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Casey Colleagues Katusa & Bustin: Alternative Energy Bull Market Coming

By: The Energy Report, Marin Katusa, and Dr. Marc Bustin

-- Posted Thursday, June 11 2009 | Digg This ArticleDigg It! | Discuss This Article - Comments:

Last week, The Energy Report brought you Casey Research Investment Analyst Marin Katusa's outlook for uranium and nuclear energy. In today's edition, Casey Research colleague Dr. Marc Bustin joins Marin to talk about major forces driving prospects for other segments within the energy sector—solar, hydro and geothermal, as well as coal, oil and natural gas.

The Energy Report: Welcome. We look forward to your sharing your short- and long-term views of the energy market with our readers. It might be helpful to break it out by specific sectors within fossil and alternative categories.

Marin Katusa: Sure. I'll start. We've already talked about uranium. As for some of the other sectors:

  • Natural gas in North American short term, thumbs down; long term, thumbs up.
  • Oil, North America, short term, thumbs down; long term thumbs up.
  • Natural gas in Europe, short term, thumbs up; long term, thumbs up.
  • LNG, short term, thumbs up; long term, thumbs up.

What I'm most bullish about in North America is the coming green bubble. Without a shadow of a doubt short term, the geothermal sector is a BIG two thumbs up; long term, as many thumbs up as I can get.

TER: How do you see it, Marc?

Dr. Marc Bustin: I pretty much agree with everything Marin said. On natural gas, although international looks great, the three- to five-year bubble in North America will keep prices pretty depressed. As a result, in the short and medium term, natural gas is going nowhere in North America. I think we have to get into the plus-five-year range before we start seeing gas prices back to $13 to $14 an MCF like last summer. I concur with Marin on everything else; he's got it pretty well nailed. (Note: MCF = 1,000 cubic feet.)

TER: How about coal?

MB: Thermal coal in North America and Europe is pretty much dead, with the CO2 issues. That's killing the thermal coal market.

MK: Congress is debating whether they tax carbon or do the cap-and-trade system. Either one or the other is coming, so we're going to see some form of a carbon tax. One thing you can always bet on is the fact that governments will tax whatever they can, and in this case, the governments around the world, led by the U.S., will bring in a tax on CO2.

MB: India and China, of course, remain highly dependent on thermal coal, so that market's still going to be strong. Certainly the African countries also will continue to depend on coal. But the big users will not be using coal; they'll be using natural gas to generate electricity. In terms of the developed world market, thermal coal is pretty well dead.

TER: And metallurgical coal?

MB: In terms of economic demand, metallurgical coal will come back as we come out of the recession. Requirements for the industrialization of China and India will continue to drive metallurgical coal prices.

TER: To follow up on your green bubble comment, what's your thinking about the solar energy segment?

MK: When you talk about solar, you have to look at the type of solar, whether you're investing in the patent technologies' or the installers' or the manufacturers' level. So it's a little bit different; a much more defined sector. In the short term, I think it's thumbs up for installers in North America because the rebates are making solar installations much, much cheaper. Whereas a residential unit just 18 months ago in the U.S. would cost over US$45,000, that same unit today with the subsidies and the grants costs about $15,000. Solar panels, which were trading above $4, are expected to get down to about $1 by 2010, so you're looking at these same units going to about $8,000 to $10,000 by 2010, which were costing the home owners US$45,000 18 months ago.

That's a 75% decrease in the cost of installing these in residential U.S. homes because of the government subsidies.

MB: Of course, solar is still the most expensive form of energy. All of the subsidies are really what makes it worthwhile at all.

MK: Right. If Obama took away the subsidies, solar would not work with today's technology, but that will change one day.

TER: Those subsidies are the biggest gift the government has given a lot of taxpayers in a long time.

MK: That's exactly how to look at it. We have the "green bubble," "green energy," and "green profits." Maybe we should call this the Obama "green kiss." With or without subsidies, though, if I had to choose between geothermal and solar, I'd go geothermal without a doubt, no questions asked.

