The Energy Report: Do you have an overall theme right now?
Phil McPherson: Yes, I have always been much more oil-weighted and a big proponent of what I kind of call the “California revolution” that’s occurring. We saw it happen in the Bakken formation with the Williston Basin, and now we’ve seen it in the Permian Basin. I think California is on the cusp of reversing the decline trend that has occurred for the past decade.

The other trend that has kind of emerged is what I call the hybrid model where companies have been 100% natural gas for the majority of their lives and have now shifted their capex (capital expenditures) to liquids. What has been surprising is those companies have actually outperformed the oil-weighted names over the last three to six months. So, money has shifted from the traditional oil-weighted names that got more expensive because they were oil-weighted.

TER: So, in a nutshell your theme now is California oil and liquids.

PM: California oil and liquids. I’ve been a natural gas bear for the better part of three years. At $5/mcf (thousand cubic feet) gas, I’m a seller. I just don’t see it from a supply and demand equation. The supply is pretty empirical in that we have a ton of natural gas reserves in this country and the demand side is tepid at best.

TER: I haven’t figured out why the U.S. and the International Energy Agency decided to release 60 million barrels (Mbbl.) of oil from our strategic petroleum reserves (SPR) in July. Do you have any ideas as to why these reserves are being tapped?

PM: Yeah, I was just as surprised. I was in a meeting and jokingly said that we woke up today with a new type of geopolitical risk. What I mean is that we’ve already got the 2012 election on the headline, and it feels like this is a very politically motivated way to drive down oil prices in the hopes that it would spur consumer confidence and, hopefully, some votes at the polls.

You know, at the OPEC meeting prior to this release we clearly saw for the first time a division among OPEC members, and you could clearly see which members are aligned with the West and which weren’t. The more important thing is that Saudi Arabia is really the only OPEC member that can increase production rapidly, but its crude oil tends to be sour, and right now, the market is missing Libyan crude, which is much sweeter. So, I think the SPR release was a hope to alleviate that perceived shortage for light sweet crude.

Interestingly enough, what’s happened with the Libyan crude and what’s happened in the European markets, most notably Brent Crude, has actually benefited our California theme. A lot of investors are still unaware that California oil prices are now trading at a premium to West Texas Intermediate (WTI) prices, and that’s a combination of the two factors. One is that the Libyan supply has come off the market, and two, that the Cushing storage facility in Oklahoma is oversupplied with WTI because of Bakken and other oils that flow into there.

So, California producers, which are typically used to a $5-$10/bbl. or $8/bbl. discount on their heavy oil here in California, are now getting a $5-$8/bbl. premium. It’s been interesting for some of the names that we cover.

TER: It appears that Libyan rebels have been negotiating with Muammar Gaddafi, and it sounds like he’s going to exit the scene. How much is the Gaddafi premium? How much will oil drop when he exits?

PM: Well, the price has already dropped a little bit, and his exit might already be built-in because we went from the mid-$80s/bbl. to almost $120/bbl. during the initial phase of the Arab revolts. Now, we have already come down below that. I think the market has already priced some of that in there. But what would really be the big deciding factor is how long it would take to get that production back in place. A lot of people don’t realize that it’s not like flipping a light switch to turn things on and off for an oilfield. It can take a lot of time—as much as a year in some cases—to get things back to normal.

TER: Since you spoke to The Energy Report six months ago, oil is up about 30%, including the recent pullback. You commented at that time on how fretful investors became when oil was down. What about now? How do investors currently feel?

PM: I just spent three weeks on the road meeting with investors across the U.S. and I was actually pleasantly surprised that most people were not concerned about a sustained downturn of oil prices. Usually, when you are in a six-week downturn like we’ve had recently, everyone is very nervous. The first question is, “What’s going to happen to oil prices?” And now the first question I’m getting in about 80% of the meetings is, “What’s your favorite name to buy on a pullback?” I think a lot of people missed this last move, were under-invested in oil from the low $70s/bbl. to over a $100/bbl., and they don’t want to miss that next potential move up.

TER: Your Global Hunter Securities Conference in San Francisco is coming up in a few days. What is the overall agenda?

