http://www.theenergyreport.com/pub/na/7569
Author and
Energy Strategist
Editor Elliott Gue looks to larger global energy trends to
establish his investment strategies in alternative energy. Two of
those trends include nuclear power development in emerging markets
and the natural gas infrastructure needed for America's burgeoning
shale gas plays. In this exclusive interview with
The Energy Report,
Elliott suggests some tried and true names that should benefit
from those trends and a few lesser-known companies with similar
aspirations.
The Energy Report:
You have coauthored two books, the most recent of which,
The Rise of the State: Profitable Investing in Geopolitics in
the 21st Century
, chronicles how the global economy got where it is today, where
you believe it's going and how people can profit along the way.
Other than money, what compelled you to write
The Rise of the State?
Elliot Gue:
Well, as you mentioned, I cowrote another book a few years ago-
The Silk Road to Riches: How You Can Profit by Investing in
Asia's Newfound Prosperity
-which discussed some of the same issues, albeit from a slightly
different perspective. I wanted to update some of those themes, as
a lot of the things we talked about in it came to pass. When we
wrote that in 2005, I think a lot of the trends in the emerging
markets weren't quite as apparent to everyone. China has seen
amazing growth since then, particularly in energy, my area of
expertise.
Over the last 10 years, Chinese oil demand has grown to more
than 4 million barrels per day (bpd); that's where most of the
international growth in oil demand has come from. Another aspect of
it is that the Chinese government, through sovereign wealth funds,
is investing directly in resource-producing assets all over the
world. For example, they're in Africa and South America. I felt
that we needed to update some of the trends we had discussed in
that first book.
TER:
The press release for
The Rise of the State
says the book contains "70 specific investing recommendations for
far-sighted global investors." Could you provide our readers with
an investment thesis or two from your book that apply to
alternative energy and uranium, in particular?
EG:
Uranium is a major part of the book, and we're seeing a renaissance
of the global nuclear power market. If you had asked most U.S.
analysts 10 years ago, they would have said the U.S. would be
unlikely to build any new reactors. In Europe, countries like
Germany had planned to phase out nuclear power entirely. In the
United Kingdom, the public was very anti-nuclear; for example,
Italy had a ban on it.
If you look at the developed world countries today, there's
really been a sea change in sentiment. Most countries recognize
that it would be impossible to generate enough power to meet
growing demand and still cut carbon dioxide (C02) emissions without
a large nuclear component.
But the real story on nuclear energy, again, is coming from
emerging markets; nuclear is going to be a much larger portion of
their energy pie. China has a very aggressive plan to build 30-40
new nuclear power plants over the next 20 years. If you look at
India, which did not sign some of the international nuclear
agreements, it has cut deals with the U.S. and other countries to
import more nuclear technology and is preparing to do a major
buildout of nuclear power.
Another interesting country is Russia. Most people think of
Russia as an energy producer, not a consumer; but the economy there
has been booming. The Russians are planning to build a large number
of nuclear reactors so they can use nuclear power domestically and
increase their exports of natural gas to Europe. Nuclear is really
a major trend.
We've recently seen an uptick in uranium prices, as it is the
key fuel for nuclear power plants. Uranium prices had been
depressed for most of the 1980s and 1990s, so why would companies
go out and spend billions developing new mines for a commodity
trading under $10 per pound? Over the last several years, of
course, we have seen a major run-up in uranium prices.
TER:
They peaked in 2007 at $136 per pound, right?
EG:
Yes, it was a very dramatic run-up that was followed by a collapse.
Prices dipped to the $40 range but not back to 1990s levels. I
believe the uptick we've seen lately stems from the growing
realization that, although there's probably plenty of uranium right
now, we may be looking at a supply crunch two to three years from
now.
The Russian program for reprocessing nuclear weapons is
scheduled to end in 2013. With some of those secondary sources
drying up, some companies and countries are concerned there won't
be enough uranium around to load all these new plants they're
building. That's really starting to push up prices and some of the
uranium mining stocks.
TER:
The price is trending up now. How high do you think it could go?
What's it going to do in 2011 and 2012 in your models?
