Brian Sylvester of The Energy Report - Thu, Nov 14, 2013

Karim Rahemtulla: Profit from Natural Gas Infrastructure Expansion

Karim  RahemtullaKarim Rahemtulla, investment director of Oil and Energy Daily and emcee at the upcoming Liberty Forum, believes the day is near when you will be able to fill up your tank with natural gas in stations from coast to coast. Why? The same large oil companies with gas stations all over the country now have a considerable stake in the success of natural gas. For producers, the trend toward greater adoption could buoy prices for the energy source, increasing margins. In this interview with The Energy Report, Rahemtulla discusses benefactors of the trend—and throws in some good news on gold.

The Energy Report: Karim, why has it been difficult during the past several years to make money in natural gas?

Karim Rahemtulla: It was difficult up until the beginning of this year, but things have since started to turn around. There are many reasons behind the turnaround. There was a greater production of natural gas throughout the country, which drove down prices but did generate more interest in that product because it was cheaper. The pricing environment for natural gas is better this year, which has allowed companies to use better hedging strategies. It costs more to get natural gas out of the ground and into market than the market is actually paying for it, but if companies adopt a hedging strategy, they can get significantly more than what the market is paying. General investor interest in the natural gas space also has contributed to prices improving.

TER: As you suggest, it sometimes costs more to get the natural gas to market than it does to sell it. Will that change?

KR: It's changing right now, but it's still in the early stages. We're not expecting a massive rise in natural gas prices, but we expect it could reach $4-6 per thousand cubic feet ($4-6 Mcf) during the next several years. It is just the function of the greater demand from transportation companies and consumers.

TER: Can investors still make money at those prices?

KR: Yes, they can. Chesapeake Energy Corp. (CHK:NYSE), a pure play on natural gas and oil, is an example. Even though natural gas prices were low, Chesapeake has managed to make money, sell some of its properties and rationalize its balance sheet. Its share price went from $14 in the middle of last year to $26 recently—that's a massive move up in share price!

TER: Do you see Chesapeake returning to pre-2008 levels?

KR: The most optimistic target price I have for the next few years is somewhere in the mid $30s. That will be highly dependent on the price of natural gas moving to the $5 range and oil staying above $90 per barrel ($90/bbl).

TER: Why shouldn't investors wait this out or even short natural gas?

KR: We are still very early in the cycle. Natural gas usage could double over the next decade. During the same timeframe, crude oil usage is expected to stay mostly flat. Natural gas is the fastest growing part of the energy sector.

The push behind that growth is related to transportation. Less than 1% of the transportation sector uses natural gas in the U.S., but that is rapidly changing. Engine manufacturer Cummins Inc. (CMI:NYSE) is incorporating natural gas. FedEx Corp. (FDX:NYSE), Waste Management Inc. (WM:NYSE) and United Parcel Service Inc. (NYSE:UPS) have incorporated natural gas trucks into their fleets. More and more companies are going in that direction, not only because the price of natural gas is so cheap, but because the infrastructure that will allow these fleets to fill up nationwide is expanding. There is already a company building natural gas stations across the country.

Companies in this sector still have tremendously cheap valuations, however. These stocks have been crushed because the natural gas price plummeted. Companies like Encana Corp. (ECA:TSX; ECA:NYSE) in Canada, which has been one of the largest natural gas companies out there, is trading at ridiculously low multiples to what it could be trading at if natural gas was up only another $0.50-1.

TER: Should investors be buying on pullbacks in the natural gas price?

KR: The cheaper natural gas gets, the better the story gets. I'm actually hoping natural gas crashes again, but it's not going to happen because there is enough sustained demand and the economy is strong enough—that's a good thing. Valuations are so low that it makes sense to get in now or if it pulls back another 10-30%. If there were another crash in prices, that would be great—investors could buy more at even cheaper prices.

