With 400 million more people set to get on the grid in India alone, smart investors will profit from new demand for all kinds of energy.
In this interview with The Energy Report, Frank Holmes and Brian Hicks of U.S. Global Investors share some of their favorite ways to build a diversified portfolio that takes advantage of opportunities large and small, domestic and international.
The Energy Report: India's new prime minister, Narendra Modi, has pledged to bring electricity to the 400 million Indians currently without power. How is he going to do this, and how can investors get exposure to this massive infrastructure investment?
Brian Hicks: One of our investing tenets is to follow government policy, because that is a precursor to change. Infrastructure investment in India is a long-term theme, and is going to require a lot of raw materials and fuel sources. The power could come from coal and nuclear. It's one thing to generate power; it's another thing to actually distribute that power and get it out to the rural areas. That means a lot of copper to build out the infrastructure grid.
In the end, this will be a massive investment, and there will be a number of ways to play it. I would consider investing in the engineering and construction firms like Fluor Corp. (NYSE:FLR), which could win infrastructure contracts.
TER: China is in the midst of a similar infrastructure build-out. Is that a coal and nuclear approach as well?
BH: Absolutely, and the Chinese are further along than India. China has invested heavily in the power grid. That has resulted in a tremendous ramp-up in production of steel, cement and iron ore, as well as an upswing in copper usage. All go into generating power. Obviously, coal has been fueling much of China's power generation, and will probably continue to do so. The government is trying to pull back on the margin because of pollution concerns, but it will probably be part of the equation for many years to come.
Frank Holmes: The global real gross domestic product annual growth rate has declined from a peak 5.4% in 2010 to 3% last year. With the U.S. economy turning up, constructive news out of China and new leadership in India, the global GDP could rise to 3.5%. This is very positive for commodities from energy to copper to gold. Modi's goal of 400 million people having access to electricity would mean a lot of copper demand and energy consumption.
TER: Aside from China and India, what energy resource areas are poised to do better in the second half of 2014?
BH: We are very constructive across the spectrum for energy. Oil prices are moving above $100/barrel, whether it's West Texas Intermediate (NYMEX:CLN14) or Brent crude (NYMEX:SCN14), and that's going to be very positive for North American energy companies. We are seeing more signs of instability in key producing areas in the Middle East, including Libya and Iraq. That is going to weigh on global supply and keep oil prices well supported. Companies with production in geopolitically safe areas should do quite well in this environment.
We are very positive on natural gas. There has been some complacency about refilling storage after the extremely cold winter, and that should support natural gas prices for the near future. As we get into the summer months, cooling demand could strengthen gas prices again.
TER: We recently published an interview with T. Boone Pickens, and he is very optimistic about the shale oil space and the possibility of oil independence for America. Do you share his optimism?
BH: We sure do. I'm not quite sure about energy independence, but we are certainly making inroads in that direction. Within our portfolio, we are investing heavily in the shales through upstream oil and gas companies, oil services companies and equipment companies. Shale is transformational; it is really changing the energy landscape. Almost overnight, companies are developing resources that are long-lived and repeatable. Remember, only five years ago we were talking about peak oil. Now, we're producing roughly 8.4 million barrels per day. That's the highest we've seen since the mid-'80s. It is a trend that is going to continue.
At present, the Permian Basin is developing just as the Bakken and the Eagle Ford did a few years ago. The Delaware Basin, in particular, could be larger than what we've seen in the Bakken and Eagle Ford combined. It looks like we will be able to unlock millions of barrels of reserves, and increase production from that historic base. The Delaware is a very exciting example of how technology, innovation and investment have changed the conversation over the last five or six years.
TER: With all that oil and gas coming out of the shales, do you see an opportunity for money to be made in refiners?
BH: We have already had success investing in refiners. San Antonio is home to two of the largest independent refining companies in the country, so we follow that area closely. We also see opportunities for Gulf Coast refiners, such as Valero Energy Corp. (NYSE:VLO). If inventory levels continue to rise, you're going to see a discount between Louisiana light sweet oil, WTI and Brent. With that spread, refiners with Gulf Coast exposure are able to source lower feedstock costs for crude oil, refine it into gasoline and diesel, then sell it at competitive global prices. That is very good for margins. And it could be sustainable.
TER: What about the majors versus the junior explorers and producers? Which has better upside?
BH: I think there are opportunities in all of the above. Some majors have tremendous resources. Suncor Energy Inc. (NYSE:SU), in the Canadian oil sands, is going to be producing for the next 40 years or so. The company has put a lot of money into infrastructure to grow production. And it pays a nice dividend yield. It looks attractive on just about any metric.
Juniors are investing in shales domestically and internationally. There are opportunities throughout the market cap spectrum. That is why we take a diversified approach, and look to invest within all those areas.
FH: I love many of the royalty companies, such as San Juan Basin Royalty Trust (NYSE:SJT) and BP Prudhoe Bay Royalty Trust (NYSE:BPT), which offer attractive high yields, growth and rising oil and gas prices.
TER: What companies in the junior oil and gas exploration and production space are poised to take advantage of these trends?
BH: We have some junior companies that have grown so much they aren't very junior anymore. Pacific Rubiales Energy Corp. (PRE:TSX) is now more of a small- to mid-cap company trading in the $6–7 billion ($6–7B) range. But we still see it as extremely cheap.
Other operators in Columbia, such as Gran Tierra Energy Inc. (GTE:TSX), look attractive to us as well. In Europe, Petromanas Energy Inc. (PMI:TSX.V) looks very attractive to us. Frank recently returned from a Petromanas site visit, where he checked out a well being drilled in Albania that looks like it has a lot of potential.
