Frank Curzio: Yes, I think so. Even without the short-term effects of geopolitical risk, the fundamentals should keep oil at an average price of $95/bbl over the next few years in the U.S. I don't see it trending too much higher, but I also don't see it dropping.
The reserve replacement ratio for some large U.S. producers remains over 100%, which is good. International oil companies, like Saudi Aramco, Gazprom (OGZD:LSE; GAZ:FSE; GAZP:MCX; GAZP:RTS; OGZPY:OTC), PetroChina Company Ltd. (PTR:NYSE) and Petróleos Mexicanos (PEMEX) have replaced less than 80% of their oil reserves annually over the past three years. That is troublesome.
Outside the U.S., it's very difficult to find oil that's economically priced. There's plenty of oil, but in a lot of places—Russia and several spots in the Middle East, in particular—explorers and producers are having trouble finding oil that can be developed for less than $90/bbl.
However, demand is still strong. Some reports show people are driving less, but according to a report by IHS Automotive, a record 82 million (82M) automobiles were sold last year around the world. Airbus set a sales record last year, as well, demonstrating strong aviation demand. The emerging markets have been down, but I expect to see more stimulus packages targeted at producing short-term growth over the next few years from the BRIC nations (Brazil, Russia, India, China), particularly China.
In the U.S., manufacturing is strong; gross domestic product is expected to hit 3%. Housing starts are solid in this low-interest rate environment, which will be around for years according to the Federal Reserve Bank. All of these are fundamental changes that will result in oil prices averaging $95/bbl over the long term.
TER: You'll be speaking at the Stansberry Society Conference with T. Boone Pickens. He takes the position that the U.S. should look to clean energy and capitalize on low domestic natural gas prices by converting heavy truck fleets from diesel to natural gas. Can that be accomplished?
FC: Yes, I'm siding with Boone Pickens; the process has already begun. Wal-Mart, UPS, Coca-Cola, Pepsi and Waste Management are all switching their engines from diesel to natural gas—compressed (CNG) or liquefied (LNG), so they're also building CNG and LNG fueling stations.
Fuel costs are the biggest expense for transportation companies. Using natural gas instead of diesel amounts to huge savings for companies with large fleets.
TER: What about cars? Can infrastructure be put in place so they can use natural gas?
FC: Some pickup trucks are already being converted to use both natural gas and gasoline. I rode in one when I visited Westport Innovations Inc. (WPT:TSX; WPRT:NASDAQ), and the only difference I noticed was that the engine made no sound at all.
Nearly every auto manufacturer produces cars that run on natural gas—they just don't do it in the U.S. because we don't have enough fueling stations yet. When that changes, natural gas cars will be huge. Clean Energy Fuels Corp. (CLNE:NASDAQ) is building CNG and LNG fueling stations, but infrastructure has to be in place before natural gas will become a mainstream fuel for cars. It could happen as soon as five years.
TER: When natural gas prices were low, many coal-burning power plants switched to natural gas. When the price surpassed $6, some returned to burning coal. Will that dance continue or will more utilities switch to natural gas permanently?
FC: I think we'll see a move to natural gas. There are price spikes and volatility in every commodity. Overall, you need to look at the average price of things, like $3.50/bbl for natural gas over the course of our 100 years' worth of supply.
We have such a huge supply of natural gas that we have to burn it because we have no place to store it. Think about that for a minute. We have so much natural gas, we are burning it. This tells me the price of natural gas will remain cheap long term, thus making it a much better alternative to coal, both economically and environmentally.
TER: The last time we talked, you had just returned from a tour of U.S. shale plays, and you were bullish on the amount of oil and natural gas coming out of the ground. Do the decline rates and transportation challenges worry you?
FC: Declining rates are a concern, as is depletion, but not in the short term.
I noticed this on my visits to the Permian and Eagle Ford. Depletion rates are high. But we still have so many locations to drill in these areas. For example, the Permian has so many layers; you can drill in the Wolfcamp, the Sprayberry and the Cline. Some experts say that oil production from the Cline could be three times bigger than the Eagle Ford. Four or five years from now, declining rates will be a big concern, but not in the short term.
Transportation challenges are more immediate. Three trains carrying oil crashed in North Dakota, which is significant, considering that 70% of the crude developed in the Bakken is shipped by rail. We also saw trouble shipping from Texas to the northeast.
