The Best Energy Investments of 2006
Elliot Gue
January 13- 2006
energyletter.com
While on holiday earlier this month, I couldn't help but follow news coverage of the devastating coal mine explosion and rescue operation in Sago, West Virginia. The Sago explosion was a terrible tragedy and ranks among the most deadly coal mining accidents of the past decade. To put the accident into context, consider that 22 miners died in the US throughout 2005 and 28 in 2004; 12 miners died at the Sago mine alone.
We all are sympathetic to the loss of life at Sago; however, all investors must consider the implications of Sago on stocks in the coal mining industry. It's been a long time since the industry was so firmly ensconced on the front pages and safety considerations play an enormous role in profitability.
The good news is that that the industry's safety record has actually improved markedly and steadily over the past 100 years. In fact, the reduction in fatalities is striking. In 1907, more than 3,200 coal miners died in the US, with more than 350 perishing in a single explosion in West Virginia. Nearly 50 miners out of every 10,000 lost their lives in 1907. Since 2000, however, the industry has averaged less than 3 fatalities per 10,000 employed in the mines. The US coal industry also ranks among the safest in the world; at the other extreme is China, where more than 5,000 miners die on average every year. That nation accounts for less than 40 percent of the world's coal production but nearly 80 percent of the world's coal mine fatalities.
Sago also reveals some important changes in the coal mining industry. It's instructive not only to view coal-mining fatalities on a nationwide basis but state-by-state, because the geographic location of coal mines helps drive my investment decisions.
West Virginia alone accounts for nearly one-third of all US mine deaths over this period; West Virginia and Kentucky combined account for close to 60 percent. The common denominator here is underground mining. Underground mining is inherently riskier than surface mining (used in the Western US). West Virginia and Kentucky sport relatively high mine fatalities because more of their annual production comes from underground mines. Sixty percent of West Virginia's 2004 coal production comes from underground mining operations; Kentucky's breakdown is similarly reliant on these more dangerous mining operations. Safety concerns, coupled with the costs of underground mining are some of the prime reasons why I avoid Eastern coal companies. Instead, I focus on the surface miners in the Western US, primarily in Wyoming’s Powder River Basin (PRB).
2006 Mega Theme #1: Coal
Coal will remain the world's pre-eminent source of electric power for years to come. And while it’s generally considered an environmentally dirty fuel, the use of low-sulphur coal from the Powder River Basin (PRB) of the Western US can go a long way towards reducing sulphur dioxide emissions. Peering a bit further into the future, I see the potential for coal liquefication and coal gasification technologies to bear fruit.
Rising coal prices spells higher profits for coal miners. But even if prices were to more than double from current levels, producing coal-fired power would remain cheaper than power produced by natural gas; coal could rise a great deal from current levels without choking off demand. Better still, the US has 200-plus years’ worth of coal reserves and isn't dependant on imports.
Our first play on coal in The Energy Strategist was Penn-Virginia Resources (NYSE: PVR). Penn-Virginia doesn't actually mine any coal; rather, the company owns major coal-producing properties and leases these properties to miners in exchange for a royalty fee. This fee is based on the value of the coal produced; Penn-Virginia participates in some of the upside in coal prices. Better still, Penn-Virginia doesn't have to foot the bill of hiring miners or paying for expensive raw materials and mining equipment.
And as a master limited partnership (MLP), Penn-Virginia pays out most of its cash flow as distributions to unitholders. Penn-Virginia has a remarkable history of boosting its payout. Over the past three years, the MLP has managed to grow its payout at an annualized pace of 10.5 percent. The current yields stands at just shy of 5 percent.
Since our original recommendation in early June, Penn-Virginia stock is up roughly 21.6 percent assuming dividends reinvested, or about 19 percent in price appreciation alone. It is but one of the MLPs in my income portfolio. For more details, please visit:
energystrategist.com
In addition to Penn-Virginia, I recommended a derivative play on coal--the railroads. My favorite rail remains Burlington Northern SantaFe (NYSE: BNI), a stock that's up roughly 30 percent from my mid-September recommendation.
Burlington has the largest network of rail in the PRB. Low sulphur coal from the region is in increasingly high demand by eastern utilities; by burning the low sulphur coal they're able to comply with the Clean Air Act. Burlington now has considerable pricing power; the utilities are willing to pay high transport rates to ensure reliable supplies of coal from the PRB and adequate investment in rail capacity in the region. Railroads will continue to be a profitable way to play the coal story. For more information about the coal story, please read my special report at:
energystrategist.com
2006 Mega Theme #2: Nuclear
Generating almost one-fifth of the world's electricity, nuclear power is a major contributor to the global energy pie. Nonetheless, while investors follow every twist and turn in the oil and natural gas markets, nuclear power and uranium prices remain largely ignored.
