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Matt Badiali's Methods for Investing in 'Cowboyistan'

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Matt Badiali The best way to make money from the shale oil boom in Cowboyistan—the Bakken, Permian Basin and Eagle Ford shales located in North Dakota and Texas—may be the service providers. Master limited partnerships building pipelines to ship oil from newly cracked shale, and companies producing frack sand, will be hot stock prospects as the price of oil inches up. In this interview with The Energy Report, S&A Resource Report editor Matt Badiali shares the names he is researching in both the pipeline and fracking equipment and materials spaces.

The Energy Report: When we talked last October, you predicted that low oil and gas prices would fuel an economic resurgence in the U.S. and impact everything from politics to job creation. Is the economy living up to its potential?

Matt Badiali: I think so. Companies moving here and building new factories are citing low energy costs. The average family is saving $1,200–2,500 per year, which is a pretty big savings. But they don't seem to be spending, so it hasn't impacted the overall economy as much as I thought it would. On a bigger scale, low energy prices beat low-cost wages and low-cost materials: In today's economy, low energy costs will bring the economy to you.

The Sprott-Stansberry Vancouver Natural Resource Symposium
July 28–31
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TER: It has had an uneven effect on jobs, however, particularly in oil-producing areas. You recently wrote that Saudi Arabia is playing chicken with oil prices. What impact is the continued flow of oil into the market from the Middle East having on companies in places like the Eagle Ford?

MB: It's having massive impacts, particularly in the Eagle Ford and the Permian Basin. Harold Hamm, CEO of Continental Resources Inc. (CLR:NYSE), calls the three big shale plays—the Bakken in North Dakota, Permian Basin in West Texas and Eagle Ford in southeast Texas—Cowboyistan.

"This extended period of lower oil prices is causing companies to become more efficient."

This extended period of lower oil prices is causing companies to become more efficient. They're not drilling willy-nilly. In fact, 60% of the rigs, some 1,000 of them, aren't working right now, and as many as 60% of wells that are being drilled are not being completed—about 4,000 of them. The expensive part of shale wells is cracking the rocks, cleaning the well bore and plumbing it. That's called completion. It's actually inexpensive to drill the well right now. When the price goes up, a lot of inventory is primed and just has to be fracked to start flowing.

However, there is a lot of oil that won't be drilled at all at the current price. The experimental shales are where the going is tough. The Tuscaloosa Marine Shale in Louisiana is dead, and will probably be dead for a while. Some of the peripheral shales in Colorado and Canada aren't going to work with oil at $60/bbl. Russian, Nigerian and Venezuelan oil cost far more than $60/bbl to produce.

Saudi Arabia continues to produce lots of oil in order to put marginal producers out of business. Saudi Arabia has a sovereign wealth fund worth more than half a trillion dollars; it can continue producing at $60/bbl oil for a long time.

TER: How long can the U.S. frackers keep this up?

MB: It depends on the company. If you're making a profit, you can keep it up indefinitely. If you're not making a profit, you're in trouble.

We're seeing mergers and divestitures, particularly when it comes to companies that took on massive debt. Take Magnum Hunter Resources Corp. (MHR:NYSE.MKT), for example. The $316 million market cap company has over $950 million in debt. It isn't making any money right now. It recently announced the sale of a major asset—the Eureka Hunter Pipeline in the Marcellus and Utica shales.

"The current lack of investment in oil development will have a global impact down the road."

I think there will be more of that, both in the shale and the Canadian tar sands. Companies are being forced to get leaner. The current lack of investment in development will have a global impact down the road. All Saudi Arabia did was maintain market share and refuse to cut production. Maintaining oil production was important to the Kingdom, particularly in the battle with Russia for Chinese market share. However, there will be fewer new sources of oil down the road. . .which could lead to higher prices.

TER: From both a short-term and long-term investment approach, what oil and gas explorers and producers are doing well and can survive?

MB: Right now, I am waiting. I'm not buying producers today. I need to see which companies are doing well at lower oil prices. We just completed the first quarter, where hedging probably didn't play a role in the bottom lines of producers. I am waiting to see the results.

I do like companies that supply fracking equipment and material. I think there is an opportunity now to buy assets that are going to be useful forever at very low prices. For instance, I like the frack sand producers. Engineers have discovered that more sand per well is more economical. I was just at the Energy Information Administration (EIA) conference and heard that, in the Permian Basin alone, from 2012 to 2014, the average initial production rate rose from 400 barrels a day (400 bpd) to 800 bpd. In two years, engineers doubled the volume of oil produced, mostly through changing the way they were fracking rocks, and a big part of that change was the volume of sand added. Now, instead of 500,000 pounds, companies are using 2 million pounds of sand per well, and producing a lot more oil. They are, in a sense, trading the sand cost for better oil production. That is an easy trade to make.

