In the past six months, I’ve covered a variety of important themes in The Energy Strategist–everything from nuclear power and alternatives to traditional oil and gas exploration firms. As we head into summer, it’s high time for a review and update of some of my favorite themes and companies.

In This Issue

In this issue, I’ll take a look at the natural gas and oil markets and what to look for as we head into the heart of both the Atlantic hurricane and summer cooling seasons. I’ll also examine some of the key comments gleaned from recent corporate conference calls including the outlook from a couple services giants. Based on these calls, I’m gaining more confidence in the prospects for an impressive recovery in the North American services market by the end of 2007.

Finally, I’ll offer an update on the latest news and my take on the fundamentals for a long list of TES recommendations.

Warm winters and a lighter hurricane season were key factors in the increase of natural gas supplies and subsequent drop in the energy source’s price. However, data regarding upcoming weather trends as well as production declines from our neighbor to the north may shift this trend. See Natural Gas.

I often look to my favorite oil and gas giants for their general market outlooks. I recently sat in on a few conference calls with companies inside my Portfolio and How The Rate coverage to hear their thoughts on the market and what we might expect to see in the future. See Insider Outlooks.

I cover several great plays in my Portfolio that are worth updating here. However, one has decided to delist from the US, which will make it more difficult to trade. I’m selling said company, but those who don’t mind the hassle of some of the foreign markets are welcome to hang on. See How To Play It.

Some great deals and interesting developments have occurred within my nuclear power coverage universe. Here are some of the recent happenings, including a deal between two of my uranium field bet plays. See The Nuclear Option.

Coal is another sector seeing some new developments, specifically in relation to coal-to-liquids technology. This technology recently made the cover of The New York Times and is being eyed by Congress as well. Here are my plays and how I see them moving forward. See Coal.

Partnerships have been a favorite theme of mine for a long time. These structures are now beginning to see some increased interest from several energy companies looking to spin off their assets. See Finding Partners.

In this issue, I’m recommending or reiterating my recommendation on the following stocks:

• BG Group (NYSE: BRG)
• Carbo Ceramics (NYSE: CRR)
• Consol Energy (NYSE: CNX)
• EOG Resources (NYSE: EOG)
• FMC Technologies (NYSE: FTI)
• Linn Energy (NSDQ: LINE)
• Peabody Energy (NYSE: BTU)
• Pride International (NYSE: PDE)
• Sasol (NYSE: SSL)
• Schlumberger (NYSE: SLB)
• Seadrill (OTC: SDRLF)
• Weatherford (NYSE: WFT)
• XTO Energy (NYSE: XTO)

I’m recommending taking profits on both of the following stocks:

• Energy Metals Corp (NYSE: EMU)
• Petroleum Geo-Services (NYSE: PGS)

Natural Gas

The natural gas markets have been the focus of considerable attention during the past year and a half. I highlighted the outlook for the natural gas market at some length in the February 21 issue of TES, All Eyes On Gas, and in the April 18 issue, More Bullish Signs. For those unfamiliar with this market, these two issues are worth reading.

To offer a simple summary, natural gas prices broadly fell through most of 2006 and remained depressed going into 2007. There were three reasons for this: an extraordinarily warm winter in 2005-06, a lighter-than-expected 2006 Atlantic hurricane season and a warm start to the winter of 2006-07.

These factors spelled weak demand for gas and a rise in natural gas inventories well above seasonal norms. Check out the chart below for a closer look at the current and past inventory situation in the US.



Source: Energy Information Administration

This chart shows 2007 inventories of natural gas relative to the five-year high and low in storage and the five-year average. For most weeks of the year, 2006 represents the high in natural gas inventories.

The chart clearly shows that inventories of gas began 2007 well above five-year highs and far above average for that time of year. But the winter turned cold across most of the Northeast and Midwest by late-January; demand for gas heating accelerated, and inventories have since fallen back to more normal levels for this time of year.

Although still above average, inventories remain significantly under 2006 levels. And despite inventories’ start toward a normal seasonal build, they’re building roughly in line with historical norms.

Looking ahead, I see several factors that should keep inventories contained this year and a bid under natural gas prices. Here are three of the key factors to watch this summer:

Hurricane Season

In the spring of 2006, the prevailing forecasts were for another active hurricane season in the summer. But the emergence of an El Nino pattern changed all that, and it turned out to be a surprisingly quiet season.

Unfortunately, most scientists believe that we remain in an up-cycle for hurricane activity and are once again predicting an active 2007 Atlantic season. Throughout recorded weather history, hurricane activity has come in waves—periods of intense activity followed by periods of relative calm. We’re still likely in for a few more years of intense activity.

