By The Energy Report, on February 10th, 2012
 Major potash stocks are beginning to raise eyebrows with impressive profit margins. But as this developing market expands, industry giants will face competition from greenfield and brownfield projects in the works. In this exclusive interview with The Energy Report, Mackie Research Capital Analyst Jaret Anderson debriefs us on some fascinating development stories that are poised to change where and how the most successful potash producers operate.
The Energy Report: You last spoke with The Energy Report in June 2011. What has transpired in the fertilizer and potash business since then, both in Canada and in Brazil’s emerging market?
Jaret Anderson: The tail end of 2011 saw a period of weak demand for Canadian potash. Fourth-quarter shipments at Potash Corp. (POT:TSX; POT:NYSE) dropped by about one-third year over year (YOY). General concern over the economy gave dealers an incentive to avoid stocking up their warehouses, resulting in soft shipments, higher unit operating costs and quarterly earnings below expectations. However, Potash Corp. posted a 68% gross margin in its potash segment during the quarter, making it one of the most profitable publicly-traded businesses of this scale.
Meanwhile, Brazil overtook India as the top global importer of potash in 2011, with imports of about 7.5 million tons (Mt) KCl. This figure was up 21% YOY, drawing even more attention to the country’s chronic domestic potash deficit.
TER: What should fertilizer producers expect in the next few years?
JA: We’re going to see bullish prospects for fertilizer producers over the next 12–18 months. Demand for fertilizer products is likely to remain soft in Q112, but as the spring planting season in the northern hemisphere kicks into gear in Q212, we expect markets to tighten.
TER: You put out a report last December showing a fairly large global number of both new and expansion projects in the works. How will these projects affect the supply and demand equation over the next five years?
JA: We actively track 19 different brownfield expansion projects and 26 different greenfield projects around the world, totaling ~67 Mt of planned capacity. If all of those projects were built on the timelines put forward by their respective owners, we would see a massive glut of capacity in the back half of this decade. The reality, though, is that only the best of these projects are going to be built, and those are likely to experience significant delays compared to their projected timelines. Potash demand in 2011 was about 55 Mt. If we assume demand growth of 3%/year for the remainder of the decade, that implies we’ll need an incremental 17 Mt of supply by 2020 in order to maintain operating rates at 2011 levels. That is pretty close to the 20 Mt of brownfield projects currently on the drawing board. Any demand growth beyond this 3% level or further delays of brownfield projects would tighten markets further.
TER: You don’t expect an oversupply or downward price pressure?
JA: In any commodity, things don’t go up forever. At some point, the supply-demand balance is going to shift in favor of the buyers. The next several years however, look very positive for potash producers.
TER: Saskatchewan is the potash capital of North America, and although it’s a major supplier to other parts of the world, the North American market is relatively mature. What North American potash companies are still attractive buys at this time?
JA: In my view, the most attractive greenfield potash project in Saskatchewan is Milestone, which is being developed by a company called Western Potash Corp. (WPX:TSX.V). The company has a very large in situ resource of about 3.5 billion tons (Bt) KCl and has the highest grade of any existing solution-potash mine in Saskatchewan. Milestone looks very similar to the former Legacy project of Potash One Inc., which was purchased by K+S Potash Canada (SDFG:FKFT) in November 2010 for $434 million (M). At a market cap of $200M today, we believe Western Potash represents the lowest-risk greenfield potash company in the world, with a very attractive valuation.
TER: Another Saskatchewan company you’ve discussed in the past is Karnalyte Resources Inc. (KRN:TSX). It is developing a relatively low-cost, solution-mining project. What are your thoughts on the company’s risk-reward ratio?
JA: Karnalyte is focused on a different type of project that will seek to extract carnallite mineralization at its Wynyard property. While its carnallite mineralization is only about half the grade of a project like Milestone, Karnalyte’s engineers have designed a plant that can be built in stages, which offers some advantages in terms of capital expenditures. Karnalyte’s shares suffered a significant decline in December after the company pulled a $115M financing. We upgraded the shares from “Hold” to “Buy” during December and believe that below $10/share, the company represents good value. However, it may be difficult to see performance for Karnalyte until it successfully raises capital to begin construction at its Wynyard project in the spring.
TER: Are its prospects reasonable for the company as long as the market holds up?
JA: Its shares now represent good value. That said, I believe Western has a more attractive valuation and project than Karnalyte. But there is a difference between a good project and a good stock. Because Karnalyte has taken a large hit of late, it has some decent upside, especially below $10/share.
TER: You recently visited Brazil to get a little better picture of the country’s fertilizer business. That’s a very large, growing market. Tell us what you learned.
JA: Each time I visit Brazil, I come away with more anecdotes that convince me of the need to find ways to invest in Brazil’s agricultural future. Brazil has over 400 million hectares of arable land, but uses less than 15% of it today for agricultural purposes. It is the largest global exporter of beef, poultry, sugar, coffee and orange juice, and that production should grow for many decades. The problem is that its Cerrado region is generally nutrient-poor and requires significant quantities of fertilizer. Brazil has only one operating potash mine and imports more than 90% of the potash it consumes. In 2011, Brazil was the world’s largest importer of potash, at about 7.5 Mt. The Brazilian government has set a goal of becoming fertilizer independent by the end of this decade and we believe investors should be looking for ways to gain exposure to Brazilian agriculture and fertilizer markets.
To that end, two companies we’ve focused on are Verde Potash (NPK:TSX.V) and Rio Verde Minerals Development Corp. (RVD:TSX). Verde Potash controls the Cerrado Verde project in Minas Gerais state, which contains a large, at-surface deposit of potash-rich verdete slate. The company has developed and patented a process to convert verdete slate into KCl, the same standardized product that’s produced in Saskatchewan and Russia today. This is known as the Cambridge process. It’s very exciting, as it could allow for large-scale potash production in Brazil from an open-pit operation—something that hasn’t been done anywhere in the world.
Verde Potash recently published a Preliminary Economic Analysis that indicated an operating cost of US$274/t during the early years of production, ramping up to $291/t over the 30 year life of mine as the stripping ratio increases. That would give Verde Potash the lowest delivered cash costs to Brazil of any large-scale competitor globally. The potash producers in Canada and Russia have lower operating costs, but face very large transportation costs to deliver product to farmers in Brazil. Capital costs for Verde Potash’s project are estimated at US$800/t, which is about 25% below a typical greenfield solution mining project in Saskatchewan. Based on these attractive economics, we recently increased our 12-month target to $19.00/share. With the stock trading at about $7.00/share today, this is a very interesting story.
Another name we believe offers good exposure to Brazil is Rio Verde Minerals, which controls a land package near Aracaju in Northern Brazil. It is located adjacent to Taquari-Vassouras, the only operating potash mine in Brazil. Rio Verde is still at an early stage of development, having completed drilling on its first drill hole in November. We visited the site a couple of months ago and inspected the core. We await assay results from that hole. Rio Verde plans to drill three holes at its Sergipe potash property and to publish an NI 43-101 resource during Q212. Given the strong outlook for good potash grades on the property and the company’s ideal location in Brazil, with nearby access to a port, roads, power and natural gas, Rio Verde looks to us to offer excellent risk-reward at current levels. Based on our target of $1.30/share, Rio Verde offers more upside to our target than any other company in our coverage universe.
TER: Can you elaborate on the Cambridge process you mentioned?
JA: In December 2010, Verde announced that it had patented a process to convert its verdete slate into KCl. This process was developed by Dr. Derek Fray at Cambridge University in the United Kingdom. This process was tested and optimized by Hazen Research in Denver, CO, and by FLSmidth in Allentown, PA, and SRK Consulting, which resulted in the publication of a Preliminary Economic Assesment in late January. We visited FLSmidth’s facilities in Pennsylvania last week and observed the process in operation. The process is relatively simple and bears many similarities to the cement production process. It employs a rotary kiln, like cement, but uses different inputs, namely Verde Potash’s verdete slate rock, limestone and salt. The Verde Potash KCL production process takes place at lower temperatures than that of cement, about 900C vs. cement at about 1,450C.
TER: Do you expect the Cambridge process to work on a commercial scale?
JA: It’s moved from a bench scale at a university to a pilot plant. To move to a commercial scale is another jump. Staff at FLSmidth and SRK have indicated to us that they typically see fewer problems with commercial scale facilities than they do with pilot plants. Every indication we have points to the commercial scale kiln as being well within the technical ability and experience of the teams at FLSmidth and SRK.
TER: There’s also been some development on the African continent, and a couple of Canadian juniors are working on projects there that are projected to go online in about five years. How are they progressing?
JA: Allana Potash Corp. (AAA:TSX; ALLRF:OTCQX) and Ethiopian Potash Corp (FED:TSX.V; FED.WT:TSX.V) are both working to develop greenfield potash projects in the Danakil depression in Northern Ethiopia. Allana is the much better capitalized of the two companies. It has published a large NI 43-101 resource based on its successful drill program over the last couple of years. The projects in Ethiopia are interesting in that the high year-round temperatures in the Danakil may allow for solar evaporation, thereby materially lowering energy costs in the solution-mining process. Ethiopia is also located relatively close to China and India, two important potash consumers.
Ethiopian projects face a major challenge, however, in that the logistics of moving thousands of tons of potash per day from the project site to the port at Djibouti some 600 kilometers (km) away over roads of varying quality may be a significant hurdle. We believe the transportation costs will end up being materially higher than current estimates.
Both Allana and Ethiopian Potash have seen their share prices languish over recent months and are both near 52-week lows. We believe both stocks have room to move up as the projects are derisked and as Allana moves toward a feasibility study in August of this year. While Ethiopian Potash has more leverage to positive developments given its smaller enterprise value, it is a much riskier investment given its very low cash levels. Allana, on the other hand, has more than $65M in cash on its balance sheet, providing it with a lot of time and resources to derisk its project and make it more attractive to potential suitors.
TER: Will Allana rely on a rail link to be built in order to get its product to market?
JA: There are plans in Ethiopia to build a rail network in the country, and that rail network is planned to approach Allana’s project site. We’ve met with the minister of transportation in Ethiopia on this topic. That project is probably a number of years away from completion, and for at least the first several years of production, Allana is going to need to find a way to transport its product by road via truck. You can’t assume the rail network is going to be ready in the next few years, in our view.
TER: What effect will trucking the material have on the project economics?
JA: Trucking will be much less economic than a rail network. Allana has published its own cost estimates for transporting the product from its project site to the port at Djibouti. We find its estimate of $12/t to be very low. We see a number closer to $50/t, based on the figures we’ve seen at other operations in existence today, such as those in Saskatchewan.
TER: Do you have any other interesting stories that our readers might find useful?
JA: The potash industry today is generating very high cash flow and strong returns on capital for incumbent producers. Potash Corp. generated a gross margin in its potash business last year of 68%. Apple Computer, by comparison, posted a gross margin of 41% in its fiscal 2011. The levels of free cash flow generated by this business and the strong secular trends in agriculture are going to attract capital and will ultimately lead to new greenfield production. With so many companies chasing so few quality projects though, we would caution investors to think carefully about the merits of each individual project. The size and grade of the deposit, the infrastructure in place, the proximity to major potash-consuming countries and the geopolitical risk are all critical drivers of value.
TER: Do you see any further consolidation in this business at this point? Or is it still too early?
JA: We’ve had a lot of consolidation in this business. The successful business strategy that greenfield potash companies have employed in the past has been to identify a good project; then derisk it by defining the resource through engineering and feasibility studies to make it more attractive to well-capitalized companies. A number of greenfield potash companies have had success with that strategy by ultimately selling to large mining companies like BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK), Vale S.A. (VALE:NYSE) and Rio Tinto (RIO:NYSE; RIO:ASX). I think this process makes sense and is going to continue.
TER: What are your top picks at this point?
JA: Our top picks in the sector for 2012 are Verde Potash and Rio Verde Minerals. Both companies offer good leverage to the Brazilian fertilizer market and have the potential to generate meaningful returns to equity investors. By their nature, development-stage resource companies involve much more risk than an operating company. We believe, though, that 2012 is likely to see very strong results for the greenfield companies with the best-quality assets, in the right locations, with attractive valuations. In our view, Verde Potash and Rio Verde check all of those boxes.
TER: Thank you for your time.
JA: Thank you.
Jaret Anderson is a research analyst covering agriculture and fertilizer at Mackie Research Capital. Anderson has 13 years of experience in the investment industry and was rated #1 for earnings estimate accuracy by Starmine in 2006 and #2 for the quality of his reports in 2005. Prior to joining the firm in July 2011 Anderson worked at UBS Securities Canada where he covered Canadian paper and forest companies, as well as chemical and fertilizer industries. Most recently Anderson covered Canadian fertilizer and chemical companies for Salman Partners. He received a Bachelor of Commerce, with honours (Finance) from the University of British Columbia, and was awarded the CFA designation in 2000.
By The Energy Report, on January 25th, 2012
 Last year marked the third-largest growth in the potash industry, but hesitancy from India and China may put things on hold in 2012. However, MGI Securities Analyst Corey Dias still expects to see a lot of positive news coming out of the junior potash space. In an exclusive interview with The Energy Report, Dias specifies which companies he’ll be following for progress.