TER: As an investor, but not necessarily a homeowner.

MK: That's right. But from an investment standpoint, I'm much more bullish on geothermal than solar because of the actual economics.

TER: If the solar subsidies continue over the next several years, given how green the U.S. is trying to be, why wouldn't that be a good play for a couple of years?

MK: Look at the number of companies in the solar sector vying for 'x' amount of subsidy dollars. As little faith as people have in the government, they don't have an open checkbook on this. There is a cap on how much they're going to give.

If you look at the geothermals, though, there's a much smaller universe of geothermal companies than there are solar companies; and to get the money and grants from the government, you actually have to have viable products, permit-ready projects. The fact is that geothermal is a much more economic sector with profitable companies, real people doing real projects, real cash flow without government subsidies. The coming subsidies just make the sector that much sweeter, or shall we say, "greener."

In the solar sector, you can be the technology producer or the installer, and you're all vying within that same small sector. That's why I'd go to geothermal. And with the geothermal, you have significant gains in the IRRs. With the new PPAs coming out from the states of California and Nevada, these are at all-time-highs. You're seeing north of $100 PPA in California, so locking in a long-term contract with the state government for 25 years, you're guaranteed profits. (Note: PPA = Power Purchase Agreement)

MB: Also, there has to be some sense of satisfaction in actually investing in something that makes economic sense, rather than something that makes economic sense only because it's subsidized. Capitalism working only because it's being supported by a socialist government really doesn't make much sense.

TER: Why are you so mega hot (pun intended) for geothermal?

MK: First off, let me say that a bull market in the alternative sector is coming. I'll explain why. Late last month, Obama announced that more than $467 million from the American Reinvestment and Recovery Act could be used to expand development, deployment and use of geothermal and solar energy. Basically, if your company is going to build an alternative energy plant—not even producing electricity—the American government will give you 30% of the capex just to start building before 2011.

TER: Wow.

MK: That is unheard of in the mining sector. If people understand how the debt-equity ratio goes, getting 30% up front covers most of your equity portion. That is a huge, huge lift, especially with the debt markets dried up. This is a very bullish signal—The U.S. government is giving money to these companies to build these plants; the savvy investors will make sure they profit from this—we are.

And the number one alternative energy sector to be in is geothermal. It is going to be the hottest sector in the next 24 months. Even before Obama's announcement, geothermal's load factor (as high as 95%) put it far at the head of the renewables class, comparable to natural gas and nuclear. As I see it, geothermal's primary limitation is geographical. At the very best, only 10% of the United States could be supplied with geothermal power, and that figure is probably optimistic.

CEO ran a full feature report on the geothermal sector in August of 2008, and again in March of 2009. We not only looked at geothermal power production, but also the emerging technology of enhanced geothermal systems (EGS), a technology comparable to and more promising than so-called "clean coal." We talked about geothermal heat pumps, too, and explained the differences among dry steam, flash steam and binary cycle geothermal generation.

TER: Coal aside, on the fossil front, what macro factors drive your outlook for oil and gas?

MK: Let's start with oil. Obama wants to convert America from being the largest importer of oil in the world to the largest exporter of green energy, so the tide is turning against the producers. The costs are still there. The spot price has decreased.

Recently the spot price has gone up above US$60, but we think that this is a short-term phenomenon—a dead cat bounce. And think about this. Even though people say reserves have decreased, if you bought oil just six weeks ago in the mid $40s, why would you not sell it today for 50% profit after just holding it for a month and a half in the oil supply? We believe the economy hasn't picked up as the oil market is suggesting and this is a false rally.

Also, the hedge positions of a lot of these companies, big companies, are coming undone in the third quarter of this year. This is very important. There's a lot of optimism in the markets right now. Everyone's hoping for larger oil. But when you do financial analysis, you can't hope. You have to use the realistic values.

