-- Posted Thursday, 20 December 2012 | | Disqus
Source: Brian Sylvester of The Energy Report
Byron King, editor of the Outstanding Investments and Energy & Scarcity Investor newsletters, is expecting surprises in the energy sector in 2013. In this interview with The Energy Report, King discusses his forecasts for fracking's impact on oil and gas prices, a worldwide uranium shortage and a possible change in the economics of alternative energy sources.
TER: Let's get to what you're calling "taxageddon." How will this affect investors?
BK: When the tax code changes dramatically on Jan. 1, a lot of people are going to feel the sting. We'll get hit by that 2% increase in the FICA Social Security in every paycheck. The capital gains tax rates will effectively double on Jan. 1, including the Obamacare increase. The personal rates will go from 15% to the 30–35% range. It's a big hit.
TER: Are you managing the Outstanding Investments portfolio differently than you were a year ago? Are there more yield-bearing stocks in that portfolio?
BK: In the last year, I've focused more on identifying yield-bearing stocks.
TER: In recent editions of Energy & Scarcity, you have discussed declining rates at fracking wells across the U.S. Do you believe this is an across-the-board problem or is it limited to certain plays or geology?
BK: It's pretty much all of the shale gas wells. A fracked well that does not decline quickly is truly the exception. Last week, at a conference at the University of Texas, the overall decline rates that were tossed around were absolutely shocking. The decline rates on wells in their first year are in the range of 35–40%, and it is a similar number in the second year. By year two, a company will have produced perhaps 75% of the ultimate recoverable hydrocarbon out of a well.
It utterly wrecks the economics of a gas well to produce most of its output up front, during a low-price environment. These frack plays are astonishing wells, in a technical sense, but the economics are very problematic.
TER: If the production rates are rapidly declining and there is not as much natural gas as first thought, won't that ultimately lead to higher natural gas prices?
BK: Natural gas prices are already starting to climb back up. About a year ago, the number of rigs devoted to drilling for gas fell off a cliff. I am bullish on natural gas in general. The natural gas price could double to the $7 range within the year.
TER: Most natural gas is used to heat homes and to create electricity at large utilities. Could declining output from fracked natural gas wells ultimately be a boon to green energy sectors like solar, geothermal or wind?
BK: Cheap natural gas has completely altered the economics of the electric utility system in North America. Natural gas base rates are now considered the number to beat, even when people are proposing nuclear power. That's a very odd dichotomy because a natural gas well can be set up and generating electricity in a few years. With nuclear, it can be a 25-year process to acquire a site, get the permitting and navigate the maze of regulation and public acceptance for a reactor. What may be a temporary glut of natural gas is truly altering the long-term investment climate for nuclear power.
TER: Are you less bullish on uranium plays as a result?
BK: I'm bullish on uranium because there's not going to be enough new uranium mined and milled to meet demand. China has an aggressive plant-building program. Every one of those plants needs to lock down a 20- to 30-year supply early in the development cycle. There are not enough new mining plays coming on to supply that.
An entire level of uranium supply is also going to go away in a year. Russia is not renewing its agreement with the Megatons to Megawatts program, which purchased nuclear reactor fuel that had been converted from enriched uranium in old nuclear weapons.
TER: The green energy sector is in the midst of hard times. It's had more downs than ups during the past few years. How would you characterize alternative energies right now?
BK: The renewable energy space has been very frustrating for most investors. It's not to say that you can't produce energy using solar, wind or geothermal. Of course you can. But it gets back to that well-known critique about how, when the wind doesn't blow, you have no power. When the sun doesn't shine, you have no power. What's the answer?
Europe has a lot of wind and solar power. It creates so much power during windy and sunny times that it actually disrupts the fossil fuel baseload within Europe. Yet, for every windmill and solar field, Europe still needs fossil fuel backups to kick on if the alternative source goes down. This kind of overdevelopment of so-called renewables may feel good to the green side, but it has completely disrupted the economics of a lot of utilities across Europe. Many European utilities have ceased being investment-grade assets.