Instead of worrying, I see it as an opportunity, especially for investors. We have to figure out why there have there been 6 incidents in the last 12 month and find a solution. This is an opportunity to improve our rail system.
We also have an opportunity to improve the infrastructure by building more pipelines. This is a great opportunity for companies like Kinder Morgan Energy Partners L.P. (KMP:NYSE) and El Paso Pipeline Partners L.P. (EPB:NYSE). These companies have high multiples because they have high yields and we're in a low-interest-rate environment. However, both will benefit from the long-term pipeline infrastructure trend.
TER: How can these pipelines be approved and built?
FC: Pipeline systems need to be approved, but they won't because it's all about votes, not about what's good for the country. Of course, the process needs to be regulated, and we need to be concerned about the environment, but it seems people would rather save birds and plants than lower our poverty rate. We need to open up fracking in areas all over the country. We've drilled tens of thousands of wells, and we haven't seen too many earthquakes. If it's done right and regulated correctly, we're sitting on a massive opportunity. We just need to open this system up a bit so more small towns, and the entire country, can benefit.
TER: In your Small Stock Specialist newsletter, you named getting governmental approval to build LNG export facilities as the biggest hurdle for energy companies selling U.S. natural gas overseas. When do you see that changing? How much money is on the table due to the gap between U.S. and European natural gas prices?
FC: Here in North America, we can produce natural gas at a much cheaper price because we have so much of it and we have the best techniques, namely fracking and horizontal drilling. Natural gas prices are 200–400% higher in the rest of the world, so there's been a mad rush to build LNG export facilities so we can sell to Europe, Asia and elsewhere.
Getting to that point is quite a process. First, you have to get through the U.S. Department of Energy (DOE), which has been dragging its feet because of politics. Only six LNG export facilities have been approved since 2011, but there are more than 24 in the pipeline.
The Domestic Prosperity and Global Freedom Act was recently submitted to Congress as a means of bypassing the DOE's current regulations to make it easier to build and permit all the facilities that were in the pipeline at the time of the bill's submission. The situation in Russia and the Ukraine is changing legislators' minds—even Democrats. Russia supplies most of Europe with energy; every time Russia gets mad, it threatens to shut off the natural gas. If the U.S. could export our cheaper natural gas to Europe, it would cripple Russia. If enough Democrats get on board, you could see LNG export facilities built nearly as fast as a new McDonald's opening across the street.
Of course, we still need regulation. Companies will have to go through certain processes, but in the long run, it could represent a massive infrastructure build valued at more than $200B. That's great news for companies like KBR Inc. (KBR:NYSE), which earns 40% of its revenue building LNG facilities. Chicago Bridge & Iron Co. N.V.'s (CBI:NYSE) revenue will soar as well. If this bill gets passed, it will be fantastic in the short and long term.
TER: KBR was beat up in the market recently, but it's still a really large stock, as is Chicago Bridge & Iron and McDermott International Inc. (MDR:NYSE). Do you buy these stocks on dips, or do you just buy and hold them?
FC: It all depends on where the stocks are trading. Right now, I'd wait for a pullback on Chicago Bridge & Iron, but I would definitely buy KBR right away.
McDermott, which builds offshore oil platforms, may be one of the most hated stocks in the sector. The stock dropped from well over $20 to around $7 and is trading at book value. There is almost no downside risk here, which I rarely say. The company has a decent balance sheet, so if it can get a few orders—any positive catalyst—it will shoot up more than 25% in the short term. McDermott is a low-risk, very high-reward play.
TER: On the topic of shales, not all are the same: some are more advanced, some are oilier than others. In your opinion, where are the sweet spots?
FC: It's very important for an investor to focus on companies in the sweet spots. You don't want to buy a company just because it has Eagle Ford or Bakken in its profile. The specific place that the company is drilling is important. In the Bakken, production could cost as much as $80-90/bbl or little as $60-$65/bbl, depending on where the company is drilling. The Eagle Ford comprises some 27 counties, but the sweet spots I note include Gonzales, McMullen and Lavaca counties.
TER: What companies of interest are working in these sweet spots?
FC: I like Swift Energy Co. (SFY:NYSE). It sold its non-core assets and put the money into drilling in McMullen and La Salle counties. The company didn't raise quite the money it wanted, so management lowered production rates. The company's stock took a hit, but it will still produce a ton of oil in Eagle Ford. It's a fantastic buy.