The Atlantic basin has already seen two named storms this year, one developing nearly a month before the official June 1 start of the season and the second tropical system developing just as the season began. Although it’s way too early to draw any real conclusions, this suggests we can’t assume 2007 will be as quiet as 2006. Hurricanes can severely disrupt natural gas drilling and production activity in and around the Gulf of Mexico; the threat of another active season will likely put a floor under gas prices this summer.

A Hot Summer

Electricity producers are more dependent than ever on natural gas as a fuel to meet peak electricity demand. Traditionally, winter has been the peak season for gas demand; gas was used almost exclusively for heating.

But that’s changed gradually during the past decade, and there’s a second peak demand season developing in midsummer—a summer cooling season for gas. A hot summer could prompt unseasonably strong gas demand and some midsummer inventory draws.

Canadian Drilling Activity

The Canadian rig count has fallen off a cliff compared to last year. For a closer look, check out the chart below.



Source: Baker Hughes

This chart depicts the percent change in Canadian drilling activity against year-ago levels. As you can see, the Canadian rig count—the total number of rigs actively drilling for oil and gas—has been down around 50 to 60 percent over year-ago levels.

Just as is the case in the US, well decline rates in Canada are ultra-high. That means, once you complete an average gas well, production from that well declines at a rate of around 30 percent annualized.

Data for US wells producing is a bit more complete than for Canada; however, we can use the US situation as a corollary for the rest of North America. Consider that, in 1997, there were just shy of 311,000 natural gas producing wells in the US; that same year, US gas production totaled 51.8 billion cubic feet per day.

In 2005, US production totaled less than 50 billion cubic feet per day, and there were more than 425,300 producing gas wells. Therefore, US production fell close to 700 billion cubic feet annualized from 1997 to 2005 despite the fact that the number of wells producing gas increased by nearly 37 percent. This is solid evidence that producers are going after more marginal wells, and those wells are seeing a high decline rate.

Just to maintain gas production, US and Canadian drillers must continually drill new wells; the North American rig count should rise over time.

The extreme drop-off in the Canadian rig count shows that’s not happening. This is already showing up in the form of reduced Canadian production, and that’s only going to get more apparent the longer the rig count in Canada remains depressed. This is an issue when you consider that Canada is the US’ No. 1 source of imported natural gas at this time.

In the US, the rig count hasn’t declined as abruptly; however, it has more or less remained flat for months. That, too, will result in lower production over time.

Bottom line: The price system is working, and falling natural gas prices last year are filtering through into falling production. Ultimately this means a rapid moderation of inventories and higher gas prices.

The fate of natural gas prices affects exploration and production (E&P) companies—the companies that actually produce and sell gas. But that’s certainly not the only sector that’s impacted by the gas drilling environments. The fate of services companies with significant exposure to North America and contract drillers that own rigs in the region are intimately tied to gas prices.

Interesting, some of the E&P, services and drilling companies I follow are, for the first time in several quarters, hinting at a possible coming upturn in activity levels.

Back To In This Issue

Insider Outlooks

Long-time readers know I follow all the news and management comments out of oilfield services giant Schlumberger very carefully. Schlumberger has operations literally scattered all over the world, so it has a unique perspective and insight into which markets are strong and which areas are in trouble.

The company’s management team has consistently sounded bearish on US natural gas activity in the past several quarters. This negative tone is apparent if you listen to the quarterly conference calls.

I was, therefore, intrigued by the company’s call back on April 20. Schlumberger specifically cited the reduced rig count in Canada and the poorer-quality, high-decline rate wells being drilled in the US as a reason to expect a fundamental improvement in the gas drilling environment.

During the question-and-answer segment of the call, one analyst asked CEO Andrew Gould to elaborate on this point further. The CEO noted that he didn’t want to outline a specific time frame for this recovery to occur; rather, he suggested that he saw the fundamentals shifting in that direction. Although that may seem a rather lukewarm endorsement, it’s the first time this management team has even hinted at such a shift in many quarters.

Schlumberger went on to note that deepwater activity in the Gulf of Mexico remains strong and that there has been a pickup in exploration work in Alaska. Therefore, the real weakness in North America is confined to US and Canada land drilling for natural gas; the bulk of that weakness is confined to higher-cost reservoirs, such as coal-bed methane (CBM) and Canadian shallow gas.

Schlumberger also stated that it continues to view pressure pumping as the most-vulnerable product line in North America. The most-common form of pressure pumping in North America is what’s known as fracturing.

