We Can't Live Without Gulf Oil
Commodities / Crude Oil Jul 16, 2010 - 01:53 AM GMT
Tragic as the situation is, "everything is going to be okay" in the Gulf of Mexico, according to Stansberry & Associates Investment Research Founder Porter Stansberry. Porter, who built his reputation on finding safe-value investments poised to give his followers years of exceptional returns, also has a reputation as an independent thinker with a penchant for "out-of-consensus" viewpoints. He shares some of his contrarian opinions in this exclusive interview with The Energy Report. Porter sees no risk of bankruptcy or default with BP, the Macondo emerging as an enormously beneficial well, and more drilling there in the future because 1) there are no good replacements for oil and 2) "we can't live without oil from the Gulf."
The Energy Report: The major discussions on the energy front in the United States seem to lead to a single conclusion, that we have to start using domestically generated alternative sources of energy and stop relying on foreign oil. We all know the hot topic since April. What are your viewpoints on the impact of this disaster—not only on the Gulf of Mexico, but also on BP (NYSE:BP; LSE:BP), deep-sea drilling and on the energy sector?
Porter Stansberry: First, full disclosure. I have recommended to my subscribers Anadarko Petroleum Corp. (NYSE:APC), BP's partner in the well that's leaking in the Gulf, and I personally own shares in BP. I bought my stake in BP recently because I don't believe the total costs of cleaning up the spill will be material to the company's earnings over the next decade. I think BP today is a phenomenal opportunity for any investor who has the emotional wherewithal to handle some volatility.
If you look at BP's debt, it barely budged. BP's bonds fell a bit more than 20%, with prices never falling below $80. Currently BP's debt is yielding 5.9%. There's no real risk of a bankruptcy or default. Folks like Matthew Simmons saying bankruptcy was likely was simply laughable. BP generates $30 billion a year in cash from its operations, and the total cost of the cleanup will not exceed $30 billion. I just don't believe it. So I think BP is a fantastic buy at current prices, and I recommended Anadarko because the way my publishing company works, we're not allowed to recommend things that we own ourselves, and I think Anadarko is a lot less at risk. I gave what I think is the better play to my readers.
TER: How is Anadarko a better play?
PS: Anadarko has fallen more than BP has, and it has even less exposure to this well. It only owns 25% of it. Even if you assume that Anadarko will be responsible for 25% of the cleanup costs, in my estimation, you're still only looking at a total bill of between $3 billion and $5 billion. That's very affordable for Anadarko. But more importantly, Anadarko has a fantastic case in that it doesn't owe a penny of the cleanup because from what we already know, it seems 100% certain that BP was negligent in operating this well. Pretty much everyone who's looked at the facts has said so, including some independent guys I hired to look at the situation. So I think Anadarko will walk away from this thing without a penny lost.
It hasn't occurred to many people yet that this one well is producing about 30% of Anadarko's entire global production. I mean this thing is a monster, and they're going to get it under control. Meanwhile, Anadarko owns something like 3 million acres around this well. They are the largest independent operator in the deepwater gulf. And they're going to drill more wells eventually. I think we'll see a big turnaround in this whole process. I think the well can be cleaned up; I don't think that it's a disaster of the scope that people are saying. And I think the discovery will eventually lead to large increases in production for Anadarko.
Look at what happened in the Persian Gulf when Iraq's troops withdrew from Kuwait. You're talking about a much smaller body of water and you're talking about much, much larger volumes of oil that were spilled—in that case deliberately—into the water. Nobody paid to clean it up. They just left it. Nature took its course, the oil eventually was broken down and everything was fine. Going back there two or three years later, you couldn't even tell it had happened.