In the Permian Basin in Texas, I like Laredo Petroleum (LPI:NYSE). It has more than 900 drilling locations. The company has already hit a few big wells.
Penn Virginia Corp. (PVA:NYSE) is in the Eagle Ford and its stock is up a lot. The company will report earnings soon, but I might want to wait for a pullback before buying.
The three biggest shale plays are Pioneer Natural Resources Co. (PXD:NYSE), Continental Resources Group Inc. (CRGC:OTCBB) and EOG Resources Inc. (EOG:NYSE).
These three companies have market caps between $20–50B, which makes them takeout targets. They still have 15–20% production growth, so if you can buy a Pioneer, Continental Resources or EOG for $20–50B and get at least 20% production growth for the next 3–5 years, that seems like a pretty good deal to me. After all, the major oil companies are spending record amounts of cash—and are struggling to grow production.
These three companies own hundreds of thousands—if not millions—of acres in these sweet spots and are set to grow production quickly, potentially four or five times faster than the average major oil company.
TER: What about oil services companies? Is there still money to be made there?
FC: Yes, but I would stick to the international plays that I've been recommending for a couple years: Schlumberger Ltd. (SLB:NYSE), Halliburton Co. (HAL:NYSE), Baker Hughes Inc. (BHI:NYSE) and Weatherford International Ltd. (WFT:NYSE).
The Eagle Ford extends into Mexico, where PEMEX just signed a $1.9B deal with Schlumberger to start development. Additionally, rig counts in Saudi Arabia are near record highs. These four companies get 60% of their sales from overseas. The rest of the world is just starting to frack, and while there will be political hurdles to overcome, fracking will win out. When that happens, these four companies will benefit hugely.
These companies not only grow three to four times faster than the average S&P 500 company, but their stocks are cheaper, too. They're still trading at 20–30% discount to the average S&P 500 company; 13 times earnings compared to 16 times for the average S&P 500 company. Even at their 52-week highs, they are cheap considering their valuations, and they are in the middle of a massive long-term growth trend.
And don't forget Barclay's estimate that oil companies plan to spend more than $700B on capex this year. A lot of that will filter down to oil service companies, but the four I mentioned are the best.
TER: In a risk-averse environment, are larger oil companies still willing to invest in difficult megaprojects—to spend $5B+ for offshore work or in far reaches of the Arctic?
FC: They have no choice. The only way they can produce more is by spending more. In 2000, oil companies took on seven megaprojects (defined as projects that cost $5B or more). In 2012, the oil companies took on 37. That upward trend is another good sign for the infrastructure plays.
Take the Gorgon gas project in Western Australia, for example. It was expected to cost $30B, but it's up to $52B, and it isn't even done yet. However, that cost isn't shouldered just by Chevron Corp. (CVX:NYSE) or Exxon—several companies split the bill.
We're seeing this trend in the LNG export facilities, too—five or six companies building a facility together as a big joint venture. In order for them to replace their reserves, they have to spend money, which is good for infrastructure companies.
TER: Why should investors consider the names in your Small Stock newsletter rather than sticking with blue chips?
FC: I think they need to go with both. I try to limit risk through small-caps, while retaining massive gains, so it's important to own some large caps that pay a high dividend, like Chevron and even Exxon. You could own those companies forever.
However, it's important to own smaller companies because of the upside potential. If you bought Continental or Pioneer seven years ago, you would be up 500–1000%.
An investor needs a basket of companies of all sizes; the large caps are steady and the small caps are speculative. It's my job to make sure people find the good speculations that offer limited downside and huge upside.
TER: Great advice. Thanks for your time and your insights.
Frank Curzio is the editor of Small Stock Specialist, an investment advisory that focuses on stocks with market caps of less than $3 billion. He is also the editor of Stansberry & Associates' exclusive Phase 1 Investor advisory. Before joining Stansberry, Frank wrote a stocks-under-$10 newsletter for TheStreet.com. He's been a guest on various media outlets including Fox Business News, CNBC's "The Kudlow Report," and CNBC's "The Call." He has also been mentioned numerous times on Jim Cramer's "Mad Money," is a featured guest on CNN Radio, and has been quoted in financial magazines and websites. Frank's "S&A Investor Radio" is one of the most widely followed financial broadcasts in the country. Over the past 15 years, Frank's investment strategies, including value, growth, top-down and technical analysis, have regularly produced 200%, 300% and 500% winners for his subscribers.
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