Oil and gas exist in the pores and crevices of reservoir rocks. When an operator spuds a well, the oil and/or gas–under tremendous geologic pressure–flows through the rock into the well and to the surface.

But if the pores in a rock aren’t well connected, there are few channels through which the hydrocarbons can travel. Although there may well be plenty of gas in the ground, that gas is essentially locked in the pores of the rock and unrecoverable.

But there are ways to produce such reservoirs. In fracturing, operators pump a gel-like liquid under tremendous pressure into the ground. That gel actually enters the reservoir and cracks the reservoir rock. By cracking or fracturing the reservoir rock, the operator creates channels through which gas can flow.

But that brings us to another problem. Once a reservoir is fractured and the operator reduces the pressure of the fracturing liquid, those channels and cracks typically begin to close up again. This, of course, reduces the efficacy of the fracturing work.

This is why operators tend to put small particles into the gel-like fracturing liquid. These particles also enter the reservoir and get stuck in the channels opened during fracturing. As the pressure is released, the particles essentially prop open the channels; that’s why these particles are called proppant.

Performing fracturing work involves using a high-pressure pump truck to push a fluid into underground reservoirs under extreme pressure. The problem with pressure pumping work in North America is twofold. First, the weakening of the gas drilling market in North America highlighted above reduced demand for pressure-pumping services.

Second, some service companies aggressively built up their pressure-pumping capacity—they built more pump trucks and equipment—adding to the supply of available trucks to perform such work. Whenever you have rising supply meeting falling demand, it’s a recipe for disaster. Pricing for pressure-pumping work is declining, and service firms with heavy exposure to the business are underperforming.

Schlumberger has only minimal exposure to the North American pressure pumping market. And based on comments the firm has made in the past few quarters, it appears that, when it comes to pressure pumping, Schlumberger has concentrated its attention not on building pump trucks—essentially a commodity—but rather on developing superior technologies for monitoring fracturing efficiency and handling more-complex reservoirs.

Right now, pressure pumping is mainly a US activity, but it does have its applications overseas. Schlumberger looks to have an advantage in this market.

Once again, it’s worth repeating that although North America has been a rollercoaster ride during the past year, international markets have remained red-hot.

Schlumberger reported strong activity in a host of international markets. For example, the company noted a particularly strong market for seismic operations—the use of sound waves to produce a map of underground reservoir formations. Its deepwater seismic Q-ships are booked out years in advance.

Management stated that the firm is receiving offers to book the ships as soon as they become available. Even better, Schlumberger is actually passing up initial offers for work, preferring to wait out for a better price. I can’t think of a stronger endorsement of the sky-high margin sustainability in this business.

Schlumberger also noted during the call that liquefied natural gas (LNG) developments in Australia are actually accelerating. Many gas consumers are interested in Australia because it’s an apolitically stable country with plenty of gas suitable for LNG development. Schlumberger also noted impressive strength in Africa and rising demand for some of its most-technologically advanced services.

Schlumberger also made an excellent point about pricing for high-tech services. Management stated that the cost of a high-specification deepwater rig is sky-high; right now, these rigs cost close to $600,000 per day to hire out. It’s not hard to see how a single group of deepwater wells could cost upward of $1 billion.

Therefore, any technology or service that allows producers to place a well more accurately, accelerate production rates, reduce drill times or abandon dry holes earlier is worth a great deal. This is also why Schlumberger has no problem raising prices for such services.

Schlumberger’s strong international leverage and unique technological position insulates it from any slowdown in North America. Nonetheless, an improvement in the North American gas market would be a positive for sentiment. Schlumberger remains a buy recommendation in my growth-oriented Wildcatters Portfolio.

And Schlumberger wasn’t the only services or drilling firm to note a firming of North American fundamentals. Patterson-UTI is a contract driller than owns primarily land rigs in North America.

For months last year, I actually recommended shorting this stock as a play on the continued slowdown in the North American gas drilling market. As you might expect, demand for land rigs falls when gas-drilling activity falls; most rigs at work in North America are drilling for gas, not oil.

Patterson made even-more-bullish comments about North American drilling activity during its May 3 conference call. Management noted that its rig count in the US had begun to tick higher. The company had about 225 rigs working in early April and is looking for about 235 US rigs to be working on average in the second quarter.

Patterson was also quick to point out that it’s been willing to allow the competition to grab contracts rather than try to cut its day-rates aggressively in the face of declining demand. Patterson has been upgrading its idle rigs to handle more-complex work when the next upturn comes for North America. A willingness to sacrifice market share for price and to spend money on rig upgrades suggests a modicum of confidence in the long-term economics of the business.