Listen, I am not saying it's not a tragedy; I'm not saying we shouldn't try to prevent it from happening, but I am saying it's not the end of the world. There have been spills this big in the Gulf of Mexico before, and they didn't destroy it. [Editor's Note: As of the date of this interview, (6/29/10), the Deepwater Horizon Gulf oil spill had not surpassed the Ixtoc 1 oil spill (6/3/79) in the Gulf.] Everything is going to be okay. But if you turn on the news right now, you'd think the entire Gulf of Mexico is a big boiling pot of oil and that the whole Gulf Coast will never going to be the same. I just don't believe those things are true.
TER: But perception is reality when it comes to regulation. In that context, why wouldn't this have the impact on oil that Three Mile Island had on nuclear?
PS: That's a good question, but if you believe the government is here to protect us, I just think that you're naïve. There's no doubt in my mind that the companies supposedly being regulated are easily capable of influencing those regulators, through lobbying or simply the essential corruption of the entire government-corporate structure, especially in the oil business. And then finally, like it or not, we can't live without the oil from the Gulf.
Will there be regulations? Sure. Is it going to be harder for smaller companies to be entrants into that marketplace? Absolutely. But is that bad for BP or Anadarko? No, it's good for them. If their costs go up, guess what else is going to go up? The price of oil will, so those are passed on to you and me.
TER: Meanwhile, in the wake of this spill, many people are talking more about alternative ways of getting oil. For instance, I've seen oil shale discussions on morning TV. How realistic is it to expect more production out of tar sands, etc.?
PS: Well, the Eagle Ford shale has a lot of condensate in it, which isn't necessarily oil, but actually in some cases is more valuable than oil because it's easier to crack it into gasoline. There's already a lot of natural gas liquid production today in various shales across the country, and I expect big increases in that.
I have an out-of-consensus view here, but my sources—all practicing oilmen in Texas who own land in the Eagle Ford and have drilled wells there themselves—tell me that they believe the Eagle Ford will be the largest single oilfield in the history of the United States. And they said oil, not natural gas. They're talking about natural gas liquids, which are just as good as oil—or as I indicated, even better in a lot of cases.
TER: That sounds like good news.
PS: Depending on your outlook, I'm afraid it means that natural gas prices will stay depressed for a very long time, but it's definitely going to be a big game-changer for domestic, onshore production. Just last month, Reliance Industries Ltd. (BSE:RIL), the biggest conglomerate in India, paid around $1.3 billion for 40% of Pioneer Natural Resources Co.'s (NYSE:PXD) Eagle Ford property. China hasn't bought anything in the Eagle Ford, but they will. I personally think they're likely to buy Petrohawk Energy Corporation (NYSE:HK). I have no evidence of that, just an instinct. Petrohawk has some of the best properties, but China is probably the only one willing to pay the very high price they're demanding. So that's the next deal I expect. You're definitely going to see a lot more deals.
TER: What stands out about Petrohawk?
PS: I think its first year's drilling campaign was in 2009, and they drilled something like 28 different holes without a single dry one. When you have no dry holes, the return on your capital from your drilling program is vastly higher. It's a whole new ballgame. It's just vastly more efficient and therefore the eventual profit margins from production will be even higher than they already are.
In my mind, horizontal drilling and the existence of liquids in these shales is the game-changer for the energy business, and I really don't think people appreciate how big a change it's going to be or how large the production from these fields is going to be. But there is one big hiccup in all of this.
TER: What's that?
PS: There are a lot of environmental concerns about the fracking process, and I don't think that they're going to go away. Thus, I anticipate much tighter controls going forward on the horizontal drilling technologies that these companies have been using, which will make drilling progressively more expensive. Right now a single well costs them about $5 million to drill, but it wouldn't surprise me at all to see the price increase significantly to $10 million or $15 million per well just because of the costs of using these chemicals and making sure they get cleaned up.
TER: Does this provide an investment opportunity—looking at the drilling companies as opposed to the oil producers?