PetroAmerica Oil Corp. (PTA:TSX) also looks very inexpensive, with a lot of potential upside via further exploratory drilling and joint venture development.
FH: PetroAmerica is going through an acquisition, and when the dust settles, it will be an attractive company on all key metrics, with growth in reserves, production and cash flow on a per share basis.
BH: Other areas, such as Kurdistan, have more oil and more proven reserves than Mexico. It's a huge resource space. Gulf Keystone Petroleum Ltd. (LSE:GKP) is drilling for oil in an area with huge reserves. It has the potential to eventually produce as much as 100,000 barrels per day. We think there's tremendous opportunity there.
TER: Are you worried about the conflict in Iraq?
BH: That is something we factor in, but Gulf Keystone is working in the north, where it is safer. At some point the dust will settle, and we will get production out of Iraq and Kurdistan. Therein lies the opportunity. If you take a long-term view and buy assets when nobody else wants them, they are cheap. That is how you can create alpha—by investing within the context of a portfolio so you're not buying a large chunk. You only need to buy a small amount of a stock like Gulf Keystone for it to make an impact.
TER: Any names closer to home that you like?
BH: We used to own Raging River Exploration Inc. (RRX:TSX.V). We almost doubled our money, so we took profits as we entered the second quarter, which seasonally can be a little slow for the juniors. We will look to reload on that name as we get into the fall, and in other names as well.
TER: The Raging River stock price really went up in the last six months. What was pushing that?
BH: We have seen a resurgence in the junior space in Canada, which has been neglected for the last two or three years as development in the U.S. shale plays have taken hold. Now we are seeing a bit of a handoff back to Canada. Horizontal drilling is developing in the Montney and Duvernay formations, and we're seeing companies operating there rise to the top. They are starting to do very well with their own unconventional drilling. We have seen value unlocked, and it's very exciting. A number of companies in the sub-$1B or $500 million market-cap range are starting to grab hold.
TER: What other contrarian opportunities do you see out there?
BH: Large oil equipment and services companies are an opportunity. Companies like Schlumberger Ltd. (NYSE:SLB), Halliburton Co. (NYSE:HAL) and Baker Hughes Inc. (NYSE:BHI) are bundling up smaller companies to provide a one-stop shop. That is attractive.
Pressure pumping prices are starting to move up. On the drilling side, more rigs are being contracted into the Permian Basin. A company like Patterson Energy Inc. (NASDAQ:PTEN) should benefit from that. A smaller operator, such as the Canadian drilling company CanElson Drilling Inc. (CDI:TSX.V), also has exposure to the Canadian sands and the Permian Basin. It is benefiting from those two growth areas.
Moving down the market cap spectrum, Xtreme Coil Drilling Corp. (XDC:TSX) is doing quite a bit in the Eagle Ford. Higher-spec coil tube drilling is starting to catch on down in that area. I recently returned from a site visit with Xtreme Coil in the Eagle Ford, and it looks like the company is doing quite well. Xtreme recently announced it is going to expand its XSR coil tubing fleet in the U.S. by six additional units, costing $54M.
TER: The Global Resources Fund (PSPFX) was up almost a percent for the first three months of 2014, after a couple of negative years. It's tilted strongly toward oil and gas. Is that part of a strategy to move toward energy stocks?
BH: We are overweight in oil and gas. We have some conviction in that area, and we feel like there's more running room. We've shifted at the margin, but we're holding steady. We're in an environment where we might see more volatility in the summer months due to instability overseas, so we are keeping a little bit of dry powder.
TER: Do you have any advice for readers looking to adjust their energy portfolios going into the rest of 2014?
BH: I would focus on the shale plays; the companies in the core regions within these plays. There are opportunities in the juniors—in the small- and mid-cap spaces in North America—that should continue to do well. There are probably attractive opportunities overseas as well, so keep an eye out for those. Overall, it's going to be a very constructive environment for energy investing.
TER: Thanks to you both.
Frank Holmes is CEO and chief investment officer at U.S. Global Investors Inc., which manages a diversified family of mutual funds and hedge funds specializing in natural resources, emerging markets and infrastructure. The company's funds have earned many awards and honors during Holmes' tenure, including more than two dozen Lipper Fund Awards and certificates. He is also an adviser to the International Crisis Group, which works to resolve global conflict, and the William J. Clinton Foundation on sustainable development in nations with resource-based economies. Holmes coauthored The Goldwatcher: Demystifying Gold Investing (2008). Holmes is a former president and chairman of the Toronto Society of the Investment Dealers Association, and he served on the Toronto Stock Exchange's Listing Committee. A regular contributor to investor education websites and a much-sought-after keynote speaker at national and international investment conferences, he is also a regular commentator on the financial television networks and has been profiled by Fortune, Barron's, The Financial Times and other publications.
Brian Hicks joined U.S. Global Investors Inc. in 2004 as a comanager of the company's Global Resources Fund (PSPFX). He is responsible for portfolio allocation, stock selection and research coverage for the energy and basic materials sectors. Prior to joining U.S. Global Investors, Hicks was an associate oil and gas analyst for A.G. Edwards Inc. He also worked previously as an institutional equity/options trader and liaison to the foreign equity desk at Charles Schwab & Co., and at Invesco Funds Group, Inc. as an industry research and product development analyst. Hicks holds a master's degree in finance and a bachelor's degree in business administration from the University of Colorado.