Which ‘Black Energy’ is the Best Bet for 2015?

Wednesday, 1st October 2014

Melbourne, Australia

By Kris Sayce

  • A different take on the Periodic Table
  • Everyone hates coal
  • From the mailbag

Yesterday’s Financial Times reports:

The US is overtaking Saudi Arabia to become the world’s largest producer of liquid petroleum, in a sign of how its booming oil production has reshaped the energy sector.

I covered this in today’s Money Morning.

It’s amazing how far the US has come in terms of its energy supply and demand over the past 15 years.

It only seems like yesterday that the US worried about an energy crisis almost on a daily basis. News reports would update the public on the size of the US government’s Strategic Petroleum Reserve (SPR).

The US was in so much trouble that analysts would call on the government to release ‘stockpiled’ reserves. They said that was the only way to cut the oil price and help the US economy.

Today, the SPR is more of a propaganda tool than anything else. It’s to show the world that if it wants, the US can control oil supply and the oil price by releasing supply from the SPR.

As Reuters noted in March this year:

The United States will hold the first test sale of crude from its emergency oil stockpile since 1990, offering a modest 5 million barrels in what some observers saw as a subtle message to Russia from the Obama administration.

Sales from the SPR 10 or 15 years ago would have caused a much different reaction than it would today.

It’s all down to the US’s new position as a key oil supplier, not just a key oil consumer.

And the big reason for this new position is the US’s shale oil and gas boom.

To most in the mainstream, the idea of shale energy is fairly new. Few have heard of it. And if they have heard of it, it’s because of the negative news stories about hydraulic fracturing (fracking).

Yet, US energy companies began developing the technology and exploiting shale resources more than 50 years ago. So it isn’t new. What is new is the commercial exploration and production of shale oil and gas.

While the oil price languished at US$20 a barrel, it just wasn’t viable to drill shale formations. It was too expensive.

But when the oil price began to climb, and with it staying around US$100 a barrel, it’s now viable.

Now the US is a major energy producer and exporter once more.

So, it’s a good time to invest in the shale oil and gas industry, right?

Yes…and no.

I’m not about to tell you to avoid oil and gas. The oil and gas industry is the most exciting and lucrative of all the commodities.

I know many folks like punting on little gold stocks or base metals or some other commodity. But give me oil any day.

However, remember one thing. The shale story isn’t new. Contrarians have watched this sector for at least the past 10 years. That helps explain some of the amazing price moves for companies involved in shale oil and gas.

But the mainstream hasn’t realised this yet. They think shale is a new story. John Dizard writes in the FT:

Shale oil and gas producers have, arguably, saved America’s industrial future and global strategic position. They are not doing quite so well for their investors.

Shale didn’t save the US this year. Shale really started to impact the US economy 10 years ago.

The article picks out three US shale exploration and production companies: Range Resources [NYSE:RRC], Cabot Oil & Gas [NYSE:COG], and Chesapeake Energy Corp [NYSE:CHK].

The article notes that these stocks haven’t done so well this year, and that shale has been a bad bet for investors.

So far this year, those three stocks are down 18.4%, 15.3%, and 15% respectively.

The article goes on to talk about profit margins and regulatory issues. It even mentions the potential for rolling blackouts if the US government doesn’t fund pipelines.

In other words, the FT completely misses the point on the shale boom. It’s not that shale energy has been a bad investment; it’s just that the mainstream has arrived on the scene late…as usual.

To prove my point, check out the following chart. It shows the performance of the three companies mentioned above. The price data goes back to 1999:

Source: Google Finance
Click to enlarge

Since 1999, these stocks are up 2,610%, 2,389%, and 2,063% respectively.

That’s a much better return. It’s not that shale oil has been bad for companies or investors. It’s about when investors become aware of it and when they could speculate on it.

If you only found out about shale this year you would rightly be disappointed with the returns. But if you knew about shale in the early to mid-2000s, it’s likely you would have a far different view.

That’s the key to contrarian investing. You should look to invest in stock stories when few others are interested in them.

That’s why each year I make a point of checking out the US Global Investors’ ‘Periodic Table of Commodities Returns’. It shows you where the hot money has been in recent years and where it could go in future years…

A different take on the Periodic Table

Note that the table of commodities returns reflects the performance of the commodity itself. It doesn’t reflect stock prices.