PM: I think when people meet management, it makes them feel better about owning these companies, and that’s the purpose of the conference. Every summer, people take some chips off the table. If they made money in the first quarter, they’re willing to book gains, sit back and take a fresh look at things. It allows them to dust off their files on companies and start updating their modeling numbers to decide where they want to put their chips going into the fall. We downgraded some stocks earlier in the year when they hit our targets and now we’re starting to dip our toe back in. This conference gives investors a chance to meet with management to kick the tires of some companies they’ve been waiting for a pullback in, or that that they may have missed on the last move.

TER: Phil, how important are the breakout sessions following the 20-minute presentations?

PM: Well, you get your initial questions answered in the breakout sessions, but we also have one-on-ones—the next level where you get the most valuable information. Investors get to sit by themselves with management teams and ask the questions that they don’t want to ask in front of their competitors. I often notice that a lot of the buysiders sit quietly in breakout sessions and take notes. But when it comes to one-on-ones, you can ask anything you want. In this day, when everyone can read headlines and make quick, snap decisions, access to management is the difference between being an investor and being a trader. The one-on-ones allow you to dig a little deeper.

TER: How are you currently advising investors to play energy? Can you give us some of your ideas?

PM: Sure. We have highlighted some of our favorite names that have pulled back like GeoResources Inc. (NASDAQ:GEOI), which has a foothold in the Bakken. It’s having issues like a lot of other companies, so you probably need to wait until the second quarter to see how those issues hit the numbers, but after that, you should feel pretty confident owning this stock. GEOI also has a significant presence in the Eagle Ford, a basin that has just blown away everyone’s expectations. To give an example, the Eagle Ford has gone from about 25 rigs to over 180 rigs running in less than a year and a half. It’s now matched the rig count in the Bakken. So you have two of the hottest basins there under one company.

As we’ve talked previously, California has been a huge win for us. One of our top picks this year has been Berry Petroleum Co. (NYSE:BRY). It’s a heavy oil producer that has been hampered by some permitting issues in California and has recently received a kind of next-to-the-last-step on the final permitting issue. Once they get that, they will have clear sailing to drill over a 1,000 wells over the next five years. That will take their oil production from around 18,000 barrels per day (bpd) to over 30,000bpd. That’s a great place to be.

TER: Berry has been one of your better performers. It’s doubled over the past 52 weeks and it’s now up to almost a $3B market cap. Do you still expect to see big returns?

PM: Yeah, I think Berry is still misunderstood. We’re in the process of redoing some of the numbers with this new permit that is supposed to come in. It gives a lot clearer view so investors can model the thing out to 2015 or so. Berry’s benefiting from a couple of things. One, it’s the first to get through this permitting process. That could open some doors for them to make some acquisitions. So you could see some growth that is not currently in our numbers. Two, it’s receiving a premium on its oil as we discussed earlier. In the second quarter, it averaged a $5/bbl. premium over WTI. In the previous 20 years, it has averaged a $5-$8/bbl. discount to WTI. So, that’s a pretty big bump up from a price realization standpoint. Lastly, the company consumes about 50 Mmcfe/day of natural gas to extract its heavy oil. With natural gas prices bouncing around between $4 and $5/Mcfe, their input costs have never been lower. When you combine this with California oil prices, margins have never been better.

TER: Another California play?

PM: One of our names that has underperformed, but that we still believe in is Venoco Inc. (NYSE:VQ). This company has been pushing the exploration pedal out here in California targeting deeper zones—the Monterey Shale. Thus far, the results have not been all that great. It’s been taking longer, but the opportunity is so huge that I always remind people when they are in a new play—particularly an exploration play or what we call an unconventional play—it takes time to figure out how to drill these wells and perfect the science. The best example that I can give is that it took the folks at the Barnett Shale almost 15 years to figure it out. Now it’s the largest producing natural gas basin in the lower 48. It took the Bakken Shale about two to three years to get to the point where people were really committing a lot of capital. It was 2003 when I first heard the term Bakken Shale at a conference in Houston. Through 2004 and 2005, people drilled a lot of bad wells. Now, some of those same areas that had poor well design and performance are producing exceptional wells.

