An Interview with Bill Powers
Today we'll be talking with energy analyst and hedge fund manager Bill Powers, of Powers Asset Management. Bill has published two successful energy investment newsletters, Canadian Energy Viewpoint and US Energy Investor, and has been a contributor and guest to Financial Sense Online and the Financial Sense Newshour.
In 2005, he decided to focus his full attention and energy to running his investment fund, Powers Asset Management.
Mr. Powers originally came from a background in technology, and had thoughts of becoming a tech analyst. After working in the securities business and technology related work, he set his sights on finding a field that was inversely correlated to the overcrowded tech sector of the late 1990s. His growing involvement in the energy sector showed him that oil and gas fit that description.
A magazine cover supplied the contrary indicator that signaled an end to the downtrend in oil prices. The appearance of The Economist's now famous "Drowning in Oil" issue was something that told him the timing was "absolutely right". During our discussion, Powers compared The Economist's March '99 cover story to BusinessWeek's infamous "Death of Equities" cover which preceded the bull market in stocks beginning in 1982.
Powers saw the need for an energy-focused investment newsletter and decided to press forth with the idea, unpopular though it may have seemed at the time. He began writing articles on Canadian oil and gas companies and launched his own publication, Canadian Energy Viewpoint, in 2002. His hedge fund, Powers Asset Management, was launched in early 2005.
Bill, let's begin by talking about some of the supply and demand fundamentals that are shaping your overall view of the oil and gas story that's unfolding. Give us an overview, if you will.
Basically, supply and demand continues to tighten for both world oil and North America natural gas. We're at a time of no spare capacity for either. This is unprecedented. Not only are we at a tight spot for supply & demand, very few large projects are going to come online to replace maturing production from existing fields. This is unlike the 1970s where we had two oil shocks, but yet we had Samotlar in Russia coming online - which is a very large field, the North Sea, Gulf of Mexico, all were in their infancy at that time, as well as Prudhoe Bay.
We've heard references to the last oil crisis of the 70s as being political in nature, a political shock due to Opec cutting off supplies to the West. Does the information we have suggest that the next shock will be driven by a lack of supply?
This is going to be a geological shock. By that I mean, sure, there will be production that will come in from offshore Brazil and out of West Africa. But the fact of the matter is that the largest producers in the world, such as Saudi Arabia, has probably had peak production. I very much agree with Matt Simmons' book, Twilight in the Desert. Venezuela is in decline, Mexico is about to go into a steep decline, and Russia will decline. Indonesia, which is a member of Opec, last year became a net oil importer. Not only that, we're seeing largest oil fields in China, Daqing, in decline.
While China has made monumental efforts to replace its production, it's struggling to do so. They have made some good discoveries in the South China Sea, but that will barely keep production flat. As their economy grows, there will be more demand for oil imports from the rest of the world.
In India, their biggest field is Bombay High, which was developed by the British before WWII. That field and the rest of their biggest oil fields are in decline. That is a very rapidly growing country that will have needs for additional imports. What we're really seeing at this time is declining production from mature basins and increasing demand from majority of developing and the developed world. Demand continues to increase even here in the US, despite high prices. I think that what will surprise people is that prices will stay high. Will prices move higher in the immediate future? Maybe, maybe not, but I think the long-term trend is very well established and it is up.
As far as North American natural gas goes, we do have somewhat of a similar situation in that there is somewhat of a supply overhang right now due to the very warm winter we have had. However, we are at 100 percent utilization for natural gas land drilling rigs, as well as rigs in the Gulf of Mexico. We have a declining rig count in the Gulf of Mexico because rigs are being shipped overseas which is somewhat of a new phenomenon. The rig count has dropped from about 150 to 90 right now in the Gulf of Mexico and this is because the rig companies are signing higher day rates for overseas. That will affect shelf production for natural gas on the continental shelf.
Is the "rig count" a metric used mostly to describe natural gas production or is offshore oil included in that as well?
Mostly natural gas. About 90 percent of the rigs drilling in the US are directed towards drilling natural gas. That's both onshore and offshore, but the rig count deals largely with natural gas, especially as it involves land rigs.
But really what we're seeing are smaller reservoirs of natural gas being discovered. Due to technology, we've had a very steep decline curve in natural gas. We're seeing what Matt Simmons has referred to as the natural gas treadmill, which means it requires more and more wells to be drilled every year to keep production flat. So any let up in drilling will have a major decline in production.
So we are seeing despite the high prices we've had over the past few years, production has declined in North America, and I believe it will continue to do so. While there are fields in Wyoming and the Barnett Shale, that will probably continue to increase but the rate of increase will not make up for the maturing fields elsewhere. We will see a much bigger move towards unconventional natural gas, but I don't think it will compensate for the decline in conventional production from mature fields.