The story is getting out there, however. Last year, it was just professionals who understood the story. Natural gas got down to $2/Mcf and there weren't really any regular guys out there buying natural gas futures, but when natural gas hit $4, somebody made a lot of money. People who knew what was going on in the industry saw greater adoption rates, saw companies innovating and using natural gas, saw all the utility companies switching over from coal to natural gas—when you see all those things from the inside, you know there is burgeoning demand for the product. What happens day to day in natural gas is less relevant than the trend.

TER: What types of natural gas equities do you find most promising right now?

KR: I like Basic Energy Services Inc. (BAS:NYSE), a pick-and-shovel company that provides services like rig management and trucking. Its share price has gone up about 25% in the last couple days since it reported earnings. It's a small company, but it should benefit from increased usage of rigs, maintenance and services that are needed to pull natural gas out of these fields. It's ideally located throughout the different shale areas in Texas.

Clean Energy Fuels Corp. (CLNE:NASDAQ) is an innovator in bringing natural gas to the market through gas stations. It's getting ready to build some stations in Florida and develop a network across the country to support natural gas fleets.

TER: Clean Energy Fuels has a relationship with Westport Innovations Inc. (WPT:TSX; WPRT:NASDAQ). What do you know about that?

KR: Westport has invested in Clean, as have a couple of other companies, to help it establish gas stations. It's very good for Clean, because it is capital intensive to build these stations.

What the market is lacking is the actual choice—you don't have a choice when you go to a regular gas station. It's premium, midgrade or regular. There's no nozzle for natural gas and it is very hard to retrofit stations. The industry has to go build new stations.

TER: If only 1% of the transportation market is in natural gas, Could the natural gas price double or triple?

KR: It should more than double in the next five years. Two weeks ago, General Motors Co. (GM:NYSE) announced it would look at natural gas to power some of its vehicles. It's the first major manufacturer in the U.S. to come out with that news.

One of the reasons natural energy is coming to the floor now is because 10 years ago, companies like Exxon Mobil Corp. (XOM:NYSE) and ConocoPhillips (COP:NYSE) had no natural gas properties, so it wasn't in their interest to push natural gas. There's no incentive for natural gas to grow if they have no vested interest. Now these companies have huge interests and it's in their best interest to push natural gas. Infrastructure will inevitably follow.

TER: A company like Exxon has thousands of stations across North America. Is there some way to integrate natural gas into those stations?

KR: It is not that easy to retrofit stations. Also, because there's only 1% of the U.S. market using natural gas, it probably doesn't make financial sense for existing stations to do that yet. At some point, major gas stations will start to integrate the technology, or perhaps a major will acquire Clean.

TER: What are some best practices to establish a geographically diverse portfolio?

KR: It depends on risk tolerance. If you have high risk tolerance then the place to go is the emerging markets. Those markets have been hammered. If you are looking for returns that are more normalized, but you want exposure to the international markets, you might want to look at the European markets, which are starting to gain momentum. South and Central America still have a lot of issues.

Unfortunately, there are very few ways to make a natural gas portfolio truly geographically diverse. There are a few Russian stocks, because the Russians control most of the gas production overseas. There is also Noble Energy Inc. (NBL:NYSE), which has the concessions to develop the gas fields offshore from Israel, and the Aphrodite fields, which are located outside of Cyprus. I have been tracking this company and actually went to Cyprus during the collapse to visit its fields there. But for the most part, if you are an investor looking to invest in the natural gas sector, the best places are going to be companies trading on the New York Stock Exchange, with operations in the U.S., because there's just not much of a developed market outside of the U.S.

Natural gas is the energy choice that's going to dominate usage in the future, but it's going to grow at a much faster clip than crude oil, coal or nuclear power in the U.S. It will grow way faster than any of the alternative energy sources like wind or solar, which are good sources but the subsidies and cost for generation of electricity from solar and wind is astronomical. If you are looking for a non-subsidized industry, then natural gas in the U.S. is the place to be.

TER: I'd like to shift gears a little bit and talk about a recent site visit you had with Eurasian Minerals Inc. (EMX:TSX.V; EMXX:NYSE). What were some of your takeaways from that experience?