The only other oil company that has gone after the Monterey and announced pretty impressive numbers is Occidental Petroleum Corp. (NYSE:OXY). I don’t cover OXY, but I have been forced to do a lot more work on it because it’s intermingled with Venoco. On a recent conference call, OXY talked about the potential of having 20,000 wells to drill on the Monterey and recovering as much as a .5Mbbl. per well bore. So, without putting it in writing, OXY said it had 10Bbbl. of Monterey oil to recover, and if Venoco, as a small-cap company, can attain a fraction of that, it could be an easy double and further out a five-bagger.

TER: Are there any other California plays?

PM: Yeah, there’s a little one that we cover that’s kind of under the radar, called NiMin Energy Corp. (TSX:NNN). It has this interesting field in California called Plieto Creek that is a heavy oil field, and it has a patented process to recover that oil using the injection of oxygen, of all things. The company recently completed its pilot test, and showed it can recover more oil and reverse a well’s decline curve. NiMin is in the process of ramping up operations in California where I can see it taking production from say 200bpd–300bpd to over 500bpd the next year and perhaps 1,000bpd in two years. In the bigger picture their patented technology could open doors for joint ventures, licensing to other E&P companies or they can simply acquire older mature fields and do the work themselves.

TER: Like so many of its small- and micro-cap peers, NiMin is down about 18% over the past three months. Is this a great buying opportunity?

PM: I would be buying it here. I have warned investors not to chase it too much because with these smaller stocks if you try to buy large volume, you can bid it up on yourself. Additionally, the company has its two-year anniversary of going public this September. In the IPO, shareholders received one share of stock and one warrant, like most Canadian IPOs. That leaves about a 7M warrant overhang going into that September expiration. That could put a little pressure on the stock going into September. But I think once you get past that, the stock could easily get back up above $2. We currently have a $3 target, so we obviously believe in it in the long term.

One other name that we just raised our target price on pretty significantly is Houston American Energy Corp. (NYSE.A:HUSA). The company is about to drill one of the biggest wells in the space in Colombia of all places. It partnered up with a major private oil and gas company called SK Energy, which is kind of the GE of South Korea. Houston American has a 37.5% working interest on the 350,000 acre CPO-4 block. There have been wells drilled next door to this lease that have come on in excess of 10,000bpd. We don’t have anything like that in the U.S. This first well, which is scheduled to start drilling any day, will produce results in the middle of August. If HUSA’s first well hits at 10,000bpd and oil prices are in the $90/bbl. range, it will pay for itself in about 40 days. Then, it becomes a self-funding operation, and you don’t need to worry about the company needing outside capital.

The company currently has about $25M in cash on the balance sheet. It’s fully funded for the next six wells, which are already permitted. Colombia has had such a renaissance over the past 10 years as new, democratic leadership has ramped up the military spending, the country became cozy with the United States and pushed a lot of the terrorist activities out to the border regions.

TER: This is an interesting stock because its relative strength has been tremendous compared to many others of its size. It’s just amazing; it’s up 21% over the past three months and I don’t see anything else close to that.

PM: We’ve been waiting for this well to be drilled for a couple of years. So, it’s pretty exciting times.

TER: Phil, many thanks to you. It’s been very interesting.

PM: Thank you.

Philip McPherson joined Global Hunter Securities in June of 2007 as a senior equity research analyst in the firm’s energy group. He was recently ranked in the top five by the Wall Street Journal’s Best on the Street Survey out of 123 E&P analysts in the U.S. Prior to joining GHS, Mr. McPherson was director of research at C. K. Cooper & Company, a boutique investment-banking firm located in Irvine, California, which focused exclusively on small-cap exploration and production companies. In his role at C. K. Cooper, Mr. McPherson was responsible for new initiations of E&P companies; additionally, he generated the firm’s macroeconomic analysis in relation to oil and natural gas price forecasts, which generated the firm’s price decks. Mr. McPherson was rated a five-star analyst by Zacks in 2002, 2003, 2005 and 2006. Prior to joining C. K. Cooper, Mr. McPherson was a partner in Mission Capital, which was acquired by C. K. Cooper in 2001. Mr. McPherson began his career in the securities industry at Mission Capital in March of 1998 as a retail stock broker. He graduated from East Carolina University with a B.A. in economics.

