committed a lot of resources and a staggering amount
of time to writing this book (Twilight in the Desert).
What are you seeing as far as energy investing goes? Do you
still find energy companies to be a compelling area for investment?
Right now we’ve found that, despite record high prices, there is a
great deal of negative sentiment in the energy investment arena. We’re
seeing companies trade at very low multiples of cash flow, reserves in
the ground, net asset value, and of earnings.
We think that a lot of the reason for this is the belief that these
prices are unsustainable and that a slowdown in the economy will drop
oil prices. I disagree with that. I think that while the economy may
possibly slow and affect demand growth in the developed world, there is
still a developing world that will continue to increase its consumption.
To think that because the US is having an economic slowdown that oil
prices will come down is, I think, incorrect. There are a lot of
consuming countries out there that spend a high percentage of their GDP,
where high oil prices mean a lot to those countries. There will be other
countries that will increase consumption due to high oil prices.
Who would you cite as an example?
The exporters. Canada is a good example. Their economy continues to grow
and they’re an oil exporting country.
What should investors look at in energy investing and what
do they have to know to invest in the energy sector successfully?
Really, what we look for are companies that we look for are companies
that can grow reserves per share, production per share, cash flow per
share, and earnings per share without having to access outside capital
in the form of equity or debt.
When we find companies that can do that, there is a very good chance
their stock price will go up. We are firm believers – we invest in
smaller oil & gas companies – that it is very important when you
deal with smaller companies, to get to know management. This helps us to
understand the companies much more deeply than you would when analyzing
larger companies.
And what’s a good source of public information that
investors can look to in order to better understand the energy industry
and the individual companies?
There’s a lot of information out there for U.S. and Canadian
companies. In the US, you can go to the SEC web site. In Canada, you can
go to SEDAR. Or, a great publication is Oil & Gas Investor.
That has a lot of North American oil & gas companies in it, and
it’s an excellent publication.
Thanks, Bill.
© 2006 David Shvartsman
Editorial Archive
CONTACT
INFORMATION
David
Shvartsman
Finance Trends Matter
Chicago, IL USA
Email
| FinanceTrends
Blogspot
The
opinions of FSU contributors do not necessarily reflect those of
Financial Sense.
|