And then the big question mark for North American natural gas is LNG, Liquefied Natural Gas which gets talked about a lot.
Does that fall under the category of unconventional gas?
It would be considered an unconventional source in the sense that it comes from overseas. Places such as Algeria, Trinidad, Egypt, Qatar. Those are major exporters, especially Algeria and Trinidad.
It has to be shipped by tanker, then reliquefied...
They have to ship it and reliquefy, yes. They are building new import facilities to take in natural gas. However, the big problem with that is there are other countries that are doing the same thing. Asia is the largest consumer of natural gas, Japan has long been the largest consumer of natural gas and they have already tied up supply for quite some time. So what we're seeing is while there is potential to import it, that lack of aggressiveness by import facility operators is going to severely limit the amount of gas that comes into this country for the next decade.
They can't get permits to build enough facilities?
Well, the facilities are actually underutilized right now, so it's not a problem of facilities. What it is, it's tying up long-term contracts. That is very, very competitive.
So the Japanese and the other countries of Asia are giving them longer-term contracts and more fruitful terms so the supply is going to Asia?
Yes, correct. And so is Great Britian, who is now becoming an importer of natural gas, Spain has built LNG. A lot of Europe is now looking for alternatives to gas coming out of Russia. So Europe is becoming very dependant on Middle Eastern natural gas and they are becoming a force in the LNG trade.
Does it seem to you that all the infrastructure that's been built up around natural gas (power plants, industrial use) is a very big bet on the reliance of natural gas supply?
Yes, well that's a good point. Actually there was a law that was passed in 1978 or 1979 that limited what natural gas could be used for, and it outlawed using natural gas for power plants, as there was a big natural gas crisis back then. Then that law eventually was repealed in the 1990s, and what happened was, from about 2000-2005 there were a huge amount of gas fired power plants built. That was because the National Petroleum Council, which is the research division of the US Department of Energy, predicted that natural gas would stay at $3 for the first two decades of this century. Almost immediately after they wrote that, gas started its climb up to where it is now.
So there have really been some errors in judgement as far as building a lot of power plants that may have difficulty in getting supply in the future. There has been a lot of industrial demand that has been destroyed along the Gulf coast. The fertilizer industry, the chemical industry: a lot of those plants have moved overseas. The smelting industry in the Pacific Northwest for aluminum and other industries, a lot of major heavy industrial users of natural gas have had to move overseas in order to secure cheap supplies.
Do you have any thoughts on Uranium and nuclear energy?
Well I'm a big believer in nuclear energy. I believe there will be more plants built here in the states. Overseas, there's a big commitment to nuclear - France gets almost 78% of its electricity from nuclear energy. Over in the developing world, such as India and China, there's a number of plants built or being built. They are going to have no other choice than to commit to that. So I think that nuclear energy has, until renewables become more competitive, the advantage. There's no real choice but for nuclear energy, because I think hydrocarbons will become prohibitively expensive to generate electricity from in the very near future.
Do you see that happening in the next 15-20 years?
I think it's a process that's already started happening. If oil continues to rise, natural gas will probably go up along with it, so the time frame is unclear but I think it's in the process of already happening.
Do you think we'll be able to use less uranium because of newer plant designs?
As far as that goes, I know there's been an increase in demand for uranium because they've done up rates for existing power plants. I think there will probably be more efficient use of uranium due to new reactor types, but there's still going to be, I think, a net overall increase in uranium demand due to the reemergence of the nuclear power industry in the United States and its continued prominence overseas.
The idea that we have no real alternative outside of nuclear energy may come as a shock for many of us. Environmentalists seem to be split on the issue of nuclear or even whether or not to build windmills offshore. But we will need energy from some source.
What do you think about alternative energy? How much electricity can we get from solar and wind?
I think clearly, that solar and wind are the two that are furthest along. I am not an expert on alternative energy, but I think that there will be tremendous advantages in both solar and wind over the next decade. They will become a larger portion of the power supply, both here and overseas.
As far from an investment perspective, I think there are going to be fortunes made in the alternative energy industry over the coming years, because there are technologies that are making it competitive with production of electricity from hydrocarbons. There are a lot of startup companies out there that are going to do fantastically well.
Let's talk about some of your previous energy price forecasts. The case for $50 oil, which you made in February 2004, has obviously been proved despite earlier skepticism. You then made a forecast in November 2004 that called for $80 oil within 24 months. We've come quite close to that mark and we still have a few months to reach your target.