PS: That's a tough question. When you can buy a drilling company at a 50% discount to the value of its rigs, it's a good buy, but drilling isn't a high-margin business, so they inevitable trade at a huge discount to book as soon as the price of the commodity falls. In my mind, that makes them really speculative for the average investor. I think it makes more sense just to buy the companies with the best acreage in the field, and sooner or later you're going to make a lot of money. Even if it takes a long time to get all the holes drilled, the resource is there.
I don't think most investors appreciate that there aren't any dry holes in these fields because they use seismic technology to look before they drill. They know the exact depth of the shale and once they know they're in it, they just drill sideways.
TER: You talked about how massive Eagle Ford is. Are other fields in the U.S. exciting much discussion?
PS: Absolutely. And they're pretty much all over the place. I think they have shale gas production now in 30 different states. The big ones are the Marcellus, Haynesville, Barnett and the Bakken. I think the difficulty is trying to produce these wells in a way that isn't very destructive to the environment, because horizontal drilling and the fracking process are very disruptive to groundwater supplies. They have to be really careful where they do this kind of drilling to avoid the risk of contaminating a large reservoir.
TER: Considering the contamination in the Gulf of Mexico, and the risks to groundwater in horizontal drilling for oil, why isn't there more focus on alternative energies? Or, considering that we have so much natural gas, why not focus on going to natural gas instead of oil?
PS: To get the natural gas out involves a lot of environmentally risky things, too, because these shales are tight rock formations, and you can't just drill a hole in them. You have to blast them apart, and blasting underground rock apart using high-pressure liquids inevitably risks busting through into underground aquifers, which can lead to a lot of problems. There are places where people can light their water on fire now when there's been drilling nearby.
So even natural gas is not risk-free, and I think it's absurd for the American people to believe that you can have natural gas at $4 and not take any risks in your discovery and drilling programs. I am not saying we should take silly risks. But look, how long have we been drilling in the Gulf of Mexico, and how many accidents have there been? The safety record's pretty damn good. Are we going to get rid of commercial airlines because sometimes they crash? You can't go on without taking any risks.
But as far as the answer to your more important question, we can't get off oil because oil is a fantastic source of energy; relatively inexpensive to find and produce, extremely dense and portable. There aren't any good replacements. Other ideas that people have put forward are not very workable. For example, the notion of powering the entire transportation infrastructure of the United States with electricity is complete nonsense. If everyone plugged in their automobiles and trucks, the entire grid would melt.
Where would that electricity come from? How many more coal-fired power plants would we need to build if everyone tries to plug in their vehicles? If you do the math, it's a very large number. We don't have the capital to build them, and couldn't survive the pollution from the coal. So there are no cheap and wonderful and easy solutions. Solar power is not going to amount to anything, despite Al Gore's claims to the contrary—certainly not in the next decade, and probably not in my lifetime. It's just too incredibly inefficient, and, of course, it doesn't work when the sun isn't up.
Likewise with windmills. How many windmills would you have to build just to replace the existing coal-fired power plants? It's an absurd number; it's not feasible; it's not economic. Not compared to a huge well like BP and Anadarko discovered.
TER: In our last conversation related to energy in December, you didn't really see anything happening in coal and natural gas, either, nor at that time, in the nuclear arena. You didn't see any of those as representing any realistic investment opportunities. Do you still feel that way?
PS: I tell you what I am getting very, very bullish on, the shares of a leading nuclear power company in the United States, Exelon Corp. (NYSE:EXC). I've recommended it to investors in my newsletter for many years. We bought it at $21/share or something like that after the correction in the tech boom in 2002, and it pays a really nice dividend, $2.10. We're getting paid 10% a year just to hold the stock, and meanwhile it's a regulated utility. There's no way it's going out of business, and if you buy it at the right price, it's a wonderful long-term investment.
It hasn't been at the right price for a very long time, but right now you can buy it for about five times cash earnings, and the yield on the stock is 5.5%. We're in the range where I would be willing to allocate capital to Exelon's common stock. It's the largest operator of nuclear power plants in the United States, and I certainly believe that going forward nuclear power is the only realistic alternative to coal-fired power plants. It's the only way to generate enough electricity at a reasonable price.