"Investors have to put in the hard work to investigate the commodity sector on the way down and then buy stocks when things start to perk up again."

Companies like Hi-Crush Partners L.P. (HCLP:NYSE) and U.S. Silica Holdings Inc. (SLCA:NYSE) are the beneficiaries of this new demand. We bought these stocks in May, and they have been down a bit, but I'm happy to buy these companies at these prices because fracking is here to stay. It is the technology that's going to drive U.S. oil production in the future. Good, clean, Wisconsin sand is going to continue to be valuable even though share prices are a fraction of what they were six months ago.

TER: Both of these companies jumped up last summer and then went right back down again. Was that an anomaly?

MB: The move was from May to August, and it was the result of the news coming out about how much sand was being used. There were dedicated rail trains, 30 cars a day, carrying nothing but sand. The demand for sand was enormous.

TER: What will make that price jump back up again? What is the catalyst?

MB: Remember the 4,000 wells being drilled today aren't being fracked? They will be. When they are, the sand demand is going to skyrocket. Once oil hits $70–80/bbl, there is going to be a massive demand for fracking equipment and sand. For people looking for oblique investments in the oil industry, sand companies offer the best opportunity right now.

TER: You recently wrote about the challenges of moving all the new production that fracking is making possible. Are we any closer to a solution for getting oil from Canada to U.S. refineries or to consumers in Asia?

MB: Yes. The problems we've had moving Canadian oil have been solved or are in the process of being solved. The last leg of a main artery that brings Canadian crude straight to Houston is almost complete. Run by pipeline companies Enterprise Products Partners L.P. (EPD:NYSE) and Enbridge Inc. (ENB:NYSE), the new route runs from Alberta, Canada, to Houston, Texas.

TER: Are there still opportunities to invest in infrastructure solutions—master limited partnerships (MLPs), in particular?

MB: Yes. MLPs have also gotten pretty beaten up of late. There are companies that I like in the space. We bought TC Pipelines L.P. (TCP:NYSE), the MLP that TransCanada Corp. (TRP:TSX) owns, specifically for that reason. It pays a nice dividend. We've held it for eight months now. Our return is basically flat. Share prices eased lower, but we've been collecting dividends.

I think Plains All American Pipeline L.P. (PAA:NYSE) is a great deal right now. This is another oil and gas infrastructure pipeline MLP. It's come down about 30% since its peak in September. For investors looking for a dividend from a pipeline company, I like this a lot. It pays about 6% today. One of the reasons Plains All American is down is one of its pipes in California burst, resulting in a pretty big oil spill. That's the kind of news that's going to go away fairly quickly, but it propelled the shares down, and the shares might be an opportunity for investors today.

Some of the MLPs have gone up in price. We looked at Scorpio Tankers Inc. (STNG:NYSE) as one of the potentials. It's up about 40% over the last eight months. This is an attractive company.

TER: You're going to be speaking at the Sprott/Stansberry Vancouver Natural Resource Symposium at the end of July. What is one thing that natural resource investors need to understand about where we are in the energy investing cycle, and how to preserve or even grow their wealth?

MB: Bear markets in commodities are opportunities. You have to think against the grain in the natural resource sector. You have to put in the hard work to investigate the sector on the way down and then buy stocks when things start to perk up again.

In the oil and gas space, we're in the investigations mode. We're looking at companies that we'd like to buy and are high-grading our list. We're looking for companies with low debt and fair to decent operating margins at low oil prices. Those are the ones we're going to buy. But we're not going to buy them until we see an uptrend. Oil has had a small uptrend. It has bounced off its bottom. We are getting a lot closer today to buying these companies than we were even a month ago.

TER: Thanks for speaking with us, Matt.

Read Matt Badiali's Guide to Avoiding Pitfalls in Resource Investing

Matt Badiali is the editor of the S&A Resource Report, a monthly investment advisory that focuses on natural resources, including silver, uranium, copper, natural gas, oil, water and gold. He is a regular contributor to Growth Stock Wire, a free premarket briefing on the day's most profitable trading opportunities. Badiali has experience as a hydrologist, geologist and consultant to the oil industry. He holds a master's degree in geology from Florida Atlantic University.

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1) JT Long conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report and The Life Sciences Report, and provides services to Streetwise Reports as an employee. She owns, or her family owns, shares of the following companies mentioned in this interview: None.
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3) Matt Badiali: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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