KR: I've visited two of Eurasian's sites this year. The first was is in Arizona, where they have copper properties, earlier this year. Eurasian's already optioned out to a couple companies.

I just got back from Turkey, where I visited two properties. First was Balya, its lead-zinc-silver property adjacent to another company property that's already producing. Eurasian is in the midst of geological surveys right now, showing that it has much of the same stuff as the company next door. It's very promising.

Second was Akarca, a copper and gold property. The initial drills are showing there are commercial quantities of gold there.

Eurasian is not a mining company, however. It's a royalty company. It explores, drills, tests and options out properties. It has joint ventures with companies like Newmont Mining Corp. (NEM:NYSE), Vale S.A. (VALE:NYSE), Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE) and Antofagasta Gold Inc. (AN:TSX.V).

Eurasian still has most of the capital on its books that it raised 10 years ago. It's already getting royalties, the most significant of which is from a project on the Carlin Trend in Nevada that provides about $4 million ($4M) a year. It has 150 properties, and it is drilling on just a fraction of those, but if you add up the royalty check from ultimately 50 or 60 different streams over the next 10 years, that's a massive amount of cash coming in for a company that has a market cap of around $72M.

TER: In general, do you prefer mining royalties as a method to get exposure to the metals sector?

KR: You have to have a combination. Mining royalty companies are great, and they tend to go down less during periods like what we are seeing right now, but they don't have the upside explosiveness either. They aren't going to triple or quadruple the same way a mid-tier miner like IAMGOLD Corp. (IMG:TSX; IAG:NYSE) or Kinross Gold Corp. (K:TSX; KGC:NYSE) would if gold prices went to $1,800/ounce ($1,800/oz) tomorrow. You have to have a combination.

TER: Please leave us with some thoughts on gold.

KR: Gold is at a very important point right now. Technically speaking, we are in the middle of two significant levels: $1,200/oz and $1,300/oz. If the market breaks down to $1,200 again, chances are the price will go much lower. If we go much above $1,300, chances are the price will go much higher. Right now, we're in limbo.

The argument for gold is that it has always been a great way of diversifying assets outside of paper currencies. That argument has worked very well—gold has been up four-fold in the last 10 years. However, it is not acting the way people want it to act right now. Budget talks in the U.S., the government shutdown, the downgrade of debt, the banking crisis—all these things should have sent gold prices up to $3,000/oz. Most investors are in a quandary.

There is good news for investors, even if they are new to the space. Companies have been forced to rationalize operations and shutter some projects. Gold production has stayed pretty steady and yet consumption is increasing from places like China, which is an even bigger consumer than India. The long-term prospects for gold are excellent.

The question is: What will happen in the short term? I can't predict that—I don't think anybody can—but the price of gold miners compared to gold is just off the scale right now. Gold mining stocks are absolute buys. Indicators are pointing to gold resurging. What is happening in the marketplace is not living up to what the indicators are predicting.

TER: Thank you for speaking with us, Karim.

Karim Rahemtulla will be an emcee at the upcoming Liberty Forum, December 4-8, 2013. The Liberty Forum provides high-net-worth individuals, multinational corporations, international investors and family office advisers knowledge, opportunity and action strategies to internationalize in order to preserve and even enhance, portfolios and lives during this unfolding period of global uncertainty. Register today.

Author of the bestselling book, Where In the World Should I Invest?, Karim Rahemtulla has covered international markets and the global movements of money for over 20 years. With an expertise in emerging markets and energy, he's regarded as one of the country's foremost resource and developing world analysts. Educated in England, Canada and the United States, Karim is fluent in several languages. His undergraduate studies were completed in economics and foreign languages, and his graduate coursework was completed in finance. Karim is also regarded as the country's foremost innovator in options trading, with strategies ranging from income to aggressive speculation. On such merits, he travels the world regularly, seeking out the best investment opportunities, and is a featured speaker at more than a dozen frontline conferences, annually.

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1) Brian Sylvester 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: None. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Karim Rahemtulla: I or my family own shares of the following companies mentioned in this interview: Eurasian Minerals 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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