The Energy Report: You last spoke with us in early June. What has transpired in the oil and gas markets since, and has it altered your investment thesis?
Chen Lin: The oil price has been going up and down because a lot of traders are mispositioned and are scrambling around. That makes the market very volatile. However, WTI is around $100 again, which is quite surprising because we are still in the middle of a recession. World oil demand is still there, and whenever there’s a drop in the oil price there’s a lot of buying. I’m quite surprised that oil is still around the $100 mark. Personally, I would like to see it in the $80 to $90 range. That’s actually good for the oil consumers. If gasoline is below $3.00 that really helps the U.S. consumer.
TER: Domestic natural gas prices, on the other hand, have been in a continuous downtrend since June. It seems shale gas has created a glut. What’s your assessment of that situation?
CL: There’s so much natural gas being produced in the U.S. that we can’t consume it and, then there are no facilities to export it. The oil/natural gas price ratio may go up further. It really depends on how much gas is produced. If you want the market to really work you need to create more natural gas demand with export facilities or a policy to make cars run on natural gas. Then drivers can enjoy $1/gallon equivalent in gas. That would be a huge demand boost and would make natural gas prices go higher. Without those on the horizon, the natural gas price may come down further.
TER: So, what do you think would happen to the oil market if the Eurozone situation deteriorates further?
CL: It would be negative for the oil market; that’s for sure. Globally, investors must take into account the demand disruption in Europe versus the demand increase in developing countries, which is still an ongoing trend. If there is a depression in Europe, of course oil will go down, probably as far as it did in 2008. If Europe can avoid a depression, we may see an even higher oil price.
TER: How has your energy stock portfolio performed since we spoke in June?
CL: Last June, I was in the process of reducing energy stocks because of the European crisis threat. In the past few weeks, I started to increase oil exposure substantially because there are a lot of very cheap energy stocks. You can buy your oil stocks for pennies on the dollar. Also, energy stocks, even though they are very capital intensive, are not as capital dependent as mining stocks. Energy companies can drill a well and then pump the oil and sell it. Then they can use the capital to finance the next well, whereas mining companies need to keep raising money to maintain production. That is why I like oil producers. With $70 -$80 oil, they can make good money, and $100 oil is really great money. They will have a lot of capital to deploy and enjoy a lot of cash flow.
TER: You get a pretty immediate payout and don’t have to sit around for years waiting for approvals and licenses and building. So, there’s definitely that advantage.
TER: In June you mentioned that your biggest holding, at that point was Mart Resources Inc. (MMT:TSX.V). Is that still the case? What’s been going on with the company since then?
CL: That’s still the case. I’m holding a lot of Mart Resources. During the summer when the market turned south, I was still holding the stock because I really believe in this project. I heard the company was making presentations at conferences where it was talking about the potential for very large dividend payouts, starting next year. Right now it’s trading about one times after-tax cash flow, according to the management. So, it can basically pay out any dividend it wants. It will probably start low—maybe $0.05 or $0.10. A $0.10 dividend is almost a 20% yield at the current share price. Then it will start going higher because it is going to accumulate so much cash from its oil drilling program. Every well in this year’s drilling program is a successful well—every well! I think two are around 10,000 bpd. One is 6,000–7,000 bpd. In North America, if you have 600 or 700 barrels, it’s a very good well. These are much bigger. So, Mart is just waiting to reach a deal with the pipeline company so it can start pumping more oil out. It’s supposed to be very soon. Once it reaches that stage, it will be cash-flowing at one times market cap. That will be a huge catalyst. Plus, the dividend payout will be another big catalyst. I’m looking for a much higher stock price.
TER: This is Umusadege Field in Nigeria you’re talking about, is that right?
