Oil, Nuclear And Alternatives
The Proven Reserves also showed the least volatility of any of the Portfolios; this Portfolio held steady during the late-February selloff that infected most stocks and then rallied nicely into early March.
The growth-oriented Wildcatters Portfolio performed slightly better than that, returning about 10.25 percent for the quarter, extending the strong performance witnessed late in 2006. This Portfolio was aided by the strong showing from my internationally levered oil services and equipment names, such as Schlumberger and FMC Technologies, up 13.2 and 9.7 percent, respectively, in the first quarter.
But the real star of the first quarter was, once again, the aggressive Gushers Portfolio, up slightly more than 21 percent over the same time period. Strong performance from my uranium, biofuels and alternatives field bets supercharged performance once again this quarter.
Although the Portfolio did show the most volatility of the three during the late-February selloff, it never erased more than 7 percent from its first quarter highs. The Gushers went on to outperform handily in March.
For the record, the returns for the Philadelphia Oil Services Index, S&P 500 Energy Index, S&P 500 and AMEX Oil Index were 7.5, 2.1, 0.63 and 2.9 percent, respectively. All three model Portfolios handily trounced those gains.
I started calculating returns for each Portfolio on a week-to-week basis starting at the end of June last year. Prior to that time, I only calculated overall returns for each Portfolio on a quarterly basis. In the chart below, I summarize the Portfolios’ performance in the past nine months.
Source: The Energy Strategist
The key to outperformance over the past year has remained selectivity and the willingness to take on at least some risk. On the selectivity front, consider that the Philadelphia Oil Services Index remains off its May, 2006 highs; however, the best three performing stocks in the index are up an average of more than 30 percent since that time.
Meanwhile, the worst three components are down an average of more than 20 percent. The moral of that story: If anyone ever tells you that all energy stocks move together, ignore them.
On the risk front, I do recommend some of the big integrated oils and MLPs remain my favorite low-risk, income-oriented group. However, those that have chosen to “hide” in the integrated oils have handily underperformed even my conservative Proven Reserves Portfolio over the past six, nine and 12 months.
In This Issue
Although Iran’s been the key headline for the energy markets during the past few weeks, it’s not the only factor driving prices. The monthly oil market report issued by the International Energy Agency (IEA) reveals growing global tightness in crude and refined products supplies. I’ll take a look at this report and detail how it effects Portfolio recommendations.
I’ll also review the rationale behind my nuclear and alternatives field bets and issue updates on several of the stocks recommended in each. I’m also adding two brand-new names to the alternatives group.
So far this year, demand for oil is a lot higher than initially forecast, thanks in part to cold February weather and production cuts. This bodes well for increased activity for oil-related stocks. See Oil’s Well.
Last year’s unusually warm winter didn’t help natural gas prices because of the increased inventory it provided. But this year’s winter, as well as expectations for a rockier hurricane season thanks to La Nina, could make for a better gas market. I’ll be keeping an eye on it. See Natural Gas.
As noted above, my Portfolio holdings have performed incredibly well. Several of the them are uniquely exposed to different areas of the oil and gas markets that should make them great plays going forward. See Playing Oil And Gas.
My field bets have provided a less-risky way to play certain alternative energy sectors. Some have performed well; some have not. I update the nuclear bet here. See Getting Warmer.
Earlier in last quarter, I recommended a new field bet to seek exposure to the alternative energy market–obviously a major topic at the moment. Now that the first quarter is over, it’s time to see how these picks have done, as well as add a couple more. See Alternatives Field Bet.
Note Proven Reserves recommendation Valero LP has changed its name to NuStar Energy. The MLP has also changed its symbol from VLI to NS. The Portfolio has been adjusted to reflect that change.
In this issue, I’m recommending or reiterating my recommendation on the following stocks:
- Alternatives Field Bet
- Uranium Field Bet
- Carbo Ceramics (NYSE: CRR)
- Chevron (NYSE: CVX)
- Dresser-Rand (NYSE: DRC)
- EOG Resources (NYSE: EOG)
- ExxonMobil (NYSE: XOM)
- FMC Technologies (NYSE: FTI)
- Petroleum Geo-Services (NYSE: PGS)
- Rowan (NYSE: RDC)
- Schlumberger (NYSE: SLB)
- Seadrill (Oslo: SDRL, OTC: SDRLF)
- XTO Energy (NYSE: XTO)
Oil’s Well
Global markets remain jittery amid a barrage of conflicting economic and geopolitical news. Meanwhile, however, oil, natural gas and related stocks have been trending higher and handily outperforming the broader averages.
In the past two months, I’ve been turning increasingly bullish on this group, adding a handful of new oil- and gas-related stocks to the Portfolios. I continue to see considerable upside ahead and will be looking to get incrementally more aggressive in the coming weeks.
Some pundits are dismissing the recent oil rally solely as a reaction to heightening tensions between the West and Iran. Geopolitical events can be significant factors, but in this case, Iran isn’t the only force driving rising energy prices. This is obvious from the fact that crude oil, gasoline and diesel prices were all rallying for weeks before Iran’s seizure of 15 UK seamen.
