₪ David Pescod's Late Edition August 30, 2006
An Interview with Eric Sprott
Of Sprott Asset Management
(From August 25, 2006)
Eric Sprott has been a leading and independent voice in the Canadian brokerage business for many years and he was one of the first and most adamant of those backing the current run in commodity prices – and he thinks there may be a lot more to go. The mutual funds at Sprott Asset Management have benefited greatly as they have been some of the best performing mutual funds one can find. We are very grateful to have been able to spend some time with Eric for our recent interview and hopefully, from time to time, we will be able to visit with him again for some of his stock picks and ongoing views of the economy and of course, commodity prices.
David Pescod: Eric Sprott is one of the leaders along with Donald Coxe, Jim Rogers and others as advocates in this natural resource cycle and we are probably three years in now and with concerns about slowing economies in the States and housing prices, Eric where do we sit in this cycle?
Eric Sprott: That’s a great question. We, amongst a lot of people, had predicted that the U.S. economy would go down and yet, at the same time, were taking a more optimistic view of almost all real commodities and that had to deal with the fact that there are economies out there that might be more important than the U.S. economy these days, that are continuing to grow and are likely to continue to grow. In fact we are even trying to develop a thesis that we might be heading into some kind of Malthusian situation where we have a scarcity of resources for all the people that demand those resources and that could be across the board in all things – whether it be oil, water, or agricultural products and it kind of looks like that what might be evolving here.
David Pescod: Okay, you have also written a lot about “Peak-Oil”. How about oil prices, what do you see for them over the next 5 to 10 years and are we facing a short term concern here at this point?
Eric Sprott: Well we are obviously “Peak-Oil” enthusiasts. Most of the information that we see everyday tends to confirm the thesis that the world has been having a more difficult time in terms of increasing oil production and perhaps the more important thing is the word “maintaining oil production”.
Because we produce 85 million bbls/day, the depletion rate seems to be getting higher almost every year and the amount that we have to maintain every year goes up. So for example, some people believe that the depletion rate is 8%, which if we use it at a rate of 85 million we have to find 6.8 million new barrels this year to “maintain” production.
There are so many issues out there about maintaining production. We see problems in Prudhoe Bay, the North Sea, the Cantarell Field in Mexico and these are all where they are declining and not even maintaining themselves and our view is that we are not going to be able to maintain oil production at these levels. The real students of Peak Oil suggested that we have produced half the oil that will ever be found and production should decline beginning right around now.
David Pescod: Natural gas has really suffered in the last while. We didn’t have a particularly cold winter as it was quite warm, inventory levels are quite high and all of a sudden the traditional relationship with oil has gone out the window and natural gas is probably more important to the “coffers” of Alberta than oil is. Your thoughts on natural gas as far as short term and long term?
Eric Sprott: Sure. Our view on natural gas – when we look at the amount of drilling that is taking place for example in Canada for natural gas (I think the numbers are up something like 30% - the actual number of wells) and then when you look at the cost of those wells (imagining that it might cost 20% more per well, is not an unreasonable number this year versus last year) and to think that we spend 50% more there and the gas supply hardly changes…it tells you that we are going to have a continuing ultimate shortage of natural gas. We just can not get the production on fast enough with a 50% increase in monetary effort. You can’t keep doing that every year, within a very short period knowing what the exponential function is, you would have to extend all the worlds resources on gas drilling at 50% a year.
We’ve had a real difficult situation with gas and I think gas prices will certainly get back to the old ratio such as 7:1 and I didn’t really answer your question on oil prices, though, but I think in our scenario we just imagine going higher and we put no limit on it and I am not going to be surprised to see it at $100.00 and I will not be surprised in the next 5 to 10 years to see it at $200.00.
David Pescod: Wow. That was the next question. Let’s say if you had to predict in the short term for this Christmas and say Christmas 2007, what numbers would you use for oil and gas?
Eric Sprott: Oh boy. Well, the short term ones are tougher than the longer term ones. I would guess that it will close at the highs of the year at the end of the year and that would be my guess and it would probably be around $80.00. Where would I see it in 2010, it would certainly be in the $100.00’s, would be our expectation or perhaps higher.
David Pescod: When we get into the metals, there are two commodities that are really standing out because there is none around and that this nickel and zinc, but what are your favorites these days?
Eric Sprott: Well, I haven’t really played the nickel or zinc market to much of an extent. We do look at them; because those prices are really quite compelling and it’s making us sort of throw off some of our bearish views on the economy because the prices are so high for the commodities it makes some of the investments look attractive.
We have focused a little bit more on copper, molybdenum, cobalt, tungsten, and of course we have had a big interest in gold and silver all along, but the prices of all these commodities have surprised everyone on the upside. It really looks like we have ourselves a shortage scenario in almost all those metals, because nobody has really taken the time to develop any new production since the prices where at a low for so long and now were way behind the eight ball. So we’re pretty upbeat, quite frankly, on things like molybdenum, tungsten, cobalt, zinc and copper right now.