We haven't built renewables to that scale in the U.S. If we do, we would have a similar problem. Rapid overbuilding of green power will degrade the investment quality of many public utilities, which are among the few things that pension funds and institutions can still count on. It's something that investors need to keep an eye on. We blew up the stock market in 2008 with a housing meltdown. Do we want to risk blowing up the market again with a utility meltdown? We're not there yet, but we could be on that track.
The Holy Grail for renewable energy is backup battery storage that charges up batteries for continued use after the wind or sun dies down. I've been focusing on a vanadium redox battery that's very intriguing and scalable. It's capable of storing immense amounts of electricity.
TER: They're only being used right now in Japan, right?
BK: The Japanese are leading the charge of commercializing it. The Chinese are close behind. In the U.S., it's the typical story of caution and underinvestment, relating to the problem of industry working with public utility commissions (PUCs). Will the PUCs of America build this new tech into the rate base?
Nobody wants to be the first one to approve a vanadium redox battery system for a public utility. People don't want to put their necks on the block. But I suspect that a lot of people would love to be the second players at bat. Unfortunately, we are very risk averse in the U.S., whereas Japan and China are charging ahead—if you'll excuse the pun. Looking ahead, if we crack the code on reliable, large-scale storage, it could truly alter the economics of alternative energies.
TER: If you were to speculate on which one of those renewable energy sectors will be the first one to be commercially viable, where would your money be?
BK: Solar panels are becoming less costly, which is improving the economics for use on a much larger scale. It will be geography dependent. The sunny Southwest and West regions ought to see solar penetration the soonest and in the greatest degree. The idea that there could be a solar-powered Boston or Minneapolis is probably not as realistic.
TER: One issue with solar is the lack of baseload power. That's a big advantage of geothermal over solar. However, if you want to talk about frustrated investors, look at geothermal energy.
BK: I started out Energy & Scarcity Investor with a number of geothermal ideas. I truly believed that these things were on the way up, but the technical problems and capital requirements have been absolutely overwhelming.
TER: Geothermal is working in Central America. Why isn't it happening in the U.S.?
BK: It's started to happen here in certain areas, such as Nevada. I drove by a geothermal facility on Interstate 80 when I was in Reno recently. Where it works, it works well. But it's getting it to work that's the hard part. The foremost reason is that there are few geologists and engineers who understand this space. It's tough to build a technical team and keep the lights on long enough to make it all work. It's been very frustrating.
Even more frustrating is that geothermal is struggling to spread in an environment that is supportive of renewable energy. California and Nevada state legislatures are telling the public utilities to have a certain percent of power coming from renewables by certain dates. The Obama administration and the Environmental Protection Agency are supportive at the regulatory level. There are tax benefits and low interest rates. Still, the geothermal space has not worked out.
TER: Have you stopped following geothermal companies?
BK: I haven't stopped. I just don't spend a lot of time on them. There are too many other ideas that offer a better return on investment.
TER: To conclude, what investable themes in energy should investors look for in 2013?
BK: In terms of oil and gas, people should look for surprises. I'm forecasting that oil prices are going to rise. There are conventional oil plays that still offer excellent returns to investors.
Natural gas prices are also going to drift up as the year goes on. The rapid depletion rates on fracked wells from the past two and three years are going to kick in, and probably with a vengeance.
There could be interesting breakthroughs in the alternative space. 2013 could be the year when investors start to better understand energy storage. This could be the year that the investing community is going to begin to realize it's out there and that could lead to the beginning of a rebound in the solar and energy storage spaces.
TER: Will we see a dramatic rise in uranium prices in 2013?
BK: I think the spot price will start to drift up late in the year. People are going to have a lot more on their plates to worry about in the first six months of the year. For some strange reason, a lot of investors have allowed their investment horizons to shorten up. What people ought to be worried about now is that at the end of 2013, there is going to be a big uranium shortage worldwide. It will happen. I don't think that it cannot happen.
Byron King writes for Agora Financial's Daily Resource Hunter. He edits two newsletters: Energy & Scarcity Investor and Outstanding Investments. He studied geology and graduated with honors from Harvard University, and holds advanced degrees from the University of Pittsburgh School of Law and the U.S. Naval War College. He has advised the U.S. Department of Defense on national energy policy.
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