Patterson also noted that, at the beginning of this decade, producers only needed to drill 10,000 new wells per year to maintain production. Now, that’s closer to 30,000 wells per annum. Demand for land rigs is increasing, and this rising demand has been obfuscated by the warm winter of 2006.

Patterson went on to say that it doesn’t yet have much visibility into what demand will be like later this year. However, management suggested that if gas prices were to hold up through the second quarter, the rig count should continue to stabilize. Then, roughly one quarter after the rig count stabilizes, Patterson expects to see rig day-rate pricing improve.

If that’s correct, we could see the situation in the North American gas market turning around as early as the third and fourth quarter of this year. Note that although my opinion of the America-focused land drillers is improving, I rate both Patterson-UTI and Nabors Industries holds in my How They Rate coverage universe at this time.

Finally, Weatherford’s conference call offered more insight in this regard. I offered my detailed rationale for owning this stock in the April 18 issue of TES. The company noted, like so many other services and drilling firms, just how terrible the Canadian market is right now. However, Weatherford noted that its North American revenues were actually up 9 percent year-over-year in the first quarter despite a severe tumble in Canada; US strength has made up for the weak showing in Canada.

Weatherford’s CEO stated point blank that the first quarter was terrible for Canada and the second quarter would be “really bad.” The company went on to say it’s not expecting much out of the third quarter either. However, the CEO went on to say that Canada has some attractive reserves and any market with attractive gas reserves would eventually see a turnaround.

The CEO stated in an answer to a question from an analyst: “…I do not know if it [the turnaround] is going to Q4 [the fourth quarter of 2007] when it’s going to be up year-on-year, but I sure as hell think it is going to be very close to it…I will be surprised if Q1 of 2008 is not high up versus Q1 of 2007.” Weatherford appears to also be looking for a turnaround in gas drilling activity by the end of 2007.

The thesis I outlined earlier this year for the North American gas market is that the stocks had begun to price in the worst possible news. That’s why many stocks failed to see selloffs even after reporting earnings shortfalls back in February and March of this year. These stocks were actually rallying on “bad” news.

Although stocks with large North American exposure have rallied off their lows, they’re still not pricing in a real recovery in gas prices and the drilling market this year. I still see upside for my favorites.

Back To In This Issue

How To Play It

Continued strength in overseas oil and gas drilling markets coupled with a recovery in North America is great news for a host of oil and gas services and drilling firms. And, as noted above, it’s also great news for a host of E&P firms, especially those with the scope to increase production into a stronger gas pricing environment.

Below is a brief rundown of my current recommendations and the latest news for each play. Please note that my most-recent advice, buy targets and stop advice appear in the Portfolio tables.

Schlumberger

I outlined Schlumberger’s recent earnings release and conference call at some length above, so I won’t belabor the points again here. And new subscribers can check out my detailed write-up in the February 7 issue of TES, Be Selective. The company owns some of the most advanced services technologies and know-how in key oilfield functions. As global producers go after increasingly complex reserves, Schlumberger is a major beneficiary.

Weatherford

I discussed some key points from Weatherford’s most-recent conference call above, and I outlined my case for buying the stock in the April 18 issue of TES. The stock was hit earlier this year because it’s historically had significant leverage to Canadian services markets; most of that exposure relates to Weatherford’s acquisition of Precision Energy Services (PES), a Canadian services firm, back in 2005.

But Weatherford isn’t really concentrating on expanding its footprint in the volatile North American market. In fact, the company has been taking expertise and technology it’s developed in the US and applying it in international markets like the Middle East. Many of the technologies Weatherford acquired with PES are highly in demand across the Middle East.

Weatherford’s international business will likely grow in the 35 to 40 percent range this year compared to single-digit growth in North America and negative growth for Canada specifically. Over time revenues from North America will get diluted as the international business takes over.

As I explained in the April 18 issue, one of Weatherford’s most successful product lines is underbalanced (UB) drilling, essentially a way of producing more-mature fields without damaging the geology of the field. Interesting, Weatherford also announced that it’s used its leadership in UB drilling to expand into project management.

Basically, that means that Weatherford is actually managing oilfield development projects on the behalf of producers–acting somewhat as a contractor. This is a new area for the company but can offer some impressive margins.

Weatherford also announced several new product lines that have seen a high degree of early success. Among these is a new technology for eliminating scale and wax buildup in a well using high-frequency sound waves; this aids production. And the company has also developed a micro-imaging tool used to evaluate reserves during drilling operations. Weatherford remains a buy in the Wildcatters Portfolio.

