(This is the second in a series of articles based on a recent interview with Rick Rule, Chairman of Global Resource Investments Ltd. in San Diego. Rule is a high profile speaker on the mining conference circuit, who has been involved in micro-cap investing and analysis for over 35 years. In the first article, published by Stockhouse on Dec. 3, 2010, Rule focused on the junior resource sector).
In this part of the interview, Rule discusses the outlook for the global energy sector. “I see the whole energy sector in the next five years being broadly and surprisingly higher,’’ he said. “ I also don’t think that the market recognizes the extent to which energy markets will surprise people to the upside.”
(SH) Where do you see oil prices in five years from now?
(RR) “I see oil at plus US$100 per barrel and the reason is pretty simple. There is increased demand for energy from societies that couldn’t afford to compete with you and me. Those people aspired to our standard of living ten or 15 years ago, but knew that they couldn’t compete. Now they can. That is a fairly well documented, well understood fact. The fact that is much less well understood is on the supply side. Most oil in the world is not produced by the big oil companies. Many of your readers believe that oil is produced by Royal Dutch Shell PLC (NYSE: RDS.A, Stock Forum), BP PLC (NYSE: BP, Stock Forum), Exxon Mobil Corp. (NYSE: XOM, Stock Forum), Total SA (NYSE: TOT, Stock Forum) , and some is. But most oil in the world is produced by national oil companies, meaning it is politically controlled. As a result, the same people who can’t deliver the mail are running the domestic oil business.”
(SH) What will be the consequences of so much oil being controlled by national companies?
(RR) “There is a strong temptation, which is almost never ignored, to divert free cash flow from a national oil company to politically expedient domestic spending programs, including paradoxically subsidizing the price of things like gasoline, at once constraining supply and increasing demand. It is my belief that as a consequence of this diversion of sustaining capital from oil and gas to due to domestic programs will produce an inescapable systemic decline in countries such as Mexico, Peru, Ecuador, Indonesia and Iran.
The countries that I just named supply about 25% of the world’s export crude. I suspect that they will all cease to be exporters within the next five years. Unless Iraqi crude ramps up very substantially, or unless the Saudis are prepared to substantially increase their production, we face a shortfall of as much as 20% of export supply on a global basis at the same time that demand is increasing by 1.5% compounded. This is truly a crisis. It is a crisis that hasn’t been addressed by many investment commentators and it hasn’t been addressed politically at all.”
(SH) What is your take on the uranium sector right now?
(RR) “ I’m less interested than I was six month ago because uranium stocks are 50 or 60 per cent higher than they were at that time. Still, I welcome it when companies like Hathor Exploration Ltd. (TSX: V.HAT, Stock Forum) and Extract Resources Ltd. (TSX: T.EXT, Stock Forum), that had very nice discoveries, respond to very good news by going down in price. There is nothing in the world I like more than that.
What is specifically interesting about uranium is that during the uranium boom from 2003 to 2007, billions of dollars were raised in the industry and they were deployed by an industry that hadn’t been looking for uranium for 25 years, as a consequence of a very long bear market. We are in a discovery cycle now, which I think the market needs to recognize.”
(SH) What does this mean for investors in uranium stocks?
(RR) “The bad news in uranium is the constituency for uranium stocks is really a constituency that was built in the boom years from 2003 to 2007. They have unrealistic expectations. If I am right about stock market volatility and a carefully constructed uranium portfolio were to fall in the context of a liquidity crisis in the broad market by 40 or 50%, you would see many speculators get shaken out of their uranium stocks. This would be for reasons that have nothing whatsoever to do with [a specific] deposit or the uranium market. Those people lack confidence in their own decision-making skills and [would be affected by] their lack of comfort with the broad market.”
(SH) What is the outlook for uranium on the global demand side?
(RR) “I think that the other thing that people miss about the uranium business is the increasingly strategic nature of uranium deposits. Some places in the world have decided that a lot of their energy future is going to be nuclear powered. That includes places like Japan, Korea, Taiwan and China. They have decided that in the interests of energy security, they can store five or six years worth of feedstock for a reactor much more easily then they can store coal for a coal fired plant, or five years worth of natural gas for a gas fired plant. So countries like Japan and Korea find nuclear energy to be an extremely efficient and strategic fuel.”
(SH) How will new construction of nuclear reactors impact demand?
(RR) “The strategic nature of the uranium deposit works like this: If you and I were to build a uranium power plant in Korea at a cost of $5 billion or $6 billion. If you were to finance 50% or 60% of that cost via debt, you might be required now to secure 20 years of supply in order to qualify for that loan. What it means is that long term supply contracts are priced substantially above spot. Increasingly you are going to see companies that normally wouldn’t be able to finance the construction of a large mine, be able to finance that construction via off take agreements with utilities and power plants.”
Stockhouse (SH) You often say that you are a fan of out-of-favour sectors. Could you name a couple that you like?
Rick Rule (RR) “There are two that I consider to be no brainers -- geothermal and run of river hydro. This is a sector that just has to work. We are going to need a lot more energy in the next five or ten years. The advantage that geothermal and hydro have is first of all that they don’t deliver intermittent power (like solar, which has a problem with night). But also, they don’t experience the same social concern that other forms of energy development can. There is widespread belief in the responsible core of the environmental community that we should be encouraging the development of green energy technology, which is not particularly disruptive, and which includes, in particular, geothermal power.
I believe that the geothermal sector will do extremely well for the next five years. I think beyond that it won’t do so well because I think all the geothermal producers will all be taken over by large power producers. But between now and then, I think it will do very well. It is completely under the radar screen with regards to the investment community.”
(SH) Are there other out-of-favour areas of the energy sector that you like?
(RR) The other area that I think is of particular interest to Canadian speculators is the small cap Canadian oil and gas (put particularly the gas sector) sector. Gas has performed very poorly and as a consequence, paradoxically is a four letter word among Canadian speculators. Nobody wants to be in the gas space. Yet there are probably 20 companies in Canada that have demonstrated competence in natural gas and are reasonably well financed, and more importantly have enough oil or liquids in inventory that they can grow for a year or a year and a half in the liquids side. I suspect that [by investing in these companies] you get the gas assets for free.
Rick Rule Biography
Rick Rule is Chairman of Global Resources Investments Ltd. He began his career in the securities business in 1974 and has been principally involved in the natural resource security investments ever since. He is both a popular speaker and a leading investor, specializing in mining, energy, water, forest products and agriculture. Rule’s investment firms will become wholly-owned subsidiaries of Sprott Inc. in 2011.