In the most-recent issue of The Energy Strategist, Looking Refined, I highlighted the growing tightness in the supply of refined products. A series of refinery incidents in the US this year slowed production of gasoline and diesel ahead of the summer driving season, a period when refiners are typically looking to build stocks.
Longer term, America’s growing reliance on imports and shortage of domestic refining capacity should be supportive of refined products prices.
But it’s not just the US gasoline and diesel markets that are seeing tightening supplies right now. It’s actually the global crude oil market. Because crude and refined products are truly global markets, we can’t concentrate solely on US inventories; demand and supply in Europe, Asia and the Middle East are every bit as important.
Although not all Organization of the Petroleum Exporting Countries (OPEC) member states are cooperating fully with announced production cuts, the organization has cut oil supplies significantly during the past six months. According to estimates from the International Energy Agency (IEA), total cuts from OPEC since September amount to roughly 1 million barrels per day (b/d).
In fact, according to preliminary data, OPEC cut production by as much as 365,000 b/d from January to February alone. Meanwhile, the same agency estimates that additional non-OPEC supplies for 2007 will amount to around 1.1 million b/d, well off prior estimates of as much as 1.8 million b/d.
The IEA even noted that non-OPEC production estimates have tended to be overly optimistic in the past. There’s a good chance non-OPEC supply growth estimates will need to be cut and revised lower more aggressively later this year.
In the IEA’s widely watched March 13 Oil Market Report (OMR), the agency included statistics for full-year 2006 and January 2007 oil demand, supply and inventories for all Organisation for Economic Co-operation and Development (OECD) countries.
In addition, the IEA discussed but didn’t explicitly provide partial data for February. The broad picture is highly bullish for crude oil. Consider the following quote from last month’s OMR:
Data are always subject to revision, and assessing first-quarter movements based on provisional data for January and partial OECD data for February is far from an exact science–but it certainly shows reason to be concerned. While stock levels in key products such as gasoline and distillate fuel are on a par with last year, and crude stocks only appear tight in Europe, these are inventory levels that were associated with higher and sharply rising prices last summer. Moreover, both the speed of the stock fall and the fact that crude inventories are drawing counter-seasonally is of greater concern.
Atlantic Basin refiners typically build crude stocks in the first quarter so they can hit the ground running to build product stocks for the driving season when maintenance has finished. This year they could end seasonal maintenance with both lower product stocks and lower crude stocks.
Prevailing targets give the producer group the flexibility to tighten supplies by another 1.0 mb/d. In reality, stock trends and prices are signaling that higher OPEC exports will be needed in the months ahead.–IEA Oil Market Report 13 March 2007
Basically, the IEA suggests that in a normal year, refiners will look to import oil and build stocks in the late winter months. By doing so, the refiners have plenty of oil on hand to feed their refineries and produce gasoline ahead of summer driving season.
But that’s not the case this year; stocks just aren’t building the way they have in prior years.
In fact, the IEA estimates that stocks across the OECD declined by 1.2 million b/d in the first two months of 2007, among the fastest recorded drops in stocks ever for this time of year. That drop-off was due, in large part, to the coldest February in the US for the past 30 years and continued strong demand for gasoline and diesel fuel across many key developed countries.
In addition, in this passage the IEA addresses a common mistake that many pundits make when evaluating oil and product inventories. As I highlighted in last week’s issue, it’s inappropriate to analyze inventories in a vacuum and compare levels to historical data because the sufficiency of inventories depends on demand as well as supply.
Typically, these data are adjusted to show inventory in terms of days of demand–the number of days’ worth of demand covered by existing inventories. So, although OECD inventories were roughly on a par with last year through the end of January, on a days-of-demand basis, inventories are low. Moreover, based on preliminary and partial February data, the IEA is looking for a major stock draw for that month.
It’s also important to note patterns in the inventory data. For example, the key pattern in this month’s oil market report is that stocks are drawing lower in a period when they should actually be building. This is a sure sign that demand exceeds supply.
Check out the chart below for a closer look at OECD oil demand.
Source: IEA
This chart shows the actual annualized change in global oil (and refined products) demand for all OECD countries based on quarterly data going back to the first quarter of 2005. Also included are the latest OECD forecasts going through the final quarter of 2007.
It’s clear that oil demand declined notably in 2006. This was driven, in large part, by an extraordinarily warm winter in the US that dampened global demand for heating oil and residual fuel oil.
High oil prices through midsummer also likely dampened demand in some markets. But so far this year, demand is actually a lot higher than initially forecast.
Demand for heating oil strengthened in the US starting in late February because of a sudden, prolonged cold snap. Demand for gasoline and diesel in the US also remained well above average for this time of year. As it stands now, the IEA’s projection for a significant rebound in global demand this year over last year’s weak totals looks on target.
Bottom line: When rising demand meets shrinking and tight supplies, the result is firmer prices. This is exactly what’s happening worldwide right now. This is also helping oil- and gas-related stocks.