Pride International (NYSE: PDE) – Pride is a drilling operator that owns a mixture of deepwater rigs, shallow-water rigs and even land rigs. I highlighted my rationale for owning this stock in the April 18, 2007 issue of TES “More Bullish Signs.”

The main problem for Pride historically is that it’s seen as too-diversified—investors would prefer to own a pure-play on one particular type of rig. But the firm has taken some steps to ameliorate this situation. Specifically, the driller has re-focused its attention on its deepwater business.

To this end, I am encouraged by the solid contract Pride signed in late May for one of its semisubmersible rigs. This rig, the Pride Mexico, is what’s known as a second-generation rig capable of drilling in water up to 2,650 feet in depth. Pride signed a five-year commitment with Petrobras the Brazilian national oil company at a day rate of 265,000 per day. This is considered a high rate for a rig of this type.

I also have increased confidence in the company’s exposure to the shallow-water Gulf of Mexico market. In the Gulf, there are currently less than 90 rigs available for work, 9 of which are coldstacked meaning they could take months to reactivate. Furthermore, several of these rigs available for work are likely to depart the region for highly lucrative contracts abroad–many higher specification jackup rigs can get long-term contracts abroad at very attractive rates. With the exodus of rigs from the Gulf and gas prices rising back to the $8/mmBTU region, the GoM jackup market is ultra-tight–demand is rising just as supply is contracting. There is significant potential for a major spike in day-rates before year-end.

Another topic of conversation with respect to Pride is that activist investor Carl Icahn has taken a near 3 percent position in the stock. My guess is that he’s looking for Pride to either lever up and pay a special dividend or potentially break up the business to become a purer play. At any rate, Pride remains a buy recommendation in the Wildcatters Portfolio.

BG Group

BG Group, still better known to many as British Gas, remains one of my top E&P plays on liquefied natural gas (LNG). The company focuses on developing so-called long-lived gas reserves–gas reserves that produce at a relatively stable rate for many years.

Many such reserves aren’t located near pipeline infrastructure; using pipelines, there’s no way to transport this gas to market. But by using LNG technology, this same gas can be loaded on to tankers and transported many miles to markets where its most in-demand.

BG has become a key player in this LNG trade. In the most-recent quarter, The company’s LNG cargoes surged 30 percent year-over-year. BG Group remains an excellent play on recovering gas prices and the general growth in LNG trade globally and a buy in my Wildcatters Portfolio.

EOG Resources

The key metric to watch with E&P firms like EOG is their ability to grow production over time. EOG is a gas-focused E&P that exploits what are known as resource plays–reservoirs where the presence of gas is well-known.

In EOG’s case, that means a strong presence in one of the hottest gas-producing reserves in the US, the Barnett Shale. EOG Resources recently reaffirmed its long-term production growth guidance and continues to rate a buy.

Petroleum Geo-Services

Petroleum Geo-Services operates a fleet of seismic ships designed to explore deepwater reservoirs. As I highlighted above in reference to Schlumberger, demand for such ships is strong and companies like Petroleum Geo-Services have extreme pricing power.

I highlighted the deepwater business at great length in the January 3 issue of TES, The Deep End. For those unfamiliar with this market, I recommend taking a closer look at that issue.

Suffice it to say that this is the last frontier of E&P work–the final oilfield region where truly giant reserves are to be found. It’s also a segment of the business that’s extraordinarily resilient to commodity price volatility.

In other words, no operator is going to delay a deepwater project because of a one- or two-month pullback in oil or gas prices. Deepwater developments have nothing whatsoever to do with the North American gas situation I outlined above. In fact, many companies have said that it would take oil prices dropping into the low $40s on a prolonged basis for such projects to be delayed; I just don’t see that happening.

Despite the long-term positives, there was some serious disappointment with Petroleum Geo’s recent earnings release. The stock is roughly 10 percent off its early May highs, though it’s still up by 37 percent from my recommendation in the Nov. 1, 2006, issue, Earnings Bonanza.

I believe the discontentment with Petroleum Geo’s report is overblown. The main reason the company missed expectations is that it has two new seismic ships scheduled for delivery that were late getting delivered. That means that the company had to divert some of its existing high-specification ships for pre-contracted work.

The problem is these ships could have been earning higher fees if they hadn’t been diverted. I see this as a one-off problem related to shipyard delivery schedules, not a longer-term issue for the stock. In addition, Petroleum Geo announced a one-time special dividend equivalent to a little less than 7 percent of the current stock price.

