"{I've spent the past three days at the Las Vegas Money Show giving a series of presentations and attending several panel discussions. The show was well attended and, as always, I enjoyed meeting subscribers and discussing all things energy.
As always, one of the most enjoyable and useful aspects of the show from my perspective has been the question and answer (Q&A) sessions that follow each of my presentations and panels. These questions give me a window into what investor sentiment is toward energy and various sub-sectors.
For today's issue of The Energy Letter , I've pieced together some of the more common questions I was posed at this week's show and my answers to each query:
Question: Why are oil prices rallying when oil inventories are near record levels in the US? Is it simply speculation or a false dawn?
Answer: Markets are not a simple reflection of current market conditions but are forward-looking, always trying to discount expectations for the future. Oil prices are rallying because recent data suggests global demand for crude will begin to recover this year as supplies continue to dwindle.
As I've written recently, data out of the US suggests that the economy is stabilizing. While the US is still mired in a recession and will be for some time longer, I suspect we'll see the beginnings of a tepid recovery by the end of 2009. In last week's issue of PF Weekly and in the April 27 PFW , I outlined some of the data I'm watching that point to this recovery.
Meanwhile, most of the demand growth in the oil markets in recent years has come from emerging markets such as China and India, not the US. The Chinese economy is mounting a more robust recovery than even the bulls would have imagined a few months ago.
Goldman Sachs (NYSE: GS) recently revised its forecast for Chinese economic growth--Goldman is now looking for 8.3 percent growth in 2009 and 10.9 percent in 2010. This is a significant upside revision when you consider that Goldman was previously looking for Chinese growth of just 6 percent this year. Goldman is just one of several prominent investment banks to raise GDP forecasts for China in 2009.
I've been arguing that the Chinese economy is recovering at a faster-than-expected pace for some time. In the May 1 PF Weekly I interview my long-time friend and colleague Yiannis Mostrous, editor of Emerging Markets Speculator .
Yiannis has been absolutely dead-on about China since late last year. Even as most pundits argued that China would see only 6 percent growth in 2009, Yiannis has been calling for 8 percent growth. The Wall Street consensus now appears to agree with him.
As for supply, drilling activity came to a standstill in most markets as oil prices slumped under USD50 a barrel. Even in OPEC, major oil exploration and development projects have been canceled or delayed for years. Ultimately, this means falling oil supplies; some markets such as Russia will see a dramatic drop in production if they don't soon see an up-tick in drilling activity.
Current global drilling activity is not sufficient to support demand from a healthy global economy. Oil prices will likely top USD70 this summer and will need to stay above that level to encourage producers to begin spending again.
One more point is that we may be seeing the beginnings of a tightening in global oil supply. This week's inventory report from the Energy Information Administration (EIA) showed a larger-than-expected drop in both crude oil and gasoline inventories. While it's too early to call that a trend, it does suggest that we'll see inventories normalize in coming months.
Question: I've heard several presenters at this show and other forums forecast natural gas prices under USD2 per million British thermal units (MMBtu). Meanwhile, you're bullish natural gas and are projecting prices over USD6 by year's end. Who's right?
Answer: As I noted in a recent post to At These Levels , my outlook for natural gas prices remains somewhat out of consensus.
Natural gas-levered equities are rallying despite the fact that inventories are rising toward bloated levels just as the market enters injection season, a period of weak gas demand when the US traditionally sees inventories rise. Market participants are beginning to price in the fact that a rapid drop in the US rig count spells a faster-than-anticipated fall in US natural gas supply.
The US gas-directed rig count--the total number of rigs actively drilling for natural gas in the US--has fallen from more than 1,600 at its peak last August to less than 730 today. That's a near 60 percent decline in the gas-directed rig count, an unprecedented decline in activity. Meanwhile, the horizontal rig count, a good indicator of drilling activity in America's prolific unconventional gas shale plays, has fallen from over 650 to 380 rigs.
This rapid decline in drilling activity spells falling gas production, pure and simple. Even most bears would likely agree that the US needs more than 730 rigs to generate growth in gas production.
If I'm right about the economy recovering this year, gas demand should begin to stabilize and even increase by year's end. The current rig count just won't support the production needed to meet more normal US demand. As a result prices will need to rally back toward USD7 per MMBtu to encourage producers to get back to work.
I'm not put off by the extremely bearish pundits out there forecasting USD2 natural gas. This simply means that a lot of traders are still betting against natural gas; as sentiment begins to change on this market, the rally will be dramatic as these bears switch their positions.
Finally, I think we're beginning to see signs of a tightening in natural gas markets in recent data. Over the past six to nine months, natural gas inventories systematically fell by less than analysts expected or rose more than expected. But over the past five weeks, storage figures have been coming in roughly in-line with estimates. The most recent data showed a build in storage that was much less than most had anticipated.
