Malcolm Shaw is looking at a modern-day map to buried treasure. He sees a company operating a shale-oil well that has tested at a free-flow rate of 590 barrels per day, a junior producer in Argentina working naturally fractured shale, an unrecognized frack sand resource, and a company that owns one of the most exciting uranium discoveries on the planet. Yet Shaw, a partner at Hydra Capital Partners Inc., is sometimes mystified by the lack of investor interest. In this interview with The Mining Report, Shaw talks about these projects and more, explaining how a savvy investor can profit from diamond-in-the-rough opportunities.
The Mining Report: Malcolm, uranium's spot price is at a 52-week low. What is your forecast for the uranium price moving forward?
Malcolm Shaw: The spot price is still depressed from overhang in the spot market that stemmed from the Japanese reactor shutdown in 2011. Japan was widely expected to begin reactor restarts this summer, but it appears that may be pushed back to early fall. It should be the starting pistol for a move in the spot price. I wouldn't be surprised to see the spot price recover, maybe to the $40–45/pound ($40–45/lb) range, by the end of the year. But it's really going to depend on the pace of those Japanese reactor restarts.
TMR: Analysts keep saying that we are looking at a uranium supply deficit and rising prices by 2018. Why isn't the market responding to these threats?
MS: The uranium market is a little different than a market like copper or gold or oil. Spot prices are around $33/lb and term prices are around $47–50/lb right now. Spot's really only relevant if you're looking to secure supply for very near-term delivery, whereas term is what an end-user would expect to pay for guaranteed delivery in the future, some years down the road. In the near term, and maybe even the medium term, there's no shortage of uranium out there. But when you consider the new reactors coming online in the coming years, the supply deficit is staring us right in the face. The number of new reactor builds underway in Asia is significant, and when you look at the growth of electricity demand and the concurrent decline in air quality in a country like China, it's no mystery why nuclear has to become a larger part of Asia's energy mix.
Spot prices are generally important for market sentiment, which ultimately correlates with capital inflows and investment in the sector. Cameco Corp. ($CCO:CA) ($CCJ) is the best market barometer that I can think of for sentiment in the uranium sector. It's been trading fairly well, up about 50% in the last six months, though it's been a little soft lately. I can't say when the market will respond, but I really do think it's a "when" not an "if." At the current spot and term prices, new production would be very difficult to finance.
TMR: How will the isolation of Russia and the nuclear reactor restarts in Japan affect the uranium as well as the oil and natural gas spaces?
MS: Russia is a juggernaut in the uranium sector. It has been one of the main suppliers for the U.S. reactor fleet for about 20 years now under the Megatons to Megawatts program. That program is over now. There are transitional supply agreements in place to meet demands of U.S. reactors in the coming years. To me, that seems like a suboptimal situation from a U.S. perspective. I think it should encourage development of domestic uranium resources.
Russia is also jockeying with Saudi Arabia for the position of largest oil producer in the world and is critical to the gas supply of Europe. To sum it up, Russia is an energy powerhouse, but there are alternatives. The U.S. is becoming increasingly less dependent on foreign oil, and I think we'll probably see the U.S. become a real exporter of natural gas in the coming years. Gas prices are much lower in North America than other markets, like Asia and Europe, where they can be twice as high or higher. It's not hard to imagine that liquefied natural gas (LNG) projects will start to take advantage of that arbitrage.
Pretty much any time a foreign dependence on one commodity or another is highlighted as a result of geopolitics, as we're seeing with Russia right now, the market tends to react to decrease that dependence. It should have regulators in Europe looking to increase LNG import capacity and should also drive them to more aggressively pursue domestic gas sources. North Africa could also see some increased interest from energy investors as a lot of European gas comes from North Africa.
TMR: Are you expecting to see more uranium mining in North America?