That said, I have another reason to be concerned with this company: Petroleum Geo announced in May that it’s planning to terminate its US American Depositary Receipt (ADR) program. In other words, the company will no longer be listed on the New York Stock Exchange (NYSE) under the symbol PGS; it will only be listed in Norway.

NYSE rules for de-listing ADRs changed on June 4. The change makes it easier for companies to delist. Petroleum Geo doesn’t feel that the volume traded in its ADRs justifies the regulatory and listing costs imposed by the US government and regulatory authorities.

As an aside, although I’m all for regulation and fraud prevention, I do find it somewhat unfortunate that compliance costs in the US have risen so much in the past few years. It concerns me deeply that many prominent firms are choosing to list in London rather than New York because of these issues.

Of course, this opens up another opportunity for investors: London is becoming an increasingly easy, cheap market for US investors to access. That, however, is the subject for another issue.

This doesn’t mean the ADR shares will be worthless. Remember, ADR shares simply represent ownership in underlying securities traded in Norway. Therefore, ADR shareholders will likely receive Norway-listed shares in exchange for ADR certificates.

However, I know from personal experience that the Norweigan market isn’t always the easiest for US investors to access. Also, although investors may be able to dump the shares on the over-the-counter exchange in the US, the liquidity in this market is nothing compared to the NYSE.

I will miss Petroleum Geo; I’ve recommended this stock on a few occasions, and it’s been a profitable play. I also continue to believe it’s one of the best plays on growth in the deepwater. Those willing to deal with the complications inherent in trading Norwegian securities should consider holding on for the longer term.

But, in this issue, I’m officially selling Petroleum Geo-Services from the aggressive Gushers Portfolio for a total profit of close to 40 percent.

Back To In This Issue

The Nuclear Option

Energy Metals Corp (EMC)

This is a member of the uranium field bet. EMC owns mines and proven reserves in the US and had plans to start producing from those projects late in 2007. But on May 18, EMC noted that it was in exclusive talks to sell the company; the stock shot up close to 20 percent on that announcement.

Finally, that bid emerged June 4. SXR Uranium One, another field bet recommendation, offered 1.15 shares of its stock for each share of EMC owned.

Given the fact that this deal was widely anticipated, EMC stock was already trading in line with that proposed price. Currently, EMC is trading at only a tiny discount to the proposed takeover value.

EMC has agreed to pay a CD55 million breakup fee to SXR in the event the deal should be scuttled. Given EMC’s current share count, this works out to only about CD0.61 per share.

That’s small enough that it would be possible for a competing bidder to enter the fray. And given the massive acquisition activity in the space in recent months, this wouldn’t surprise me entirely.

Nonetheless, given that this is an all-stock deal, I don’t see the risk of holding EMC and waiting for another bidder worth the potential for this investment to be dead money. And because I already recommend a position in SXR, I see no reason to double-weight that stock by accepting shares under this deal.

Therefore, I recommend selling Energy Metals Corp for a total profit of more than 240 percent since my recommendation last July. I’m planning an issue that will focus on uranium sometime next month; as part of my research I’m looking for a new play or two on the group.

FMC Technologies

FMC Technologies manufactures subsea equipment that’s needed to produce deepwater wells economically and efficiently. Deepwater development work continues to accelerate; every services and drilling firm has reported that this market remains hot.

However, the stock recently ran above my recommended buy target. I’ve already raised that buy under target twice since recommending the stock, and it’s up more than 30 percent since that recommendation. So I’m cutting FMC Technologies to a hold from a buy in the portfolio and tightening up my recommended stop.

Carbo Ceramics

I explained the concept of fracturing and proppant above, and I highlighted Carbo Ceramics specifically at some length in the February 21 issue of TES. The company makes a sophisticated ceramic proppant that can improve the efficacy of fracturing jobs.

The stock was hit somewhat in the wake of its first quarter report mainly because of weaker-than-expected sales of proppant. I see this as related to the still-weak North American market.

However, as I noted above, I expect the market to start turning the corner toward the end of this year. I see Carbo as an excellent play on that turn.

Moreover, although overcapacity may continue to be an issue for services firms performing frac jobs, it’s not an issue for the ceramic proppant industry. Finally, I like the company’s growing Russian business; Carbo recently opened a factory there as planned.

Seadrill

Seadrill owns a vast fleet of deepwater drilling rigs. Many are the highest specification rigs available anywhere in the world today. Better still, unlike many rig operators, Seadrill has a number of this rigs uncommitted.

The company has been pushing some truly massive day-rates for these rigs. I highlighted this stock in the January 3 issue.