The Energy Report: Total potash demand in 2011 was estimated at 56 million tons (Mt), and the market has traditionally grown at a rate of about 3.5%/year. Do you believe we’ll see a similar increase in 2012?
Corey Dias: I think 3.5% could be at the high end of growth for 2012. I would expect slightly lower growth this year given that India is delaying its potash purchases until the end of Q112. China is also determining its exact needs, and there are rumors that it may reduce its imports this year versus 2011. Everything tends to depend on price. Canpotex (the marketing company for Saskatchewan potash producers) and its Belarusian counterpart are holding out for higher prices than India and the China currently seems willing to pay. With those delays, demand will probably be slightly below the historical 3.5% growth rate.
TER: Potash Corp. (POT:TSX; POT:NYSE) of Canada has shut down two mines in that country, and The Mosaic Company (MOS:NYSE) says potash buying is slow right now as buyers are taking a wait-and-see approach. What do you make of Potash Corp shutting down those two mines?
CD: It is a prudent approach. The company doesn’t want to flood the market with product as it would like to sustain a reasonable potash price that could provide a reasonably profitable return. By shutting down these mines, it’s limiting the output and that should keep the price at a fairly stable level. It’s not a question of shutting down so much capacity that prices are going to spike; it’s simply a way to keep potash prices relatively stable until the moment when a larger buyer comes back into the market, whether it’s India or China.
TER: In 2011, potash had the third-largest price increase among the 32 commodities ranked by the Scotiabank Commodity Index and, over the span of 2011, potash rose about 32%. The leading indicator of potash prices is often the price for corn, which is down significantly after some bumper corn crops in Eastern Europe, Russia, and Australia. What do you believe will be the average price per ton (t) for potash in 2012?
CD: Potash prices seem to be ranging between $450 and $550/t at the moment, depending on the port of delivery. It will probably stabilize around the $500/t level in the short term. I don’t see any reason for a significant spike in the price at this point. Although the corn price has recently seen a dip, it still remains above its historical average. Moreover, given the fact that the U.S. Department of Agriculture said that its stocks-to-use ratio is still well below the historical average, it would take a significant amount of corn production to reach the normal level of 15–20% in terms of that ratio, and reaching that level of production to meet this ratio could be a real challenge, especially when corn demand continues to grow. Therefore, while corn is slightly down, I don’t think there is going to be a downward trend in the corn price, or a complementary downward trend in potash.
TER: You don’t believe that potash will be in the top 10 performing commodities in 2012?
CD: I think it will have a fairly average year. I don’t think it will repeat its price performance in 2012 as it had a relatively low price point from which to start in 2011. It will probably stay somewhere in the middle of the park vis-à-vis other commodities.
TER: In an interview with The Energy Report in May 2011, Dundee Securities’ senior analyst Richard Kelertas predicted that we would see $750/t potash at some point before May 2013. What’s your perspective?
CD: As you said, that was in May 2011. The market looks a little different now than it did then. The fact that India is pushing back on pricing and delaying its purchases and China is reassessing are going to mitigate the potential upside of the potash pricing. Probably $600–650 is a reasonable price going to 2013, but there are a number of different factors that come into play in addition to India and China, whether it is production capacity being added to the market via brownfield or greenfield projects, whether or not there is a recovery in the European market, or whether or not the U.S. recovery continues. The fact that farmers seem to have a lot of money coming out of 2011 could, at worst, bode well for holding a pricing floor on potash at current levels and could potentially even support a higher price. I think that $600–650/t is reasonable.
TER: Tell us about your coverage universe and the types of companies you cover.
CD: I’m now ramping up coverage in the potash space. My first report was about Passport Potash Inc. (PPI:TSX.V; PPRTF:OTCQX), a name that I’ve followed since early 2011 when I was working in an institutional equity sales capacity at MGI. I really like this story and the fact that it’s in a safe, mining-friendly jurisdiction. An opportunity to build a mine in a potash-rich region—the Holbrook Basin—with only two competitors in the Basin could provide an opportunity for consolidation. It is a story with a great deal of appeal.
Generally, I’m looking at small-cap developers and am not restricted to North America. There are developers in Africa and South America that could be appealing in the same way. It will be up to clients to decide whether or not they have the risk tolerance for assets outside North America.
TER: Is that typically the type of company that MGI covers even in the other sectors?
CD: We tend to cover smaller-cap names. Large-cap names would be a bit more difficult for us to champion in a lot of ways because we wouldn’t necessarily get the mind space from clients for large-cap ideas because clients are well covered by banks and bulge bracket firms that are looking at the Potash Corps of the world, companies like Agrium Inc. (AGU:NYSE; AGU:TSX) and Mosaic.
TER: Passport Potash’s share price took a beating in 2011. It’s currently developing the Holbrook Basin potash project in Nevada. Why do you believe that junior is going to rebound this year?
CD: Part of Passport’s problem this past year was based on the market itself being quite volatile, especially toward the end of the year. In general, small-cap names tend to suffer the most in those circumstances. But management made a few promises to the market that it was unable to keep and probably didn’t realize the extent to which it would be punished by the market by having missed deadlines. However, I believe that the company is starting to right itself. It is in the process of putting together an NI 43-101-compliant resource estimate, which we expect to be released by the end of Q112. Following that, we should see a preliminary economic assessment or scoping study and, further, a prefeasibility study from Passport in order to show the economic viability of its project. In addition, there was an announcement on January 18th that Passport has brought on a new chairman who has significant operational experience gained during his time with Rio Tinto (RIO:NYSE; RIO:ASX). It also has added Ali Rahimtula, who has experience in India, which is key in this type of business because there is the potential for an offtake agreement with an Indian partner. Passport has acknowledged the fact that it needs more relevant experience on the board, and has clearly begun to address this shortfall.
Like most of the names in the junior developer space, there tends to be a rerating—in terms of valuation—of these types of businesses once milestones are met along the road to production. As Passport meets its milestones, the market will likely provide the company with a more positive valuation via a re-rating of its stock. The company’s stock price hit bottom at $0.17 toward the end of last year. Since then, it has been able to at least project to the market that it does have some deadlines, which it intends to meet. Passport has engaged the engineering firm ERCOSPLAN to complete its NI 43-101. ERCOSPLAN has a really good reputation in the marketplace and has done a lot of work for developers in the potash space worldwide. The market now understands that the company is working very hard to meet its current deadline and, once met, Passport will have a potash resource estimate to put to the market. The market at that point will respond favorably, in my opinion.
TER: A competitor operating in the same basin that Passport is operating in, the Holbrook Basin, already has an NI 43-101 resource of 125 Mt potassium chloride (KCl). How large do you expect Passport’s resource to be once it’s published?
CD: The competitor has about 94,000 acres of land, while Passport has about 81,000 acres. If we were to use a ratio of acres to contained tons of KCl for the competitor and apply it to what Passport has, Passport would probably come in somewhere about 100–101Mt of contained KCl. Remember, this is in no way a forecast that I am making as to the size of Passport’s resource. Even if Passport has something like 80% of that number, I think it’s still a decent-sized resource. In my report, I am forecasting that Passport will produce about 1Mt/year over 40 years. That implies about 40Mt of in situ KCl. If we’re talking somewhere between 80–100Mt of contained KCl, there is significant opportunity for Passport to increase the size of production on an annual basis, or it gives a bit more leeway in terms of what the potential resource size could be, on a contained-ton basis.
TER: You have a Speculative Buy on that particular equity. What is your 12-month target?
CD: My 12-month target for Passport is $0.75.
TER: Another junior in that space, Allana Potash Corp. (AAA:TSX; ALLRF:OTCQX), jumped out of the gate in 2011 and slipped above $2 in June 2011 before spending the rest of the year retreating from that benchmark. It now sits well below $1. Will that junior rebound this year? If so, what are the catalysts that are going to make that happen?
CD: I think so. Allana probably jumped up based on speculation more than anything else, but as the actual resource-related numbers come in, then it tends to start trading at some kind of multiple based on its enterprise value (EV), whether it’s EV:resource or EV:ton KCl, et cetera. When the market sees that it’s getting closer and closer to production, that’s when the valuation will start to improve. I think that is something that could happen this year. When one has an asset that doesn’t have any economic information tied to it, it’s very easy to speculate as to what you think the value should be. Obviously, the closer one gets to production, then there are hard and fast numbers that one can start applying some kind of multiple to in order to value a company like Allana Potash. That’s probably why it’s now down below $1. It’s probably more reasonably priced here and as more news comes out that’s favorable to the company, then you should start seeing the stock move back up.
TER: What are your thoughts on the Danakil potash project in Ethiopia?
CD: The Danakil project is interesting because it’s a near-surface project, which means the capex should be low. I think that it will have a fast track to production, which is another positive. And the fact that it’s probably selling to India, and perhaps China, is another positive because there is a quicker trade route to those countries when compared to North American or South American potash producers.
That said, there is no domestic demand for the product in Ethiopia. The companies that I believe have an advantage are those that have domestic demand or significant domestic demand, whether it’s a place like the U.S., which imports most of its potash needs, or South America—Brazil in particular—where 90% of its potash needs are imported. Ethiopia is also landlocked, that is, it has to go through another country in order to reach the port. Moreover, there is a greater possibility of political risk in Africa than in the U.S. or in Brazil. However, if everything remains stable, I think there could be a big opportunity for Allana, especially given its low operational cost base.
TER: What are some other small-cap potash plays that you expect will outperform in 2012?
CD: Verde Potash (NPK:TSX.V) is planning to produce a unique product called Thermopotash. Thermopotash, derived from the combination of glauconite and limestone, is a slow-release potash product with no chloride, which is great for crops like tobacco, coffee and oranges. In addition, the company is exploring the use of a new technology—the Cambridge process—which could potentially convert Verde’s potassium-rich rock to regular KCl. This would be a massive opportunity in Brazil. In terms of available infrastructure, Brazil falls behind North America but is certainly ahead of Africa.
Rio Verde Minerals Development Corp. (RVD:TSX) is another small company operating in Brazil that recently confirmed that it has potash on its property. The stock has moved up a little bit on the back of that news. Once an NI 43-101 resource estimate is released for Rio Verde Potash’s potash asset, we should see another re-rating of the stock.
Karnalyte Resources Inc. (KRN:TSX) is another one. Once again, I tend to favor the junior potash developers that have a bit of a unique element or bring something a little bit different to the table. Karnalyte is focusing on extracting potash from the potash-bearing carnallite layer, which is unusual for Saskatchewan because other producers and developers target the sylvinite layer that is usually closest to the surface. Karnalyte’s deposit is based on an anomaly where there is a significant carnallite layer that is relatively near-surface vis-à-vis the sylvinite layer. The technology that it is planning to use also could provide a magnesium byproduct and sodium chloride byproduct, both of which the Company could potentially market and sell in the future. Karnalyte has a number of things going for it; I think management is very strong. The fact that it has four patents pending for its technology could mean that what it ends up with is going to be very unique. It has a massive land holding and has only conducted advanced exploration on 20% of it. Fnially, it plans to expand its plant by using cash flow generated from its initial buildout.
TER: It has done a nice job of managing its share flow, too, with only about 21M shares outstanding vs. something far greater for a company like Allana.
CD: Yes.
TER: Or do you prefer a larger share count, such as Allana, with its 193M shares verus 20M for Karnalyte?
CD: When you’re in the small-cap space—and especially if your float is small—it becomes a bit riskier for clients to hold when the markets are a bit more volatile. It’s one thing to get into a stock, but when the market is volatile and a client is looking to exit a position, it’s very difficult to do if the trade volumes aren’t there. That’s the risk with Karnalyte. The average trade volume is 34,000 shares a day. So if you have a position that’s 100,000 shares, it’s going to take you roughly three days to get out of that position, and that assumes that you can be 100% of the trading volume over those days. And you could end up driving its price down significantly while you’re trying to exit your position. Having a more liquid position in a stock like Allana that you can get in and out of a lot more easily would likely appeal to portfolio managers.
TER: Could you give our readers an outline of what to look for in the small-cap potash space over the next year or so?
CD: You’ll see a number of companies starting to reach the prefeasibility and feasibility stages. At that point, these companies will start to look for strategic partners, whether it’s to fund the buildout of the products or secure an offtake agreement for the product that’s going to be produced a few years out. At that point, we’ll start to see which projects are going to be viewed as more viable. There probably won’t be enough demand to drive a need for every single junior potash developer that is currently out there to actually move into production. That said, there is also the possibility that some of these companies will be absorbed by larger entities that are looking to enter the potash space given the future, positive fundamentals for potash or those that are currently in the market and are looking to increase potential capacity moving forward. I expect to see a lot of positive news coming out of the junior potash space, especially as a few of these companies meet milestones in order to get a little bit closer to production and production becomes more of a reality.
Corey Dias has worked in the capital markets industry since 2003 and has spent eight years in institutional equity research and institutional equity sales. In addition, he has worked for a U.S. hedge fund, where he shared responsibility for the running of a $400M portfolio and sought out assets for private equity investment on behalf of the fund. Mr. Dias holds a Master of Business Administration from the Richard Ivey School of Business at the University of Western Ontario.