MS: I would think so. In terms of domestic companies that are active, we're looking for producers like Energy Fuels Inc. ($EFR:CA) ($EFRFF) ($UUUU),Uranerz Energy Corp. ($URZ:CA) ($URZ), Ur-Energy Inc. ($URE:CA) ($URG), Uranium Energy Corp. ($UEC) and maybe even an early-stage project like Powertech Uranium Corp. ($PWE:CA) to get the market behind them, maybe get their equity values a little higher so they can raise some money and advance their projects. Energy Fuels, Uranerz and Ur-Energy are all pretty advanced. Each of them has production and is well financed, but again, their equity prices aren't reflecting the underlying value of their assets if you believe in a higher uranium price in the long term.
TMR: In your last interview, you were excited about the early reports from the Patterson Lake discovery by Alpha Minerals Inc. and Fission Energy Corp. How has that panned out?
MS: The two companies merged late in 2013, and the combined company is now called Fission Uranium Corp. ($FCU:CA). Patterson Lake has turned out to be one of the most exciting uranium discoveries on the planet. The ultimate size of the resource is still unknown, but it has all the hallmarks of a world-class deposit in terms of the holy trinity of scale, grade and depth.
One of its holes came back recently with a grade thickness of 992. That's equivalent to almost 100 meters (100m) of 10% U308. It's hard to describe how good that hole is. For its depth, it's probably one of the best mining exploration holes ever drilled for any commodity. The true thickness of that intercept is still unknown and uranium deposits are often irregular in shape, but to be in a system that can produce a hole like that at a depth of only about 60m from surface is very impressive. Ultimately a deposit like that will almost certainly be bought by a larger player. For me the only question is when.
TMR: So, what does the future look like for the company? Is it going to buy up or is it going to be selling out?
MS: Again, it does own 100% of Patterson Lake. I expect Fission to take that project through to an NI 43-101 resource estimate so that investors can have a formal idea of what the resource size is, because there are a lot of numbers being tossed around by the market. Ultimately, in terms of buyers, it's a relatively select club of companies that would make an acquisition like that, but any time you have a deposit with this kind of grade at that depth you're talking about a best-in-class deposit, and those tend not to stay in the hands of juniors.
TMR: Are there any other companies that are getting comparable results in the Athabasca?
MS: It's almost an unfair question. Patterson Lake has set the bar so high that other companies really can't be expected to compare. There's a reason why Patterson Lake gathered so much attention despite a sluggish spot market in uranium: When you make a world-class discovery, the commodity price tends not to matter quite as much. It will be tough to follow up, but companies can always try. NexGen Energy Ltd. ($NXE:CA) is on trend to the northeast. It has some pretty interesting-looking rock and a few of its holes drilled from the winter program, but the assays are still pending.
TMR: Changing focus, natural gas appears to have escaped the bargain basement $3 per million Btu ($3/MMBtu) price range. What was the catalyst for that?
MS: It was definitely the cold winter that we just went through coupled with historic lows in gas rig counts. Those two things together made the 2013–2014 winter season a real outlier in terms of storage drawdowns. The Energy Information Administration reported storage levels for natural gas right now are about a trillion cubic feet (1 Tcf) below the five-year range for this time of year. That's just a huge deficit to make up for, and rig counts are only starting to pick up for natural gas.
TMR: Is the $4/MMBtu range where gas is going to live now?
MS: I think so. With the storage levels that we're seeing right now it's hard to see us getting into an oversupply situation any time soon, unless the summer is unusually cool and the next winter is warm. It's not like you can just crank up gas production on a dime. It takes time to move rigs and people to increase that production, and the gas delivery system itself only has so much capacity to deliver gas to storage. We should be stable in this $4 range, maybe even $5.
TMR: So your expectation for the gas price this year is to continue some upward pressure?
MS: Yes. I really try not to forecast gas or oil prices, but directionally I would say my price bias for gas is positive. As an investor I would generally look to be long gas producers.
TMR: You were talking about LNG exports. Is the rising price of gas going to have any influence on that?