As the table shows, investors were hot for natural gas (up 26.23%) in 2013. Investors were icy cold for corn, which fell 39.56%.

But the commodity to look at is oil. In 2013, it gained 7.19%. The previous year it fell 7.09%. But what you’ll notice is that the oil price hasn’t had a truly big drop since 2008 when it fell 53.53%:

Source: US Global Investors
Click to enlarge

Of course, while useful, the chart doesn’t show the whole picture. For instance, for the year to date the crude oil price is flat. Yet, it has fallen 15% since the end of June.

If the oil price stays where it is for the rest of this year, the Periodic Table of Commodities Prices won’t reflect this intra-year volatility.

But if history is a guide, it could suggest crude oil is heading for a weak period. That could see the price fall further. That doesn’t necessarily mean bad news for oil stocks. Any oil discovery should result in a big share price spike.

But it could have an impact on the viability of the US’s shale gas industry. Although, resources analyst Jason Stevenson doesn’t see a price fall as likely. He’s backing crude oil to nudge US$150 per barrel next year. More from Jason below in reply to a reader email.

If nothing else, the Periodic Table is a great starting point for ideas. You don’t need to look at this table to know one commodity has taken a beating this year. It’s firmly on the nose as far as it concerns investors.

I’m not talking about iron ore; instead, I’m talking about coal.

Everyone hates coal

Since the start of the year, the Australian thermal coal price is down 18%. The main use for thermal coal is in power generation.

Coal is a big target for the green lobby groups. Emerging markets analyst Ken Wangdong has written about the poisonous atmosphere in China’s megacities due to vehicle and power station pollution.

Coal (and other fossil fuels) are so on the nose that a number of philanthropic and endowment funds are selling out.

The Rockefeller Brothers Fund and other groups plan to sell US$50 billion-worth of investments in fossil fuels. This number likely includes the Stanford University endowment. It has said it will sell US$18.7 billion-worth of coal mining assets.

They won’t be the first, and they won’t be the last.

Coals stocks have taken a hammering. ASX-listed New Hope Corporation [ASX:NHC] is down 34.7% over the past year. Coalspur Mines [ASX:CPL] is down 88.4% over the past year…including a 23.3% drop today.

It’s a neat PR move to sell coal assets and talk up green energy. But before folks rush to give coal its last rites, just think about this note from the (clearly biased) World Coal Association website:

Coal provides around 30.1% of global primary energy needs, generates over 40% of the world’s electricity and is used in the production of 70% of the world’s steel.

Despite its importance, everyone hates coal. That makes it a ‘must watch’ commodity for 2015.

From the mailbag…

Let’s get back to oil. Yesterday, resources analyst Jason Stevenson published the latest monthly edition of Diggers and Drillers. He covered the impact of war in the Middle East on the supply and demand for oil.

In simple terms, Jason puts it down to politics, money and arrogance. In response to the issue, reader David wrote:

A great edition. But you do not refer in your analysis the significance of Azerbaijan and its gas pipeline, which bypasses any of the Middle East countries you mention — via Turkey and Georgia, I think.

Only recently I learned that the defining battle on the Eastern Front (in WW2) at Stalingrad was really about who would have access to the energy of Caspian Sea off Baku. Whoever got Baku won the war in Europe on the eastern front.

From your research, do you have a sense of the importance of the pipeline from Baku to the geopolitical situation you describe?

Jason replies:

I’ll cover this topic in more detail in next week’s Diggers and Drillers weekly update.

But to be brief, Western sanctions on Russia are utterly moronic. In my view, these sanctions will backfire hard. It’s likely that, come this European winter, Russia will fight back and turn off the gas to Europe.

This action would send the bond market into panic and crunch what’s left of Europe’s economy. It would be the starting point that sends Europe down the road to massive sovereign debt defaults.

Russian sanctions are magnifying geopolitical risk to another level. The whole region is a strategic hotspot…and every pipeline is a bargaining chip. Crude oil is fast on its way to US$150 per barrel.

I like to call it the ‘Black Energy’ wars. Crude oil or coal? Which does the green lobby hate most?

If that many people hate oil and coal, it has to be something worth looking at closely. Jason is already on the case. I’m not far behind him.

We’ll be back with more from Port Phillip Insider tomorrow.

Send your comments, questions or vitriol to letters@portphillipinsider.com.au and type ‘Port Phillip Insider mailbag’ in the subject line.