The stock caught a bid late last month after it emerged that it’s nearing a deal to lease one of its advanced deepwater rigs out at a day-rate of $600,000 per day. This would be a new record for this class of rig and highlights the extreme earnings leverage that Seadrill has to a very supply constrained deepwater rig market.

XTO Energy

Like EOG Resources, XTO Energy is involved in exploiting resource gas plays. The stock soared this week after announcing it’ll be acquiring a vast array of gas reserves from Dominion Resources for $2.5 billion. The list of reserves acquired includes some very attractive properties in the Rocky Mountains and the San Juan Basin. That deal should close by August and will give XTO scope to grow its gas production at an even faster pace.

Better still, XTO has a plan to spin off some of its more-mature reserves into a separately listed limited partnership (LP). By listing these mature reserves in an LP, XTO will be able to raise capital cheaply for further expansion because LPs are popular with investors.

And the proposed LP could be attractive in its own right for income-oriented investors. Production-focused LPs offer high dividend yields and are free from corporate taxation. I highlight this potential further below.

Back To In This Issue

Coal

I highlighted my case for owning coal-mining stocks in the May 2 issue of TES, King Coal. I won’t repeat all those arguments here. Suffice it to say that my favorite coal plays, Peabody Energy and CONSOL Energy, remain among my favorite picks for this summer.

But two new developments are worth noting. First, I continue to prefer coal mining firms with leverage to the Powder River Basin and relatively limited exposure to Central Appalachia (CAPP).

Although miners of all stripes will undoubtedly benefit from rising coal prices, CAPP miners face high cost inflation, difficult geology, a dearth of qualified labor and a host of new safety regulations. This will limit their ability to benefit from rising coal prices.

As I noted in the May 2 issue, Peabody has announced it will be spinning off its Eastern-focused and CAPP operations into a separate company. This will allow the management team to focus its attention on the fast-growing Powder River Basin and Peabody’s Australian operations.

The company has announced the details of its upcoming spinoff: The new company will be called Patriot Coal Corp and will trade under the NYSE symbol PCX. Existing Peabody shareholders are slated to receive one share of Patriot for every 10 shares of Peabody currently owned.

I expect this spinoff at some point this summer. As Patriot will have some of the highest-quality reserves in the East, I may recommend hanging on to the stock for a while after you receive your spinoff. Look for more details and my updated advice as we get closer to the spinoff date.

The second point to note is the increasing attention now being paid to coal-to-liquids (CTL) technology. The basic process of converting coal into synthetic diesel fuel is named after the two German scientists who established it in the 1920s.

Fischer-Tropsch (FT) has been employed on a large scale several times since its invention. The German military was starved of energy during World War II; Germany’s comparatively large coal supplies were liquefied to produce a fuel.

During the apartheid years, South Africa was under an embargo and used FT-generated diesel fuel as a source of energy. Even the US at one time produced FT diesel in smaller-scale plants along the Gulf Coast; those projects were largely abandoned when oil prices dropped in the ’80s.

At present, the total global capacity for FT diesel production of just 150,000 barrels per day comes from three operating plants. All of those plants are located in South Africa, which has retained its leadership in this technology.

The beauty of FT is that coal is an ultra-cheap fuel relative to oil. So, if you can convert plain old coal into expensive liquid fuel, the value of that coal rises close to tenfold.

In addition to this economic appeal, CTL is also potentially the subject of a truly massive government subsidy package. Basically, the Democrats have spoken a great deal about the environment and global warming since taking control of Congress and are generally seen as against “dirty” coal.

However, that’s not exactly the case. In fact, several of the bills currently being pushed through Congress are actually sponsored by Democrats, many from heavy coal-producing states.

Furthermore, one of the most vocal proponents of CTL technology is Brian Schweitzer, the Democratic governor of Montana. The truth is that CTL has surprisingly broad bipartisan support and is, perhaps, even more widely supported among congressional Republicans.

Interesting, on May 29, an article on CTL made the front page of The New York Times. The paper detailed that one of the plans circulating through Congress is to offer loan guarantees for six to 10 major US CTL plants, a 51-cent tax credit per gallon of CTL fuels used until 2020 and additional subsidies should oil prices drop under $40.

The US Air Force even has plans to offer long-term contracts to buy as much as 1 billion gallons of CTL fuel per year; that’s equivalent to around 40 percent of Air Force fuel use. Simply put, this package of subsidies is reminiscent of the subsidies currently given for ethanol. It’s the sort of generous package that Washington just loves to put together.