MS: Basically it's transportation arbitrage. If you can buy gas cheaper in North America and make money by shipping it to Asia or Europe as an LNG company, you're going to do that. If gas prices go to $8 per thousand cubic feet ($8/Mcf) in North America, there's going to be a lot less incentive to ship that gas offshore. However, I don't see those price levels coming to North America any time soon, which is why I would be biased towards the view that LNG projects will move ahead and that will provide more stability in the North American pricing. I think we're unlikely to see those lows that we saw in the past year or so.
TMR: What companies are having luck drilling shale internationally?
MS: One of the themes that I see is that shale oil and shale gas are here to stay. Producers are literally going straight to the source in the hydrocarbon industry. Drilling and completion technology has given us the ability to unlock resources that were previously beyond our reach. It's a paradigm shift. North America is showing us what's possible with the right services and technology, but, geologically, the same resource potential exists elsewhere in the world as well. I've been looking for resource plays internationally where I can get low-cost exposure to companies looking to take North American know-how abroad.
Canacol Energy Ltd. ($CNE:CA) is a Colombian producer. Colombia has a long history of hydrocarbon exploration and production. I think that over the next year or so we're going to hear a lot more about the La Luna, Tablazo and Rosa Blanca shales. These Colombian shales are proven and prolific hydrocarbon source rocks and are comparable to the names like the Bakken and the Eagle Ford in a lot of ways. One of the key differences is that they are 1,000–2,000 feet thick. That's anywhere from 3–10 times thicker than any comparable Bakken or Eagle Ford in North America. That means that the oil-in-place numbers can get very large very fast.
Canacol has over 500,000 net acres of exposure to these plays in Colombia, which puts it second only to the state oil company, Ecopetrol S.A. ($EC) ($ECP:CA). To put things in perspective, Canacol has seen Exxon Mobil Corp. ($XOM), ConocoPhillips ($COP) and Royal Dutch Shell Plc ($RDS.A) ($RDS.B) all farm into its acreage within the last year or so, all in separate blocks, but all in the same play.
The first well, drilled by the Canacol/Exxon joint venture into a naturally fractured section of La Luna, was tested at 590 barrels/day (590 bbl/d) oil earlier this year. The test was short term, but it was under natural-flow conditions, which means that the oil is literally free-flowing to surface at that rate. I'm pretty amazed that the market appears to be completely ignoring this shale option value right now. I can make a case for the company trading at 0.6–0.7 times its net asset value on its existing conventional production alone and there's no lack of running room there either. The company's recent discovery at its Pantro-1 exploration well really firms up the Leono-Pantro development area, and I think it's reflective of the overall potential of their LLA-23 block in terms of production growth and prospectivity. I really like the risk/reward on Canacol.
Crown Point Energy Inc. ($CWV:CA) in Argentina is similar to Canacol in the sense that the company is backstopped by existing production from its conventional assets while offering huge leverage to another one of the hottest international oil shale plays out there, the Vaca Muerta. We're seeing this trend where the majors are coming into these plays to secure reserves for future growth because it's very hard for them to move the needle any other way. The Vaca Muerta is being pursued by Exxon, Chevron Corp. ($CVX), Royal Dutch Shell Plc, Yacimientos Petrolíferos Fiscales ($YPF), Petroliam Nasional Berhad (Petronas) and Total S.A. ($TOT), to name a few.
The Vaca Muerta is very thick and a very proven source rock in the early stages of exploitation. There was a successful Vaca Muerta test by YPF to the south of Crown Point's land in 2012, but YPF hasn't followed up on that despite the fact that there are a number of proven, producing fields in various formations on trend to the south. We know Crown Point's acreage is in an oily area. Crown Point has about 100,000 acres of Vaca Muerta that is modeled as being in the oil window. It's outside of the main area of activity, but the data in the company's area of interest is very compelling. It's 6 kilometers (6 km) from a pipeline in an area of proven historic production and only 4 km from a Vaca Muerta well that tested about 350 bbl/d in the 1990s.