By The Energy Report, on November 11th, 2011
 Fertilizer companies have felt the pain of global monetary chaos, but as indicators lag, some potash equities are positioned ahead of the curve for big gains. Dundee Capital Markets Vice President and Senior Financial Analyst Richard Kelertas believes investors need to be sharpening their pencils and establishing positions. In this exclusive interview with The Energy Report, Kelertas shares his best names.
The Energy Report: There’s been damage done to potash stocks over the past six months. Why?
Richard Kelertas: Macro issues have hurt all commodities. When the world is worried about its next breath, all these stocks get hit very hard. We’ve had the Euro crisis and then the Greek debt crisis since these stocks peaked in summer. Also, I think there were expectations that North America and Europe would emerge from the last serious recession with half-decent growth going forward, and that recovery would be moderate, measured and continual from 2010 all the way up to 2013–2014. That’s now been interrupted by macro events, and the odds that they will be quickly resolved is almost nil. We are going to have to deal with slower economic growth worldwide, not just in the eurozone and North America, but also in China and all of Asia because it’s all interdependent.
We will also have to expect that the consumer will be drawn back a bit, both in Western societies where food is a necessity and a luxury, and in developing economies where it is a necessity. So, high-end food values, high-end organics and food stocks that are higher priced will be under pressure. That means lower requirements for meats, which means that the farmer may be cutting back on his crop output.
TER: Can you make a case for growth in potash consumption?
RK: For the next six months, I expect flat growth. Prices and volumes have retreated slightly. Inventories dropped in October. That’s good news. I expect prices will be flat to down.
However, if Europe’s debt crisis and low North American growth are resolved in the next 6–12 months, we could then see Asian export nations gear up again. That means that their diets will improve again, and crop prices and speculation in crop price increases going forward will pick up. That will happen sooner than six months in the futures market, but at the same time my expectation is that the next six months are going to be slow.
Within the next year, we should see some growth return. That will be composed of three components: Farmers will use potash at normal levels and growth will be reflected in shipments and prices. Lands that will be brought back into production will expand demand. This is fallow or abandoned agricultural land throughout the world, especially in Africa, that has been bought up by either investment pools or sovereign wealth funds or specialty farm land managers. In the grand scheme of things that doesn’t seem to be a lot in terms of the total farmland area throughout the world; however, potash application rates will be much higher than normal because you are bringing it from infertility to fertility levels. So, we could see a substantial push and it will show up in perhaps a 0.5–0.75% increase in potash demand worldwide.
TER: Are you able to venture a forecast on the price of potash?
RK: My international price forecast, the Vancouver export price, is about $450–465 per ton (/t) right now. For 2012 we expect an average price of $505/t and then moving to $520/t average price in 2013. The peak price in 2013 should be around $650/t, maybe $625/t. But, it won’t be as high as the $700-725/t that I thought may take place when I made that forecast a year ago.
TER: Are fertilizer prices leading or lagging economic indicators?
RK: They are lagging indicators. We need to see economic activity pickup first. The mood of farmers is always pretty gloomy, and getting them to change their view on world markets requires crop prices to move. But, crop prices won’t move really unless you see economic activity pickup.
TER: Is potash still low-hanging fruit? Or is it getting much more difficult to mine?
RK: That’s a good question. We just put on a seminar and heard from ERCOSPLAN, the German exploration consulting firm that has provided a lot of NI 43-101s for potash projects throughout the world. If you’re doing deep shaft, it is very expensive and time consuming, and there are long lead times. I would say that most of the best sites, except in Saskatchewan and Russia, are deep-shaft mines. There may be one or two open-pit opportunities in Ethiopia or in Utah where you’ve got very shallow deposits. Solution mining, though, provides you with the opportunity to get several large sites into production in a relatively short period of time.
But the limiting factor right now is financing, and that’s because you’re dealing with $800 million (M)–1 billion (B) for a 1–1.5 billion tons per year (tpa) equivalent of potash, even for a solution mine. The second limiting factor is cash balances. If we are going to have a long, drawn-out economic downturn here, which is quite possible, then very few of these projects will come to fruition and get into production. They will run out of cash before they can either get taken out or get the financing. So, there are only a couple of strong plays that have plenty of cash and, where cash-burn rates are low, can survive this downturn and lack of liquidity in the marketplace. The third thing is that we could possibly see some deep-shaft mines flood over the next 6, 12, or 24 months like we had in Russia with Sil’vinit (acquired by Uralkali OAO (URKA:RTS; URKA:MICEX; URKA:LSE). We could see something possibly happen in Saskatchewan or in other areas. And I don’t think it’s a question of “if”; I think it’s a question of “when”. Many deep-shaft mines are 2,200 meters down. A lot of money is being spent pumping out water, and you could see some production disruptions. If that’s the case then the market could get tighter very quickly.
TER: Limited access to financing could be a major problem for small companies, couldn’t it?
RK: Yes, absolutely. I think about 100 worldwide projects are being considered in potash, both public and private. I would say 10–15% of them have a hope of getting financing, and of that, I think perhaps three or four might actually get financing.
TER: From everything you’ve just said it sounds like margins are going to have to contract or that prices are going to have to go up. Where does this put the potash producers?
RK: Well, at the current pricing their margins are pretty good. For instance Potash Corp. (POT:TSX; POT:NYSE; Not Rated) is the most visible, and its operating margin, not gross margin, so we’re talking before interest, is about 40%–45%. Terra Nitrogen Co., L.P. (TNH:NYSE; Not Rated) is 65%. CF Industries Holdings Inc. (CF:NYSE; Not Rated) is 60%. Now CF is urea, and it’s a different kettle of fish, but Potash Corp. is about 40%. So, prices can come off quite a bit before they’re going to have any issues. However, I can tell you that any projects that are not in progress will be put on the back burner. You need to have potash pricing power. For instance, BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK; Not Rated) Jansen Project in Saskatchewan needs average long-term potash prices of about $500–550/t really to make a go of it, and from my work the long-term international price is about $410–425/t.
But to answer your question, in a lot of cases their cost inputs have gone up too. So, if they have the combination of prices falling while their cost inputs remain high for let’s say two, three or four quarters, their margins are going to get squeezed quite substantially. But there is no doubt about Q112 and Q212, so If this economic crisis settles down, they’re going to push for higher prices.
TER: The large-cap companies have so many advantages. It seems like there’s so much risk in the small-cap potash equities.
RK: Right: That’s why they’ve been hit very hard. The juniors are the most at risk.
TER: What regions are the most favorable for companies right now?
RK: I would say the best places are Saskatchewan, Utah, Arizona and Ethiopia in Africa.
TER: What specific companies are you telling your clients to invest in?
RK: We’ve been very consistent in the stocks we like since the economic crisis of 2008. On the large-cap side, Agrium Inc. (AGU:NYSE; Buy) has probably had the lowest margins of the big-cap names, but it tends to have the most diversity in its product mix. It has a wholesale nutrient division, a retail division and a specialty fertilizer division, which includes distribution. In a tough economic environment, we opt for diversification. In a very strong commodity market, it makes sense to go to single commodities or pure nutrient plays like Potash Corp., CF Industries, Terra, The Mosaic Company (MOS:NYSE; Not Rated) or Intrepid Potash Inc. (IPI:NYSE; Not Rated). Because we expected the economic recovery to be very difficult, we liked Agrium the best in the large-cap space, and we still feel that way. Until we see commodities fundamentals suggesting a speeding up of economic recovery, we’ll stick with Agrium on the large-cap side.
TER: What about small caps?
RK: On the small cap side our top picks continue to be Allana Potash Corp. (AAA:TSX; ALLRF:OTCQX; Buy) and Karnalyte Resources Inc. (KRN:TSX; Buy). They have the most cash, the lowest burn rate and they are the closest to production and financing. They have all the components in place, including their NI 43-101 resource estimates. But they both have different advantages and disadvantages. Allana has the possibility of being an open-pit mine, or open-pit/solution mine combination, or just a solution mine, which would be low cost because of the solar evaporation in Ethiopia.
Karnalyte is a solution mine, but it’s a gigantic deposit and will probably only need one cavern for 10 years. It does not have to do a lot of drilling. But if it does, the drilling will be horizontal. The key thing with Karnalyte is that it has boron-free magnesium chloride. That is attached to the potassium salt, KCL. The magnesium chloride comes out with the potassium. Thus, its extraction costs are not any different. Refining costs are going to be a little bit more expensive to separate the magnesium chloride, but that’s an extra revenue source.
TER: So, Allana is getting the magnesium chloride practically for free?
RK: That’s correct. Allana has not only the opportunity for MOP (muriate of potash), which is the standard potash, but also SOP (sulfate of potash), which sells at a premium. When the first million tons is fully operational, Allana will be able to produce 20–30% SOP.
TER: Karnalyte is up 31% over the past 12 weeks, and it’s the only one I see with its head above water over that period. Most others are the mirror image of that, down anywhere from 20–40%. Why such high relative strength?
RK: I think there are a few things: One, it has been getting its story out aggressively. Number two, it has been very close to getting the feasibility portion of its magnesium chloride production, and that will be ready by the end of November. I think that’s the most important thing, and it is just now starting to be understood by the market, which has been quite anticipatory of that. Three, there’s been some talk on the street that Karnalyte has worked a 30% contingency into its production costs, which is a lot higher than what it will actually work out to be. That means that its return on the project is much higher, we think, than what the company has been telling the street.
TER: How much per ton is the magnesium chloride right now?
RK: Well, it sells anywhere from $450–700/t depending on the end-product use and the purity levels. It will almost be a one for one. I think that Karnalyte will be able to get 600,000 tpa of magnesium product that they’ll be able to take out of the ground. That’s not factored into its numbers, but my NAV reflects that expectation to a small extent. So, it could be double the size in terms of profitability and revenue than the consensus on the street.
TER: Your target price on Allana is $3.05, which is an implied return of about 200% from current levels. I’m wondering about its preliminary economic assessment (PEA) due out before year-end. What is that going to tell investors?
RK: Well, I think it is going to solidify the resource in terms of measured/inferred. And of course, you’ll get a good idea of whether Allana can go to an open-pit or solution or both. More than everything else it’ll firm up the opex and capex. It will be quite clear that the area will support not just a million tons per year (Mtpa), but 2–2.5 Mtpa.
TER: If it is a solution mine, how much advantage will the solar heat evaporation be?
RK: If it’s open-pit, opex will be $40–50/t. If it is a solution mine it’ll be $65–70. A typical solution mine with natural gas or coal evaporation costs would be close to $90–100/t.
TER: What other companies are you talking to investors about?
RK: Well, at our conference we had nine presenters. Of course Allana and Karnalyte were there. We also had Passport Potash Inc. (PPI:TSX.V; PPRTF:OTCQX; Restricted). There were others at the conference that we have put on our watch list, and we are bringing them forward to investors as items of interest. We are looking at the resource and numbers on each one. They include Western Potash Corp. (WPX:TSX.V; Neutral), which just came out with a further update on its NI 43-101 and firmed up its resource estimate and capex/opex. We had IC Potash Corp. (ICP:TSX.V; ICPTF:OTCQX; Buy). We had Encanto Potash Corp. (EPO:TSX.V; Buy) and we also had ENP Minerals, which is hoping to get going in Utah. We had Rio Verde Minerals Development Corp. (RVD:TSX; Neutral), Epm Mining Ventures Inc. (EPK:TSX.V; Neutral) and Verde Potash (NPK:TSX.V; Neutral). So, we’re talking about those and getting up to speed as well on the numbers and the resource for each one of those companies. We’ve issued research on them and put them on our watch list, but we don’t have firm numbers or target prices for them yet. We will continue to speak with those companies.
TER: Western Potash CEO John Costigan noted that his company has the largest resource base of current junior potash explorers and developers. What does that mean to you?
RK: Well, there’s the old adage: It’s not necessarily how big it is but how low-cost it gets. To me, quality or concentration of the resource is number one. You have to take a lot of brine out before you get a half-decent concentration of potash. So, it is going to be all about costs. It seems to have fairly low opex costs, but I have to check into that and do more work on it. On the surface, costs seem to be a bit low compared with comparable projects. The initial capex of $2.5B to get it started sounds reasonable for a 2 Mta mine. I think it’s going to be a question of distance to market and ease of getting the mine up and running.
TER: Encanto was one of the presenters at your conference. How much can it expand its resource?
RK: From the information we have, we think the resource could be expanded quite significantly. With all the agreements Encanto has with native groups in Saskatchewan and its proximity to the Esterhazy deposit where Potash Corp., Agrium and Mosiac all operate, I think it has a good chance of expanding its resource anywhere from 25–50%. That is quite possible. But, again, before we make any pronouncements on it, we’re going to be speaking with management and talking with the engineers and geologists.
TER: Were there any other companies you wanted to mention?
RK: Not at this stage. We haven’t done enough work on, for instance, Ethiopian Potash Corp. (FED:TSX.V; FED.WT:TSX.V; Not Rated). We haven’t done enough work on IC Potash or EPM Minerals. So, we’ll reserve judgment on those for the time being.