CL: Right. Mart just found an amazing amount of oil. Its well production in the past 2–2 ½ years has shown no decline. In North America, after a month or two it could drop in half, like in the Bakken. The steady production means the company is sitting on a much larger pool than people can imagine. The next catalyst will be its reserve calculation. With all the production it’s had and all the successful drilling, this year’s reserve will be much higher than last year’s. With last year’s reserve, if I remember correctly, the 3P net asset value (NAV) of 2010 is way over $1.00 per share. This year it could easily double that, maybe even more. Meanwhile the stock is still at $0.64. That tells you how much upside it has just from the NAV. Then you can look at it from cash-flow side and the dividend side and you can see that the stock is very, very undervalued.
TER: So, what’s the market cap for the company at this point?
CL: I think it’s about $200 million (M) and they will probably cash-flow more than $200M.
TER: Boy, that is a real bargain, isn’t it?
CL: I’ve been holding this as my largest position because I feel so compelled. It’s been undervalued for a long time. Partly it’s because the market was very bad this year. Nobody really paid attention. In the meantime, the company has had one drilling success after another. Not just successful but very successful. The market has shown no response to that. But the company can immediately sell the oil and get into cash-flow. So, if the market doesn’t respond now, it will respond later. That’s why I was holding it as my largest position throughout the turmoil this year.
TER: Do you think is the project’s location in Nigeria might make some investors wary?
CL: That could be the case. The Nigeria situation is a little bit volatile. But, again, this is an OPEC nation and Mart exports through its standard pipeline. It has some interruptions from time to time, but management has already factored that into its cash-flow calculations.
TER: What do you think the chances are that the company will get bought out by a major with this kind of production?
CL: It could be. There was another Nigerian company that was bought out by a Chinese company for $7 billion (B) last year. Mart will likely be producing at that level in a year or so. Right now it only has a $200M market cap. So, you can see the upside is huge. Furthermore, the company does not need to come to the market to raise money. That’s why it’s in an ideal situation and why I like it.
TER: Another one that you were quite positive on last time was Harvest Natural Resources (HNR:NYSE). You said that you thought that it might be up for sale. What has transpired with that one?
CL: Its Venezuelan project is still for sale. That project is actually generating very nice cash flow. The company has about $3–$4.00 cash on its balance sheet. So, it’s pretty well cashed up. It is producing oil from its oil field in Venezuela and it is paying dividends. It uses the money to drill wells elsewhere. The stock had a little bit of a setback when the company hit a well in Indonesia and the first part of the well was not as good as people expected. But it hit a very good well off of Gabon in Africa and then it will drill another well in Oman. Plus, it is continuing to drill in Indonesia. So, it has a lot of excitement coming. The company is still trying to find a buyer for its Venezuelan asset and probably a Chinese or Russian company that is closer to the government that might buy it.
TER: So, the upside still looks pretty good for that one as far as you’re concerned.
CL: Yes, the upside is big. It’s just that the market has not put all the pieces together yet and calculated how much the company’s assets are potentially worth.
TER: Maybe that’s because Harvest is spread out geographically and people have a hard time understanding it versus if it were all in one country or one location.
CL: Exactly. That’s also a big issue.
TER: Another one you talked about last time was Porto Energy Corp. (PEC:TSX.V). It had a new gas discovery in Portugal. At that point, the value of that was much greater than the price of its stock. What’s going on with that one and where do you think it is going?
CL: Right now the market is so afraid of risk that investors seem to be getting rid of any company that’s associated with risk. Porto is a perfect example. It already has a natural gas discovery and is trying to expand and bring that into production. The natural gas pipeline runs through its property. The company was IPO-ed earlier this year at $1/share. Right now it’s about $0.25. It’s getting close to the cash it has on hand and it can generate immediate cash-flow. The Portuguese government is extremely supportive of what the company is doing because the nation wants the tax revenue and the jobs. Portugal’s government is trying to help Porto anyway it can so production can come online.
TER: So that one is definitely undervalued, compared to where it was in June, with a lot more upside potential.
CL: Exactly. There are a lot of companies, both in energy and in mining, that have been hit hard. If you are willing invest with a little bit of risk appetite, you can find a lot of very undervalued stocks that can go up very significantly once the market stabilizes. I’m still trying to stay with companies that have strong cash flow, and good balance sheets so that they don’t need to come to the market to raise money. That can help you weather the storm.