Recently, Crown Point drilled into a naturally fractured volcanic section that's embedded within the Vaca Muerta shale, which should be tested probably by the end of May. That well had persistent oil shows during the drilling of that section. That naturally fractured volcanic reservoir is interesting for a couple of reasons. First, it means that development might not require the expensive horizontal drilling and fracking typically associated with shale oil because the natural fractures may act as high-permeability conduits for the oil. Second, there's analog production from fractured volcanics in a field directly to the south, where this play type has been proven to be productive. We still need to see a test, but right now I think it looks pretty good.
Industry valuations per acre in the Vaca Muerta can range anywhere from $1,000 to $10,000/acre depending on who you talk to and where the acreage is. My math has Crown Point valued at around $200/acre. I'm finding that pretty compelling.
Crown Point is going to start a 10-well drilling program very soon in Tierra del Fuego, which should continue to build on its current core production of about 1,700 barrels of oil equivalent per day (1,700 boe/d). It should provide some additional material exploration upside, because eight of those wells are development wells and two of them I would characterize as being low-risk exploration wells. One of those exploration wells is a target called Puesto Quince that probably has the potential to double corporate reserves if it's successful. It's covered by a 3-D seismic survey and is flanked on three sides by production, so I like that target a lot.
TMR: There's been a long-running civil war in Colombia, and Argentina has a record of nationalizing. What is the political risk for companies operating there?
MS: There's always political risk. I joke sometimes that there's political risk in Canada. A number of years ago we saw Alberta overhaul royalties, which caused a lot of fuss and has since been straightened out, but I see your point. The FARC, a guerilla group, is active in Colombia, typically in the border regions with Venezuela and Ecuador. Since about 2000, maybe 2002, the Colombian government has taken a pretty hard line against the FARC. It started with President Álvaro Uribe, and President Juan Manuel Santos has continued that. I see no sign of that diminishing in the future. It's simmering in the background and it's flared up a little bit lately with elections coming up. From everything I've seen, though, the FARC has really been marginalized.
People also like to talk about nationalization in Argentina, and it has happened. The Repsol-YPF debacle was forefront on everybody's minds. That dispute has been settled. Repsol (REP:MC) was recently compensated for the assets that it did lose. There's a relatively long story and history between Argentina and Repsol that surrounds that. I would encourage people to look up some of that history. But a junior company is really too small to be on the radar of the Argentinean government for expropriation, I think.
TMR: You're very impressed with Canacol's shale-oil flow rate in Colombia. Why aren't other investors equally impressed?
MS: I think because it's early, for one. The Canacol/Exxon well test was literally one of the first well tests from the La Luna Shale in Colombia in recent memory. There have been historical producers out of that formation, but they were viewed more as outliers, and they were drilled back in the days before we really recognized the potential of oil shale resource plays. I also think that the market may have had unrealistically high expectations of something in the 1,000–3,000 bbl/d range. Also, Colombia is still working on regulations for unconventional resource plays. It is expected that they will follow a North American model in that regard, and when those regulations are in place, I think it might be a trigger for the market.
Any time you get a well that's free flowing at surface at a rate of 600 bbl/d, that's a very good oil well. That means you literally have 600 bbl flowing out of the ground unassisted. There were two 24-hour tests, so some people may find that production test a bit short, but again, it's early days in the play. The well should soon be on long-term production test and all signs are positive so far. If I was paying anything for the shale option in Canacol, I might have a different opinion. Like I said, with the core assets underpinning the value of the company, I could see the stock trading at $10/share just based on the existing conventional assets. To also get that kind of leverage to the shale for free, that's what gets me excited.
TMR: Which of the companies you cover offers the best value for an investor and why?
MS: Advantage Oil and Gas Ltd. ($AAV) ($AAV:CA) is an interesting value play. It's not the cheapest stock in terms of valuation metrics, but it is just a prime chunk of Montney gas acreage in Alberta. It has 1.7 Tcf of Proven and Probable reserves, and industry-leading finding and development costs in the $1 to $1.25/Mcf range. Its operating costs are also industry-leading at around $0.30/Mcf. Even though it's generally dry gas, the economics are great. You're talking recycle ratios in the 2–2½ times range, even at current gas prices. Advantage has really executed and it has recently been trading really well, so I think the market has started to take notice.
