The joint monthly web chat for subscribers of The Energy Strategist (TES) and MLP Profits (MLPP) took place last week. The chat is conducted by Igor Greenwald, who is managing editor for TES and chief investment strategist for MLPP, and myself.  

There were four energy sector questions remaining at the end of the chat that required an extended answer, or a bit more research. This week I will answer two of the four questions that were left: One on the importance (or lack thereof) of the Keystone XL pipeline, and one on Nordic American Tankers. Next week’s issue will tackle the other two questions: One on Argentina’s expropriation from Repsol in 2012 and one on Shell’s massive floating liquefied natural gas project.

For answers to some of the remaining MLP questions from the chat, see this week’s MLP Investing Insider.

Q: With the impending development of Canada’s own Western and Eastern pipelines, does the Northern leg of Keystone remain essential for Canadian E&Ps or is it just important to transport from the Dakotas?

Given the recent release of the US State Department’s final environmental impact statement (EIS) for TransCanada’s (TSE: TRP, NYSE: TRP) Keystone XL (KXL) pipeline, this is an opportune time for an update. The EIS concluded that “the proposed Project is unlikely to significantly affect the rate of extraction in oil sands areas…” This is something that I have maintained all along, but this also means that the importance of KXL has been incredibly overblown.

This pipeline project has gotten more attention than any pipeline project since the Trans-Alaska Pipeline of the 1970s. Many environmentalists have protested KXL out of the belief that it is the key to expanding oil sands production in Alberta, but this only demonstrates a general lack of understanding about how logistics projects are executed.

Major North American oil, gas, and product pipelines. Source: Theodora

Before KXL, there were many pipeline proposals that would have exported Alberta bitumen. But the Keystone XL got a lot of commitments from the industry because it made the most sense to ship the heavy oil to US Gulf Coast refineries that were configured to refine it. Now that KXL is facing formidable opposition, TransCanada’s competitors are dusting off old proposals, and coming up with new ones.

As you suggest, there are pipeline proposals going both east and west. Enbridge’s (TSE: ENB, NYSE: ENB) Northern Gateway would provide an outlet to the Pacific Ocean, but there is significant opposition in British Columbia and from First Nations groups. More likely to be approved for a western route will be Kinder Morgan’s Trans Mountain pipeline expansion.

Kinder Morgan Energy Partners (NYSE: KMP) has filed an application with Canadian regulators that would nearly triple the 300,000 barrels-per-day Trans Mountain pipeline capacity to 890,000 bpd, and would terminate in Burnaby, British Columbia. The $5.4 billion expansion would be along the existing right-of-way, greatly simplifying the environmental permitting for the project. Last year, 13 companies signed firm contracts, bringing the total volume of committed shippers to 710,000 barrels per day (bpd). The pipeline is scheduled to begin construction in 2016 with incremental product online in 2017.

TransCanada has its own KXL alternative with its Energy East pipeline — a 4,500-kilometer pipeline that would carry 1.1 million barrels of crude oil per day from Alberta and Saskatchewan to refineries in Eastern Canada. Much of the project will involve conversion of an existing natural gas pipeline and modifications to enable it to transport oil. This project would be nearly 50 percent larger than KXL, and would give Alberta’s bitumen an outlet to the East Coast.

Enbridge also has a pipeline project running south and east. Enbridge is expanding the capacity of its Alberta Clipper Pipeline from 450,000 bpd to 570,000 bpd. The Canadian portion of the pipeline transports oil from the Hardisty Terminal in southeastern Alberta to Enbridge’s Gretna Station in southern Manitoba, then connects at the international border to the US portion of the system and continues to Superior, Wisconsin. The project is expected to be completed and in service by July 2014.

Whether KXL is approved is unlikely to have a big impact on any particular company. TransCanada would probably see the most significant share price movement, but the project isn’t a make-or-break for the company. Oil sands producers like Cenovus Energy (NYSE: CVE, TSE: CVE) have signed up to ship on KXL, and could see some share price movement as well. KXL would probably be the low-cost shipping option for Cenovus and other oil sands producers, but during my visit to Fort McMurray in November Cenovus emphasized that whether KXL is approved or not, the outcome would have no effect on its growth plans given the ready availability of alternatives.

Q: What about Nordic American Tankers? I read that there are even more ships coming onto the market which should kill the latest rise in tanker rates, which would obviously be bad for tanker companies like NAT. Is this what you expect as well?

Nordic American Tanker (NYSE: NAT) is a Bermuda-based tanker company that acquires and charters double-hull tankers. Its fleet consists of 20 double-hull Suezmax tankers. Besides the factor you mention about more ships coming onto the market, NAT has underperformed — period. Shares have lost two-thirds of their value over the past five years, and the dividend has been cut multiple times.

The company was in one of our portfolios when Igor and I assumed responsibility for the newsletter, and we removed it in a purge almost exactly one year ago. Shares were trading at just under $9 when we removed it, and in the year since, the price has traded as low as $7 and as high as $12.61. Right now it is trading at about $10, around 15 percent higher than it was a year ago.