And look at the drill counts. These companies are down 60% on the drill count. People are saying there's going to be a supply crunch. Yes, there will be, but not in the near term. There's a lot of natural gas out there and with the huge finds in the unconventional sectors, a lot of natural gas supply just waiting to be produced. There's not a supply shortage right now, so until the economy picks up, you won't see natural gas going +US10/MCF.

And with the coming cap-and-trade or CO2 tax, oil is going to be more expensive to produce in North America, especially when you look at the Canadian oil sands.

TER: So this is why you're negative short term oil and domestic natural gas. What makes you long-term bullish on oil?

MK: The number one reason is the development of China, India and other third world nations; it's just a simple supply and demand issue. And when the economy gets going again, it will become a supply issue. That's the big picture in a sentence or two. There's a lot of demand in China, India and the Southeast Asian countries. Right now global demand has slowed down, but it will get going again, and that's the long-term reason. Marc and I literally live on an airplane. We've seen the changes over the last seven years in these countries, and this is just the beginning.

MB: We're still discovering more gas resources than we're consuming and that's certainly not the case for oil. We're not in any kind of "peak gas" situation in North America; we've been very, very successful in finding gas. Gas discoveries have been so successful, it's actually killing the industry.

MK: A victim of its own success.

TER: What about internationally on the gas market and LNG? Why are you so bullish?

MB: Let's talk about Europe first. The most powerful man in Europe is Putin. OPEC has 12 member nations; Europe has one man to worry about. He controls the gas market. Germany, Italy, Serbia, Finland, all these countries are most reliant on Russian natural gas. On a downturn, the 12 nations of OPEC will compete against each other, but Putin has his grasp very tight on those pipelines and he can control the market in Europe. Even the U.K. gets more than 25% of its natural gas from the Russians. It's surprising how this isn't a bigger story as all these countries really rely on Putin for their natural gas supply. In the natural gas sector, that is severe dependence on one nation, and that is the single reason we're so bullish in Europe. Nor has Europe seen the exploration on the unconventional side that North America has, if you just compare the number of unconventional discoveries.

TER: Are such discoveries likely at some point? Is the geology similar?

MB: The geology is different, but the unconventional gas has not taken off internationally the way it has in North America. What's driven down the price of oil and gas is that we've gone into a recession and the speculators got beaten up. When we come out of the recession, there's no reason we wouldn't anticipate the price of oil going back up or the price of gas internationally going back up as demand goes up.

However, in North America the price of gas has gone down not only because of those two factors, but also because we've been so successful in finding it. Gas in North America is still an anomaly. Its price is low for a number of reasons, but one of the factors is our success in discovering it. That's not the case yet in Europe or anywhere else. Certainly many companies are starting to look internationally for large unconventional gas resources, but they're not anywhere near where we are in North America.

The geology is different, but there's also less exploration. Currently, of course, the rig count is at an extreme low. Worldwide about 2,000 rotary drilling rigs are working today. That includes offshore, onshore, everywhere in the world. Here's a statistic you might be interested in: More than half of those rigs are operating in North America alone. With over half the world's rigs operating in Canada and the U.S., that just gives you an idea of how much exploration is taking place elsewhere.

TER: Any news on the LNG front in Europe?

MK: I would actually focus on LNG in Asia. LNG isn't going to hit North America because of the new unconventional discoveries. Two or three years ago, there was big talk about LNG in North America; it's a non-issue now. Because of the huge, huge capex and the fact that there's just so much supply of unconventional gas waiting to be tapped in the U.S., it ain't going to happen.

These liquefaction plants cost multi billions—not hundreds of millions, but billions of dollars—to build. The second largest liquefaction plant in the world is in Indonesia. If you find a world-class discovery, that's fantastic. But how are you going to tap into it and convert it into liquid natural gas? The costs are huge to build one of these plants that convert the gas into a liquid ready to be shipped. What you want to do from an LNG perspective is reduce your overhead. The way we've approached at it is, "Well, let's look at the largest liquefaction plants in the world and find the closest projects with the most upside potential that can tap into the existing infrastructure."

TER: Do we want to move around the world with other LNG opportunities? Or do we stop in Asia because the biggest opportunity for LNG is there?