It should come as little surprise that oil services and drilling companies with international exposure continue to report strong activity and interest in oilfield developments. This market hasn’t slowed down and is unlikely to do so at all this year.
Back To In This Issue
Natural Gas
Of course, the situation with natural gas remains different than oil. As I noted above, oil is a global market; crude and refined products are regularly transported long distances by tanker ship.
Natural gas is currently a far-more regional market than a global one. Most natural gas is still transported by pipeline rather than by tanker ship in the form of liquefied natural gas (LNG).
In the US, for example, the No. 1 source of imports right now is Canada, not LNG. Therefore, inventories of gas in North America are very important for determining the price of gas in the US market.
The inventory situation in Europe has less bearing on natural gas markets in the US than it would for crude oil or gasoline. This will remain the case until LNG becomes a more-important source of supply.
The warm winter of 2005-06 meant low demand for natural gas; inventories rose to very high levels, putting pressure on prices for most of last year. That selloff was rendered more dramatic because gas prices were just coming down from their hurricane-induced spikes in late 2005.
A more-normal winter this year, coupled with the coldest February in 30 years, has brought inventories far closer to average levels. Check out the chart of gas in storage below.
Source: Energy Information Administration (EIA)
I highlighted my outlook for the natural gas market at great length in the February 21 issue of TES, All Eyes On Gas. I won’t belabor those points here.
Suffice it to say that the decline in gas prices last year has had a dramatic effect on Canadian drilling activity. This is starting to filter through in the form of lower Canadian production.
Lower production has also helped the normalization of gas inventories so far this year. Although inventories are still above average, the situation isn’t as dire as it was last year at this time.
Nonetheless, North American gas-related drilling activity remains the only energy market in the world that’s showing any real signs of weakness. For the most part, the weakness is limited to higher-cost resources such as coal-bed methane and Canadian shallow gas, though weakness has spread to other aspects of Canadian drilling in the past few months.
This is solely due to those excess inventories and the hangover from the 2005-06 winter heating season. This softening in North American drilling activity is behind the earnings warnings witnessed from oil services and contract drilling companies such as Baker Hughes, Patterson-UTI, BJ Services, Nabors Industries and Halliburton.
These companies are most heavily exposed to North America. For much of last year, I recommended shorting BJ Services and Patterson-UTI as a play on this weakness.
But the potential for further weakness in North America remains nothing unknown or unexpected. Consensus analyst expectations for Nabors’ 2007 earnings are down by more than 17 percent just since the beginning of 2007. Check out the two charts below.
Source: Bloomberg
On both of these screen shots, note in particular the charts in the upper right-hand corner. These charts indicate consensus estimates for full-year 2007 and 2008 earnings. As you can see, estimates have come down considerably for both companies since the end of 2006.
My point is that much of the worst possible news is already priced into the gas-levered energy patch right now; these stocks are already reflecting the potential for further weakness in North American drilling markets. That limits the downside potential in the group.
This is also why I upgraded all the North America-levered services names from sells to holds earlier this year and why I’m not recommending shorts in any of these companies, despite the North America-led weakness.
It’s also worth noting that the Atlantic hurricane season is once again just around the corner. Last year, the hurricane season was mild by historical standard and certainly far, far less destructive than either the 2005 or 2006 seasons.
Long-range hurricane forecasts can never be expected to be all that accurate. That said, there are some troubling signs emerging that this summer could bring another active season.
The warm-water current in the tropical Pacific, known as El Nino, is disappearing. This is the phenomenon that brought a warmer-than-normal start to the 2006-07 winter. It’s also a phenomenon that apparently helped keep last year’s hurricane season under wraps.
Many prominent meteorologists are now worried about the development of El Nino’s evil stepchild, La Nina. Basically, this is a cold-water current in the tropical Pacific.
The bottom line: In La Nina years, conditions tend to be favorable for hurricane development in the Atlantic basin. La Nina will be something to keep an eye on over the next month and a half.
Back To In This Issue
Playing Oil And Gas
My advice for playing these trends remains twofold. First, companies with significant exposure outside North America should remain well insulated from any slowdown. There’s absolutely no sign of any slowdown in drilling activity outside the US, and the bigger, multinational firms that tend to be behind overseas oilfield developments are unlikely to pare back their activity, even if oil returns to $40s.
This also includes any firms related to deepwater development plays. As I explained at length in the January 3 issue of TES, The Deep End, deepwater is one of the final, promising frontiers for exploration.
My top internationally levered names would include oilfield services behemoth Schlumberger, subsea equipment maker FMC Technologies, seismic mapping specialist Petroleum Geo-Services, deepwater driller Seadrill and my two integrated oil picks, ExxonMobil and Chevron.
In addition, it’s worth highlighting the recent strength in Dresser-Rand, the world’s largest premium compressor manufacturer.
Compressors are used in refineries; they’re a crucial part of equipment used to process heavy crude oil. (I explained this concept at great length in the most-recent issue of TES, Looking Refined.) Compressors are also used in natural gas pipelines and on drilling rigs.