Question: Has President Obama proposed changes to the tax code governing MLPs? Will he?
Answer: The answer to the first part of that question is a resounding “no.” There's a great deal of misinformation among investors due to a handful of totally misleading and inaccurate stories published about MLPs late last year.
However, Mr. Obama's recent budget contains no tax proposals that would change the basic tax-advantaged structure of MLPs. For those unfamiliar with this tax structure, check out the free report I wrote with Roger Conrad on the group.
No one can tell you for certain there won't be changes to the tax code governing MLPs in future. However, right now that doesn't look likely; in fact, Congress expanded the scope of the industry to include renewable fuels as part of the TARP bill passed late last year.
President Obama has, however, proposed raising income tax rates and cracking down on offshore tax havens. A crackdown on corporate tax havens would expose more US companies to America's 39.25 percent corporate tax rate, among the highest in the free world.
Because MLPs don't pay corporate taxes and allow significant tax deferral, they're one way of lowering your tax liability in a world where taxes are generally rising.
Question: It's been a long time since uranium stocks have been hot. You sound bullish on uranium and nuclear power. What are the prospects for uranium, and how do we play the trends?
Answer: I'm turning incrementally more bullish on uranium prices and believe it's time to increase your exposure to the uranium mining industry.
Source: Bloomberg
As I noted in last week's issue of The Energy Strategist (the reference is to the chart above):
This chart shows the spot price of uranium in US dollars per pound over the past few years. As you can see, prices appear to have found a low in the upper USD30s to USD40 per pound, as I projected in the January 21, 2009 issue of The Energy Strategist . This represents the cash cost of production for most major uranium producers, with the possible exception of Canadian giant Cameco (NYSE: CCJ). I still look for prices to recover to the USD60 to USD70 range in coming months.
According to Trade Tech , a firm that publishes data on the global uranium markets, volumes of uranium traded in April surged on a total of 20 transactions reported. Even more encouraging is the fact that Trade Tech reported that utilities were the most active buyers. Utility demand is a far better predictor of fundamental demand/supply conditions than speculative demand from buyers looking simply to profit from a long-term rise in prices. The obvious conclusion is that utilities are grabbing uranium at current spot prices because they feel the price is unlikely to go much lower.
Cameco is the world's largest pure-play uranium producer; it churns out about 20 million pounds of uranium annually out of a total world market of less than 200 million pounds. Its outlook for uranium supply, demand and prices contains invaluable information for investors in the sector.
During Cameco's May 1 earnings release conference call, management offered a number of interesting tidbits. First, during the big run-up in uranium prices back in 2007 the company purchased little if any uranium on the spot market. But in the first quarter of 2009 the company was a significant acquirer, as the following quote indicates:
…[W]hile we are reporting lower net earnings than [the] comparable quarter of 2008, a major component of that changes relates to opportunities Cameco finds in the uranium market. Our reason for purchasing [spot uranium] in the first quarter was for one purpose only, to seize trading opportunities which our marketing staff identified. When we enter the market to take advantage of trading opportunities, we often acquire uranium at prices significantly higher than our production cost. This action results in our reported unit cost of sales being driven higher. And of course that flows through to margins and earnings.
Cameco is simply saying that current uranium spot prices--even at recent lows--are significantly higher than its production costs. When it actively buys uranium, the cost of its inventory goes up; its cost of sales rises and depresses profit margins.
Cameco wouldn't be making these purchases if it felt uranium prices had more downside. The company is essentially speculating that the price of uranium is likely to rise from current levels.
Because Cameco knows a lot more about the uranium market and has more perfect information than I or any other analyst does, I prefer to bet with the company. In other words, if Cameco is buying uranium, you should consider following its lead.
Another interesting comment from the company's call relates to the source of uranium demand. Consider the following:
...I believe that about half of the purchases [of uranium in the spot market] that have taken place have been made by utilities...a good portion of that would have to be attributed to the Chinese. And in their case, they're certainly looking to stockpile significant quantities of inventory for the Chinese program.
It seems that the Chinese utilities are also convinced uranium prices have bottomed and are likely to head higher. The Chinese have been extremely smart and strategic when it comes to locking up natural resource supplies they know they'll need in coming years. It's not a bad idea to follow China's lead into uranium.
One of my favorite plays on this market is Paladin Resources (Australia: PDN, TSX: PDN). The company is an existing producer with production ramping up from its two major mining projects in Africa. Paladin is also a potential target for the Chinese, who've been looking to secure supplies of uranium for their ambitious nuclear reactor program."
http://www.petroleumworld.com/sf09051601.htm
TOE Price at posting:
20.5¢ Sentiment: None Disclosure: Held
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