Chen Lin: Actually, the most exciting development for me is closer to home. I think the major action is in the U.S. and Canada. The whole fracking revolution is picking up steam. We could see as much as a 1 million barrel per day (1 MMbbl/d) increase in North American oil production! The United States is finally inching closer to energy independence, which could have a profound impact on the world.
TER: What are the catalysts that are going to move oil and gas in the coming year?
CL: Right now the key to watch is the Fed—if it's going to taper, when it's going to taper. This year I was betting the Fed would delay tapering. I think it probably will taper, at the latest, early next year. Fed action could have a very strong impact on the commodity space, for commodity prices as well as commodity stocks.
TER: How will these conditions affect the oil and gas companies in your portfolio?
CL: My portfolio in oil and gas is quite broad. I try to pick the stocks that can move on their own. They can move on their news, trading results, their success in certain areas. They won't be affected too much by the Fed or by the commodity price. The tapering will actually have a negative impact on energy and stocks in general.
TER: How has your oil and gas portfolio been doing this year?
CL: The first half was very difficult for commodity stocks in general, not just energy. Mining of any kind was hit hard. Stocks just continued to go down without any reason. Then oil stocks started to scream back in the past month. I was very lucky this year because in the summer I was buying gold stocks. Then when gold hit $1,400 per ounce ($1,400/oz), I told my subscribers that I was planning to sell. I sold most of my gold stocks in late August/early September. I was just buying energy, and energy bottomed around that time, so many have already moved a lot in the past month.
TER: Are you expecting to add to your oil and gas portfolio or drop any companies?
CL: I've been adding energy plays lately. I also sold some of the energy plays, like Coastal Energy Co. (CEN:TSX.V), in which I had quite a large position. I reduced my position because it depreciated a lot. The next 6–12 months will probably be quite a tricky timeframe, so you have to actively manage your portfolio. I try to add and drop, get in and out of companies actively.
TER: In one of your letters you said you were buying fracking plays this year. Why weren't you doing it earlier?
CL: Because they were very bad performers in the past three years. I sold fracking plays three years ago with a very good profit. At that time, fracking had just started and people were rushing into the space. I got out because I realized the capital costs are very high for a lot of companies. Issuing debt for a small company costs a lot of money.
Three years later, fast-forward, the fracking play companies have done so badly since then. Many are down as much as 90%. They are down so low that if the management chooses to sell all its land and the shale position, you can get a lot of backers at this current stock price, which means that the stock price was pressured very, very hard.
Meanwhile, Exxon Mobil Corp. (XOM:NYSE) is actively buying, and all the other major companies are moving into the fracking plays. There are a lot of deals going on. Also deals from China, from Korea, from Japan. Then the deals traded at a much higher premium to stock prices. Part of the reason I got into the fracking play is that it's a good value proposition. There are not a lot of management teams that are not willing to sell in case of a takeover, for example, so that also could benefit shareholders. That's why I got back into the fracking plays about one to two months ago.
TER: You say the fracking companies were doing poorly before. Were the oil companies doing any better than the average, or were oil and gas doing about equally poorly?
CL: The oil and gas companies were not doing well in the past two years in general, but the fracking plays were doing even worse. There were multiple reasons. West Texas Intermediate (WTI) was low, and the spread of WTI to Brent was very high, $20–25 sometimes. Companies were forced to sell at a price well below Brent. In order to continue drilling, they had to borrow money or issue shares. Even my recent best performer, Penn Virginia Corp. (PVA:NYSE), performed very poorly. It was a $30 stock in 2010. It went down all the way to $4/share this year. I bought it at $4.70, and it went over $7 in one month, which is good for me and my subscribers, but imagine a shareholder who bought at $30 in 2010. Same thing for my other best performers lately: Rock Energy Inc. (RE:TSX) was trading at $6 in early 2011; it dropped all the way to $1. I was fortunate to get in at ~$2 a couple of weeks ago; now it's over $3. BNK Petroleum Inc. (BKX:TSX) was more extreme, trading at around $6 in early 2011, it dropped below $0.40 and is now close to $2. If BNK has any successes in Poland in a few months, I believe the stock can revisit the old high. You can see how volatile these stocks can be, and I was very fortunate to have sold my fracking stocks in late 2010 and early 2011.