Dresser recently reported a huge jump in its backlog of orders to just shy of $1 billion; most of this backlog is related to refining equipment. The company also stated that it expects its profit margins to expand this year by around 3 percent. This is important because one concern that’s been hanging over the stock in recent quarters is its ability to push through meaningful price increases.
Dresser is also involved in some high-tech deepwater equipment work. The company has designed a subsea compressor and separator for Norway’s Statoil. This equipment literally sits on the seafloor; the compressor helps to separate gas from oil and transport these commodities by subsea pipeline to distant floating production platforms.
To make a long story short, use of such equipment can lower the cost of deepwater developments. It’s a promising new market for the company. Dresser-Rand is among the strongest stocks I cover right now; I’m raising my buy target to 33.
In addition–as I outlined in the February 21 issue of TES–there isn’t much downside left in quality companies levered to natural gas. These stocks offer the promise of a big move if, as I expect, gas inventories gradually normalize in the next six to nine months.
For now, I prefer to focus on companies with a specific story to tell. I recommend stocks that are focused on strong submarkets or niche technologies within North America that have been guilty by association; they’ve been beaten up solely because of their American exposure.
My favorites are Carbo Ceramics, a leader in the ceramic proppant market that I analyzed in depth in the February 21 issue. In addition, shallow-water drilling specialist Rowan should benefit from the mass exodus of jackup rigs from the Gulf of Mexico this year.
Finally, I recommend both XTO Energy and EOG Resources. Both are US-based, gas-focused exploration firms with the potential to rapidly increase their production in the next few years. (I analyzed the exploration and production (E&P) industry at length in the Dec. 6, 2006, issue of TES, Looking For Some Upside.)
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Getting Warmer
Apart from the latest news on Iran, the other item grabbing headlines during the past few months has been global warming. In fact, I can count on one hand the times I’ve perused the Wall Street Journal or Financial Times this year without reading at least one article on global warming or an editorial piece from some scientist on the topic. Most recent, Al Gore’s testimony on the subject before Congress attracted considerable attention.
Views on global warming differ wildly, and as investors, we really have no need to enter this debate. The constant barrage of commentary surrounding the subject, coupled with anti-carbon legislation from the US, Europe and elsewhere, will have important impacts for investors. It’s possible to profit from global warming without fully believing in it or trying to save the world.
At any rate, in many parts of the world carbon dioxide (CO2) is now firmly public enemy No. 1.
One way to look at carbon-emissions data is to examine carbon intensity. This is a measure that compares total emissions of carbon dioxide to a country’s gross domestic product (GDP)–in other words, how much CO2 a country releases compared to the size of its economy.
The table below presents carbon-intensity data for a list of countries.
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Carbon Table
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Country
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Intensity
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Nuclear Share (%)
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| Sweden | 0.23 | 46.7 |
| Japan | 0.26 | 29.3 |
| France | 0.29 | 79.6 |
| UK | 0.36 | 19.9 |
| Germany | 0.46 | 31.0 |
| Brazil | 0.51 | 2.5 |
| USA | 0.55 | 19.3 |
| Spain | 0.57 | 19.6 |
| Mexico | 0.62 | 5.0 |
| Belgium | 0.63 | 55.6 |
| Netherlands | 0.72 | 3.9 |
| Canada | 0.74 | 14.6 |
| South Korea | 0.81 | 44.7 |
| Australia | 0.88 | 0.0 |
| India | 1.88 | 2.8 |
| China | 3.1 | 2.0 |
| Russia | 5.1 | 15.8 |
Source: EIA
Note that adjacent to each country’s carbon intensity number is a percentage of how important nuclear power is to each nation’s electric grid.
Although I’m well aware that there are outliers in this data, there does appear to be a meaningful relationship between use of nuclear power and carbon intensity. Note, in particular, how carbon-efficient France is compared to most other countries in Europe; this is due, in no small part, to the fact that France gets around 80 percent of its power from nukes.
If you’re worried about global warming or looking for ways to reduce carbon emissions without crippling the economy, nuclear power looks like the most-logical way forward. Therefore, all the attention currently being paid to global warming is another major positive for my recommended nuclear field bet.
Recall that I use “field bets” as a way of playing some of my favorite long-term energy themes. Uranium mining is a risky business. Production delays, unforeseen project cost, and simple labor and raw materials inflation can all have important effects on the economics of a particular mining project. And production costs vary wildly depending on the grade of ore mined and how large overall reserves are.
Riskier still is exploration. Uranium explorers buy acreage and drill holes, taking core samples to evaluate reserve size and ore grades. Sometimes even the most-promising reserves just don’t pan out and can never reach economic production. It’s impossible to know this for sure until you’ve spent considerable sums on exploration; only once uranium is produced can we really know for sure the full costs and viability of a project.
To account for this higher level of risk, I’m recommending that risk-tolerant investors take a more-diversified approach to playing the junior uranium producers and exploration companies. You must recognize that no matter how careful your selection criteria, some promising uranium exploration stories will never work out.