TER: Are there any other companies that you might want to mention at this point?
CL: I’ve been taking a position in quite a few energy companies, some quite aggressively. One is Pan Orient Energy Corp. (POE:TSX.V). I had the stock before. It’s at $2 recently from $6 earlier this year. The company raised money at more than $6 earlier this year, so it has a very strong balance sheet with about $1/share on its balance sheet. It drilled two wells in Indonesia. One was a failure. The second one was non-conclusive. The company couldn’t finish it. So, it stopped and tried to find another driller. It will start drilling, I believe, this month. In the meantime, the market hit the stock hard. Pan Orient has a producing oil field in Thailand, which is producing a lot of cashflow (It is trading at about 2 times cashflow). It also has an oil sand property in Canada. In addition, it will be drilling this big potential well in Indonesia. Can the stock go lower? It’s possible. But, I feel it’s so undervalued that I started buying it quite aggressively.
Another stock I bought quite aggressively recently is PBN, PetroBakken Energy Ltd. (PBN:TSX). It is paying a 10% dividend right now and the stock is less than $10.00. You get a monthly $0.08 per share dividend. The stock was hit very, very hard because it missed its earning guidance in the past few quarters. In addition, it has a sizeable debt. So investors are worried about that, which has caused rounds of selloffs. It sold down to where it was paying a 15% dividend. So, I picked it up not long ago at a slightly lower price. It had very good production in the recent quarter and seems to have hit its targets. Management has indicated it has no problem paying all the dividends as long as the oil price doesn’t crash. So, basically you’re getting paid a 10% dividend while you wait for the stock to appreciate, which it is.
TER: How do you think energy investors should plan for the coming year, given the turmoil in Europe, the world and domestic economic situations and the 2012 elections?
CL: I’m just looking at global production, supply and demand. Investors should know that India has no strategic oil reserves and it is a very important oil user right now. China is still expanding and building its strategic oil reserves. Last time I checked, China’s oil reserves can last only one-third as long as U.S. reserves. China will likely fill up more of its tanks on any dip in the oil price. There should be good demand for oil in the current market unless we have a complete breakdown of the euro.
On the investment side, I like to invest in land-based oil producers because sea-based oil production has high capital requirements. I also prefer oil producers versus natural gas producers in North America because these kinds of companies tend to perform better in this market.
TER: Do you expect the year-end tax loss selling season to present some good buying opportunities?
CL: Oh, yes, absolutely. For example, on Pan Orient, one of my plans was to wait until tax-loss selling in December to buy, but in November it already dropped to below $2.00. I said, “Okay, let’s buy it right now, right here.” There could be more tax-loss selling coming, but these are very good opportunities to buy—especially companies with very strong balance sheets and good cash flow, which don’t need to raise money. The dip will, most likely, be temporary and there will be very good buying opportunities for a lot of these stocks.
TER: So, we’ve got another few weeks to pick up some bargains before the end of the year.
CL: Yes. I do want to mention that, generally, the oil market bottoms in the winter and then goes up in spring all the way to summer. So, we’re coming to a very strong part of the seasonal oil price cycle.
TER: That’s a great suggestion. Thanks for taking the time to talk to us today.
CL: Thank you for the opportunity.
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) Zig Lambo of The Energy Report conducted and edited this interview. He, personally and/or his family, own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned are sponsors of The Energy Report: Mart Resources Inc.
3) Chen Lin: I personally and/or my family own shares of the following companies mentioned in this interview : Every stock. I personally and/or my family am paid by the following companies mentioned in this interview: None. In early 2010, when Porto Energy was a private company, Chen Lin received shares from the company to introduce it to hedge funds.
( Companies Mentioned: NYSE:HNR, MMT:TSX.V, TSX.V:POE, TSX:PBN, TSX.V:PEC, )
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