CTL fuels are cleaner in terms of sulphur-dioxide emissions, but there are potential concerns with reference to carbon-dioxide emissions. Many environmental groups are opposed to CTL subsidies.

Nevertheless, according to the Times, congressional Democrats would like to pass this subsidy bill by mid-July. This would be a major boost for our coal-related plays in the model Portfolios.

Peabody Energy has been the most aggressive in promoting and investing in CTL. The company recently announced a plan to pledge 1 million short tons per year of coal and a $10 million investment in an Illinois CTL plant. Peabody has also been among the most vocal firms in lobbying Congress for CTL subsidy legislation.

The truth is that I’m not recommending Peabody because of CTL. The stock’s fundamental merits are based solely on its traditional steam-coal business. Nonetheless, if the bill does go through this summer, look for a positive move in Peabody’s stock.

My pure-play on CTL is South Africa’s Sasol, currently a member of the Proven Reserves Portfolio. I profiled this stock at length in the April 12, 2006, issue of TES, Finding New Btus. To make a long story short, South Africa-based Sasol is the global leader in CTL and FT; it’s been the world’s only commercial CTL producer for the past 50 years.

Peabody has partnered with a smaller firm called Rentechon that firm’s CTL plant. Rentech is a smaller company with an unproven technology; I’ve consciously not recommended this as a play on CTL, and I continue to prefer the more-stable and proven Sasol.

That said, I have the utmost respect for Peabody’s management team, and its involvement with Rentech certainly increases my confidence in the story a great deal. I’m adding Rentech to my coverage universe as a buy; however, I’m not yet ready to recommend the stock in my model Portfolios.

Lately, Sasol was hit because of some delays at its Oryx gas-to-liquids (GTL) project in Qatar, coupled with the continued threat of a windfall profits tax in its native South Africa.

GTL is somewhat similar to CTL: It’s a technology for converting natural gas into a liquid fuel. Because of some production problems, volumes from this project aren’t ramping up as quickly as the company had expected. It’s important to remember, however, that Oryx is among the first large-scale projects of its kind; there are bound to be difficulties in any such cutting-edge product.

As a result of these difficulties, Sasol trades at only nine times next year’s earnings, a significant discount to the average integrated oil. Meanwhile, as its announced projects come on line in the next few years, it’ll have one of the fastest production growth profiles of any integrated oil company. I also think this cheap valuation is pricing in the possibility of a windfall profits tax on Sasol.

If the company does eventually make a move on the US CTL market, as I expect, the stock could really grab investors’ attention very quickly. Sasol remains a buy.

Back To In This Issue

Finding Partners

Last week, I had the occasion to participate in a lengthy conference call with the chief financial officer and several representatives of Canadian trust Enerplus Resources. During the course of the conversation, we noted that one of Enerplus’s competitors, Provident Energy Trust, has spun off many of its US production assets into publicly traded US LP called BreitBurn Energy.

I highlighted the publicly traded partnerships at great length in the Nov. 22, 2006, issue of TES, Leading Income. I suggest that all new subscribers not familiar with this group check out that issue, as well as the most-recent issue of TES, Stability In Income.

We noted in the call that both BreitBurn and Provident had been solid performers so far this year. We asked if Enerplus had any plans to list an LP in the future as a means of raising cash to fund further acquisitions in the states or, potentially, as a way to shelter its US assets from the proposed new taxes to be levied on the trusts by the Canadian government.

It’s quite clear from the conversation that Enerplus has given a great deal of thought to this issue. The company pointed out that 14 percent of its current production is from US fields.

But, amazingly, some 50 percent of the acquisitions it’s currently looking at are in the US. That suggests that Enerplus is indeed interested in expanding its US presence. I suspect that a solid majority of these assets would be appropriate for the LP structure.

I was happy to hear the Enerplus team specifically mention Wildcatters Portfolio recommendation Linn Energy. Linn was the first E&P focused partnership to list in the US since the ’80s.

Since that time, another half dozen have gone public and still more are planned. As I noted above, Wildcatters Portfolio recommendation XTO Energy is the latest to announce it’s considering the potential to spin off some of its assets into this same partnership structure.

Here’s my point: We have Enerplus considering an LP for its US assets, while Provident and another Canadian trust, EnerVest Diversified Income Trust, have already gone down that route. All of these companies have plans to expand by acquiring mature fields that offer low-risk, long-lived production.

At the same time, the vast majority of US production assets still aren’t held in publicly traded partnerships. There are still plenty of mature reserves left to be acquired.

This sounds like a recipe for an acquisition spree. That, too, should benefit Linn as it may be a potential target.

Back To In This Issue