But ignoring nuclear power is a big mistake for investors; uranium stocks have been among the best and most reliable performers in The Energy Strategist Portfolios in 2005. Most of these stocks held up remarkably well even when oil and gas stocks corrected sharply in October and my top pick, Canada's Cameco (NYSE: CCJ), is up more than 60 percent from our original recommendation back in March. And this trend is far from over; I see major catalysts for uranium stocks and uranium prices as we head into 2006. For more information, please visit:
energystrategist.com
There are a couple of different ways to buy into the nuclear story. The most obvious beneficiaries of an expansion in nuclear power capacity globally are uranium miners and companies that process uranium into nuclear fuel.
Uranium is currently in short supply and the utilities are working off very thin inventories. This marks a dramatic change from the ‘90s when inventories and supply were more than sufficient to meet demand. In recent years, global uranium demand has hovered near 180 million pounds annually; total global mine production is, however, only around half that amount. The world's utilities hold some stocks of uranium and have been drawing down those stocks to meet their needs, consuming roughly 30 to 40 million pounds out of inventories annually.
With the utilities sitting on dwindling inventories of uranium, they're looking to secure new supply. Like coal, uranium is often sold under multi-year supply contracts to utilities--the utilities are increasingly paying up to secure uranium under long term contracts from reliable suppliers. This is precisely why my favorite plays in the nuclear patch are the mining firms.
Companies with reliable production of uranium will gradually see their legacy supply contracts roll off over the next few years. As those contracts expire, the better miners will be signing new contracts at much higher prices. This is obviously a big earnings driver.
Mining Information
Our top nuclear play has long been Cameco (NYSE: CCJ), a stock we added to the growth portfolio when it was trading in the upper 30s. Cameco's quarterly conference calls are truly informative; the company discusses not only its own prospects, it also frequently offers commentary on the nuclear and uranium industries at large. Because Cameco is the world's largest miner of uranium and sits on more than 65 percent of the globe's known reserves, its management team is uniquely positioned to comment on the nuclear industry.
Cameco has long held that 2008 will be a critical year. Many utilities have projected supply needs that will arise after 2007. They simply do not have the inventories or supply agreements to cover their uranium fuel needs.
In Cameco's most recent call, management stated that the duration of uranium supply contracts is getting longer. A few years ago, utilities were willing to accept uranium supply contracts of roughly three to five years duration, a sign that the utilities were relatively confident in their ability to obtain supply. But now the utilities are increasingly looking to sign 10-year or longer supply contracts. They're desperate to secure long-term supply of nuclear fuel.
Perhaps even more interesting, Cameco offered some color on the contracts it's been signing. Increasingly, the company has been able to sign long-term contracts at a premium to prevailing spot rates: Utilities are willing to pay premium prices to secure supply from a reliable producer. Cameco is also signing contracts with escalation clauses.
We were early in recommending Cameco and the stock has proved one of the best recommendations in 2005. Nevertheless, it's still the blue chip play on the nuclear industry and one of the only miners with scope to dramatically ramp up capacity over the next few years; Cameco has promising projects in Canada, Australia, the US and even Kazakhstan. With some of the lowest mining costs of any miner globally, Cameco will see tremendous growth in profitability over the next few years. If you want to play the nuclear story, buy Cameco.
In 2005, subscribers to The Energy Strategist saw their portfolio far outstrip the major averages. I expect the same for 2006.
While Penn-Virginia, Burlington Northern and Cameco are three companies poised for a big year, they’re just one small part of the energy story that I’m currently developing for The Energy Strategist. My subscribers have made money in offshore drillers. They’ve also made money in refiners, integrated oils, and oil services companies. In fact, they’re making more money by being in the right energy stocks, than they would have by just buying the OSX or some other oil index or fund. But that’s only the beginning.
To fully take advantage of the bull market in energy stocks, please considering joining me in The Energy Strategist. You can learn more by visiting:
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In future issues of The Energy Strategist, I’ll explore key issues like:
1. Can the Canadian oil sands serve as a future replacement for Saudi reserves?
2. Will the rise of national oil companies like Saudi Aramco and Petrobras impact the profitability of integrated oils like ExxonMobil?
3. Which companies you should avoid (or even short) due to their un-hedged exposure to high energy prices.
Profit opportunities for savvy, informed energy investors abound. It’s time to take the next step and get “inside”. In the energy markets it’s all about having access to the right information and acting upon that information at the right time. And that’s what I’ll give you in The Energy Strategist.
I’d like to have the chance to prove to you that energy should be a cornerstone in your investment portfolio for the next 5 to 10 years and that you can achieve both capital gains and strong income from investing in the right energy stocks.
To back up my claim I’m offering a 90-day 100% money-back guarantee!
Go ahead, read all my archived issues, chart the performance of my growth and income portfolios, and see what I have to say about your energy picks by checking out my “How They Rate” portfolio.
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The Energy Strategist doesn’t come cheap, but I firmly believe it could be your best investment of the year. It’s already paid off in spades for hundreds of savvy investors.
Don’t delay. Learn more about the letter and my current thinking on the topic of Peak Oil by visiting me at:
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Sincerely,
Elliott Gue, Editor
The Energy Strategist
Elliott H. Gue is editor of The Energy Letter.
Sincerely,
Elliott Gue
Editor, The Energy Strategist
Copyright 2005
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