TER: What has changed in the fracking plays to make them more attractive now?
CL: There a couple of reasons. The WTI/Brent spread has narrowed dramatically in the past six months. At one point, WTI/Brent was trading at par this year. That's the first reason. Second, the fracking technology has improved. Most companies know how to drill a well cost-effectively and to get the most production out. As technological development is ongoing, a lot of questions have been answered. Infrastructure started building up. We see there are some pipelines at least in the lower part of United States already built up. Finally, large companies and Asian countries are starting to buy into the fracking play, paying as much as $60,000 per acre. That was a record.
TER: Are you still expecting a major decline in the price of oil?
CL: I'm concerned about the oil price. One of the reasons is that the production going on in the United States and Canada has tremendously increased. The annual production rate increased by nearly 1MMbbl/d between 2011 and 2012. The Middle East situation is starting to quiet down as well. Recently I heard Saudi Arabia has been cutting back to maintain the high oil price. It's hard for me to imagine the country continuing to do that at its own expense.
CL: Companies I favor have their own unique stories; the companies can move on their own. They're not dependent, for example, on the financial market. They don't need to raise money. They're going to have a very significant company-changing event potentially happening in the next 3–6 months. Those I believe can significantly move the stock price.
TER: Which companies on your scorecard have been doing their best work this year?
CL: If you look at the long-term performance, probably Mart was still my best performer. I got it at $0.15. I think I told my subscribers it would become one of my largest positions. It's over a dollar now. Consider how much dividend that's paid. You get all the money back if not more.
Mart is going to build its own pipeline for its Nigerian oil field because the current pipeline is poorly maintained, and the stock suffered because the pipeline loss recently was as high as 20–25%. People were concerned so much oil was stolen. However, when Mart builds its own pipeline, which the company expects to do in H1/14, then it can improve oil production and move to a much better maintained pipeline with much less loss. That will be a major catalyst.
Again, it's a Nigerian company. A lot of people have doubts about a Nigerian company. Sometimes people need to see the pipelines built before investing in the stock. You need some patience. They're paying about $0.20/ year dividend. I just received my recent quarterly dividend. You keep getting paid while waiting.
TER: Mart Resources' production losses at the Umusadege oil field in Nigeria were much greater this year than last. It looks like it was because of longer and more frequent export pipeline shutdowns and oil theft. How would Mart make its new pipeline better protected?
CL: It will go through a completely different system. This is the other export route where losses are a small fraction of the AGIP pipeline.
It's an old Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE) pipeline. At last report, Mart was only a few kilometers away from connecting.
If you look at the pipeline from this year and last year you will understand why the stock went down this year. Last year, the pipeline was running fine and Mart was doing fantastically. In the past two or three years Mart was the best performer among all energy stocks. This year the pipeline has had a lot of issues—flooding, theft. Mart shares were hit hard, though it was completely out of the company's control. Hopefully when the new pipeline starts, the new route from the Shell exit facility, we will see a very different company. Then Mart will triple production, so you will see much larger production, more cash flow and potential increase of dividend, which is already very high. I think that dividend is 13–14% right now.
TER: Do you have a target expectation for Mart's performance or stock price after the completion of that line?
CL: Right now I do not, but I expect the stock will be substantially higher than the current price because the company can triple production and the cash flow. The year 2014 could be a banner year for the company with huge cash flow coming in. The stock should be a multiple of the current price, but time will tell.
TER: Is religiously motivated violence in the northeast of Nigeria likely to affect Mart's profitability?
