As an investor you should be on the look out for paradoxes because that’s where opportunities often hide. In energy, the paradox is that today’s low prices typically help create tomorrow’s supply squeeze. Specifically, the rapid retreat to $50-a-barrel has hammered global production to the point where meeting current needs is highly tenuous, to say nothing of future growth. Production from existing major oil fields is depleting rapidly and any major new finds are inadequate to compensate for the loss.
Oil prices have been rising gradually since their February bottom in the $30’s, even as oil inventories have
been on the upswing. Nevertheless, the world remains unprepared for any supply shock or unexpected rise in demand. As I said, the seeds are being sown today for higher energy prices tomorrow. Luckily there are ways to play this trend while getting paid to wait for the price to rise.
Go North, Young Man
As my colleague Eric Roseman points out in this issue, Canada has a healthy banking system with far fewer problems compared to the United States and Western Europe. The Canadian dollar should strengthen as well, buoyed by greater resource reserves and greater fiscal responsibility vis-à-vis the United States.
In fact, the estimated U.S. budget deficit for 2009 is expected to be $200 billion more than Canada’s entire GDP, a compelling reason to go long the Canadian dollar. But that’s icing on the cake for this investment. (A little sweetener to high yield and the prospect for significant capital gains.) For straight plays on the Canadian dollar (or any other currency), I leave that to our currency experts. What I’m interested in here is the greatest energy bargain north of the border.
The United States is still the world’s largest consumer of oil, and Canada is its largest supplier. Natural gas also plays a critical component of the energy infrastructure in North America. That’s a form of energy that can’t be supplied cheaply from overseas, and Canada is no slouch in natural gas either.
The best way to invest not only in Canadian assets but specifically the energy patch lies in Canadian energy trusts. Energy trusts are equity structures that typically pay out monthly dividends to unit-holders in exchange for preferred tax rates. That’s right: every 30 days, like clockwork, the cash comes rolling in. Getting paid to wait is a great way for the impatient investor in all of us to watch the cash roll in — even if energy prices continue to remain depressed on fears about the severity of the global recession.
Show Me the Money!
Harvest Energy Trust (HTE), with a 70% exposure to oil and 30% exposure to natural gas, as well as a refining facility, is an attractive investment. Harvest is now paying a dividend of $.04 per month, after mas-sively slashing the dividend in the wake of the decline in oil and natural gas. Nevertheless, at its current price of $4.00, the new, lower payout still represents about a 12% annual dividend. That’s about the same yield you could have gotten at Harvest’s peak price. But today, you get that yield against a share price that’s nearly 80% cheaper, and, more importantly, with oil priced to sell at just $45 per barrel.
A potential downside with energy trusts lies in their depletion rates. Oil wells face a limited lifespan, and any energy trust with an asset base with less than 10 years is a potential red flag for investors. Harvest estimates they have 12+ years left on their asset base, one of the strongest asset bases in the industry.
Harvest, like so many of its peers, is massively undervalued in terms of its underlying assets, having suffered from the one-two punch of expected changes in preferential tax rates by the Canadian government in 2011 and declining energy prices. Harvest has over 219 million barrels of oil equivalent, with only 146 million shares outstanding. This works out to about 1.5 barrels of oil equivalent per share, about $75 at $50 oil, yet the stock trades for less than a tenth the price. On a valuation basis, it’s unbelievable — as the prices of commodity-driven companies often are during the ‘bust’ stage of the typical ‘boom and bust’ pattern of commodity prices.
What Goes Around Comes AroundThe most important aspect of the ‘bust’ stage for investors is that prices nearly always overcompensate as they decline and set up shortages which allow for higher prices down the line. It’s what’s happening in oil and natural gas right now. As consumers, we can enjoy the lower prices…while they last. As investors, we can take advantage of the lower prices to prepare for energy’s next move… and get paid to wait.
Oil prices could reasonably move toward a $60-$80 range in the coming months as oil wells with marginal production continue to shut down and the U.S. dollar fluctuates amidst the tug of war between the effects of the Fed’s printing press churning away and the flight to the relative safety of cash as equity markets continue to wildly oscillate. One indicator that oil prices are headed higher can be seen in the oil to gold ratio. This ratio indicates how many barrels of oil you can purchase with one gold ounce. Historically this ratio has a mean that it reverts to around 15. At the bottom of the oil market in February, this ratio went all the way to the high 20’s! Currently, however, it stands in the high teens.
The oil to gold ratio can indicate either one of two things at the current level. Either we are due for a correction in gold or a rise in oil. Given the ongoing agony in financial markets, I, along with my other TSI colleagues, cannot possibly see gold going lower for any prolonged period of time. The expectation, then, is that oil will continue to rise from its bottom. I don’t know if that will come from a supply crunch, causing prices to skyrocket upward in a short amount of time, or if prices will continue to lazily drift higher. That’s why I’m a huge fan of being paid to wait.
A functional market system indicates the relative scarcity of a particular good or service via a price. At current prices, the market seems to be saying that oil is plentiful and abundant — natural gas even more so. But the truth is, in a world where most of the easily obtainable oil has not only been found but consumed, oil below $60 is a bargain; and below $50 is a gift. Invest accordingly, and be patient.
Recommendation: Buy HTE up to $5.50 and pocket a double-digit dividend while you wait.