The reason we removed NAT is that the company has consistently failed to meet its own forecasts as well as investors’ expectations. Last month, in a move familiar to Nordic American investors, the company once more cut the dividend from the previous quarter’s $0.16 per share to $0.12 per share. (The quarterly dividend in 2012 was $0.30 per share). The share price had been rallying, but now has dropped 11 percent in the past three weeks.

This is one that I would avoid based on past management performance, regardless of the overall drivers in the tanker market.

Next week we will discuss Shell’s massive Prelude project, which may help put that company in a dominant position in the world’s LNG market, as well as the expropriation of YPF from Repsol by the Argentine government.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

WPX Writes Off Marcellus, Gastar Soars  

Two drillers we recommend saw their shares lurch in opposite directions last week based on shifting market perceptions about the value of their assets. Since we continue to recommend them, you won’t be surprised to read here that the buyers of the winner got it right and the sellers of the loser wrong. Considered together, their stories help illuminate the forces shaping industry decisions today and commodity prices far into the future.

We’ll start with the earlier and the purportedly the bad news first. On Feb. 11, Growth Portfolio holding WPX Energy (NYSE: WPX) pre-announced a write-off of “up to $1.4 billion” in the value of some of its gas reserves, mostly in the Marcellus shale beneath Pennsylvania. WPX cited the “decline in forward market natural gas prices particularly in the Northeast, where Appalachia pricing declined 26 percent in the fourth quarter and 34 percent overall during 2013.”

It may seem odd to see a 10-digit impairment charge even as spot natural gas prices reclaim three-year highs, but WPX must value its reserves not on the spot but on the forward futures, which are more relevant to the value of gas destined to remain in the rocks for years to come.

And even as spot prices have rallied the forward end of the futures curve has sagged like an overcooked souffle. Eighteen months ago, futures were pegging the price of natural gas a decade out at $6.50 per thousand British thermal units.

Now they’re implying an expected price right around the current spot of $5 and change. This oddly-timed change in market sentiment has forced WPX to reassess just how much gas it will find economical to extract from the Marcellus, among other places.

The market’s reaction was swift: the stock fell nearly 10 percent, absorbing the worst drubbing on the day within the S&P 500.

The good news is that this is a bit like getting judged based on the rattiest t-shirt in the back of the drawer, the one you weren’t going to wear again outside the house. WPX’s Marcellus leases, which appear to be clustered around but not in the play’s most productive “sweet spots,” are not the company’s principal moneymakers now, and didn’t figure prominently in its plans for the future.

Marcellus, which accounted for the bulk of the impairment charge, represented just 7 percent of WPX’s estimated reserves at the end of 2012, and less than 1 percent of the company’s recent production by volume.

And of course the impairment is essentially a backward looking accounting exercise, comparing the company’s best estimate of the value of its asset today with the number on its books since before WPX was spun off from Williams (NYSE: WMB). It does not require any cash outlay whatsoever and values the reserves based on a static snapshot of the futures curve.

Which may or may not prove prescient, but seems to pay no heed either to the tightening reserves of natural gas today nor to the multitude of LNG export and industrial projects cheap domestic gas has spawned, and definitely not to the understandable reluctance of many drillers to explore for natural gas at current prices.

Perhaps the futures think the coming flood of production from the Utica and the Eagle Ford as well as the Marcellus will more than offset declines elsewhere. Or perhaps it has decided that higher spot prices will stimulate investment. Meanwhile, companies continue to invest in the production of the more lucrative crude at the expense of gas, leaving one to wonder who will supply all of the extra gas the futures currently suggest is coming.

It won’t be WPX, which forecast flat production this year based on declines of its mature gas fields, even as domestic crude volumes are projected to grow nearly 40 percent. Crude and natural gas liquids are getting the lion’s share of the 2014 capital budget, because while they  accounted for only some 20 percent of the recent production volumes, they delivered 43 percent of the revenue in the first nine months of 2013.

Continuing to increase that proportion in the current price environment is a lucrative no-brainer for WPX, which does have attractive oil acreage in the Williston basin, alongside a promising new discovery in New Mexico.

Meanwhile, by making an example of WPX, the selloff in forward natural gas futures will only discourage investment in dry gas production. In this way current market signals could end up a self-negating prophecy, helping to bring about future scarcity.

As for WPX, although it’s now a modest loser for us, we have no intention of selling cheaply here. The economics of WPX’s principal production areas are far more attractive than those of its Marcellus holdings, yet remain dramatically underappreciated. We’re happy to wait while the company delivers more of the valuable crude the market craves, while retaining lots of upside if those gas futures should end up way off base, as futures have been know to do now and again. Buy WPX below $22.

Gastar Exploration (NYSE: GST) had a better week, rising nearly 11 percent Friday after its Utica neighbor Magnum Hunter Resources (NYSE: MHR) reported a spectacular initial production rate from a new well suggesting payback on the cost would take months rather than years. The celebratory Valentine’s Day surge brought Gastar’s gains to 23 percent on the week and 32 percent since we recommended it two months ago.

And yet despite its Utica potential, Gastar too is responding to market incentives by delivering more crude, drilling for which will consume the bulk of this year’s capital spending. Gastar’s increasingly richer looking Utica drilling inventory constitutes an excellent Plan B, however. Buy GST on any retreats below our original target of $5.75.

— Igor Greenwald

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