David Pescod: As far as gold, do you still like the precious metals and do you think the take-over game is going to continue?
Eric Sprott: We have liked gold now for last six years, since the bottom in 2000. We continue to like it for many, many reasons — as a safety value for investment, as a leverage play on some of these stocks as the prices go up their range of course rise dramatically, and we have committed a large part of our funds to gold and silver. The silver supply/demand situation might even be better and the dynamics and price probably will be better. So no, we’re kind of all in on the precious metals game!
David Pescod: The price of gold?
Eric Sprott: Well, I’m sure it will go north of $1,000 over the next two or three years. I mean it has been moving up very steadily, it has these little gyrations from time to time, but generally it’s in a bull market and I think it will continue to rise quite strongly.
David Pescod: The most interesting part, of course, is always the stock picking game and your funds have done amazingly and we notice that one of your biggest holdings is Delta Petroleum. Is it potentially a new Ultra Petroleum?
Eric Sprott: Well I think potentially it is way bigger than that! They have two world class projects that they are working on, one of which is in the Columbia River Basin in Washington where EnCana is currently drilling the test well, it has been drilled to depth, and it will be testing in the next 1 to 2 months.
The President of Delta has made a comment recently that if everything goes according to plan, they will have many tens of trillions of cubic feet of gas – possibly in the 100’s of trillions. And, to put that in perspective the U.S. consumes about 25 trillion a year, so this would be a lot of gas, or you could put it in other way: we value a TCF of gas at about a billion dollars, so with a market cap of around a billion anybody who finds 10 TCF’s has a stock that can go up a long way.
In fact there was a recent report out of a U.S. Broker suggesting that the unrisked potential for Delta Petroleum is $190.00, with a downside of possibly $12.00. So it kind of gives up a scope of what can happen if the Columbia River Basin comes together and they also have something called the Utah hinge line, which is an oil play, where again it could be of a world class size and hopefully they will drill or start their first well within 30 to 60 days.
So, we have been hopeful on Delta for a long time. The well in the Columbia River Basin, when we first bought it, was supposed to be completed in January of 2005 and here we are in August 2006 and it still really is not completed. So, Delta really hasn’t done much on a relative basis, but it has picked up a lot of interest recently so we are really hopeful that this stock can go along way.
David Pescod: Okay, on your top three would Delta be on the top three and which would be other two top picks?
Eric Sprott: Well, Delta certainly is our largest holding, so yes it would be in our top three. In terms on where we have our money, of course our largest investment is basically in the metals – the bullion, gold and silver.
We also have another play in the oil and gas area called Falcon Oil that is basically hunting for the same type of thing that Delta is, but is doing it over in Hungary and they’ve drilled a couple of wells there that look spectacular. They have not been tested yet, but it is the same type of situation that if you find the source rocks for these things you tend to extend the discovery over the hole Basin that you are in, so that is another one that will look every interesting. There should be test results confirmed, well we think they are going to confirm.
David Pescod: And a third pick?
Eric Sprott: In terms of individual stock, well I think that there are two companies that are certainly coming along here that are picking up a lot of interest and we do have interest in both of them and one is a company called Petrolifera…which has some very interesting discoveries in Argentina and looks like they have really got a good grip on the play and I would say another one is Aurelian Resources, that has a gold discovery in Ecuador. It looks like it’s going to get very large. So those are the types of things we like to try to be early on, recognizing the huge prospectivity and it sounds like there will be in both those cases. We don’t have nearly as large a position in those as we do for Delta and Falcon.
David Pescod: One last question, you’ve written about real estate and you concerns that the American real estate market could be on the verge of, well, if not a correction, maybe something even worse…house prices and real estate in Alberta in the last couple of months has acted as if it was all beachfront, California properties and have gone through the roof. Any warnings to these people?
Eric Sprott: It’s very difficult for me being in Ontario, to understand the Alberta real estate market. Our primary focus is to figure out what’s going to go on in the States. I would say for example, that real estate in Ontario experienced some of the same bubble-type characteristics that it did in the States, where you get multiples bids, you had special financings, prices were roaring up, and all the signs of mania. That’s manifested in Alberta. The question is, so when is the top? And that is a very difficult thing to know in Alberta because with our view of where energy prices are going, it could sustain itself for quite a while. I’m not an expert in Alberta real estate, so I’m not going to try and call the top, but I actually believe in Eastern Canada, we may have seen the top. But Alberta is its own self-contained situation.
David Pescod: Thank you so much Mr. Sprott.
Disclosures: Aurelian Resources: Canaccord Capital covers this stock and has a Speculative Buy rating on it. (Speculative buy: Stocks bear
significantly higher risk that typically cannot be valued by normal fundamental criteria. Investments in the stock may result in material loss.)
EnCana Corporation: Canaccord Capital covers this stock and has a Buy rating on it. (Buy: The stock is expected to generate risk-adjusted
returns of over 10% during the next 12 months.) |