TER: Richard, it was a great pleasure speaking with you once again.
RK: No problem, my pleasure as well.
Richard Kelertas has 25 years experience as a research analyst covering the forest products sector. He has been one of the top-ranked analysts in the sector over the years consistently, and was most recently ranked No. 1 by Brendan Woods. Kelertas has worked for a number of well-known brokerage firms, including ScotiaMcLeod, Deutsche Morgan Grenfell, UBS Warburg, and Desjardins Securities. He has a bachelor’s degree in forestry and a master’s degree in forestry and economics from the University of Toronto. Richard is also a Registered Professional Forester.
By The Energy Report, on August 19th, 2011
Rising corn production acreage highlighted in the latest USDA crop report could lead to increased fertilizer demand and prices, says Richard Kelertas, a senior analyst at Dundee Securities. In this exclusive interview with The Energy Report, he points to which potash juniors could hit the market while demand is still high.
The Energy Report: U.S. corn production is up 4% from last year, according to a new Crop Production Report released this month by the National Agricultural Statistics Service. The August 11 report forecast a 12.9 billion bushel harvest. “If realized, this will be the third largest production total on record for the United States,” the report stated. Will this result in an increase in domestic demand and prices for fertilizer, particularly potash?
Richard Kelertas: Yes. We expect a gradual, but steady increase in crop and fertilizer prices going forward.
TER: Last May you predicted potash prices of $750/ton. When might that occur and what countries are the main drivers for this?
RK: A peak could come anywhere from 18–24 months from now. Our thoughts are as follows: We are seeing very tight potash markets. The Chinese have been asking for more. The Indians have now settled a contract for significantly higher than what they wanted to pay. Farmers have been pressuring the government to make sure there is plenty of fertilizer—especially potash and urea—in the fields, but they also want to make sure it’s at a half-decent price.
The supply is now getting out to the fields, but the price has gone up simply because there is a bit of a monopoly, with the major producers represented by Canpotex Ltd. Our view is that the price pressure will continue for the next 12–24 months. No major new capacity additions—brownfield or greenfield—are planned for the next two to three years. Really, the new capacity doesn’t kick in until 2014–2015. So 2011, 2012 and 2013 are going to be very tight markets. That’s on the fertilizer side.
On the food side, we have stock:use ratios that are very low. Crop prices are starting to recover although the second economic crisis we are going through now may cause those prices to ease off a little bit. Some crop harvests are going to be low throughout the world. The stocks of various staples will be tight for the next one to two years. So we think this is a perfect storm for fertilizer prices to continue to run up. It won’t reach the level of the last run up in 2008–2009, but it is certainly a very buoyant market.
TER: What impact do short-term stock fluctuations and economic challenges have on both food prices and fertilizer prices? What about the prospect of a weaker dollar?
RK: As you’ve seen in the past, it has had a short-term impact. If the fundamentals were weak to begin with—meaning crop stocks were high, harvests were very, very good throughout the world and inventories of nutrients were either at their 5–10 year averages or above—then you saw a significant downturn in nutrient and crop pricing along with usage. Farmers back off if crop prices aren’t high enough because they won’t get enough per-acre to justify putting in more nutrients. Plus, the bounce back in 2009–2010 and the beginning of 2011 was because of both strong fundamentals for fertilizers and crops and a tremendous amount of stimulus from governments that were pumped into the market. It remains to be seen whether governments still have those arrows in their quivers. I would suspect that this is going to be a little more drawn out.
Several governments are near crisis situations. The European Central Bank has said it will buy Spanish and Italian bonds; that will certainly help for the time being. The real question is: Are international consumers going to back off on buying feedstuff for cattle, poultry and their own diets? Will the middle class throughout the world continue to demand better nutrition? If that’s the case, even with an economic crisis, you will still see crop prices hold up fairly well. If everyone goes into a cocoon and cuts back on everything, then we could see prices fall back and the recovery will be that much longer. So it does have an impact. In this particular case, we think it is going to be short lived. We think it is going to be a couple of months where everyone steps back and commodity prices generally step back along with that. Nutrients and fertilizers are like any other commodity. They react to the individual fear factors going on in world markets.
As the U.S. dollar continues to weaken over time compared to other major currencies, potash prices in U.S. dollar terms will strengthen alongside the strong fundamentals.
TER: You mentioned some new capacity that might be coming on in 2015. Where is that and what companies are going to be behind it?
RK: PotashCorp (TSX:POT; NYSE:POT; Not Rated*) and Agrium Inc. (NYSE:AGU; Buy Rated) have some new plants. Those are brownfields. We also have the possibility of a couple of larger mines. Allana Potash (TSX.V:AAA; OTCQX:ALLRF; Buy Rated), for instance, may have its open-pit mine in Ethiopia up and running in early 2014. You will probably see only 300–500 thousand tons of potash come out of that operation in 2014, and it probably won’t be fully ramped up for 1 million tons (Mts.) until 2015–2016. We may have some more brownfield projects, but if they are deep shaft, those are going to take a heck of a long time. So, the most we are going to see is probably 2–3 Mts. with some brownfield plant expansions coming on by 2014–2015. Allana, which would probably be the first greenfield operation to come on-line, could be producing by sometime in 2014.
TER: Are fertilizer company stock prices going up along with food prices?
RK: No, they haven’t. Q211 results for most of the major players—The Mosaic Co. (NYSE:MOS; Not Rated), PotashCorp and Agrium—showed a bit of a perk up, but just as some real traction was starting to develop again, the debt ceiling issue put a stop to all upward momentum. Then we had the debt downgrade. That is going to put us on ice for the time being. Stock prices for all commodities will be off. If the U.S. dollar weakens enough, which we think it probably will over the next several weeks, then you may get a pickup in commodity prices as international buyers find it cheaper to come into the marketplace and any commodity priced in U.S. dollars tends to perk up. The light at the end of the tunnel could be negotiations with the European banks and U.S tax and spending reform.
TER: Let’s talk about what companies are going to be in a good position to capitalize on global demand when stock prices do come back.
RK: There will be, we believe, another run up going into 2012–2013 on stock prices. A prevailing fear factor will position well-established producers as the first ones to benefit when the market recovers. So Agrium, Potash, Mosaic—those are the key ones along with CF Industries Holdings Inc. (NYSE:CF; Not Rated) and Terra Nitrogen Corp. (NYSE:TNH; Not Rated). Those are the companies that have been around, have established solid earnings growth, have upped their guidance for 2011–2012 and have the volume and the staying power in this particular market. They have clean balance sheets, are well run and have some new capacity in brownfield tonnage coming into 2013–2014. So they are in good shape. Those are the ones we think will recover first.
The juniors will follow if there is a sustained market recovery. That includes Allana, PotashCorp, Karnalyte Resources Inc. (TSX:KRN; Not Rated), Passport Potash Inc. (TSX.V:PPI, OTCQX:PPRTF; Watchlist Buy Rated) and IC Potash Corp. (TSX.V:ICP; OTCQX:ICPTF; Not Rated). We could see Ethiopian Potash (TSX.V:FED TSX.V:FED.WT; Not Rated) and Encanto Potash Corp. (TSX.V:EPO; Not Rated) move as well. It all depends, however, on how far along these companies are in their development and the results of either updated resource reports or first-time NI 43-101s.
These things will all depend on how strong the potash market has remained even though the stock market has fallen off. So in the next three to six months, if the economy is actually in the dumps and all these potash prices have come off, then these juniors will basically go nowhere. Farmers are a pretty fickle bunch. If they smell that there is going to be any weakness in the overall economy or in crop prices and their returns, they will step back. And they can step back fairly quickly.
If, on the other hand, potash prices hold up at the $474.90/ton price recently signed by the Indians, then you are going to see these juniors perk up. As it stands right now, the fundamentals are still extremely strong—they haven’t deteriorated at all. Demand is high worldwide for crops, the stock:use ratios are very low and farmers have lots of money in their pockets. They are feeling pretty good about the next harvest. This is important because right now they are making decisions about the spring plant for next year. We expect crop prices to be very good and that application rates will actually be higher in 2012 because farmers are planting more and trying to bring back drought and floodplain areas with extra fertilizer applications where nutrients have been washed out of the soil.
TER: You mentioned some of the catalysts that would be necessary for the junior stocks to start appreciating. Do you want to go through a few of those, starting with Allana?
RK: We expect Allana to go ahead with its plan to get an open-pit operation in Ethiopia up and running by 2014. Additionally, Allana could be a takeover target for the Indian government, which is still bristling about signing a higher-priced contract for 2011 and 2012 delivery. Along with the Chinese government, the Indians have been very active in Ethiopia, delivering foodstuffs to drought victims and committing $300 million to a major railway infrastructure project. They may be looking to sign either long-term contracts or purchase a producer or an up-and-coming junior to deliver 2–3 Mts./year reliably. That makes a lot of sense long term. So, it is quite possible that someone like Allana or Ethiopian Potash—although it doesn’t even have drills in the ground yet—may have several suitors come calling. That is one catalyst.
We also believe Allana is talking to several banks to act as a project finance lead bank. When that is announced and the market sees that Allana is serious about going forward with production plans in 2014, we think that will perk up the stock. That is catalyst number two.
Catalyst number three will be the updated resource report coming out toward the end of the year and the bankable feasibility report coming out in February or March of 2012. That will show quite clearly the low open pit mining and extraction costs predicted. We believe it will be the lowest-cost operation and the first to production in the world. Once that becomes clear, it will be a catalyst for the stock price. So we have three events coming up in addition to the extra drilling in the Danakil Depression deposit. Those will be smaller catalysts that continue to show 25%+ potassium chloride (KCI) at very shallow depths and significant thicknesses.
TER: Another one you mentioned was Karnalyte?
RK: It is a solution-mine potential operation in Saskatchewan so you don’t have any of the country or transportation risks that you might have in Ethiopia. Investors who want to stick close to home during an uncertain market might like Karnalyte. It is a contiguous, large-scale deposit. There could be anywhere from 2–3 Bts. of potash there. The company has come out with its NI 43-101 and an updated resource report will be out at the end of the year. It believes it can get up to 3 Mts. in the next five years quite easily. This would be a solution mine with high capital costs to start up, but it is not a deep-shaft mine, which is five to six times the cost. It will be very low extraction costs, $100–$120/ton delivered to British Columbia seaports. The added benefit here is the extent of the magnesium-oxide deposits along with the KCl. Magnesium oxide is used for many applications, including as liners for arc furnaces in steel manufacturing. Manufacturers are willing to pay more for secure, zero-boron content magnesium oxide. That is another revenue stream that has not been factored in by the markets. The company has hired a specialist in magnesium oxide extraction and end-use processing to capitalize on that opportunity. It will issue a report in the next six months on the conclusions. That could be the catalyst that drives Karnalyte to new heights.
TER: Very impressive. How about Passport Potash?
RK: Passport is coming out with its NI 43-101 in September, so that will be the first catalyst. It is not as great a deposit as Allana or Karnalyte, but it is located right smack dab in the middle of Arizona with all the infrastructure in place—road, rail, power and water; it has everything there. There are no environmental issues to deal with and all state, federal and local governments, including the Native American community, are on the company’s side. They all want this thing to be developed. The area is economically depressed and this project will employ 300–400 full- and part-time workers. So the catalyst here is the NI 43-101, that is number one. Number two is that the deposit could be big, although with not as high a KCl content as Karnalyte and extraction costs may be a little bit higher as well. To get the concentration of KCl that it needs to produce a good, modern organic product, it is probably going to have to extract more slurry than some of the other producers. However, this deposit could be 2–2.5 Bts. and there are other interested parties. A large oil company just to the south of Passport Potash’s concessions is looking to diversify its product mix. So it is quite possible that we could see Passport Potash have a suitor or two come calling.
TER: Interesting. IC Potash?
RK: IC Potash has a very interesting story. It is a little bit further behind everyone else in terms of getting its project up and running. We will probably have more information for you in the next call.
TER: The last one you mentioned was Encanto?
RK: Encanto is, again, in Saskatchewan. It has all the native groups on its side. It has a substantial resource, but will come online later than some of the others. We don’t expect it to be up and running until 2015–2016. It is a solution mine with a good management team and a fairly contiguous deposit. We wouldn’t rank it at the top of our list. Allana is No. 1, Karnalyte No. 2, Passport No. 3. Encanto is in the middle third of the juniors we watch.
TER: Anything else that our readers should be watching out for in the potash space in the next six months?
RK: I think you will find that there is going to be a race to get things up and running as quickly as possible. The savvy investor should get into the space now. By 2015–2016, you will have a lot of projects, and if any of these juniors come online, which two or three of them certainly will, you are going to have enough potash coming on market to supply all demand through 2017–2018. That could lead to a pullback in these stocks from 2014–2015. So you have two-and-a-half years of good market returns coming. To take advantage of that window, get involved with potash players that are established—Agrium, PotashCorp. or Mosaic, and Agrium is our favorite of those three. But also play the select juniors that have a good chance of getting up-and-running with a better-than-even chance of getting linked up in a large offtake agreement or having a suitor come calling. Those would be Allana, Karnalyte and Passport Potash.
