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-- Posted Wednesday, 11 August 2010 | | Source: GoldSeek.com
Blue Phoenix Inc.'s Chief Commodity Strategist John Licata says BP's Deepwater Horizon accident in the Gulf of Mexico has already resulted in oily names acquiring gas names. It will soon result in more joint ventures as companies try to mitigate the risk of deepwater drilling. In this exclusive interview with The Energy Report, John tells us why he's bullish on natural gas and why he sees more M&A activity ahead. He also offers some E&P and services names that could ultimately benefit from the rapidly morphing oil and gas landscape.
The Energy Report: Just before our interview you were talking about how the recent spill had fundamentally changed the energy sector. Could you talk about some of those changes?
John Licata: I think that we've learned some lessons on the heels of the Horizon spill. We could see a lot of revised capital cost estimates for these offshore drilling projects because many of these projects have never been done at these depths. We just saw how difficult it was to close this well at 5,000 ft. (below surface). A lot of the cost estimates to develop these wells are quite conservative. You're going to see more joint ventures because companies don't want the full responsibility of an economic catastrophe on their hands.
I think companies will be more willing to work with other companies to share the costs and technology. Technology is going to become very, very sophisticated. It's essential to find technology that can go through some of these subsalt surfaces that, quite frankly, are very corrosive.
TER: Do you see joint ventures happening in both the oil and gas spaces, or will they happen more on one side than the other?
JL: Right now more companies are looking to diversify their portfolios and acquire more gas assets.
TER: What were some of the unexpected results of the spill?
JL: There are a lot of opportunities that could come out of this. After speaking to various management teams from drillers to E&P players themselves, and many of the service names, it seems that everyone is waiting to see what is going to happen in terms of new government legislation. They also want to see if the duration of this moratorium will be six months or not. I think that many companies, justly so, don't want to boost their capital expenditures in that region when they don't know the ramifications of the oil spill.
TER: What do you think the federal government will do?
JL: Over the last several weeks the U.S. government and Interior Secretary seem more willing to consider shelf drilling, which is obviously much closer to land. The shelf wells are typically up to 20 ft.; I have seen some up to 40 ft. That's shallow water drilling. I think the offshore drilling market is very speculative but not just because of the oil spill. It has been for years; it's very expensive to drill. But we've seen over the last few years so many companies look to offshore drilling as a means to expand their reserves, because it can be quite lucrative.
TER: You're basically saying the industry is in a holding pattern. How long will that last?
JL: I think that's going to depend on the moratorium. A lot of executives want to see if we are going to wait until November before we get the green light to move forward. At that point, it might be too late for some companies to reactivate their rigs by the end of 2010. There's no reason to have idle assets when other things could be more attractive.
TER: You said the changing landscape was creating opportunities. Can you point to some specific ones?
JL: As you know, for the last two years natural gas prices have been very suppressed, and I think that has caused a lot of opportunities because many natural gas companies had to delay projects. That has caused the price of futures to be contained, but to the point where I think we're seeing some of that overcapacity start to reverse. Because natural gas has been cheap for a while, many of the coal-powered generation plants are looking to switch from coal to cheaper natural gas. The industry as a whole, which has been out of favor, is starting to get a little more attention. There's still a fear factor with natural gas, and that fear factor has been amplified by increased storm activity in the Gulf of Mexico. Even today, we were talking about another tropical storm that could possibly hit the region. So, natural gas, in my opinion, is a phenomenal play.
Many of the oil companies are going to look at these gas names and try to get involved in M&A. Some of the market caps of these natural gas companies have been hit hard over the last 18–24 months, and there are opportunities out there. It's cheaper to buy capacity than to create capacity.
TER: I was recently reading a report on shale plays, and the Granite Wash Shale had the highest internal rate of return.
JL: One of the reasons that's true is that it is cheaper to drill in that area than it is in, say, the Haynesville area. You're talking about $3 million in the Granite Wash versus like $7 million in the Haynesville or Marcellus. That's one of the selling points: it is much more economical than a lot of other areas in the states.
TER: The NGLs are playing a role in that, too, right? It's a fairly liquid-rich play; but maybe not as much so as the Eagle Ford.
JL: The natural gas liquids are becoming much more attractive to Chinese companies as well.
TER: Are you more partial to the oily names or the gas names right now?
JL: I am more partial to the oily names that are becoming more diversified companies by beefing up their exposure to natural gas, as well as by other means, including solar. Some of the oil companies have relied too long on mature assets. A lot of these companies need a fresh injection of life. In today's marketplace, if you're not embracing alternative energy sources and cleaner energy—and natural gas is extremely clean—then you're probably doing yourself and your shareholders a disservice.
TER: Something else that is gaining momentum is liquefied natural gas (LNG). You have done some research on what's going on in Egypt.