Well, when I predicted $50 oil in February '04, I believe that oil was near $35 and that was viewed as somewhat of an unsustainable price. Really, the same reasons behind my thesis on $50 oil were true for $80 oil. Supply is becoming increasingly difficult to grow, demand is continuing to increase, and also I think what the general public is now starting to understand is that higher oil prices do not necessarily destroy the economy.
There was a fantastic article that was written by Andrew McKillop, "Price Signals or Cheap Oil Noise?", that refers to this fact. In 1984, which was Reagan's reelection year, the economy grew at 7.5%. In 2003 dollars, adjusted for inflation, the oil price range for daily crude was $57 -$65. So high oil prices do not necessarily quash economic growth.
I think that while there are definitely strains that are put on, especially, lower-income members of society and certain industries feel the pinch of higher oil prices more than others, but overall the economy does adjust. And I believe that even higher oil prices, while they will likely slow economic growth, there are other headwinds that will slow economic growth such as the decline in housing. This will probably damper demand for energy as much as high energy prices themselves.
So we are seeing that the economy is adjusting to higher oil prices. I think that as long as prices do not spike, and they move up gradually, we will see higher highs and higher lows as far as the price of oil goes.
[As far as the forecasts go] I felt that it was somewhat of a stroke of luck to have given the times and prices, but I think the trend that started all the way back four years ago, we're clearly seeing it play out. And there's going to be lots of ups and downs.
What do you make of the argument that higher oil prices will bring on more supply?
Right now, that's one of the big conundrums that a lot of economists are struggling with.
Higher oil prices- what's somewhat different from the traditional economic thinking, as far as this bull market goes- no matter how high prices go it's not going to bring on a significant amount of production. That's because we are at, or very close to, peak oil. We may have already passed it, or it may still be in front of us, but to meaningfully grow oil supplies from here will be extremely difficult and extremely expensive.
So we're in a situation where, no matter how high prices go supply will not be increased significantly. The same is somewhat true of natural gas. When the industry worldwide is working flat out, there's not much more that can be done that's not already being done.
I'm kind of amazed to see so many people applying this textbook economic principle to something in the ground that is an exhaustible resource. It's almost as though they are thinking the resource won't run out or will quickly replenish itself.
But you also have to remember that for a period of 24 years, from '78 -2002, when oil prices went up, supply did come on. Basically that type of thinking is similar to the generals who are fighting the last war. It really is. When Churchill went on the offensive in WWII, he fired all of the generals and put young twenty-something lieutenants in charge.
So who has the power to put these kind of influential thinkers in policy positions?
Well, there are some people who are clearly out front on this issue. Colin Campbell, Ken Deffayes, Jim Rogers has been out front on this issue, Matt Simmons, Julian Darley.
People like these and many others who have been sounding the alarms that this situation is happening and that it does deserve attention.
So basically we're looking at private individuals and industry veterans who have done their own thinking on the issue and are able to come out and stir the pot.
Yes, and unfortunately that's the way society works.
Matthew Simmons isn't afraid that he's going to get fired from his job for speaking out...
Right, and he has committed a lot of resources and a staggering amount of time to writing this book (Twilight in the Desert).
What are you seeing as far as energy investing goes? Do you still find energy companies to be a compelling area for investment?
Right now we've found that, despite record high prices, there is a great deal of negative sentiment in the energy investment arena. We're seeing companies trade at very low multiples of cash flow, reserves in the ground, net asset value, and of earnings.
We think that a lot of the reason for this is the belief that these prices are unsustainable and that a slowdown in the economy will drop oil prices. I disagree with that. I think that while the economy may possibly slow and affect demand growth in the developed world, there is still a developing world that will continue to increase its consumption.
To think that because the US is having an economic slowdown that oil prices will come down is, I think, incorrect. There are a lot of consuming countries out there that spend a high percentage of their GDP, where high oil prices mean a lot to those countries. There will be other countries that will increase consumption due to high oil prices.
Who would you cite as an example?
The exporters. Canada is a good example. Their economy continues to grow and they're an oil exporting country.
What should investors look at in energy investing and what do they have to know to invest in the energy sector successfully?
Really, what we look for are companies that can grow reserves per share, production per share, cash flow per share, and earnings per share without having to access outside capital in the form of equity or debt.
When we find companies that can do that, there is a very good chance their stock price will go up. We are firm believers - we invest in smaller oil & gas companies - that it is very important when you deal with smaller companies, to get to know management. This helps us to understand the companies much more deeply than you would when analyzing larger companies.
And what's a good source of public information that investors can look to in order to better understand the energy industry and the individual companies?
There's a lot of information out there for U.S. and Canadian companies. In the US, you can go to the SEC web site. In Canada, you can go to SEDAR. Or, a great publication is Oil & Gas Investor. That has a lot of North American oil & gas companies in it, and it's an excellent publication.
Powers Asset Management