Wednesday, January 25, 2012

Keystone pipeline rejection creates opportunity for Pacific Rubiales Energy, Oil Update (OPEC, refinery margins, oil prices, Gulf Coast)

     As promised, Saudi Arabia increased its crude output during the third quarter of 2011 bringing OPEC crude production up to 29.9 mbbls/d from 29.2 mbbls/d (opec implemented a 30m b/d cap a couple years ago). However, it wasn't enough to offset the 1.6 million barrels a day of crude lost due to the situation in Libya. Average WTI price fell from $102.3/bbl in 2Q11 to $89.5/bbl in 3Q11 meanwhile Brent Crude fell by only $3.6/bbl to $113.4/bbl, contracting the spread by $8.6/bbl.
A small increase in refinery margins boosted demand for oil by refineries. Margins dubbed crack spreads were at $6.8/bbl during the last three months (4Q) which is up from the previous quarter but still down from the previous year when they were $10.1. Refineries have responded to the marginal increases in the third and fourth quarter by increasing capacity: In the 3Q the following changes hapened: Repsol up 86,000 bpd, Port Arthur up 50,000 bpd, Brazil's Araucaria up 50,000 bpd. In Aruba, a 235,000 bpd refinery was reopened.

Refineries in the Gulf Coast the destination of the proposed Keystone xl pipeline, also receive regular bulk-cargo shipments of oil from Colombian producers like Ecopetrol (58% of exports in April went to the Gulf Coast/foreign investment limited due to state ownership however if you're from Colombia then I recommend taking advantage of the country's recent domestic sale of 10% of the company's stock) and Pacific Rubiales Energy (Toronto-based but Colombia-focused).  The Keystone Pipeline would carry 700,000 bpd of Albertan oil to refineries in an area known as Padd III where WCS oil commands higher prices than it does in Padd II due to a glut of supply there already (55% of Canadian oil goes to the Northern region Padd II due to its proximity to Canadian pipeline routes).

Some background on Pacific Rubiales Energy
Pacific Rubiales Energy produces castilla-blend crude, a commodity type that has seen its realized market price grow by 39% in the third quarter of 2011 to $93.87. Pacific Rubiales is a joint partner in Colombia's most lucrative oil fields at Rubiales & Quifa (gross production from the two areas combined is up 56.9% in the 3Q11 stemming from more than 27 successfull drills).
In just the last quarter, Pacific Rubiales sold 9,342,859 barrels of oil equivalent which is more than it sold during the entire year only a few ago (837,860 bbls is from purchases used in trading). New drilling at Quifa increased total daily production there to 40,000 barrels up from just over 3,000 bpd last year. Rubiales production hit a high of 190,000 bpd at the end of September 2011 up from the daily average of 125,145 barrels in the third quarter of 2010 (keep in mind that PRE's share is only 50% at Rubiales and 60% at Quifa; there's also royalties that bring the net production down slightly). The company has four other semi-major producing fields which produced at a rate of 12,752 bpd combined in the last quarter (up from 11,187 in 2010). One of them, the largest which is La Creciente is significant to the company because it is one of a few that is 100% owned. Total production at La Creciente was up 18.2% during the last quarter.

Risks associated with Pacific Rubiales - Union disruption at the largest fields Rubiales and Quifa cost the company 1,343,084 total barrels of output last quarter (491,933 net share after royalties). Each time a disruption takes place it takes the company a week to bring production back to normal levels. Also of note: due to higher royalties on higher production, PRE's net ouput share after royalties from the 60% owned Quifa field was only 1.77X La Creciente (19,241 vs 10,857) in 3Q11 despite avg total gross field production being 3.19X greater (35,222 vs 11,053). The OCENSA pipeline which Pacific Rubiales now relies on for most of its pipeline transport, is being blamed for soil, groundwater and crop contamination. That resulted a lawsuit against British Petroleum and Ecopetrol who built it back in 1997.

Positives - For the third quarter 2011 revenue increased by 103% qoq even though the price of oil only increased 42%. Net income per share was the second highest for a quarter in company history at 72c basic, 68c diluted. That compares to a 26c loss in the first quarter of 2011. Net revenue in the third quarter was $828,285 up 41.9% compared to quarter ended March. Quarter revenue was down, however from $957,509 in the quarter ended June, due to the price of oil being slightly lower.
In just the last quarter the company along with partner Ecopetrol (EC) built 4.4 km of new road and 30 new electical substations at Rubiales and 27.7 km of new road at Quifa. In addition Rubiales increased its water treatment capacity by 150,000 bpd to 1.8 million bpd. The company keeps breaking production milestones! Total production at all the fields it has a joint/controlling partnership in reached 239,000 bpd on November 7, 2011. In terms of public companies Pacific Rubiales is one of Colombia's fastest growing oil producers. On January 24, 2011 Pacific Rubiales Energy stock (TSX:PRE) was up 2.6%. By the end of the day the stock price was 37% higher than 1-year low. Its 50-day moving average is up 0.5% in just the last five days.