TER: Are there other nuclear facilities, or nuclear companies, that you also see as also being undervalued at this time?
PS: I am sure the large-cap nuclear stocks are all going to be pretty cheap. Another large operator I like a lot is Duke Energy Corp. (NYSE:DUK), which is probably roughly the same in terms of price and value as Exelon right now. I just happen to like Exelon better because I have owned it for longer, and it's actually cheaper than Duke when you look at it on an enterprise value basis. When you get 5.5% owning the best nuclear operator in the U.S., you don't have to look anywhere else.
TER: That's true. A moment ago, you said that nuclear is the only way to generate enough electricity at a reasonable price. If that's the case, do you foresee a play in uranium again, as there was three or four years ago?
PS: That's a whole different question. To tell you the truth, I just haven't looked at uranium. Some analysts I'm friendly with follow it, but I haven't been excited about uranium in a long time. At the New Orleans Investment Conference in 2007, I put up a chart on uranium and said, "This is the biggest bubble in the world." I was maybe 60 days early and the whole thing just collapsed. I am not saying you can't make a lot of money in uranium mining, because I am sure you can. To buy a uranium producer, though, you've got to really know a lot about the quality of the ore and that goes well beyond my expertise.
TER: Any other insights you would like to give to our readers?
PS: We have been in such a bizarre period since 2006. Nothing makes any sense in terms of economics or finance globally. It didn't make sense for people to be able to get a 30-year mortgage with no income, no job and no equity in the home. We haven't yet recovered from all of that and other nonsense that's been going on, and it continues. It doesn't make sense for General Electric Company (NYSE:GE) to be levered 30 times tangible equity. It doesn't make sense for America's largest and most important conglomerate to have that much debt. It doesn't make sense for a country like Italy, which has a horrible record of repaying creditors, to be able to borrow 110% of GDP. So we have all these things that just don't make any sense going on, and then people ask, "What should I do with my money?"
And the thing to do, my friends, is be very, very careful because there are tremendous panics and volatility to come. We are a long way from the lifeguards coming out and declaring the "all clear." So be very, very cautious; don't be upset about having a large cash position. I told my readers earlier this year that if they weren't prepared to put half their portfolio in short stocks, if they weren't prepared to truly hedge themselves this year, that they should be 50% in short-term Treasuries and 50% in gold. That's the only way to have a totally safe cash position, because you're hedged with the gold versus the dollar. I am happy to sit in that position for a long time until I see some terrific values.
TER: Porter, once again, we appreciate your time and your insights.
After serving a stint as the first American editor of the Fleet Street Letter, the oldest English-language financial newsletter, Porter Stansberry put out his shingle at Stansberry & Associates Investment Research, a private publishing company. Celebrating its 10th anniversary last year, S&A has subscribers in more than 130 countries and employs some 60 research analysts, investment experts and assistants at its headquarters in Baltimore, Maryland, as well as satellite offices in Florida, Oregon and California. They've come to S&A from positions as stockbrokers, professional traders, mutual fund executives, hedge fund managers and equity analysts at some of the most influential money-management and financial firms in the world. Porter and his team do exhaustive amounts of real world, independent research and cover the gamut from value investing to insider trading to short selling. Porter's monthly newsletter, Porter Stansberry's Investment Advisory, deals with safe-value investments poised to give subscribers years of exceptional returns, while his weekly trading service, Porter Stansberry's Put Strategy Report, shows readers the smartest way to book big gains during the ongoing financial crisis.
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DISCLOSURE:
1) Brian Sylvester and Karen Roche of The Energy Report conducted this interview. They personally and/or their families own shares of the companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: None.
3) Greg Gordon: See Morgan Stanley disclosure that follows.*
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