Fortunately, there are high rewards to be found in this sector as well. Famed mutual fund manager Peter Lynch used to look for what he called ten-baggers–companies with the potential to earn investors 1,000 percent or more on their investment. Obviously, you don’t need many ten-baggers to make a solid return and make up for the inevitable losing plays.
For the best chance at big returns, I recommend casting a wide net. Instead of just buying one or two high-risk names, I recommend placing a smaller amount in five to 10 such companies. I call this the uranium field bet.
To date, this strategy has worked. Note in the table below, the average return form my field bet plays stands at 97 percent. They’re up an average of 27 percent this year alone.
In the table below, I revisit my current advice for nuclear field bet picks.
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Uranium Field Bet
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Company Name (Exchange: Symbol)
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Change From Recommendation (%)
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Change From Year-To-Date (%)
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Current Advice
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| Paladin Resources (Australia: PDN, TSX: PDN, OTC: PALAF) | 148.7 | 18.9 | Buy |
| SXR Uranium One (TSX: SXR, OTC: SXRFF) | 79.5 | 4.9 | Buy |
| Energy Metals (TSX: EMC, NYSE: EMU) | 149.5 | 48.8 | Buy |
| Pitchstone Exp. (TSX V: PXP, OTC: PEXPF) | 140.3 | 44.2 | Buy |
| UEX Corp (TSX: UEX) | 92.6 | 28.9 | Buy |
| UNOR (TSX V: UNI, OTC: ONOFF) | -1.8 | -9.4 | Buy |
| Uranium Part. (TSX: U, OTC: URPTF) | 101.3 | 40.7 | Buy |
| Uranium Resources (OTC: URRE) | 66.1 | 41.7 | Buy |
| Average | 97.0 | 27.3 | – |
Source: The Energy Strategist
Here’s the rundown on the latest news from all the nuclear field bet plays:
Paladin Resources (Sydney: PDN, TSX: PDN, OTC: PALAF)
Paladin Resources began producing from its Langer Heinrich mine in Namibia, Africa at the beginning of 2007. The company experienced some unplanned downtime on the project in January and February because of problems with holding tanks at its processing plant. This has more or less been fixed, and Paladin expects to be producing at an annualized rate of 2.6 million pounds of U-308 by the end of June this year.
There are always unplanned events at mines. I consider it encouraging that Paladin is basically on track to meet its production goals from this particular mine in 2007.
The other big piece of news out of Paladin recently is that it’s trying to acquire Summit Resources, an Australian rival that has some joint venture (JV) projects with Paladin. So far, Summit has been rejecting or at least resisting Paladin’s bid. Paladin obviously wants full control of its JV projects with Summit.
The situation with uranium mining in Australia remains tenuous and confusing. Australia has enormous reserves of uranium–likely the world’s largest–but it only produces a little under a quarter of the world total. The reason is a ban imposed on new mining in 1983 by the then in-power Labour government. Labor was tossed out of power when the country’s current prime minister, John Howard, and his center-right party were elected in 1996.
Howard’s election cleared the way for the opening up of uranium mining in parts of Australia. But the national government only directly controls mining in the Northern Territory, not the Australian states. Mining has also been allowed in projects where uranium is produced as a by-product of other metals, such as gold. Finally, mining is allowed in certain Australian states, namely those controlled by Howard’s center-right party.
However, in key mineral-rich states such as Queensland and Western Australia–where the Labor Party is still in power–mining projects have essentially been banned. Howard’s been pushing hard for these remaining bans to be lifted and has supported a plan to build 25 new nuclear power plants in the country. Australia currently has no nuclear power plants at all, a by-product of both a very powerful anti-nuclear movement in the 1970s and the country’s abundant energy resources.
Apparently, the Labor Party is seriously reconsidering its position on nuclear mining development and is expected to announce its new position later on this month at a party conference. Several prominent Labor politicians have come out and supported repealing and softening the Labor’s anti-nuclear stance.
It’s unclear how such a change in national Labor policy would change state-level politics, but it might spur some change. I suspect that if the Labor Party does announce a change ahead of the election, concerns over global warming will play no small part in the rationale.
Also, with spot uranium prices now hovering at $95 per pound, the economic rationale for mining uranium is more apparent than its been in many years. The outcome of all this political wrangling will have an impact on the potential for Paladin and others with landholdings in Australia to go ahead with their mines.
This is why Paladin has focused most of its attention on developing African mines. Paladin remains a buy on the strength of its existing mine in Namibia and an advancing development in Malawi.
I suspect Australia’s policy will eventually be changed, as is widely anticipated, but this will be something to keep an eye on this month. If it does change, Paladin will be well-positioned to benefit.
SXR Uranium One (TSX: SXR)
SXR has projects in Canada, Australia and Africa. The company’s Dominion mine in South Africa started up on schedule in the first quarter. Upon completion of the first phase on the mine, SXR is looking for about 3.8 million pounds of annualized production. SXR is also looking at the possibility of boosting that to 7 million pounds by 2015.
In Australia, SXR owns the Honeymoon mine project in South Australia where uranium mining is allowed. The company has a permit from the government to export uranium and plans to start up the project within 12 months.