Why Pacific Rubiales matters to refineries in Houston
The Gulf Coast received four of the seven large cargos of oil exported from terminals operated by Pacific Rubiales Energy. That's nearly half of the 8.2 million barrels of oil that was exported (over 90,000 bpd), up significanty (just over 5.0m barrels exported in 2Q10) due to the increased oil output. With the crack spread recovering from early 2011 levels, refineries on the Gulf Coast of the U.S. are welcoming the increased supply. There's already a binational pipeline connecting Venezuela and Colombia meaning that Pacific Rubiales most likely has access to refineries in Venezuela too so there's nothing limiting demand as in the case with Canadian companies. Canada hasn't seen one new refinery built in the last 35 years/there is one however that's pending, it will be operated by Canadian Natural Resources. Also of note: In April, 58% of Ecopetrol's exports went to the Gulf Coast.

Mexico's Oil Reserves are falling fast
Through partnerships with Ecopetrol Pacific Rubiales is well connected. Ecopetrol accounts for 60% of Colombia's oil output, it also has pipeline networks throughout the country. Pacific Rubiales transports over 14,000 bpd by truck (that's growing) and as of October 21, 2011 Mexican trucks are allowed to cross over into the U.S.
Perhaps in the near future pipelines will be built to connect Colombia/Venezuela to Mexico considering Mexico's oil reserves are rapidly being depleted (down to 14.7 billion barrels in 2008 from 25 billion barrels in 1999, that's a 41.2% drop in only nine years!). In addition to that the oil field that used to account for two-thirds of Mexico's oil production in 2011 only accounted for about 25% (current production at Cantarell is around 900,000 bpd the lowest since the 1990's). I think that a pipeline connecting Mexico to Venezuela and Colombia will eventually happen. Could be a couple years could be a decade but it's not unfathomable.

Sunday, January 15, 2012

Diversified Investments Hon Hai Precision Industry, Seabridge Gold -sorry Motley Fool, Royal Gold

     With all the market turbulence it's imperative that investors not only diversify their stock portfolio but choose companies that are already diversified within themselves. Here are a few companies that fit the bill.

Hon Hai Precision Industry better known as Foxconn - This is the company that manufactures everything from the xbox game console for Microsoft to the iPhone4S for Apple as well as laptops for Hewlett Packard; Its HP laptop plant in Chong-qing that produces upwards of 20 million laptops annually, was built in 2009/2010 and made Hon Hai into one of the leading employers in China's 23rd largest mainland economy (where the electronics industry ranks first ahead of vehicle manufacturing). Keep in mind that each plant can have anywhere from a couple to 15 or even 20 factories, in fact Hon Hai's largest in Shenzhen is home to some 300,000 workers. In total Foxconn has factories in nine Chinese cities.
The technology industry has recorded massive growth over the last seven years led by Apple Inc (market capitalization 6X bigger today than it was in 2005 - 390 billion vs 65 billion) which is important to remember since Hon Hai plays an integral role in Apple's success (the iPad is made by Hon Hai at a plant in Chengdu, China, the iPhone4s is manufactured at the world's largest smartphone production facility, the 200,000 unit/yr plant at Science Park, Zhengzhou). In January 2012 it announced a plan to increase its workforce by ten times in a major Chinese manufacturing city, as well Hon Hai recently stated that it will be doubling the size of its flagship smartphone-manufacturing plant in Henan province with a $1.1B investment.
-The company is obviously preparing itseslf for huge jump in size and why not? the iPad holds anywhere from 60-90% of the global tablet market, a market which could grow by 42% in 2012 to 40 million units up from 29 in 2011. As of January 2012 Hon Hai's workforce numbers 1.2 million. On March 11, 2011 Hon Hai Precision Industry (Foxconn) had a market capitalization/valuation of $36.9 billion US dollars. (source: Forbes Global 2000 List 2011 Edition)

Hon Hai recently reported a 19.8% year-on-year jump in revenue to $92 billion over the 2011 calendar year (37% increase in December) boosted by especially strong results in the month of December (revenue in the fourth quarter alone was $30B). That's significant considering that Taiwan's other technology companies Quanta Computer, Compal Electronics and Acer, all reported decreases in revenue (-1% for Quanta to $60b, -21% for Compal to $23b, -23.5% for Acer to $12.4b). Hon Hai profited over $2.5B in 2010 only slightly higher than 2009. The company has $32.0B worth of assets. One thing that could become a problem for Hon Hai is fake Apple products in China. Since the iPhone4s launch was delayed in China, more fake products have been introduced to the market.

