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-- Posted Sunday, 19 September 2010 | | Source: GoldSeek.com
Eric Nuttall, portfolio manager of Sprott Asset Management's Energy Fund, believes there are opportunities in both oil and gas, regardless of commodity prices. "I'm entirely agnostic when it comes to the commodity price. It all comes down to the valuation," Eric explains. He seeks companies with existing production priced at a reasonable multiple and, as he puts it, gets all the exploration upside for "free" in this exclusive interview with The Energy Report.
The Energy Report: Eric, please give us an overview of what's been happening in the oil and gas sector since we last talked with you in May.
Eric Nuttall: Last time we spoke, I was pretty cautious on the space both because of the macroeconomic data points that we were getting and a pretty negative outlook on both natural gas and oil pricing. That's remained relatively constant. It's an extremely difficult environment to navigate when you're looking for strong performance.
Generally, I still think there's quite a bit of headwind for oil and natural gas stocks. Most of the data points that we see seem to suggest that there's a deterioration in the overall economic well-being in the United States and globally. That has a profound impact on the demand for crude oil. We've seen oil prices soften from the mid-$80s down into the mid-$70s. I think for the next year to two we're looking at a pretty tight range, with a floor of about $70 and a ceiling about $85, because of weak global demand, multi-decade high inventory levels in the U.S. and OPEC sitting on roughly 5.6 million barrels a day (bpd) of spare capacity.
Roughly speaking, you would need about a 12% expansion in global GDP to bring that 5.6M bpd number down to a more reasonable 2.5–3M bpd. It's my guess that that would take another two years or so. Until then, I think there's a plentiful amount of oil. Any time oil approaches the mid-$80s, OPEC will just turn on the taps and bring on more oil to an already oversupplied market. It's really a call on global GDP expansion. That's what you need. It's more a demand question than it is a supply question.
The outlook for non-OPEC supply growth beyond the next year is pretty cloudy. A lot of non-OPEC projects have been brought on this year; we're looking at about a 700,000-bpd increase in 2010 from non-OPEC sources, which is pretty strong, certainly stronger than people would've anticipated a year or two ago. However, we still continue to believe that we're going to be hard pressed to increase global production beyond 87–90 million bpd.
TER: In terms of natural gas, there's some opposition to exploration fracking in some states, especially in New York and Pennsylvania, where there are some large shale plays. Can you comment on those concerns and how they could affect the gas price?
EN: I think it's really important and it's impacting some producers in some of the northeastern states, such as New York, where there's a fracking moratorium, and in Pennsylvania, where there are growing concerns. But we need to separate fact from fiction. Politicians are not involved in the industry, so they're obviously somewhat amenable to suggestions from the lobby groups countering the oil and gas business. I'm not an engineer, but about 98% of fracking fluid is water and sand. Beyond that, there are some chemicals in diluted quantities.
Secondly, the distance of separation between the zones being fracked and an aquifer often surpasses 5,000 ft. Sometimes the distances are as high as 8,000 ft. It's somewhat beyond me to imagine that a vertical frack plane can permeate that much rock when no producer has permeated more than 200 ft., let alone 2,000 ft.
It's my initial impression that there's a lot of overhype and a lot of ignorance. That just means the public needs to be educated about fracking. I know the industry's working hard at that, but it's going to take time. For politicians, it's much easier for them to have a moratorium or to slow down development until they have 100% of all facts.
TER: Perhaps, but perception is often reality. Could those fears impact the gas price?
EN: Potentially, but I really don't think they will. We've mostly seen concerns in the northeastern U.S., where it would impact development of the Marcellus Shale. We're seeing that now in New York, where the Marcellus is totally on hold. However, in other states, such as Louisiana, which has a slightly more mature oil and gas business, I don't think you're seeing nearly as much environmental opposition.
And it's not just pollution in groundwater. There are concerns about emissions from the drilling rigs and that type of thing. Personally, I think it's overblown. Is it going to impact the overall short-term supply? I don't think it will. We're certainly not seeing that. The most recent data I have is for the first week of September, and natural gas production's up about 4 billion cubic feet (BCF) a day in an already oversupplied market.
TER: What are your gas projections then over the short term?
EN: I'm more bearish on natural gas at least from a historical pricing perspective. I think there's been a total paradigm shift, which still isn't being appreciated by the market in terms of the changing economics and the price needed to bring on reasonable amounts of supply. Historically, we would've thought that a $7.00, $8.00 price was required for a reasonable rate of return. The overall required price threshold has dropped to a ceiling of $5 and then a lower band of about $4 in short-term pricing. NYMEX pricing is at about $3.56. Canadian gas is in the low $3s. I don't think that's sustainable. But until we see more discipline from producers in terms of reducing the rig count, I don't see any upward pressure on the price of gas—certainly not above $5, which I think over the next two years is probably a very reasonable ceiling. TER: In terms of an investment thesis, are you looking for companies with an oil and gas mix or leaning more toward the oily names?
EN: I'm entirely agnostic when it comes to the commodity price. It all comes down to the valuation. What's important, especially for natural gas companies right now, is that they absolutely have to be low-cost operators. They also need some critical mass because there's been an evolution in the nature of the wells that we're drilling. Typically, a horizontal multi-stage frack well is going to cost around $3.5 to $4.5 million. If you're a little company, you can only afford to drill a few wells a year. If that's the case, you better hope that they all hit. I'm trying to target companies that if they're going to be "gassy" are producing around 10,000 barrel of oil equivalents (BOE) a day, because they'd better be able to generate enough cash flow to fund an adequate drill program. But when it comes down to whether I favor oil or gas, it's pretty irrelevant. It comes down to each individual opportunity.
TER: Do you have some parting thoughts on the sector that you'd like to leave us with?
EN: There are times to be offensive and times to be defensive. Now, given the level of uncertainty when it comes to both the economy and the underlying commodities, I think it's time to be somewhat defensive. My fund is currently carrying a healthy cash weighting of about 17% and then a short weighting of about 5%. I'm seeing opportunities in shorting. But at the same time it's important to distinguish that you don't have to be a bull on the underlying commodities to be bullish on individual investment opportunities. We still see quite a few opportunities in that small- to mid-cap space where the companies aren't totally relying on the commodity price increasing to get the share price moving. You need to focus on stocks with underlying catalysts, either the ability to grow production or delineate some type of resource that will get the stock to appreciate.
Eric Nuttall is a portfolio manager with Sprott Asset Management (SAM). He joined the firm in February 2003 as a research associate and was subsequently promoted to research analyst in 2005, associate portfolio manager in 2008, and then to portfolio manager in January 2010. Eric is co-manager of the Sprott Energy Fund along with Eric Sprott, and also co-manages the Sprott 2010 Flow-Through Limited Partnership with Allan Jacobs. In addition to his responsibilities for those two funds, Eric supports the rest of the Sprott portfolio management team with identifying top performing oil and gas investment opportunities. Further, Eric contributes towards internal macro energy forecasts, and his insight into emerging unconventional plays has been covered in several financial publications such as The Wall Street Journal, Asia and Barron's. Eric graduated with high honors from Carleton University with an Honors Bachelor of International Business. 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, nor does it endorse or recommend the business, products, services or securities of any industry or company mentioned in 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 Sunday, 19 September 2010 | Digg This Article | Source: GoldSeek.com
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