CL: It's possible. Nigeria is a risky place. As you said, the northeast part of the country, which is dominated by Muslims, has a lot of problems with violence against Christians. Fortunately, Mart is operating in the southwest part. It's closer to the shore, in a relatively stable area, so they don't have too much religious violence.
TER: In an interview with The Energy Report in January, you said that Pan Orient has the potential to be a tenbagger this year. How has it performed?
CL: It has not performed very well, certainly below my expectations. Part of it was that the big wells it's trying to drill have not been very successful. Five big wells all turned out to be dry holes, which is very disappointing, but that's the risk we take by investing in exploration companies. However, right now it's entering a very interesting phase because Pan Orient's neighbor just found a large oil pool just on the border of Batu Gajah (77% owner and operator). The crest part of the discovery—the best part—is on Pan Orient's land. The discovery is rather large. It may be over 150 million barrels of oil equivalent (150 MMboe). It has oil, it has gas condensate and it has gas.
The discovery well was drilled only 175 meters from Pan Orient's border. You can go to Pan Orient's website and see the location of the well. You can see the crest of the discovery is right on the Pan Orient concession. That makes a very interesting play because you can drill right there and it becomes very low-risk drilling, because the other company drilled three wells. The first two wells averaged more than 6,000 boe. The third well they're still testing. It's right on the border. Pan Orient has the best part of that. This could be a very nice discovery.
My understanding is Pan Orient is going to partner out all three of the major Indonesian concessions. It expects to receive a large down payment and to have the partner carry out the next few wells on each concession. Since Pan Orient spent close to $100 million in all the drilling, the seismic, the groundwork, I expect it to get a lot of the money back from partnering. Potentially, it could be tens of millions. It's very hard to give an exact number because it is negotiating with its partners right now.
Its cash position should substantially increase. I would guess it would be around $1.50 after everything's over. Right now the stock is a little over $2/share. So the company will have around $1.50 in cash, then it has its partner(s) drilling the well—potentially I would say 8–10 wells in Indonesia at the partner's cost. It has a big oil target coming up in Thailand that it's going to drill. You can see the 3D seismic on the website. It's a very large target. Over there in Thailand, it only costs $1–2 million to drill. Then it also is fully funded to do the heavy oil in Canada. The company has three possibilities, and all three have a very good chance to succeed. Success in each of them can dramatically change the stock price.
TER: Andora Energy has a steam-assisted gravity drainage project at Sawn Lake. When is that one going to produce its first oil?
CL: It's going to start drilling in early October. First oil should be in Q1/14. Sometime in Q1/14, we will know the results of the well. Remember, the second largest French company, Maurel & Prom (MAU:EPA), is already Pan Orient's partner there. The company subscribed a private placement at 1,200% premium to the stock price, which tells you how undervalued the whole area is.
TER: Can you talk about some other companies in your portfolio?
CL: I'm buying different energy plays. About the end of August/early September, my major additions were BNK Petroleum, Penn Virginia Corp., Ithaca Energy Inc. (IAE:TSX) and Harvest Natural Resources (HNR:NYSE). We had a very tough H1/13 on commodities. I was very lucky to buy gold miners during the summer, when gold was testing $1,200/oz. When it hit $1,400/oz, I was extra lucky to sell these gold miners to use the money to buy those energy stocks. That actually turned out to be a very good trade.
BNK is an interesting company. Its recent well results in the U.S. have been fantastic. It is surrounded by Exxon, and will likely sell the assets to Exxon, which it has done before. Then the company cash level should be around its market cap. It has about one million acres in Poland and will drill the first well in early 2014. If it is successful in Poland, the sky is the limit. Remember, BNK had a billion-dollar market cap just based on Poland in early 2011!
I already sold Penn Virginia; it jumped 70-80% for me in one month. Though I still believe there is value in the stock, I would wait for a pullback to buy it again. Ithaca Energy also moved up a lot, but it still has a lot of upside room. It's a North Sea-based oil exploration company trading at 1–2 times cash flow. If the company can continue to execute, I think it still has substantial upside.