Royal Gold (MV 3.77B, 5-day -2.37%, 1 month -4.01%, 3 month +2.77%) Is one of the world's largest and most diversified royalty companies with direct exposure to many of the world's key mining operations through royalty agreements (buys the royalty usually before the mine enters production phase). It then collects royalties (in most cases net smelter return royalties) on the net revenue made from one of five precious or base metals (or all as in the case with Peñasquito). There is little risk considering it is not responsible for mining or exploration costs (like Silver Wheaton). Considering the fact that many of the mines are either not producing or in very early stages of production (Penasquito, Pascua Lama, Malartic) strong growth in revenue (& profit) is likely; unlike other mining stocks, for Royal Gold growth isn't contingent on metal prices (unless of course they collapse which is unlikely given that we're in a commodities bull market). In the 3rd quarter of 2011 Osisko Mining's Malartic gold property reached commercial production producing 73,814 ounces of gold and 40,000 ounces silver (Malartic is home to 10.71 million ounces of gold) - Royal Gold owns a 3% royalty on Malartic.
Diversification: The company remains gold-dominant but that's slowly changing with new base-metal mines coming on tap (like Goldcorp's billion ounce silver Penasquito mine in Mexico). During the 2011 fiscal year 64% of revenue came from gold which is down sharply from 81% in 2010 and 84% in 2009. In 2011 silver contributed 6% to revenue (up from 3% the two previous years), copper steady at 10%, nickel up significantly to 15% from 4% in 2010, 1% in 2009. Other minerals like zinc and potash made up 5% of revenue up from 3% and 1% in 2010 and 2009 respectively. Most of the royalty agreements are for 2-5% however a couple like Andacollo (1.6M oz of gold reserves) which is at 75%.
more on Royal Gold HERE including nickel, lead & zinc production data by mine by year updated to reflect 2011.

Financials: Stock is up 2.77% between Oct 17 and Jan 13 2012, up 7.98% during the six month period ended Jan 13 but down 9% in the month of December. Key royalty claims; 2% NSR claim on Canada's biggest gold/silver/copper/molybdenum project (KSM) purchased in 2011 for $160m; 2% claim on Goldcorp's only major silver mine Penasquito; Barrick Gold's Pascua Lama mine in Chile. In fiscal 2011 (ends in June) revenue was up 58.5% to US$ 216m which is great considering total operating expense was virtually unchanged at $97m pushing gross profit up 190.0%. The company profited 232% more ($71.39m) however dividends were up only 23.5% to 42 cents/share. Update second quarter 2012 fiscal year (ends December 2011): profit/earnings were a record for a quarter at $23.4M up 28% yoy or 42 cents a share on royalty revenues of $68.4M, up 22% qoq. For the 2012 half, net income was $45.9M (up 52.5%) or 83 cents a share (up from 55c) on revenue of $133.3M (up 31.07%). adjEBITDA was 90% of revenue in the second quarter or $62.1M up from $48.9M in 2Q2010. For the September-December 2011 period (2Q of the company's 2012 fiscal year) the price of gold increased 23% from $1367 to $1688 an ounce. The company recently paid $170 million on its debt (credit facility) expanding available credit under the facility to $225 million. $268.3 million was raised in an equity offering held in January 2012.

Royal Gold production update for 2012 Second Quarter
According to Goldcorp/operator of Penasquito (one of Royal Gold's most lucrative interests) gold production will be 425,000 ounces and silver production 26 million ounces for the 2012 calendar year. Malartic (1.0-1.5% nr) will produce between 610,000 and 670,000 ounces of gold in 2012. Barrick Gold's Pascua-Lama mine will bein producing during mid 2013 at 800,000 to 850,000 ounces a year in the first five years. Thompson Creek's Mt. Milligan (31% complete end of 2011) will begin producing 4th quarter 2013. Lac Cruces (produces copper cathode) will operate a 90% of design capacity in 2012, total production estimated to increase by 55% versus 2011 (calendar year). In the second quarter of 2012 Andacollo contributed $16.18 million of the comany's $68.84 million in royalty revenue which is 23.50% of the total up from 20.12%. The only other mine that contributed over 10% of RG's revenue is Voisey's Bay (2.7% net smelter return royalty) which gave the company 17.49% ($12.04M) of its second quarter 2012 revenue (up from $8.06M in the corresponding period of 2011). Royal Gold's four largest sources of revenue contribute 56% of revenue (second quarter 2012); total gold production by them was approximately 92,358 ounces of gold (up from 65,862 ounces) 27.4 million pounds of nickel (all from Voisey's Bay) in addition to Penasquito's output of 5.0m oz silver, 40.2m pounds lead, 78.4m pounds zinc. Quarter on quarter increases at Penasquito were mostly from zinc which was up 35.0%, silver was down 100,000 ounces but gold was up 23.8% or 13,052 ounces.