SXR also agreed to acquire UrAsia Energy in February. This gives SXR, among other assets, access to producing mines in Kazakhstan. SXR remains a buy.
UNOR (TSX V: UNI, OTC: ONOFF)
UNOR has been our most-disappointing play in the uranium field bet. But I remain encouraged by the fact that the 800-pound gorilla of the industry, Cameco, owns a 19.5 percent stake in the company.
UNOR formed a new JV with Cameco to explore a reserve owned by Cameco. This is a sign of Cameco’s deepened interest in the company.
Most of UNOR’s developments and exploration JVs are in their early stages, so this remains a risky play. But Cameco’s interest is a sign of faith in the basic strategy.
Note several of the exploration-oriented field bet picks, including Pitchstone Exploration and UEX, have some aggressive drilling plans for 2007. I’ll be offering more detailed news and updates via flash alerts and in future regular issues.
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Alternatives Field Bet
I inaugurated my alternatives field bet in the January 24 issue of TES, Another Alternative.
My thesis surrounding alternative energies such as solar and wind power is simple: The potential for these technologies is often overstated. None of these “alternatives” will be able to replace traditional fossil fuels and nuclear plants. The fact is that they will always remain a small part of electric grid in the US and most other countries.
Take Germany as an example–the country has been the most aggressive in the developed world in terms of pursuing expansion of its wind power industry. The country has the largest installed base of wind generation in the world at 20,621 megawatts (MW), nearly double the installed base of the two runner-ups, Spain and the US. That installed base accounts for 13 percent to 16 percent of that nation’s electric grid.
But there’s a big difference between installed base and actual generation. When it comes to wind plants, there’s often a major difference between a given wind farm’s capcity and what it’s actually pumping into the nation’s electric grid.
So although Germany’s wind capacity is around 15 percent of the national total, according to the IEA, wind farms only generate about 4.1 percent of German’s actual electricity production in 2004. To put that into perspective, check out the chart below detailing Germany’s production of electricity by fuel source.
Source: IEA
Note that wind and solar aren’t important in Germany compared to nuclear power and coal, despite the massive investments made by that country in the past 17 years. But from an investment standpoint, that really doesn’t matter.
Alternatives are growing quickly from a low base in just about every developed country you’d care to examine. Although not the world’s most-important sources of power, alternatives are definitely the world’s fastest-growing sources of power.
Alternative power technologies are growing quickly, and they receive continued support from favorable government policy. Rapid growth spells big opportunity for investors.
Like nuclear power, alternatives are benefiting from all the rhetoric surrounding global warming. I can’t imagine a piece of environmental or energy legislation passing through Congress that doesn’t contain some reference, subsidy or incentive for alternative power. This is even truer in Europe, where alternatives have been made one of the centerpieces of the region’s energy policy.
Here’s my current alternatives field bet table with statistics detailing the return since my recommendation in January and my current advice on each picks. Note also that I’m adding new plays to the alternatives field bet this issue (highlighted in boldface type).
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Alternatives Field Bet
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Company Name (Exchange: Symbol)
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Change From Recommendation (%)
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Change From Year-To-Date (%)
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Advice
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| Vestas Wind Systems (Denmark: VWS, OTC:VWSYF) | 23.2 | 34.4 | Buy |
| EDF Energies Nouvelles (France: EEN, OTC: EDFEF) | 23.3 | 14.7 | Buy |
| SunPower Corp (NSDQ: SPWR) | 13.9 | 26.8 | Buy |
| MEMC Materials (NYSE: WFR) | 31.2 | 52.9 | Buy |
| SolarWorld (Germany: SWV, OTC: SRWRF) | 5.8 | 26.4 | Buy |
| Hexcel (NYSE: HXL) | NEW | NEW | Buy |
| US Geothermal (OTC: UGTH) | NEW | NEW | Buy |
Source: The Energy Strategist
Here’s a rundown on all the latest news from my recommended plays and my rationale for the two newest additions to the field bet:
Vestas Wind Systems (Denmark: VWS, OTC: VWSYF)
Vestas reported its fourth quarter and full-year 2006 earnings results in late March. The 2006 results were a bit better than analysts’ consensus expectations; more important, the firm maintained its strong guidance for 2007 and 2008. The company remains the largest manufacturer of wind turbines globally.
Total deliveries of turbines jumped 33 percent last year; pricing also improved markedly amid strong demand, particularly in Europe and the US. The company cited new carbon regulations as a major driver of, in particular, European demand for turbines.
The biggest problem for Vestas and all the other turbine manufacturers isn’t a lack of demand but a lack of capacity, raw materials and labor. This remains the biggest risk for the stock.
However, fears that this would be a big problem have been at least partly dispelled by management’s decision to maintain forecasts for 2007 and 2008. This shortage of materials for windmill blades is also part of the reason I’m adding Hexcel to the field bet this issue; see my full rationale below.
In addition to earnings, Vestas has announced a number of new projects and contracts in the past few months, including an 88-windmill order for a wind farm in Wisconsin. The company also laid out plans to build a new $60 million windmill blade factory in Spain to serve that fast-growing market.