TER: Thank you so much for your time today. It has been very enlightening.
RK: Thank you.
*Dundee Securities rating
Richard Kelertas has 25 years experience as a research analyst covering the forest products sector. He has been one of the top-ranked analysts in the sector over the years consistently, and was most recently ranked No. 1 by Brendan Woods. Richard has worked for a number of well-known brokerage firms, including ScotiaMcLeod, Deutsche Morgan Grenfell, UBS Warburg, and Desjardins Securities. He has a bachelor’s degree in forestry and a master’s degree in forestry and economics from the University of Toronto. Richard is also a Registered Professional Forester.
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By The Energy Report, on August 12th, 2011
 The Williston Basin is a hot area of exploration and production that oil and gas analyst Jason Wangler follows from his SunTrust Robinson Humphrey office in Houston. In this exclusive interview with The Energy Report, he shares his thoughts on the near-term prospects for oil and gas demand and prices, and tells us about several attractively priced names with good upside potential from current levels.
The Energy Report: Thanks for joining us today, Mr. Wangler. You and your associate, Neal Dingmann of SunTrust Robinson Humphrey, follow quite a number of energy stocks as well as the oil and gas markets in general. Oil prices have been relatively stable over the last few months with oil in the $90-$100/barrel (bbl.) range, and gas in the $4.20-$4.80/thousand cubic feet (Mcf) range. What are your expectations for the oil and gas markets in the next 6 to 12 months?
Jason Wangler: I think we’re really going to see a lot more of the same trading ranges. In the last couple of years, the economy, especially in the United States, has been building back from the terrible situation of late 2008 and early 2009. In 2009 and 2010, we were growing slowly and getting back to a level that was making more sense. But now that we’ve gotten a little more than halfway through 2011, there are still a lot of issues here in the United States. The debt ceiling and budget crisis and the general concerns with the economy not growing as fast as people expected have all had their effects.
We see the Brent crude prices $15 to $20 ahead of where the West Texas intermediate (WTI) oil prices are here in the States because there is excess supply in the U.S. right now and not as much expected demand for that oil. If you look at gas, it’s very much the same way, not only in the U.S. but worldwide. The other countries around the world would love to have the amount of natural gas that we have. The U.S. is blessed with the riches of natural gas from its shale plays. So you’re probably going to see gas stay in the $4-$5/Mcf range and, I think, probably below $4.50/Mcf for the most part, until we have either a demand or supply change that’s very dramatic. That would probably have to come from the demand side either in exporting natural gas or additional uses, whether it be for vehicles or heating more homes or something of that nature.
TER: It’s interesting how the whole gas situation has turned around because there was all this talk a few years ago about building ports to import liquefied natural gas (LNG) and now we’re talking about exporting LNG.
JW: It is amazing. The “shale revolution” has really changed the dynamic for a fuel that was very hard to come by but can’t be easily transported. You have to build these very large, expensive ship-loading facilities. Some people looked at the market in the U.S at the time and wanted to build import facilities because we would need them and we’ve leaned on Canada and Mexico for quite a few years to supply us with natural gas. Now we have so much at $4/Mcf, we wish those countries would need some of ours. Exporting LNG could start to balance out how much oil we have to import.
TER: Looking at your coverage list, some of the stocks are under $0.50 with market caps under $20 million (M), and others are big institutional favorites that trade above $100 with market caps over $50 billion (B). How do you decide which companies you want to follow?
JW: My colleague Neal Dingmann and I look for names and stories that interest us. We look at the management teams as well as where the assets are located and actually break our coverage down based on specific basins. I cover the Williston Basin in North Dakota and everything west. He covers Eagle Ford in Texas and everything east. And then we try to cover a group of names in each basin in different life cycles of each play. It could be one that’s just a very early entrant, which may have a $100M market cap, such as a Voyager Oil & Gas Inc. (NYSE.A:VOG) in the Williston, up to somebody who’s in the $10B+ range, such as a Continental Resources Inc. (NYSE:CLR) or a Whiting Petroleum Corporation (NYSE:WLL).
TER: You seem to be quite hot on the Williston Basin. Tell us why you like it so much.
JW: It’s one of the most economic and best resources that we have, not only in the U.S., but, really, in the world. There’s lots of running room and we’re very early into the play with lots of acreage still to be drilled. We could be up there for 50 or more years drilling very, very strong wells and putting lots of oil into U.S. tanks. The Eagle Ford and the Utica in Ohio have interesting and up-and-coming plays, but the Williston really has been shown to be as economic as any other, if not the best. It’s always nice to be in an asset that has the best type of results.
TER: A lot of these Williston stocks that you’ve recommended in the last few months have had some respectable moves. Is there still some good upside available there?
JW: I think there still is. The winter was colder than usual in North Dakota and Montana. After the winter season they had floods, which caused a lot of problems throughout the Midwest in general, starting up in North Dakota and Montana.
So, there were a lot of problems with shut-ins. They couldn’t work at the same pace they typically had been able to so production numbers were not as high as expected. Wells were not coming in on the expected timeframe. So, some of these stocks took a significant hit. The weather has been good since the beginning of June. Now we’re really starting to see some very impressive rates. Going through the second quarter earnings season, when we start hearing these names report, I think people are going to understand why they’re going to be a little bit lower than we originally expected entering the year.
Today, a month or two since the weather improved, we are able to say that this is a resource that makes sense. And as long as the weather works, we can really start churning out some very impressive numbers. So, I look for the Williston names to really have some impressive growth rates, not only for the full year, but, mostly based on just the second half of this year, because the weather has finally started to cooperate.
TER: Can you tell us about some small-cap names you particularly like at this point?
JW: One of them is a very early stage play in the Williston called Kodiak Oil & Gas Corp. (NYSE.A:KOG). The company has about 100,000 net acres at this point and is really starting to turn on a lot of wells. It should actually be able to start talking more and more about some very impressive production growth rates, not only for this year but next year. In the next couple of quarters, Kodiak could double production in only one quarter because it is able to bring on three, four or five wells. It currently has a couple of rigs running and will be moving to five rigs by the end of this year. Next year, 2012, we should see explosive growth much as we saw from Brigham Exploration Company (NASDAQ:BEXP) a few years ago. So, I look at Kodiak as an earlier stage play in the Williston with a very nice acreage position and cash on the books. When the additional rigs start running, it’s just a matter of focusing on operations and getting the oil out of the ground.
One other one is GeoResources Inc. (NASDAQ:GEOI). It’s a very interesting small company with a strong management team and a great balance sheet. The company has been around for quite some time and has been able to put together nice positions in both the Williston and the Eagle Ford. It’s just starting to drill now on those positions as the operator. It has a couple of wells in the Bakken that weren’t as great as maybe some other results. But, I think you will see some better results coming out of there as the company comes to understand the resource. Then down in the Eagle Ford, GeoResources just reported some very impressive results a few weeks ago coming out of the Gonzalez County area, a little bit further north than most people thought the Eagle Ford to be. It has some good partners and I think you’ll continue to see it be able to add rigs and really start moving that production level much higher.
TER: What else do you like?
JW: Another one that makes a lot of sense to me is Gulfport Energy Corp. (NASDAQ:GPOR). The company is in the Utica Shale as well as a lot of other places. Utica has become a play that everyone’s really curious about and Chesapeake Energy Corporation (NYSE:CHK) is really the only other one that’s talked about Utica very frequently. According to Chesapeake, Utica has the potential to be better than the Eagle Ford. It will be very interesting to see as we start getting some results out of that Ohio area. Gulfport is also drilling wells in south Louisiana and in the Permian Basin of Texas, and in the Niobrara in the Rockies. It also has some oil sands in Canada. Gulfport has a lot of different very strong assets predominantly focused on oil. And it’s been able to keep the production moving forward. So, I think that the good asset base will continue to turn into better and better cash flows moving forward.
TER: Any other low-priced ones you like?
JW: One other one I like is Abraxas Petroleum Corp. (NASDAQ:AXAS). It’s a smaller name with a position in almost every interesting play that’s not only already being produced in the U.S, but also a few others that are emerging as well. The company is in the Bakken area, the Eagle Ford and the Niobrara. It’s also in a couple of other plays including a small one called the Alberta Basin in Montana that’s becoming more and more exciting as Newfield Exploration Company (NYSE:NFX) and Rosetta Resources Inc. (NASDAQ:ROSE) start to do a little more work there. Abraxas is really a very good company getting out there early and picking up some acreage. Now it’s focusing on drilling that acreage, getting the production to the market and then growing its cash flows. But it’s one that I think is very interesting from an asset standpoint. With a stock price under $5, this is one you could really look at as a nice entry point into quite a few different interesting plays.
TER: You also cover Venoco Inc. (NYSE:VQ). Do you have any thoughts on it?
JW: Venoco is an interesting story but the company has had a tough year so far. It’s in the Monterey Shale in California. It and Occidental Petroleum Corp. (NYSE:OXY), are really the only two companies that are in that play in size, at least that we hear about on a regular basis. It’s taken the company a little bit longer than I think it would have hoped for. Tim Marquez is a smart guy and he’s been the CEO for quite some time. But the play has just really not come along quite as quickly as it had expected. Venoco has got some solid assets and solid production but the stock’s really gotten hit pretty hard over the past six months or so.
A lot of people are banking on this Monterey Shale becoming a very interesting and substantial shale play, and it just hasn’t done that yet. I think ultimately it will work, whether it’s Venoco or somebody else out there. I think Venoco has a great position. But, like a lot of other things, it just takes a little bit more time than we or even the company would like to see and so we’ve seen the stock come down. But it’s starting to get a lot more interesting down here in the sub-$12 range. I think it’ll start looking a little better as production ramps up and Venoco gets a little further up the learning curve on the Monterey Shale.
TER: So, generally, what are your expectations for the coming months that people ought to be aware of, concerned about or hopeful for, as far as investing in oil and gas stocks?
JW: The last few quarters really have all been very strong for the entire industry. Oil prices have been very healthy but gas prices not necessarily as much. The biggest questions have really been the macro situation. Is the economy going to grow? Is there going to be a situation like we had a few years ago where oil just absolutely fell off of a cliff? If it can stay in a range bound area, it will be much easier to make smart decisions on a company-to-company basis regarding who you really like and why you like them, as opposed to the whole industry having to come down.
I think that the industry right now is still severely undervalued, probably closer to the $70–$75/bbl. range for these stock prices versus oil trading in the $80-95/bbl. range. That’s because there’s a fear that the economy is going to pull down the market and oil and the stocks are just going to have to come down because higher oil prices have taken a toll on potential growth.
But the $90/bbl.+ range is a fair range. I think it makes sense as far as the world economy and I think that there’s still enough room for the country to grow, in terms of GDP and everything else, to keep these stocks moving and to keep oil prices where they should be. So, I think there’s a lot of room for these stocks to move. I would just continue to watch what the economy and oil prices do because those are going to be your two big drivers as, right now, these companies are making a lot of money at this $90-$95/bbl. range.
TER: So, to sum up, as far as you’re concerned, there’s more upside at this point than there is downside.
JW: Yes, I think so. For the companies, there’s a lot of upside and not as much downside. The assets they should be able to find with these shale plays are very repeatable. They are capital intensive but as long as the companies can maintain a good balance sheet, you’re safe there. At this point you’re in a price area where you really need to pick one or two that you want to get into and get comfortable with their management teams. The biggest overriding factor at this point is going to be what oil prices do. And what drives that is what the economies, not only here but across the world, are going to do. That’s the thing I think is going to be the most important factor.
And, like you said about the upside, I think one other thing that’s interesting and that could be one of those big upside drivers is that there’s going to be a lot more consolidation. Many of these smaller names will get picked up by larger names that have a lot of cash and want to find a way to grow their production and cash flows further. They need to go out to these new emerging plays in order to do that. So, I think you’re going to see continued consolidation in the market, which I think again, would be very positive for investors who go into these smaller to mid-cap names that may be taken out by the larger names at a nice premium.
TER: That sounds like a pretty optimistic picture for people who are willing to take a shot at some of these promising deals.
JW: Absolutely.
TER: We appreciate your taking the time to talk to us this afternoon and all the good information you’ve given us, Jason.
JW: Thank you.
Jason Wangler has over five years of equity research experience focused on the exploration and production (E&P) and oilfield services (OFS) sectors of the energy space. Jason previously worked at Wunderlich Securities Inc. and Dahlman Rose & Company before moving to SunTrust Robinson Humphrey. He also previously worked at Netherland, Sewell & Associates, Inc. as a Petroleum Analyst. He received his master’s in business administration from the University of Houston, where he was also named the 2007 Finance Student of the Year. He received his bachelor of science degree in business administration with a focus on finance from the University of Nevada, where he was named the 2003 Silver Scholar award winner for the College of Business Administration. In 2010, he was highlighted as a “Best on the Street” analyst by the Wall Street Journal and has been a guest on CNBC.