EG:
The thing with uranium is that prices don't really make much
difference to the cost of nuclear power. Natural uranium accounts
for only 5%-10% of the price of nuclear energy, whereas natural gas
accounts for 80% of the cost to produce power from a natural gas
plant.
With nuclear power plants, most of your costs are upfront
capital costs for construction and the cost of the regulatory
burdens. Uranium prices could go back up over $100/lb., and it
really wouldn't have much of an impact on the economics of nuclear
power. That's a big difference from natural gas or oil. When oil
prices spiked at $125 per barrel, you saw real demand destruction.
And when natural gas prices spiked up into the teens, you saw
demand destruction. With uranium, I would expect to see less of
that.
I think you're going to see a lot of these countries, especially
China, going out and securing uranium under long-term supply
contracts. If that happens, you'll see all these new sources of
supply scheduled to come online get locked up. I think that could
be a catalyst for a pretty aggressive run-up in uranium prices. I
wouldn't be surprised to see prices exceed $100/lb. And some of the
smaller mines in the U.S. and Canada might need those price levels
to make them economic.
TER:
Last week, the CEO of
Exelon Corporation (
EXC
)
-one of the biggest uranium power producers in the U.S.-said that
with gas prices where they are, it's not remotely profitable to
build a merchant nuclear plant. Does that mean uranium is mostly a
long-term play?
EG:
I think there's a little bit of a difference between the U.S. and
other countries on that score. U.S. gas prices are very depressed
right now, and it really isn't about a lack of demand. In fact, we
just had a very hot summer in the United States-about 40% hotter
than the 10-year average; and we had a very cold winter-about
20%-30% colder than average. Those seasons drove very strong demand
for natural gas in electric power plants. What's amazing is the
growth in U.S. natural gas production from these shale fields,
these unconventional natural gas fields around the U.S.
TER:
Those supplies are keeping the price low.
EG:
That's exactly it. It's truly astonishing to think that the United
States is the world's largest producer of natural gas, producing
about 15% more than Russia. We produce almost as much gas in the
U.S. as the entire Middle East and Africa combined. Just 10 years
ago, we were hearing that U.S. gas production was declining. I
think gas prices in the U.S. will remain relatively low for a long
period of time; and, when I say "relatively low," I imagine that
ultimately a price around $6 per BTU will be required to encourage
ongoing production and drilling.
A lot of foreign countries don't have that advantage. If you
look at Europe, some unconventional plays are being looked at but
that industry is probably at least a decade away from becoming
significant. If you look at Asia, China has some shale fields; but,
again, those are only in the very early stages of development. And
those countries are probably going to face higher prices. That
makes the economics of nuclear power in a country like China, India
or even Europe look a lot more attractive than it would in the
United States.
TER:
What are some uranium plays you're following?
EG:
The largest, of course, is
Cameco Corp. (NYSE:CCJ; TSX:CCO)
. It owns some of the richest uranium mines in the world, in terms
of the quality of the ore. As a result, Cameco is a very low-cost
producer. It can produce uranium profitably even at prices in the
upper $20s or low $30s, and we're a long way from that now. And,
because of its size, Cameco has been able to make major investments
around the world. One example is Kazakhstan, a major nuclear
producer, and Cameco's been able to make investments in other
countries with promising uranium projects. It is sort of the
800-pound gorilla, if you will, of the uranium mining industry.
TER:
Yes, it's the
Exxon Mobil Corp. (
XOM
)
of uranium. But what are some off-the-radar, small-cap plays?
EG:
If you move down the scale a little bit, you want to look at some
of the companies that are already producing uranium. They are
smaller producers, but they often grow faster. An example would be
Paladin Energy Ltd. (TSX:PDN; ASX:PDN)
in Canada. The company has two major mines in Africa, which
traditionally has been a pretty significant uranium
producer-Namibia, in particular. Paladin is really emerging as an
important producer there.
Another company to look at is
Uranium One Inc. (
UUU
)
. The company actually sold a majority stake in itself to a Russian
company to help them develop uranium mines in Kazakhstan. That
scares some people, but Russia is a major investor in Kazakhstan.
You really want to have the support of a Russian company when
negotiating deals in that country. Uranium One is a fast-growing
producer; it's smaller than Cameco but, potentially, could become a
major producer with the mines it has underway in Kazakhstan.