EDF Energies Nouvelles (France: EEN, OTC: EDFEF)
EDF Energies Nouvelles is a pure play on the generation of electricity from renewable and alternative sources. Currently, the company is the No. 1 renewable power company in France and No. 3 in Portugal.
Roughly 78 percent of the power that EDF EN generates comes from wind turbines. However, the company also has installed hydropower, biomass and solar-generation facilities.
EDF EN announced earnings in mid-March, reporting a 32 percent jump in profits for 2006. Most of this was due to a rapid expansion in wind-generating capacity last year from a global total of around 600 MW in 2005 to more than 810 MW at the end of last year.
So far in 2007, EDF EN has expanded wind-power capacity further to more than 1,000 MW; the company appears on track to meet its goal of 3,000 MW of wind-generated capacity by 2011.
While many pundits focus on Europe’s wind-power markets, EDF EN is actually a huge player in the US; 40 percent of the company’s total production capacity is in the US market. And pricing trends in the US are even more favorable than Europe. Prices have increased by 35 percent in the past two years compared with about 20 percent for EDF EN’s European business.
EDF EN’s US business has also been aided by the decision to extend a wind-power production tax credit through the end of 2008. Not surprising, the company ordered another 276 MW worth of turbines at the end of March.
SunPower (NSDQ: SPWR)
SunPower’s PowerLight subsidiary has announced a series of new construction projects across southern Europe. The company opened an 11 MW facility in Portugal last month and has three projects going on in Spain totaling about 50 MW. Spain and Portugal are promising markets for SunPower thanks to their generous feed-in tariff systems that guarantee premium rates for solar and other forms or renewable power.
MEMC Electronics (NYSE: WFR)
MEMC has been the best-performing play in the alternatives field bet, up more than 30 percent since my initial recommendation. As noted in February, MEMC reported blowout earnings immediately following the late-January recommendation and soared on that news. Since then, the stock has followed through with additional gains.
Polysilicon is the key raw material used to make solar cells. Raw polysilicon is used to manufacture wafers; wafers are, in turn, the key building block for both solar cells and semiconductors. MEMC Materials is the world’s third-largest supplier of wafers to the semiconductor industry. It’s also one of the world’s largest suppliers of wafers for the solar-power industry.
Polysilicon orders from the solar industry remain very strong. In addition, there are signs of an important order recovery for wafers in the semiconductor business–still MEMC’s most-important market. This offers a double benefit for MEMC.
Finally, there have been some disruptions at plants owned by MEMC’s Japanese rivals. That’s further helped to tighten supply for polysilicon.
SolarWorld (Germany: SWV, OTC: SRWRF)
SolarWorld remains the most-disappointing pick in the field bet, though it’s up slightly from my initial recommendation. The prime drag on the stock was the company’s softer-than-expected earnings guidance issued in late March. Although the company’s still looking for 2007 profit to jump 20 percent, that was slightly under what some bullish analysts had projected.
But this doesn’t change the longer-term rationale for owning the stock. The solar business continues to expand, and SolarWorld is one of the largest fully integrated suppliers of solar equipment and materials.
Hexcel Corp (NYSE: HXL)
Hexcel isn’t an energy company at all but a manufacturer of advanced materials that’s typically associated with the aerospace industry. The company is the world’s leading supplier of composites and so-called prepregs to the aerospace market.
Prepregs are a type of material used to make airplane wings and other parts. They’re a sheet made of carbon fiber threads. These sheets are actually impregnated–hence the term–with specialized resins that harden and stiffen when heated.
Aircraft manufacturers keep these sheets refrigerated and then essentially bend these sheets into shape before heating them. The benefit of this sort of composite material is that it’s much lighter that aluminum or steel and can actually be stronger and more durable in some applications.
When it comes to aerospace markets, the use of composite materials has been steadily rising in the past few decades. For example, the airframe of the original Boeing 747 (circa 1969) comprised almost all aluminum. The new B787 Dreamliner airplane will comprise about half composites, such as those produced by Hexcel.
And for the record, Airbus planes contain even more composites as a percent of total weight than Boeing planes.
There’s a simple reason for that, and it all comes down to energy. The heavier an airplane, the more fuel it consumes; as oil and jet fuel prices have been rising in recent years, this has become an increasingly important factor in aircraft construction.
So although composite materials are more expensive and in shorter supply right now than aluminum, they’re worth it when you consider the fuel savings on the overall aircraft. This is also why you’ve seen a number of older aircraft models–such as MD-80s–retired by the major carriers in the past few years. Such planes just aren’t economical to run in a high-fuel-price environment.
Because this isn’t an aerospace newsletter, suffice it to say that the aerospace business is booming. Both Boeing and Airbus have full order books and are literally struggling to keep pace with demand. Most of that demand is currently coming from foreign airlines that are seeing rapid growth in travel demand as emerging-market consumers become wealthier and start traveling more.