Seabridge Gold - Unlike Motley Fool I take a bullish position on the company. Since January 6 when Motley Fool considered a plunge in the stock Seabridge Gold is up 10% after being down more than 27% over the three months prior. Why has the stock underperformed in the long term? a couple reasons stand out. The spot price for gold is down 11.0% since early September, also down is silver (-29.1%), copper (-27.5% to $3.63/lb from $4.2 in September) and molybdenum. But unlike other metal companies Seabridge's long term valuation is predicated upon development of key mines Kerr-Sulphurets-Mitchell (capital cost is $4.7B) and Courageous Lake (capital cost is $1.26B).
When those projects do reach production-stage the company could become the next Ivanhoe Mines (keep in mind that royalty company Royal Gold has already committed $160m for a 2% nsr royalty on KSM). KSM is 100% owned by Seabridge and has a 52 year mine life (adjusted up in May 2011 from 37 yrs due to reserves increasing by 27% for gold and a whopping 61% for silver) and very low cash costs ($105/yr in the first seven years). Also of note: about half of the world's molybdenum production comes from China and China has at times threatened to limit production by labeling it a "national mining resource," which limits the export of the metal in the same fashion as rare earth elements and China can do that through its control of the China Molybdenum, the country's leading molybdenum producer. Seabridge is also exposed to Molybdenum having 257 million pounds of molybdenum in reserves.

Why have investors suddenly shown more interest over the last week? On January 10, 2012 the Courageous Lake property in the NWT added approximately 1.2 million ounces of gold to measured and

Tuesday, January 3, 2012

European Bank Stocks Oversold?

     When European-debt exposed Intesa Sanpaolo and Societe Generale begin showing any signs of growth you know they've reached rock bottom. As you can see in the months leading up to November 24, 2011 Europe's twelve largest financial institutions were in a free fall, granted Canadian and Australian banks were also losing value but not nearly as fast. In the month of December top European banks nearly matched their Canadian and Australian counterparts (I use Canadian and Australian banks as the reference because they performed ok during the economic crisis and are in an enviable position rating-wise, though some like the Royal Bank have risk exposure). The comparable growth in capitalization as measured in US dollars, over the six weeks leading to January 3 even takes into account exchange rate effects and the strong US dollar. Before jumping in however, take caution; On December 15, 2011 UBS, Credit Suisse, Barclays, BNP Paribas, and Societe Generale were all downgraded by Paris based ratings agency Fitch Ratings. Before deeming that too great a risk keep in mind that those banks are also on the g20's list of 29 too big to fail financial institutions (5 of the 8 banks downgraded are European) taking away some of the perceived risk. What does too big to fail mean exactly?
Financial institutions whose distress or disorderly failure, because of their size, complexity and systemic interconnectedness, would cause significant disruption to the wider financial system and economic activity. To avoid this outcome, authorities have all too frequently had no choice but to forestall the failure of such institutions through public solvency support. As underscored by this crisis, this has deleterious consequences for private incentives and for public finances.
The g20 made the list in part to put pressure on the banks to increase their loan loss reserves. Have they done it yet? We'll find out in their 2011 annual reports which will be coming out over the next couple months. I'll report on that when they come out. European banks typically leverage about 80 times (debt used to acquire additional assets), that puts the EU in a more preciarious situation than the Canada or Australia (in the US leverage is typically 40 times).

Strength in the European market: Societe Generale gets 20% of its net banking income from less risky Russia.
For Credit Agricole cost of risk didn't increase between 2010 and the 3rd quarter of 2011.
Deutsche Bank profited 3.985 billion EUR in the first nine months of 2011. In stark contrast, it lost 612 million EUR in the second half of 2010. One thing to remember about Deutsche Bank though is that it waited until the quarter ended December 2010 to hand out a dividend of 75 cents per share. It could do the same again this year considering the company reported no losses in 2011 (pending last quarter).
Strength in the Canadian market: Canada’s top six banks currently offer a dividend yield of 4.69 per cent (average). The S&P/TSX Financial Services Index which closed at a 14-month low at the end of November, is 75% weighted in Canadian bank stocks. Canadian banks don't have much direct exposure to European debt but their stock performance seems to be tied to the situation in Europe.

BNP Paribas is by some measures the largest of the European banks (assets especially) but be warned, as of the 3Q of 2011 it had over 14 billion euro worth of soveign debt exposure in Italy (12) and Greece (2) alone. European Stability Fund bonds are not attracting as much investment as anticipated and that affects BNP's situation. If you want to invest in EU banks but want to take a less riskier approach, check to see if they own any credit default swaps (CDS): contracts made with insurance companies who have agreed to take on losses incured by the institution in the even of a credit situation (country defaults and the bank is left holding worthless bonds).