JL: It's not all liquefied natural gas in Egypt. Some of the plays are just flat out gas fields that they're looking to cultivate. Whether it's liquefied natural gas or just pure gas, I think that Egypt is a very interesting play. I have written a note called "Egypt, the Real Jewel of the Nile." I am absolutely amazed at how their strategic location could help Europeans get more gas through LNG or through a pipeline from Turkey that might get the green light by the end of this year. If that happens, then Egypt could become strategic in the natural gas world primarily because they could help the Europeans lessen their dependence on Russia for gas supplies. In recent years Russia has pretty much held many Europeans hostage in terms of gas, which has caused them to pay higher gas prices at very inopportune times like a very cold winter or a very hot summer. I am very excited to be at the forefront of research in that area.
TER: Some of that LNG from Egypt could go to China and India, right?
JL: Egypt is very fortunate in terms of its location. They can actually sell a lot of natural gas and transport it to Asian markets.
TER: And LNG sells at a premium there.
JL: It can fetch a very large premium because the Asians are looking for many different alternative energy sources. They're looking for gas because they realize that to move forward as leaders in the global economy, they need to get cleaner energy sources. Getting LNG from an area such as Egypt could be very, very beneficial to them, regardless of the premium that they're paying. It's my view that natural gas is the most attractive energy source we have, and that's globally.
TER: Do you have some price projections for gas through 2011?
JL: I haven't yet released my forecast for 2011, but I have an aggressive target of about $5.50 on natural gas for the end of this year. It's actually starting to get more into my range if you look at the back months trading on the NYMEX. I think that's very credible. As for next year, I think that's going to be very dependent on—and this relates to oil, too—the recovery of the employment picture not only in the United States but also abroad. I would like to better assess the landscape here at the end of the year before I start making definitive calls for 2011.
TER: Alright, what about oil?
JL: Yes, it's the same for oil. In January, I wrote a report that said oil was going to hit $87. Well, we hit $87, and we have come off since. Unless we get a really positive turn in the employment picture in this country or we have a storm that knocks out production, I think we've seen the highs in crude oil for this year.
don't think oil prices can be sustained above $90 this year. It doesn't seem credible, but for 2011, I would not be surprised if we see triple digits in crude oil again.
TER: Are we going to finish 2010 over $80?
JL: You know what? I think we will finish the year over $80. I am hopeful that at the end of Q3 and Q4, we're going to start to hear about better hiring trends, and that's going to help with demand. OPEC is really watching those prices but is not able to do anything in terms of their supply and production metrics. I think OPEC becomes a non-factor. If demand is going to increase, and supply is going to stay where it is, it makes me think that oil can very comfortably stay above $80. But I would be shocked if we end 2010 over $90.
TER: There are some plays at the refinery end that you have been researching. Tell us about those.
JL: I think the refinery business has been challenged in recent years because of pressures on the margins. We've seen that crack spreads have deteriorated over the last couple of years, but it's my opinion that the worst is over. Companies have done a very good job of cutting back output at strategic times. I think those that were able to capitalize on the misfortunes of others are set for brighter days.
TER: Crack spreads?
JL: The crack spread is the difference between the price for a barrel of crude oil, and what you can get by breaking that oil down into refined products like heating oil, jet fuel, diesel or countless others.
TER: Any final thoughts on the oil and gas sector?
JL: The companies involved in the cleaner side of the energy landscape are going to do very well moving forward. Natural gas historically trades at a discount to oil of between of 10–12 times; right now we're about 19 times below. That gap is going to narrow with natural gas prices moving higher. I think that prices could be comfortably higher a year from now.
And most people are not focusing on the congressional elections in November, but it's my belief that many of those races will be determined on stances related to cleaner energy. On the heels of the BP oil spill, I think that we're going to see a more concerted bipartisan effort to focus on cleaner energy. We have a really amazing opportunity in our lifetime to improve our domestic sources of alternative energy and lower our reliance on Middle Eastern oil. To me, that time is now.
TER: Thanks, John, for your insights.
John J. Licata is chief commodity strategist at Blue Phoenix, Inc., an energy/metals independent research and consulting firm based in New York City. He has appeared regularly in the media (CNBC, Bloomberg TV/Radio, Business News Network, Barron's, etc.) over the years for his insights and forecasts in the commodity spectrum.
After studying economics and graduating from Saint Peter's College (where he received The Wall Street Journal Award for economic excellence), Licata set his sights on Wall Street. During his more than 15-year career, John has held both trading and research positions on the NYMEX, and at Dow Jones and Smith Barney. Early in 2005, he founded Blue Phoenix, a leading independent research and consulting firm focused on energy and metals. John is also the editor of The Commodity Chronicles, the Blue Phoenix energy and metals newsletter (click here to receive a 30-day trial membership). John is currently in the EMBA program at New York University's Stern School of Business, and was recently voted "Up and Comer Natural Gas Analyst" in the 2010 Institutional Investor All-America Research Team Poll. You can follow John on Twitter and LinkedIn. Streetwise - The Energy Report is Copyright © 2010 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part. The Energy Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report. From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise. Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported. Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734. Participating companies provide the logos used in The Energy Report. These logos are trademarks and are the property of the individual companies.
-- Posted Wednesday, 11 August 2010 | Digg This Article | Source: GoldSeek.com
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