UNITED STATES CONSTITUTIONAL MONETARY SYSTEM

The language of the Constitution is both exceedingly simple yet extremely profound in its consequences. In Article I, Section 8, Clause 5 and Article I, Section 10, Clause 1, silver and gold coin are adopted as the exclusive money and currency of the United States. The term ‘dollar’ is written twice in the Constitution in Article I, Section 9 and in the Seventh Amendment. But what is a dollar?

Constitutionally, a dollar is a silver coin containing 371-1/4 grains of silver. Thus, the legal value of silver coinage must be proportional to the weight of silver contained and any gold coinage must be proportional to the exchange value between silver and gold based on the exchange rate in the free market.

Despite these clear Constitutional prescriptions the commonly accepted instrument in the United States is the Federal Reserve Note. The market share for Federal Reserve Note coupons, emblazoned with images of sacrosanct sociopaths like Abraham Lincoln or Alexander Hamilton, is increased because they are given preferential yet unconstitutional treatment under 31 USC 5,101-5,118. Now California appears to be attempting to infringe on this hallowed monopoly.

LEGAL TENDER FIAT CURRENCY

Fiat currency is a currency issued by a State which is neither legally convertible to any other thing nor fixed in value in terms of any objective standard such as gold or silver. Thus, fiat currency is without intrinsic value.

Because fiat currency is usually just some form of little colored coupon with no intrinsic value the State often has to resort to violence to increase liquidity. These immoral market interferences to enhance the little colored coupon’s market share generally consist of four prongs: (1) making the currency the unit for payment of taxes and fees for public expenditures, (2) by declaring the little colored coupons ‘legal tender for all debts, public and private’, (3) imposing taxes on competing currencies and (4) by outlawing contracts payable in any other form of money or currency, especially currency that does not require force to be accepted such as commodity money like gold or silver.

CALIFORNIA IOUs – A THREAT TO FEDERAL RESERVE NOTE COUPONS

By issuing IOUs and passing a bill requiring state agencies to accept them at full face value, California will be infringing on the Federal Reserve’s Congressionally granted monopoly. Like the Kelantan State in Malaysia that is encouraging the use of gold and silver coins in ordinary daily transactions this seemingly small action actually poses a significant threat to the Federal Reserve Note’s status as the world reserve currency.

Why? Because the next few steps California could easily take is to either declare the IOUs legal tender for all debts public and private or impose taxes for using FRN$s in California or completely outlaw the use of FRN$s in California.

Given that California GDP is the largest of any US State and the eighth largest economy in the world, between Italy with $1.76T in debt and Russia, it seems fairly perplexing that they are worried about a measly $19B budget deficit when the United States budget deficit is about $1,500B. In other words, California’s budget deficit is 1.267% of the United States’ while its GDP is about 13%.

How could California access its ‘credit worthiness’ when compared with other sovereigns like Italy with its nearly $2T in debt? Slap a bear on its IOUs, call it a California dollar while making it redeemable in silver, pass a bill to make California dollars legal tender and then impose taxes or prohibit the use of Federal Reserve Notes in California. Indeed, in conjunction with H.R. 4248 The Free Competition In Currency Act every State should begin issuing their own currency.

IRS PROTECTION OF FEDERAL RESERVE’S MONOPOLY

The Federal Reserve does not want any competition to its little colored coupons in the currency market. Want to know why gold rises at most only about 30% per year? Its the gold price suppression scheme as uncovered by GATA in conjunction with IRS Topic 409 where the net capital gain of collectibles, such as American Eagle gold coins which are legal tender under 31 USC 5,103, are taxed at a maximum rate of 28%.

But either way California is being pulled into a situation it cannot recover from. How will California fund its chronic budget deficit and debt when can neither be surreptitiously bailed out by the federal government via Citigroup nor print its own California dollars?