By The Energy Report, on July 20th, 2011
 Marshall Berol and Craig Valdes are concentrating their focus on resource stocks in their Encompass Fund portfolio. In this exclusive interview with The Energy Report, they share their current thinking regarding the energy sector and give us the names of some stocks that are attractively priced now and that could do well as global energy demand grows. They remain very positive on the prospects for nuclear and see oil demand growing.
The Energy Report: Your Encompass Fund has had some pretty spectacular returns over the past three years. How have you been able to do this and what are your selection criteria?
Marshall Berol: Malcolm Gissen and I started Encompass Fund five years ago. We’ve been very ably assisted by Craig Valdes and Kevin Puil. Our concept was to invest globally in any market cap size company, utilizing both a top-down and bottom-up approach. That results in us looking at sectors we find to be attractive going forward, and then selecting companies within that segment that could experience long-term capital appreciation, which is the objective of the Encompass Fund. We also look at individual companies regardless of industry, where we like the company’s fundamentals.
We have liked resource companies for the past decade. When we started Encompass Fund in 2006, we had already been invested on behalf of individual private client accounts in various sectors of the resources industries, including energy, primarily oil and gas. We have continued to be invested in those industries because they have had some excellent growth and we expect that to continue in the future. So, that’s what led to the Encompass Fund performing very well in the last several years.
The end of 2008 is very painful to recall, as I’m sure it is for all of your readers. But, in late 2008 and the beginning of 2009, we eliminated some companies in the portfolio that we didn’t feel were as strong as some of the others and added to the companies that we thought were particularly strong, but suffering from the general stock market problems. That led to a 137% gain for Encompass Fund in 2009 and a further 60% gain in 2010. For the trailing one-year and three-year periods, Encompass Fund ranks as the top International Mutual Fund, according to Morningstar.
TER: In reviewing your portfolio, nine of the 10 largest holdings are resource companies. Is that the approach you’ll likely be following in the future?
MB: At this point, the outlook is bright for resource companies, including precious and base metals as well as oil, natural gas, coal and uranium. At some point in the future, one or more of these sectors will be less attractive for investment opportunities and we’ll adjust accordingly.
TER: What is your current thinking on where the various energy areas are headed now, in light of the changes since our last interview here in May 2010?
Craig Valdes: We like natural gas as a commodity and as an energy supply. But, because of advanced technologies such as “fracking” and horizontal drilling, you’ve seen an abundance of supply. And so, we might not be as positive on the direction of the price, meaning that it’s probably going to stay in the $4 to $5 Mcf. (thousand cubic feet) range in the near-term. But, as an energy component, we strongly believe that over the longer-term our energy policies will lean more toward natural gas.
Oil has backed off from its recent highs, but the oil price is really a function of how well the global economy is doing. As long as we have an environment with even slow to expanded growth in emerging economies, there’s going to be a continued demand for energy. So, we like oil for the near and long term.
TER: Do you expect any sort of a stabilized price range for oil, or are we going to see big moves up and down?
CV: I think that has a lot to do with energy policy. It also has to do with global growth and the emerging growth economies. We believe that prices on the low end may trade somewhere in the $70-$80/barrel (bbl.) range and at the high end it could be as much as $100-$120/bbl. I think oil stays in a reasonable trading range over the near-term and the next couple of years. The only thing that could easily change that are the Saudis and the Middle East geopolitics, which could affect pricing and supply. We believe that pricing is not going to change that much over the next couple of years.
MB: Certainly, geopolitical issues will have a large bearing in the short-term. We take a nine- to 12-month view in any of these industries. Short-term you get a lot more volatility. For example, when it was announced they were going to release 60 Mbbl. of oil from strategic reserves around the world, including 30 Mbbl. from the U.S. strategic reserve, the WTI oil price went down about 10% from around $100-$90/bbl. Now it’s back up to near $100/bbl. So, in the short-term it had some affect. In the long term it doesn’t. Overall demand continues and overall supplies are basically tight. Some particular situations could lead to a larger decline or, more likely, a larger spike.
TER: Can you tell us about some oil and gas situations you particularly like at this time?
MB: One company that is a major holding in Encompass Fund and has been for some time, is a smaller low-priced stock, GeoPetro Resources Company (NYSE.A:GPR). GeoPetro has five different projects, any one of which could be a real company maker. We have participated in private placements with the company, as well as buying the stock in the open market. The company has an operating natural gas plant and some natural gas wells in Texas. It has a very interesting project in the San Joaquin Basin area in south-central California. It sold a couple of large land positions it held in Alaska to Linc Energy Ltd. (ASX: LNC; OTCQX: LNCGY) of Australia and retained an attractive royalty interest. It is also one-third partner in a project in Canada with PetroBakken Energy Ltd. (TSX:PBN). That is less likely to be acted upon in the near future, but it’s got some very good promise.
GeoPetro has a minority interest in a project in Indonesia with the majority interest held by Chinese companies. The Chinese are actively doing seismic work and plan on drilling later this year. Any one of those projects with drilling success could be extremely beneficial for the company’s stock. GeoPetro has contracted to sell some excess equipment this September that will bring in more than $9M. That would be used to increase production from the Madisonville, Texas, wells and improve the natural gas processing. Those improvements should take the company to at least a positive cash-flow situation, which would be very attractive also. It’s a low-priced stock and there aren’t hundreds of millions of shares outstanding, as you sometimes see.
TER: What else do you like?
CV: We’re very bullish on the San Joaquin Basin in south-central California. NiMin Energy Corp. (TSX:NNN) is in the San Joaquin Basin. There are some big players down there like Occidental Petroleum Corp. (NYSE:OXY) with its huge find in 2009. NiMin is just a stone’s-throw away from some of that production. It’s heavy oil and NiMin has an enhanced oil recovery process called CMD, (Combustion Miscible Drive) on which they have applied for a patent. The company creates steam using a kind of soapy oxygen and injects this into the well reservoir. That heats up the heavy oil and it comes to the surface at a faster rate. The first well they demonstrated this on was producing about 30 bpd (barrels per day) of oil. Now it’s up to about 250 bpd. NiMin has identified a number of heavy oil opportunities in old existing wells in the U.S., which they can pursue. The company has a nice land package in the San Joaquin Basin (Santa Margarita Reservoir) and it is going to drill two additional wells in the second half of this year. Secondly, it may joint venture this enhanced oil recovery process with some larger oil companies. We think that’s a great opportunity, which only enhances the company’s other primary exploration and production focus in Wyoming.
Another company we like that has a large land package in the San Joaquin area is called Zodiac Exploration Inc. (TSX.V:ZEX). It is actually targeting light oil in the Kings County region, and drilling very deep wells. It just started drilling a horizontal well and we look for some updates on that in the next few weeks. When the company finished its first vertical test well to 14,000 feet a few months ago, it found between 500 and 1,000 feet of actual pay in about four different zones. We think Zodiac has a great opportunity long term in the Southern California oil sector.
MB: One of the things we look at in junior companies is the management, because it’s extremely important that management has been in the industry for a number of years and has achieved past successes. That’s the case with Zodiac, NiMin and GeoPetro. These smaller companies will often seek out a larger joint venture industry partner or partners with technical expertise, knowledge and the ability to handle financials. Then the junior will have an ongoing interest in any of the production that comes out of that well and any succeeding wells.
TER: A lot of oil and gas exploration is going on in South America these days. We don’t hear that much about it, but there have been some big finds down there. Can you bring us up to date on what’s going on?
CV: Obviously the interest has been spurred by the big find by Petrobras in Brazil (NYSE:PBR) in the last year or two. There’s oil and gas all over South America but we’ve focused on companies in Colombia because of the way it is regulated, much like the way the U.S. and Canadian governments operate. So, many of your Canadian and U.S. operators have gone to Colombia. We presently own three oil and gas companies in Colombia. One is actually a mid-tier company, Gran Tierra Energy Inc. (NYSE:GTE; TSX:GTE). It’s a larger company with current production of approximately 18,000 barrels of oil equivalent per day. One of the smaller exploration companies in our portfolio is PetroDorado Energy Ltd. (TSX.V:PDQ). PetroDorado, has working interests in a number of different blocks in Columbia and Peru. It has a 30% working interest in one block called CPO-5 that it would like to increase, but its partners are reluctant to sell any additional interest based on the recent seismic work completed. The company is going to be drilling that later this year. We’re looking for excellent results from this exploration region.
Another company that we like in the area is a service company called Estrella International Energy Services (TSX.V:EEN) working in Colombia, Peru and Argentina. Management was working for Schlumberger Ltd. (NYSE:SLB) and left a few years ago and formed Estrella. It’s a full-service oil and gas service company consolidating a fragmented industry in South America. Obviously the exploration companies and producing companies are looking for teams that have expertise and these guys have a great reputation. We think there’s a great opportunity just on the service side for Estrella. The company has demonstrated over the last couple of years that it is able to bid and win good contracts with top-tier companies, including some of the large ones such as Pacific Rubiales Energy Corp. (TSX:PRE; BVC:PREC), Petrobras (NYSE:PBR) and Canacol Energy Ltd. (TSX:CNE). That’s another company that we like on a long-term basis.
MB: Colombia has come a long way in the past decade. There is a lot of growth there and a lot of industry. A number of mining projects and energy-consuming industries are located there. With increased stability in the region, there has been far more activity. We think it has led to some significant oil and gas discoveries and a bright future for some companies.
TER: Moving on to uranium; it’s seen some turbulence since Fukushima. What are your thoughts on that market?
MB: There has been a lot of turbulence. But, long term we’re very bullish on uranium and the companies that are exploring for and producing uranium. Approximately 440 nuclear energy plants operate today around the world. Maybe half a dozen will be taken out of operation in Japan and another half dozen in Germany in the near future. The overwhelming majority of the 440 plants are continuing to operate.
As many as 50 new nuclear energy plants are still being built around the world. South Korea, France, Slovakia and even the United States, have said they intend to continue on the road to increased nuclear energy. There will be increased safety precautions. New designs have been developed for reactors over the last several decades and put in place subsequent to the reactors that were built at Fukushima. Nuclear energy provides 15% to 20% of the world’s growing electricity needs.
While 180 million pounds (Mlb.) of uranium is currently being used around the world to fuel nuclear energy plants, only about 110 Mlb. to 120 Mlb. is currently being produced. The balances come from inventories above ground and from the deactivation of the Soviet Nuclear Arms Agreement. This agreement ends in 2013 and Russia has stated it does not intend to renew it. So, somewhere between 25 Mlb. and 30 Mlb./year will need to be replaced. We think it’s going to cause an increase in the price of uranium in the years to come. The companies that are either producing it or exploring for it and will be producing it are very attractive and we remain very bullish.
Solar and wind are fine, but it’s a minuscule output now and probably for many years to come. Geothermal and hydro are also fine, but they’re extremely limited in production and location. Other difficulties emerge with increasing electricity generation from oil or gas or coal. So, nuclear energy plants have a definite long-term positive outlook.
It’s strange, but in the investment business, people don’t want to buy things that are on sale. The uranium companies are currently on sale. We were in uranium companies prior to Fukushima. We have increased some of those holdings and added new ones. People should pay attention to the uranium industry and what’s actually going on in the nuclear energy industry, rather than merely drawing conclusions from headlines.
TER: Can you tell us about some of the ones you like that are in your portfolio?
MB: One of the top holdings for some time has been Uranium Energy Corp (NYSE.A:UEC). The company’s primary projects are in South Texas. It started production in November 2010 using in-situ recovery (ISR). It’s a far less costly and far more environmentally friendly method than either open pit mining or underground mining. Uranium Energy Corp also has other projects they are bringing into production in South Texas. The company recently made an acquisition of a very large land package in Paraguay. It also owns additional exploration properties in Arizona, Colorado, Utah and Wyoming. It just recently signed its first long-term contract to sell some production.
Another current producer we find attractive is an Australian company, Paladin Energy Ltd. (TSX:PDN; ASX:PDN) with projects in Australia, Malawi and Namibia. It also acquired a project in Labrador and Newfoundland that looks very attractive.
A company that is near production is Ur-Energy Inc. (NYSE.A:URG; TSX:URE), which has some advanced projects in Wyoming and should be in production within the next year.
Tournigan Energy Ltd. (TSX.V:TVC, FSE:TGP), which is in Slovakia, is an interesting situation. More than 50% of Slovakia’s energy is generated from the four nuclear energy reactors currently operating in that country. The country is currently building two additional reactors. Tournigan is in advanced stages of exploration and prefeasibility on its Kuriskova project in Slovakia, which will be able to provide uranium for all the European Union countries.
A company we think is attractive and is earlier stage, is Crosshair Exploration & Mining Corp. (TSX:CXX). It has uranium projects in Wyoming, Labrador and Newfoundland along with some other commodities. Currently, the major uranium producer in the world is Cameco Corp. (TSX:CCO; NYSE:CCJ). BHP Billiton Ltd. (NYSE:BHP; OTCPK:BHPLF) and Rio Tinto (NYSE:RIO; ASX:RIO) are major multi-metal and multi-commodity miners that are also involved in uranium production.
TER: Do you have any thoughts on coal?