TER:
In a recent edition of
Energy Strategist,
you said numerous alternative energy companies carry little debt
and are posting earnings growth, but then you added: "The trick is
separating those alternative energy companies with low debt,
positive earnings and/or deep-pocketed partners from the
fly-by-night junk." How do you separate the wheat from the chaff
there?
EG:
When you're talking about alternative energy, I think one of the
problems is that the sector tends to attract a lot of hype. Let's
look at solar energy. A lot of people think it's a great way to use
a freely available resource to produce power and it doesn't produce
C02 or any other pollutants. The problem is, it is extremely
expensive.
TER:
And it takes up a lot of space.
EG:
Absolutely; just the sheer size of some of these solar power plants
makes them almost impractical. The only reason use of that
technology is growing is because of government subsidies,
particularly feed-in tariff subsidies in Europe. For example, if
you build a solar power plant in Germany, you're guaranteed a very
high rate for the energy you generate for 20 years. That makes it
very economically attractive to build the plants, even though
Germany gets about 5% of its energy from solar. It's been a major
builder of solar facilities in recent years because of these
subsidies.
You really have to be careful in investing in solar companies.
Some of the better ones, like
First Solar Inc. (
FSLR
)
, will likely survive and make money in the long run; but you have
to remember the government side of that equation. A lot of what
solar companies do depends on the largesse of governments. Most
European countries are cutting back on spending to bring their
deficits under control and, as a result, they're cutting back on
these subsidies. I think that's really going to create a lot of
problems for solar companies.
Looking more at the uranium side, one of the problems is that a
lot of these small-cap junior companies advertise that they have
all this acreage for the exploration or development of uranium
mines. But there's no way to know how much it will cost them to
mine that uranium. In some cases, uranium prices may need to exceed
$100 before those mines become economically viable. One of the
things I look for on the uranium side is companies that actually
produce some uranium.
TER:
When our readers visit a company website to view financials, what
should they look for on the balance sheet?
EG:
Energy can be a cyclical business, so you want to look for
companies with relatively low debt. If you look at a lot of the big
energy companies, the Exxons of the world, they have tons of cash
on the balance sheet; that allows them a lot of flexibility. When
credit markets are in turmoil, such companies can take advantage of
that and make acquisitions.
Most alternative energy companies have relatively low debt.
First Solar, for example, is one that has a very clean balance
sheet. But you also have to weigh that against the particular
segment of the energy business they're in. For example, one group
that I like a lot is energy midstream companies-companies that own
pipelines and natural gas storage facilities.
TER:
Master limited partnerships (MLPs)?
EG:
Yes. Their balance sheets typically have a humongous amount of
debt, but it's really not a problem because their revenues are
pretty stable from their basic business, so they can carry high
levels of debt. You have to look at how much debt is on the balance
sheet, and then what part of the energy business they're in. Are
they in a segment of energy that is very cyclical, or are they more
of a fee-based, MLP-type company?
TER:
Is there a certain threshold, as in a price-to-earnings (P/E)
multiple, that you prefer when it comes to alternative energy
companies?
EG:
I don't really have a specific target. I typically look at how a
company is valued compared to other similar companies. If you're
analyzing a natural gas producer, you want to look at how its P/E
compares to, say,
Chesapeake Energy Corp. (
CHK
)
or one of the other big producers. There are often wide variations
in the valuation, so you want to determine why. Is it because the
company has much better growth prospects? You want to know exactly
where its acreage is. In the energy business, it's pretty
complicated to do a proper valuation of companies because it really
depends on the quality of the resource base.
I like to look at the underlying business. What is it? How is
the company going to grow? How is it going to make money? Does it
have any forthcoming news events that will likely catalyze a big
run-up in the stock? For example, the catalyst with nuclear power
is the uptick in uranium prices that gets more investors interested
in the sector. The other thing is a looming expiration of things
like the Russian reprocessing program. Those types of catalysts can
really get a stock or sector moving, and that's what I tend to look
for more than any particular valuation metric.
TER:
Can you share a few more of your favorite alt energy investment
ideas that most people probably haven't heard?