MK: I think you want to end it there because of the costs. For example, there's a great project in Papua, New Guinea. Fantastic geology, great people, great project, but what's missing? A plant. In today's dollars in a depressed market, a plant there would cost in excess of $10 billion.

TER: How about hydro?

MK: Let's start in British Columbia. Every single river in BC has been staked. Regardless of slope, river flow, whether it has fish or not. The prospectors have claimed this well. Because of the terrain, there's a lot of hydro potential.

TER: For readers who may have missed last week's interview, please describe a Casey Free Ride again.

MK: It's a bonus. When returns make you feel you want to take a profit, always take your initial investment out or more if you want. What remains invested is like playing with the house's money in a casino. At that point, you can't lose.

TER: Is there a downside?

MK: Unlike geothermal, other renewable alternatives don't work 24/7. This is an important factor. With hydro, flow rates depend on the season. Solar doesn't work at night. The technology hasn't been made yet. Maybe one day it will, but right now it's not. So with hydro, you look at your stability rates, your flow rates.

MB: As a point of interest, there's actually some pushback against run-of-river power in British Columbia.

MK: Casey Energy Opportunities said, "Buy under $2, the election is coming." The NDP is more government, less business, but the liberals won and they're less government, more business. The liberals' victory is very positive for development and just the general business philosophy and psychology in British Columbia. Plutonic popped to over $3.50 at that point. We had big gains, so we took that opportunity to take our profits, not only because of that pop but also what Marc just indicated about the little bit anti run-of-river sentiment. It's supposedly based on the environmental impact, which is really just silly when you think about it.

TER: So basically, you like hydro?

MK: North America hydro, definitely short term, thumbs up; long term, very thumbs up.

TER: And the rest of the world?

MK: It's actually much more exciting in Europe, believe it or not, for the hydroelectric power when you look at countries like Germany and Italy trying to tap into the credits that the European governments are giving.

TER: Terrific. Thank you both.

Casey Energy Division's Senior Researcher and Chief Geologist, Marc Bustin is a registered Professional Geoscientist in British Columbia. He earned his PhD in geology from the University of BC, subsequently serving as professor of petroleum and coal geology in its Department of Earth and Ocean Sciences. He has consulted and served as a director and technical advisor for various enterprises in Europe, Africa, North America, and Asia (including CBM Asia as of January 2009). Marc's many distinctions include being an Elected Fellow of the Royal Society of Canada, the A.I. Levorsen Memorial Award for the best paper presented to the American Association of Petroleum Geologists (AAPG), and the Thiesson Medal from the International Committee for Coal Petrology for contributions to coal sciences/organic petrology. For his contributions to the study and development of unconventional gas resources alone, he won both the J. C. "Cam" Sproule Memorial Award and the Canadian Society for Unconventional Gas Annual Achievement Award. With more than 150 published scientific articles, he has been Associate Editor with the Canadian Society of Petroleum Geology Bulletin, Sedimentary Geology, International Journal of Coal Geology and the Canadian Journal of Earth Sciences. He also writes a monthly analysis for the Casey Energy Speculator (CES). Marc is a member of the AAPG as well as International Congress on the Carboniferous and Permian (ICCP), the Society for Organic Petrology (TSOP) and the Geological Society of America (GSA).

Marin Katusa is Chief Investment Strategist for Casey Research's Energy Division, also serving as senior editor of Casey Energy Opportunities (CEO) and Casey Energy Confidential. Marin, who earned his Bachelor of Science degree from the University of British Columbia, obtained a degree in education and went on to pursue a successful teaching career before his attention shifted to analyzing and investing in junior resource companies. In addition, Marin participates in the Vancouver Angel Forum (whose members evaluate early-seed investment opportunities), manages a portfolio of international real estate projects and serves on the Copper Mountain Mining Corporation Board of Directors.


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-- Posted Thursday, June 11 2009 | Digg This ArticleDigg It! | Discuss This Article - Comments:

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