One last company that I'd like to touch on is called Athabasca Minerals Inc. ($ABM:CA). I've followed this company for years and I bought it about six months ago. I think it's on the verge of a major rerate by the market. The company has been quietly working away on a frack-sand project called Firebag, which is just off a main highway about 100 km north of Fort McMurray. I would expect that project to get permitted sometime this year. Canada uses around 2.5 million tons per year of frack sand and something like 70% or 80% of that comes from places like Wisconsin in the U.S. That's a long way to ship sand. Athabasca's deposit is so much closer to the Alberta market; I can't imagine how a foreign sand resource could compete once Athabasca Minerals Firebag project is up and running. Firebag would be one of the closest frack sand sources in a business where proximity is everything and transportation is by far the largest cost in the equation. For perspective, Firebag is about 2000 km closer to the core of the Alberta Deep Basin than any competitor out of Wisconsin would be.
The company has already secured land at the end of the Canadian National Railway Co. ($CNR:CA) ($CNI) line just south of Fort McMurray for infrastructure; you need a place to load that sand onto rail. Athabasca's had its sand independently tested and it compares favorably with all the existing frack-sand industry benchmarks. I get excited about it. Frack sand is just an absolutely essential component of the energy industry now. For anyone even thinking about LNG shipping from British Columbia in the future, you have to consider that those gas molecules are going to be unlocked by frack sand at some point, and that's on top of the domestic gas market. I think Athabasca's Firebag project could be a strategic asset down the road. It's a real, "made in Alberta" solution.
Athabasca Minerals also has a history of profitability from its core gravel operations in the Fort McMurray area, which is closely tied to development activity in the oil sands. I should point out that there is no NI 43-101 on the sand resource yet, but my back-of-the envelope math says that there are decades of supply there. I expect margins to be quite robust. I think once the market figures out what's in play here, the stock has a very good chance of being quite a bit higher.
TMR: To wrap up, can you recap your investment advice for uranium and then for oil and gas?
MS: For any industry, I would encourage investors to look for a backstop in value and then look for good management teams focused on giving investors exposure to good upside. I like to find companies where I know the valuation is underpinned by the existing assets. To me that's a big deal. The other thing that I look for is long-tail optionality on the upside. I highlighted some of those names today with some of the shale oil plays and this frack-sand opportunity. If people gear themselves towards thinking about the downside first and then thinking about what they're paying for the upside, it can make for much more successful investing in the long run.
TMR: Malcolm, thank you very much for your time. This has been a good discussion.
MS: Thanks for having me.
Malcolm Shaw is a partner at Hydra Capital Partners Inc., a group of buy side and sell side industry professionals focused on underfollowed companies. Shaw holds a Master of Science in geology from the University of Toronto and has 13 years of experience spanning the resource and investment industries. He started his career as a geoscientist at PanCanadian Petroleum (now EnCana), before transitioning into the investment industry as an international energy research analyst at Wellington West Capital Markets. Before joining Hydra, Malcolm was a vice president at K2 & Associates Investment Management, where he focused on the energy and materials sectors.
Source: Tom Armistead of The Mining Report (5/6/14)
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1) Tom Armistead conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Fission Uranium Corp., Energy Fuels Inc., Uranerz Energy Corp. and Royal Dutch Shell Plc. Streetwise Reports does not accept stock in exchange for its services.
3) Malcolm Shaw: I own, or my family owns, shares of the following companies mentioned in this interview: Canacol Energy Ltd., Crown Point Energy Inc., Uranerz Energy Corp., Energy Fuels Inc., Athabasca Minerals Inc., Cameco Corp. and Powertech Uranium Corp. I also own bonds in Advantage Oil & Gas Ltd. and warrants in NexGen Energy Ltd. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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