EG:
Sure. In
The Rise of the State
and in
Energy Strategist,
I look mainly at uranium companies, nuclear power companies and
natural gas. I think natural gas will eventually be the most
important play of all on alternative energy. I say that because
wind and solar plants generate intermittent power; therefore, you
typically need a natural gas-fired facility to put power on the
grid when power drops off from solar or wind plants.
I think natural gas is going to be a major factor in the
development of alternative energy, and those are the companies
we've been focusing on in the newsletter. One example is
Range Resources Corporation (
RRC
)
-a major gas producer in the Marcellus Shale. The interesting thing
about the Marcellus is that it's very high in natural gas liquids
(NGL) content, which includes ethane, methane and butane. A barrel
of NGL is priced much more like a barrel of oil. So, in addition to
producing natural gas, Range produces something of much higher
value-NGL.
With gas prices around $5, Range is probably earning north of $7
for every 1,000 cubic feet of gas it produces based on the value of
the NGL. And because we're producing so much gas from shales and a
lot of the major shale reserves are rich in NGL, it's become a
major boon to the petrochemical industry. They use ethane to
produce ethylene, which is a basic building block of plastic. Range
Resources is a player I would look at and, with natural gas prices
depressed, now's not a bad time to start prospecting for value in
that sector.
TER:
You mentioned some MLPs earlier. What names do you like in that
space?
EG:
Well, they're really facilitating the development of shale. In
order to produce all these new plays, we need more basic
infrastructure. That is one of the untold stories of the shale
plays. One of the largest players there and one that I have
recommended for many years is
Enterprise Products Partners, L.P. (
EPD
)
. It's working on a lot of major projects, including a new pipeline
in the Eagle Ford Shale in southern Texas. The Eagle Ford is
another major gas play with a high NGL component. Enterprise also
offers a really nice dividend yield of around 7%, and it's been
growing distributions at a very steady rate for years. Not only do
you get a nice yield with EPD, you also get a lot of upside in
terms of future distributions.
A little bit further down the size curve is
Targa Resources Partners, L.P. (
NGLS
)
, another MLP. As its ticker implies, it really focuses on the NGL
side of the business-NGL storage, pipelines and gathering and
processing. These are all major businesses that are booming because
of all the NGL production coming from shales.
As far as pure alternative energy plays like solar and wind,
we're pretty much advising people to stay out of those right now. I
think that there's potential for a glut of solar cells,
particularly in Europe. That's going to bring down prices. There
are some promising projects underway in the U.S. but, as the money
from Europe starts drying up, how quickly are we going to see a
ramp-up in U.S. utility activity to offset that weakness? There
will be some struggles there. Currently, I am focusing more on
uranium and natural gas.
TER:
You've given our readers lots to ponder. Any final thoughts you
would like to leave us with today?
EG:
Be very careful about hype. Sectors like solar and wind are often
subject to a lot of promotion and a lot of hype. For example, when
Barack Obama was first elected president, I read all kinds of
newsletters that recommended buying alternative energy because the
new president was going to be a major promoter of it. As it turns
out, he has promoted alternative energy; but those stocks have
generally underperformed the rest of the energy space since he took
office. You have to be very vigilant and very selective. Don't
assume alternative energy is a sure road to riches just because
it's carbon free and people are talking about it.
Elliott Gue's semimonthly newsletter,
The Energy Strategist
,
unearths profitable opportunities-from traditional fuels like
coal and crude oil to the latest alternative energy sources-in this
booming sector and outlines the interrelated economic and
geopolitical forces that drive these markets. Gue also brings an
international perspective to
Investing Daily
,
analyzing the complexities of global energy markets and related
industries for
Personal Finance
,
as well as more specialized publications.
In addition to his work on energy markets, Elliott is co-editor
of
MLP Profits
,
an online newsletter that takes the guesswork out of
identifying high-growth, high-yield partnerships through studied
advice and sound market intelligence.
Before joining KCI, Elliott lived and worked in Europe for five
years, earning a bachelor's degree in economics and management and
a master's degree in finance at the University of London-the first
American student to complete a full degree at this prestigious
business school. He also coauthored a book on investment
opportunities in Asia,
The Silk Road to Riches: How You Can Profit by Investing in
Asia's Newfound Prosperity.
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