MB: We think coal is also attractive. While it has some environmental and safety problems depending on where the coal is being mined, 50% of the electricity in the United States comes from coal. It’s a higher percentage in China. That’s not going to change dramatically for quite some time. We are invested in several coal companies, one of which is operating in Mongolia, 20 miles from the Chinese border. Every bit of coal that is being produced by SouthGobi Energy Resources Ltd. (TSX:SGQ) in Mongolia is being purchased and used in China. SouthGobi has been in production for several years and is increasing production every year. We think it’s a very attractive company and very attractively priced because the price is down, for whatever reasons.
A large quality coal company is Peabody Energy Corp. (NYSE:BTU). We have holdings in Forbes Coal (TSX:FMC), which is in production in South Africa, and in L&L Energy Inc. (NASDAQ:LLEN). L&L is a U.S. company that has acquired several coal mines and coal washing projects in China and is producing and selling coal in China. We think coal is a very attractive industry now and going forward.
TER: Do you follow the potash industry? What are your thoughts there?
MB: We do and we like it because the growth of the population and economies in the emerging markets means that more people have more money and can afford, and want, better food. There’s a tremendous ongoing need for potash and the other types of fertilizers.
Over the years we’ve been in and out of PotashCorp (TSX:POT; NYSE:POT). While we are not traders, sometimes the price of a company gets bid up and we believe it’s time to either sell some or all of a position depending on valuation. That has been the case with PotashCorp.
The Mosaic Company (NYSE:MOS) is another very attractive large fertilizer company. A smaller one that we have invested in is Verde Potash (TSX.V:NPK), which is developing a large potash project in Brazil. There is enough demand from Brazilian agricultural industries that the company will probably sell the majority of its production in Brazil.
Passport Potash Inc. (TSX.V:PPI, OTCQX:PPRTF) is an early stage company with a very large land package in Arizona that likely will be brought into production. Another smaller company is Western Potash Corp. (TSX.V:WPX), which is using the ISR process in Canada’s Athabasca region.
TER: Can you to summarize your overall view of where the energy industry is going?
MB: As should be apparent, we are positive on the energy industry and the various components of it. Oil, coal and uranium are very attractive and there are a number of companies in those industries that we believe will do well. The Encompass Fund is focused on the long term and not day-to-day trading. When you look at the long-term factors involved in supply and demand for the various segments of the energy industry, they are very positive. Natural gas is in a somewhat different situation, but as evidenced by BHP’s proposed $12.1B acquisition of Petrohawk, natural gas is also valuable.
TER: We greatly appreciate your time today.
MB: We appreciate it. We’ve enjoyed it. And, if your readers are interested in more information about the Encompass Fund, we would refer them to the website, www.encompassfund.com. The ticker is ENCPX.
CV: Thank you.
Marshall Berol has been involved since 1982 as an investment manager in San Francisco, CA. He and Malcolm Gissen co-founded and co-manage the Encompass Fund, a no-load mutual fund. Also since 2000, he has been the chief investment officer of Malcolm H. Gissen & Associates, Inc. Mr. Berol did his undergraduate work at the University of California (Berkeley) and received a JD degree from the University of San Francisco School of Law.
Craig Valdes has been an investment manager in the San Francisco Bay Area since 1982. Since 2006, he has been the director of research and trading at Malcolm H. Gissen & Associates Inc. He previously was a partner and portfolio manager at Genesis Capital Management and Hutchinson Richardson Investment Management in San Francisco, CA.
By The Energy Report, on June 26th, 2011
 Domestic demand for fertilizer is good news for small, U.S. potash producers. In this exclusive interview with The Energy Report, Weiss Research Natural Resources Analyst Sean Brodrick explains the international market forces behind agriculture-related stocks and points to the companies that could benefit in the long term.
The Energy Report: I understand you’re not really bullish on energy these days. Can you give me a brief synopsis as to why?
Sean Brodrick: I’m concerned about the perception of a slowdown in the global economy. With so much free money floating around the market, the psychology becomes so much more important. And, right now, people are really worried about a slowdown in the global economy. They’re starting to pull back and retrench.
Recently, we saw a rally in the market that could go on for a while because things have gotten so oversold to the downside. But the fundamentals haven’t changed. We are seeing fewer government financial injections, thus taking away the punch bowl. That weighs on energy stocks and a recovery generally. Also, we’re seeing worrisome news out of China. The country is still using a lot of energy—more each year. But, the demand for copper is falling off quite a bit. In fact, the most recent numbers I saw said that last month we saw Chinese copper demand drop off 47% year-over-year. May was down 6% from April, which was another down month. Copper is often an indicator of the global economy. Now, the Chinese just might be messing with us as they often do because they like to manipulate the market to get cheaper prices, but it also could indicate a global slowdown. If that is the case, then energy prices usually follow. So, we could see lower energy prices for some time.
You and I know that these energy companies make fantastic money even when oil is over $85/barrel. They make great money. But, again, it’s the perception, the psychology. People worry about quarter-over-quarter comparisons. They tend to punish stocks—perhaps a little unjustly, but they punish them anyway. So, we could see more downside in the broad energy sector.
TER: However, I understand you are very bullish on the potash market these days. Why is that?
SB: Short-term perceptions and worries about a global slowdown aside, the long-term reality is that we have 70 million people in China who are joining the middle class every year. We have millions more in places like India and Malaysia. All these people want to eat and live like big, fat Americans. So, the agricultural producers of those regions are hard-pressed to keep up with that demand. In fact, global consumption of things like grains, nuts and seeds—everything except meat—has gone up 2.5 times since 1970 and it keeps accelerating. This is driving the demand for potash, which has gone up something like 5.6% for the last three years in a row. It doesn’t seem like it’s really going to slow down. Now, if we saw a major downturn in the global economy, we would have to worry about that. But until we do, we’re going to see increasing global potash demand because farmers need it to increase their yields. The green revolution sent agriculture yields much, much higher. Now you have to put in a lot more fertilizer just to get incrementally larger yields. The only way you’re going to get those grain yields is by using potash.
Only 12 countries actually produce potash. Canada, Russia, Bellerose and Germany account for more than 75% of the global supply. And only eight companies control 80% the world’s potash production. Do you see how this could lead to a price squeeze? China will probably try to lock in potash supply going forward because of its need to feed its people. As China starts hoarding international potash supplies, we will have to look for domestic sources. That is good news for new, small potash producers in the U.S, which is already an agricultural powerhouse. We are to grain what OPEC is to oil. Increased U.S. demand for potash could certainly make a difference in the share prices of these small companies as long as they can continue to go into production and/or increase production.
TER: The U.S. gets most of its potash from Canada today, correct? What are the small players in the U.S. you like right now? Can they completely fill the domestic potash demand? Where do you see that market going?
SB: Right. Well, I like Intrepid Potash Inc. (NYSE:IPI) in New Mexico. This company seems to be doing things right. This is an example of a stock being punished unjustly. It has been brought down with the rest of the broad market. The correction in the broad stock indexes compressed the price of Intrepid Potash even as the company increased production.
Another one I like is Passport Potash Inc. (TSX.V:PPI, OTCQX:PPRTF), which you and I visited. It is a developer in Arizona with a great project near the American heartland. The company is doing more drilling, moving it along. I think the dominos are lining up. Passport is moving down the path to production of a million tons a year. This company is in a good position to do pretty well, but it has to get into production first.
TER: Passport Potash announced some initial drill results recently.
SB: Yes, they did and boy, they were good. Preliminary results from two core holes showed significant potash deposits at relatively shallow depths. The company intersected 9.5 feet of 12.29% KCL. Some parts were actually richer. More results should be coming in over the summer. As they report those, maybe the market will take a second look. Because of the risk of not being in production yet, Passport has really been punished along with the broader market. But the payoff could be much higher, especially if the company attracts the attention of one of the big boys, which I believe is going to happen down the road. Then I think Passport could do very well. We could see this thing jump quite nicely. Remember, Passport won’t be ripping up a huge hole in the desert with big trucks. This is planned as an in-situ leaching project. Passport will pump solution in one side of the field through the potash deposit and filter it out the other side. So, you don’t move a lot of dirt. That makes it easier to get environmental approvals.
TER: There has been some talk about the possible end of the ethanol subsidy affecting the broader fertilizer industry in the U.S. Do you think that is significant?
SB: It is significant in that it affects market psychology. The market mentality impacts all kinds of stocks. There was some action in the corn markets that you would not believe. However, let’s face it, 2012 is an election year. Do you want to be the political party that takes away the ethanol subsidy when you’re going into the Iowa caucuses? You could argue about whether subsidies are a good thing or not, but I just don’t think it’s politically feasible to take it away. I don’t think it’s actually going to happen. It’s all politics in ethanol.
TER: I hear even Al Gore is now saying that it was a mistake to suggest that ethanol could be a significant alternative energy source.
SB: Right. But that subsidy is probably not going away. It looks like an easy target, but when you take political considerations into account, and you have to, then it’s not a target you’re going to hit. Ethanol subsidies will be in place at least through the 2012 elections.
TER: Thank you very much Sean.
SB: Sure.
A natural resources analyst for Weiss Research, Inc., Sean Brodrick travels far and wide seeking out investment values, primarily among the small-cap and micro-cap players. He edits Weiss Research’s Crisis Profit Hunter and Red-Hot Global Resources, as well as making regular contributions to Uncommon Wisdom Daily. He is also a contributing columnist to Dow Jones MarketWatch and a frequent commentator on one of Canada’s premiere financial websites, HoweStreet.com. Sean’s expertise has led to many financial talk show appearances, including CNBC Squawk Box, Fox Business, CNN, The Glenn Beck Program, Your World with Neil Cavuto and Bloomberg Market Line. He is the author of The Ultimate Suburban Survivalist Guide, a guide to surviving the ever-changing economic landscape from stock market shakeups to oil and currency crises to natural disasters. A graduate of the University of Maine, Sean has more than 25 years experience as a professional journalist and financial analyst, including a stint as investment director of the Sovereign Society—the world’s leading publisher of offshore asset protection strategies and global investment opportunities.
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By The Energy Report, on June 10th, 2011
 Brazil offers an ideal environment for potash developers, according to Salman Partners Analyst Jaret Anderson. A robust agricultural sector, favorable government policy with excellent transportation and infrastructure are leading to the development of a number of very attractive potash projects in Brazil. In this exclusive interview with The Energy Report, Jaret details his Brazil play and others.
The Energy Report: We know the general factors responsible for the growing need for fertilizers, but are there any growth drivers that aren’t quite so obvious?
Jaret Anderson: Absolutely. Everybody knows the earth’s population needs more food, and there’s a greater desire for increased meat consumption in a number of countries. Hundreds of millions of Chinese and Indians are making the transition from poverty to having some level of disposable income, and one of the first things people in that situation tend to demand is a higher protein content in their diet. One of the things that tends to get lost in the debate is the fact that in order to produce more protein we need a lot more arable land, or we need significantly more production from the arable land currently available.
In order to produce a kilogram (kg.) of beef, it takes about 7 kg. of feed, whether it’s corn or soy or what have you. In order to produce a kilogram of pork, it takes 4 kg. of feed, and for poultry it takes 2 kg. of feed. So, as hundreds of millions of people in India and China and around the world continue to move toward higher protein content in their diets, there is a need to produce more feed grains on a pretty much finite arable land base in order to satisfy those demands.
TER: It sounds like making protein is a very inefficient process.
JA: Regardless of whether it is efficient or inefficient, it’s what the world is demanding. I have no desire to give up my meat and I don’t think anybody else does either. There are ways we can achieve this with better farming techniques, such as more efficient use of fertilizers, genetically modified seed and superior irrigation. All of these things can help us improve crop yields and help us to offer everyone on the planet the food and protein they desire. So, moving yields up in less developed parts of the world to the levels that you see in North America and Western Europe, etc. is something that can be achieved over a longer period of time.
TER: Food producer risks would trickle down to the fertilizer producers. What are the risks?
JA: At the end of the day, the major risks are the impact of prices, which incorporate the supply and demand for the various crops, cattle, poultry, pork, etc. One macro-risk that could have a big impact on the agricultural system overall—and therefore on fertilizer producers and those who are trying to bring new fertilizer projects to market over the next number of years—is the political and economic debate surrounding ethanol.
A change in the political will to continue to subsidize ethanol in the United States could potentially have a significant impact on farm economics. Something like 40% of U.S. corn production is used to produce ethanol. A $0.45 per gallon subsidy currently goes toward the production of ethanol, and if that were to go away during this 2012 election season, it could hurt fertilizer producers.
TER: One Republican presidential candidate went to Iowa recently and made no bones about the need to reduce subsidies for ethanol.
JA: Yes, Minnesotan Tim Pawlenty made that statement pretty aggressively. Sarah Palin, whether she’s in or out, can have an impact on this issue. She’s saying some of the same sorts of things regarding the need to end all energy subsidies, including ethanol. So, it’s a risk. I don’t think it’s something to lose a lot of sleep over, but it is certainly something that can change the debate and the economics for corn production and, ultimately, fertilizer products.