Harvest Natural Resources is a special play here. If you calculate the recently announced transaction, you will see the company can pay off all its debt and have $10/share cash left on its balance sheet, from which it intends to distribute around $6 to shareholders. The stock's still trading around $5. Potentially you can get your money back plus you have another valuable spin off with very interesting asset in Indonesia and in Colombia plus $4 on the balance sheet for free. Most important, the company's worth is independent of market fluctuations. That's why I like it.
Rock Energy has been another great performer for me lately. It should have more upside left since the recent wells derisked the whole area. One interesting play is RMP Energy (RMP:TSX). Its recent well flows 2,000 barrels per day (2,000 b/d) oil. The payback of the well is less than one month, something unheard of in the fracking space. The company just consolidated the area and has around 100 drilling locations just on that property. They are planning to upgrade the oil processing facility to 20,000 b/d in Q1/14, when we will see a huge jump in production.
Recently I found a very interesting stock I've been accumulating. The company name is NXT Energy Solutions (SFD:TSX.V; NSFDF:OTCBB). It can fly airplanes over a field and detect if oil is present or not. It recently did a very large survey with PEMEX (Petróleos Mexicanos), the Mexican oil company. PEMEX already has seismic data on a certain field, they knew where it has oil deposits and where it doesn't. PEMEX asked NXT to fly over, and the results were shockingly good. NXT found every large field for PEMEX! The report is on the website. PEMEX is the co-author.
If NXT can continue like this, it can change the oil industry as we know it. You probably need seismic later on to pinpoint where the oil is, but you can fly a plane over a very broad space and then detect where the oil is. That will be a revolution in the oil industry. It's a very interesting company. It has a strong balance sheet. Recently it has started to go to the oil exploration companies and negotiate payment through royalties in exchange for its services. That can be a very interesting move. It's an interesting company. I think if everything's successful it has a very bright future.
TER: What is your outlook on energy in general for the next year?
CL: Like I said, I'm cautious about the oil price in 2014. The production from the U.S. and Canada is just amazing. If you read the Eagleford reports and Bakken reports you can see how many new wells are drilled. The completion techniques are getting better and deliver more oil production during the life of a well. I'm a little bit afraid the oil will fall much below $100/bbl. It's possible.
On one hand, you have very high oil prices now. Most of my energy companies are making money. They're doing fantastically. Though I'm not very confident the high oil price is here to stay. I want to remind everyone that if oil drops to below $80/bbl, the party of fracking stocks may be over. I would be careful and take profits as they go up. I'm going to watch the market month by month and see if the situation changes. I also believe that 2014 will be a stock pickers' market. If you pick the right stock with the right catalyst, a stock can go up a lot just on its own. That's what I'm looking at for 2014.
TER: Chen, thank you very much. This has been a fascinating conversation.
CL: Thank you. I appreciate it.
Chen Lin writes the popular stock newsletter What Is Chen Buying? What Is Chen Selling?, published and distributed by Taylor Hard Money Advisors Inc. While a doctoral candidate in aeronautical engineering at Princeton, Chen found his investment strategies were so profitable that he put his Ph.D. on the back burner. He employs a value-oriented approach and often demonstrates excellent market timing due to his exceptional technical analysis.
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1) Tom Armistead conducted this interview for The Energy Report and provides services to The Energy Report as an independent contractor. He or his family owns shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Pan Orient Energy Corp., Royal Dutch Shell Plc and Mart Energy Resource Inc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Chen Lin: I or my family own shares of the following companies mentioned in this interview: Mart Resources Inc., Pan Orient Energy Corp., Ithaca Energy Inc., Penn Virginia Corp., Harvest Natural Resources, BNK Petroleum, Rock Energy, RMP Energy and NXT Energy Inc. 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 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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