Eventually, we’ll see more orders also from the developed-market legacy carriers looking for a way to conserve fuel and replace aging fleets. This is bullish for companies such as Hexcel that supply a key material.
And Hexcel should also grow longer term at a rate faster than the aerospace industry. That’s because not only are airplane orders growing, but so is the share of composite in their structures.
But airplane wings aren’t Hexcel’s only connection to energy prices. One of the company’s largest, fastest-growing businesses right now is blades used on wind turbines.
Just as composite materials make sense on airplanes because they’re lighter, they also make sense for turbines because carbon-reinforced blades generate more power from same-size blades. Major wind blade manufacturers such as fellow field bet recommendation Vestas are major Hexcel customers.
Commercial aerospace markets account for roughly half Hexcel’s current revenues, and defense-related businesses (military aircraft, missiles and space equipment) account for another 18 percent. The company doesn’t break out the percentage of its business that comes from wind-power blades; instead, the company lumps this unit together in its “industrial” business, which makes up 28 percent of revenues.
In its first quarter conference call, management did mention in response to an analyst’s question that wind power recently overtook ballistics as the most-important source of revenue in its industrial business. Wind is also the company’s fastest-growing major source of revenue; Hexcel projects at least midteens growth from that line this year.
The company’s stock suffered last year for two major reasons. First, the company makes ballistic materials used in applications like bulletproof vests for the US military; the business is considered part of the company’s industrial business, not part of its “defense” segment.
Government orders slowed sharply midway through last year as the military has more or less completed re-equipping troops with these vests. Hexcel has been looking to divest this business.
Second, as most investors are well aware, Airbus delayed shipping its A380 super-jumbo planes last year because of a series of problems with wiring and production. Because Airbus is a major customer, this shift has obviously had a huge impact on Hexcel’s revenue growth for 2006-07. Of course, Boeing’s 787 plans are proceeding on schedule, helping to balance that effect.
But these issues are well known and have been largely priced in. I’m also looking for Hexcel to eventually break out the revenue contribution the company receives from its rapidly growing wind-power business. This should dramatically boost the visibility of that segment of the business.
Also, demand for carbon fiber currently exceeds available supply to the point that Hexcel can’t manufacture enough of the material to meet its own needs. This necessitates buying in carbon fiber from other firms for relatively high prices. But that’s changing as Hexcel adds manufacturing capacity; this will be a long-term positive for the company’s profit margins. Hexcel is added to the alternative energy field bet.
US Geothermal (TSX V: GTH, OTC: UGTH)
Note before I get started explaining US Geothermal, it’s worth saying that US Geothermal should be considered a highly speculative play. I strongly recommend that all subscribers place only a relatively small portion of their capital in this name, even less than you’d normally put in a field bet pick.
I’ve recommended small speculative picks before, and most have gone on to produce decent gains, several well in excess of 100 percent. But don’t let that success fool you into complacency. One speculative field bet pick from last year, Earth Biofuels, has been a big loser so far.
All told, we’ve made solid gains in speculative picks. But it pays to be well aware of the risks. This is definitely a high-risk, high-potential play.
As you’ve probably already gathered from the company’s name, US Geothermal is involved in the generation of power from the earth’s natural heat. Unlike solar and wind, geothermal hasn’t to date received much attention from the investing public. That said, it’s economical in certain regions and also benefits from government subsidies.
US Geothermal builds geothermal power plants and sells the electricity it generates onto the grid. The company’s first geothermal plant–the Raft River Plant–is located in southern Idaho.
This plant was originally developed by the US Dept of Energy as a sort of test facility for geothermal energy; it was only designed as a 7 MW facility, tiny by any standards. US Geothermal acquired the site in 2003.
Obviously, US Geothermal has been expanding the size of the project and expects it to go on line by the end of this year. To start with, the plant will only produce about 20 MW to 40 MW of power, but eventually it should ramp up to 100 MW to 200 MW of output.
New geothermal plants that go on line before the beginning of 2008 earn an annual subsidy of $19 million per MW hour produced for 10 years. According to US Geothermal, that would work out to about $155 million over a 10-year period. This credit is likely to be extended for plants build after 2007.
As noted above, political support of renewable energy isn’t in short supply on either side of the aisle. Because geothermal power is emission free, it also benefits from emissions credits, possible future carbon credits and some state-level subsidies as well.
The company also has another project it’s working on that could be as big as 100 MW. But this project is in an earlier stage of development.
Granted, even a 200 MW plant is tiny–around half the size of the smallest commercial coal power plants in operation today. That said, the company is only capitalized at about $60 million, so it’s not exactly a large stock either.
If the plant comes on line as expected and begins generating power, I’d expect that to generate considerable investor attention. The company is already in negotiations with Idaho Power, a unit of IdaCorp, for the latter to buy an annual average of 45.5 MW from US Geothermal over a 25-year period.
I’m adding US Geothermal to the alternatives field bet; I recommend you not pay more than $1.50 for the stock.
Please note that with the exception of my two newest picks, I’ve just reviewed the latest news for each stock. For a full rundown of my rationale for owning these companies, consult the January 24 issue.
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