CONCLUSION

The Federal Reserve’s monopoly over the currency market is increasingly facing overt and covert threats. The more credible the threats the less demand for its little colored coupons. But the Federal Reserve Note is merely the King Ghost of currency illusions and has no substance compared to the Ancient Metal of Kings, gold, or Tears of the Moon, silver. Countless fiat currencies have come and gone through the ages while these elements have always been worth something. The Great Credit Contraction continues and even if there is a California dollar created the smart holders of capital will bypass it and move directly into the monetary metals.

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“Californians have responded by leaving the state. From 2000 to 2009, the Census Bureau estimates, there has been a domestic outflow of 1,509,000 people from California — almost as many as the number of immigrants coming in. Population growth has not been above the national average and, for the first time in history, it appears that California will gain no House seats or electoral votes from the reapportionment following the 2010 census… Texas is a different story. Texas has low taxes — and no state income taxes — and a much smaller government. Its legislature meets for only 90 days every two years, compared with California’s year-round legislature. Its fiscal condition is sound. Public employee unions are weak or nonexistent.”

Well, as much as I have enjoyed this jaunt down memory lane, the fact is, as Mr. Fry points out, that California “is facing a budget deficit this year of about $40 billion, which is roughly equivalent to 2% of the state’s $2 trillion economy (GSP). That’s”, he says, “dismal.”

At that display of stoic calmness, I held aloft a shot of tequila and toasted his amazing serenity in labeling California’s $40 billion budget deficit to be merely “dismal”, mostly because there are less than 100 million workers in the entire private sector of the US, and this $40 billion represents $400 for each and every one of us private-sector workers in the Whole Freaking Country (WFC)!

My voice a sudden peal of thunder, I shout, “In the Whole Freaking Country (WFC)!”

Immediately, I thought Mr. Fry’s eyes would glaze over in one of those, “Oh, hell! The Mogambo is yammering about something and he never shuts up!” expressions of disrespect and outright loathing, but instead he decided to just change the subject, and with that, he left this global hemisphere, and went to Greece, completely on the other side of the globe!

As my brain skidded to a shuddering stop at the sudden change of vector, he went on, “But over on the Mediterranean, Greece’s budget deficit is on track to hit $50 billion, which is a very big number for an economy that is one fifth the size of California’s. In fact, that’s a horrific number.”

At this point, I think that vomit, tinged with blood, coming out of my mouth and crapping all over myself in pure terror about such financial calamity speaks more eloquently than mere words allow, and Mr. Fry filled the sudden void with, “What’s more, Greece’s accumulated debt totals $443 billion – a whopping 113% of GDP.” Gaaaahhhh!

So, to distract both you and me from any acts of hysteria caused by such fiscal insanity, I ask you the following question, that will constitute 40% of your final grade: “If you were the prancing, preening, know-nothing, government-leech blowhard who wanted a shot at fame and glory by fixing what cannot be fixed, with lots and lots of other people’s money, while paying yourself and your friends handsomely, what would you do?”

Well, since this constitutes 40% of your final grade, I decided to get a little help to make sure I knew the answer, and I emailed Mr. Fry this very question. Either he did not know, or he just rudely decided not to answer either my original email or the follow-up phone call where his stupid answering machine said that he was “not available” and that I could leave a message “at the beep” and that he would call me back, which I did, and where I said, quite plainly, so there would be no mistake, “Call me back, and if I am not here, keep calling me and leaving messages proving that you called, or I’ll kick your butt, Fry! I’m not kidding!”

Well, whether or not this means anything, he does seemingly answer the question when he writes, “Well, the correct answer is the pricing of credit default swaps (CDS) on 5-year bonds from California and Greece. (Simply stated, a CDS is an insurance policy against default. The higher the CDS price, the higher the cost of the insurance).”

Of course, I understand none of this because I am tragically stupid, pathetically ignorant, am too lazy to do anything about it, and thus totally disinterested in the whole concept, which means that it all sounds like gibberish to me, especially since the bottom line is always the same; losses are on the books, somebody is going to have to take the hit.

Fortunately, mastery of such complexity is unnecessary for me, as I just buy gold, silver and oil, which will benefit mightily as the government and the Fed ruin everything with their deficit-spending of more and more fiat money. Whee! This investing stuff is easy!

Calm in the Face of Fiscal Insanity originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”