TER: In an industry report, you expressed some thoughts about the significant advantages of producing potash in South America versus Africa. What thesis are you presenting to your clients regarding these two areas?
JA: Transportation costs represent approximately 40% of the total delivered North American potash costs. That’s another way of saying that location and infrastructure are critical elements for any prospective greenfield potash project. It’s critical to think about how infrastructure and transportation costs play into the various projects whether they’re located in Saskatchewan, Canada, Brazil, Ethiopia, Eritrea, the Republic of Congo or wherever else these projects are being developed.
Brazil, in my view, is a particularly interesting location. It’s the second-largest consumer of potash in the world today, and it has posted some of the best potash demand growth over the last 10 years. In addition, Brazil has a number of positive factors going for it. It has a well-developed infrastructure system, including modern roads, a well-developed rail network, access to water and power. By comparison, a number of projects in Africa have very interesting deposits but face significant challenges with respect to infrastructure, including a lack of access to rail, water, power and ports.
TER: Potash stocks are taking a well-deserved breather after phenomenal returns over the past 52 weeks. Is this an opportunity now for phosphates to catch up?
JA: There has been a big uptick in interest in phosphate projects over the last six months. I definitely receive more incoming calls on them than I did a year ago. I believe that phosphate projects do offer some advantages over potash projects because they are less expensive to build, and they’re generally brought to market faster than the five-plus years it can take to bring a potash project to market. Overall, though, the potash industry has offered much better returns over the cycle than phosphates.
PotashCorp (TSX:POT; NYSE:POT)—one of the largest fertilizer companies in the world—has generated an average gross margin over the past five years of 63% in its potash business. Its phosphate business, by comparison, has only generated an average gross margin of about 22%. I think that is the order of magnitude you can expect in potash versus phosphate over the cycle. That makes potash the more attractive business over the long term, but it doesn’t mean there aren’t attractive phosphate projects out there that can generate decent returns for investors.
TER: Companies vary how they report their resources. Investors would like to understand resource values on an apples-to-apples basis, specifically when it comes to understanding recoverable potassium chloride versus total tonnage of ore. This can have significant implications, can it not?
JA: It can. A number of these greenfield potash companies have taken different approaches with respect to the way they have chosen to report their resource figures. As you point out, some companies have reported the total number of tons of potash-bearing rock in the ground while others have been more conservative and report the amount of potash that they expect to be able to extract after accounting for the grade of the rock, allowances for losses during extraction and further losses during processing.
In general, we have found that companies with assets in North America have been more conservative in the way they have presented their figures than the companies with assets in Africa. In any event, when comparing two potash resources, investors have to take into consideration things like the resource grade, mineralization depth, existing infrastructure and the viability of moving forward over the long term.
In our opinion, too many of these companies have been painted with the same brush. Ultimately, not all of these projects are likely to make it to production. You have to consider carefully which of these projects have the most desirable characteristics and the lowest risk when making an investment decision.
TER: Does the Street typically give the recoverable potash resource reporter a premium?
JA: Not from what I’m seeing when I look at my comps, and that’s where I think there are some opportunities. To me, a company such as Western Potash Corp. (TSX.V:WPX), which is located in Saskatchewan and has a very large resource, has been conservative in the way it has presented its information compared to a lot of its peers in the greenfield potash space. Yet, it’s trading at a discount in terms of absolute EV or market cap to some of the companies operating in Africa with a fraction of the resource who have perhaps been less conservative in the way they’ve presented the figures. So, I think there are some opportunities there, and I think that a company like Western Potash does warrant a second look.
TER: Can a prolific producer command a premium price, or is the idea to get a better margin with lower infrastructure and transportation costs? Or is it both?
JA: In an ideal world, you want a large potash resource located close to a large source of end demand with good infrastructure already in place and a stable geopolitical environment. In our view, the projects in Saskatchewan and Brazil check most of these boxes. Brazil is particularly interesting in that it offers well-developed infrastructure, a stable political environment and very strong growth rates for potash demand going forward. If I had the ability to create a potash deposit located anywhere in the world, I would choose to locate it in Brazil. Brazil is likely to overtake China as the world’s largest consumer of potash sometime in the next decade. In my view, it offers the best combination of end-user demand, well-developed infrastructure, and an accommodative and stable government.
Something to keep in mind is the very long-life nature of these projects. When you’re building an operation that is expected to run for several decades, you need to think strategically about how the world is likely to unfold. Brazil is currently the world’s number one exporter of beef, chicken, sugar, coffee and orange juice. Given its very large undeveloped arable land base, those factors are only likely to go in Brazil’s favor. So, in my view, locating in a country with great agricultural promise going forward, a stable government, and good infrastructure makes a lot of sense.
TER: Could you give me a specific example?
JA: Sure, take the example of Verde Potash (TSX.V:NPK) (formerly Amazon Mining Holding), which has a very interesting greenfield potash project located in Brazil. Verde plans to produce a new type of potash in an area called Minas Gerais, a state with a very high level of agricultural production close to a number of fertilizer blenders that buy fertilizer today from companies such as PotashCorp, The Mosaic Company (NYSE:MOS), and OAO Uralkali (RTS:URKA, MICEX:URKA, LSE:URKA). Verde is likely to face freight costs of only about $45/ton to truck product from its location a couple hundred kilometers (km.) to the fertilizer blenders in Minas Gerais and Mato Grasso states. A supplier today in Saskatchewan such as PotashCorp or Mosaic is likely to face transportation costs of $35/ton to move its product from Saskatchewan to the port in Vancouver, another $35/ton via ship from Vancouver to the port in Brazil, and another $80-$115/ton to move the product from the port in Brazil to the inland location where the fertilizer blenders actually need the product. The total cost of end-to-end transportation is somewhere between $150 and $185/ton. So Verde’s $45/ton transportation cost gives it a very material competitive advantage. It really can’t be frittered away over time unless you believe rail and transportation costs are going to go down over the years, which is highly unlikely. This is an enduring competitive advantage.
TER: I am looking at Verde under its old ticker symbol as Amazon Mining, and its total return for the past 52 weeks is 383%. It’s given back about 14% over the past three months. Is there much left on the upside?
JA: Verde has plenty of upside left. I have a target of $11.50 per share, and you’re talking a return of 64% to my target. I believe there is certainly another $3–$4 left in the stock over the next 12 months. If the company’s R&D initiatives show positive developments, the stock has much, much more upside from here.
TER: Is there another company you might discuss?
JA: If you want to play in the Danakhil Basin in Ethiopia, I would steer someone toward Ethiopian Potash Corp (TSX.V:FED TSX.V:FED.WT), which has a land package located directly adjacent to Allana Potash (TSX.V:AAA; OTCQX:ALLRF) and yet has a market cap at roughly one-third that of Allana’s. If you’re bullish on the Ethiopian plays, they’re not all the same. Some are less expensive than others, and I think that Ethiopian Potash is an attractively valued name.
TER: Isn’t the Danakhil project 600 km from a port?
JA: It’s roughly 600 km by road to the nearest available port that it can use, which is Djibouti. Closer ports exist in Eritrea, but political problems limit access to those ports. Eritrea and Ethiopia have had troubled relations in the past. So, projects located in Ethiopia may have trouble gaining access to the ports in Eritrea. That could be resolved over time, but right now it looks like that’s going to be a challenge.
TER: Sticking with that transportation theme for a moment, you’re obviously very positive on Western Potash, but it’s 1,730 km to port.
JA: Yes, it’s a long ways away from the port in Vancouver. The difference is that there’s well-established rail infrastructure in place, which has been transporting large quantities of potash from Saskatchewan to Vancouver for several decades. The risk and the cost in moving potash out of Saskatchewan is much, much lower than I think you’re going to find in other parts of the world. So, it’s a large distance, but the infrastructure is largely in place to make that feasible.
TER: Thank you for your time. Best wishes.
JA: Thank you.
Jaret Anderson covers the fertilizer, agriculture and chemical sectors and brings over 10 years of research experience in the basic materials space to the Salman Partners research team. Jaret spent seven years at UBS Securities Canada covering paper & forest, fertilizer, chemical, gold and steel names prior to joining Salman Partners. In 2006 he was ranked #1 for earnings estimates accuracy in the paper and forest sector by Starmine, and in 2005 he was ranked #2 for quality of written reports (also in the paper & forest sector) by Brendan Woods International. Jaret holds a B.Com. (with Honors) from the University of British Columbia and became a CFA charterholder in 2000.
By The Energy Report, on May 27th, 2011
 Siddharth “Sid” Rajeev isn’t a miner. But in his search for value, Sid, head of research for Fundamental Research Corp. in Vancouver, digs deep into the world of small- and micro-cap stocks to find undiscovered gems. In this exclusive interview with The Energy Report, Sid drills down on some relatively unknown resource stocks he has uncovered.
The Energy Report: Sid, you’re an electrical engineer by training. How did you end up the head of research at your boutique investment bank?
Sid Rajeev: I initially worked for an engineering firm for a few years. I developed a strong interest in finance and investment analysis in those years, so I decided to pursue an MBA degree. Soon after I got my degree, I joined Fundamental Research and it’s my sixth year here. At Fundamental, we have a team of analysts, including financial analysts and geologists. We cover about 150 companies, three-quarters of which are in the natural resource sector. The rest are from agriculture, technology, aerospace and other industries.
TER: Instead of putting target prices on stocks, your firm uses a fair-value metric. Does that imply perfect pricing, a theoretical point at which there’s no upside or downside?
SR: Fair value, basically, is the intrinsic value of a stock on a particular day, which is calculated based on the stock’s fundamentals. And you’re right, essentially, it’s the point at which there’s no upside or downside.
TER: When shares reach fair value, do you recommend them as momentum plays?
SR: No, our valuation methodology is always based on fundamentals—we will not give a buy recommendation on a stock if its share price is higher than its intrinsic value. We tend to evaluate or review our valuations on a particular company every three to four months—sooner if some significant news develops.
TER: With a fundamental theory, you recommend taking money off the table when a company achieves fair value and seeking fair value in another company’s shares.
SR: Exactly.
TER: What are you trying to achieve for your clientele through your general investment theory?
SR: Our main goal at Fundamental is to bring out those underexposed small- to mid-cap companies that no one really follows—those are the companies most likely to be undervalued. Our geologists look at the technical aspects. They work in conjunction with our financial analysts to come up with the intrinsic value and a recommendation.
TER: Are you generally bullish on commodities right now and, if so, which ones?
SR: Our favorite now is uranium. We’ve been bullish on uranium for the past couple of years. Yes, the incident in Japan caused uranium to take a huge hit, along with the companies that follow or track uranium, but we believe the fundamentals of uranium are still intact. It’s still one of the cheapest and cleanest sources of power out there. Particularly when fossil fuels are at extremely high prices, we need sources like uranium going forward. Having said that, I don’t think we are going to see any spike but rather a slow and gradual recovery in uranium prices and, therefore, we believe uranium is very attractive for investors with a longer time horizon (at least 12 months).
TER: Where should investors be deploying capital?
SR: Our three top picks are Western Potash Corp. (TSX.V:WPX), Compliance Energy Corp. (TSX.V:CEC), a coal company, and Strathmore Minerals Corp. (TSX:STM; OTCQX:STHJF), a uranium company.
Western Potash is an advanced-stage exploration company with potash in Saskatchewan. We think it’s a good acquisition target.
We picked up Strathmore Minerals when it was at $0.57. It traded as high as $1.60 but, after the disaster in Japan, the stock dropped significantly and now is sitting at about $0.62. We believe uranium companies with quality assets, like Strathmore, should do well going forward.
Compliance Energy recently announced a positive feasibility study, and it should go into production in the next 24–36 months. It has a quality management team, strong cash and investments—especially its significant position in Copper Mountain Mining Corp. (TSX:CUM).
TER: Great. Any others?
SR: Rock Tech Lithium Inc. (TSX.V:RCK; OTCPK:RCKTF; Fkft:RJIA) is a very interesting company under our coverage. Its main focus is on the Georgia Lake lithium project in the Thunder Bay Mining District in Ontario. That project has a historic resource of 9.8 million tons (Mt.) at 1.18% lithium oxide. We like this company particularly because it is expected to complete several milestones in the next 6–12 months. Number one, Rock Tech is expecting to convert its historic resource to an NI 43-101-compliant resource in the next month or so. Second, the company is awaiting metallurgical test results on a 1-ton bulk sample, which will determine the recovery rates for different separation methods and also evaluate the potential to produce battery-quality lithium carbonate. Third, in addition to Georgia Lake, the company also plans to advance its recently acquired projects in Quebec, which are located close to some well-known lithium projects.
The Kapiwak project (James Bay area in Northern Quebec) is located close to a new discovery and the Lacorne project (Val d’Or) is close to a near-term producer (18–24 months). We expect this stock to move closer to our fair value estimate of $0.55 per share if these developments turn out to be positive. The current share price is $0.25.
TER: The main driver here is the growing popularity of electric cars?
SR: Exactly. We think lithium is attractive for use in electronic devices and vehicle batteries because lithium is the lightest metal in the periodic table. Lithium has the highest specific heat of any solid element. Lithium batteries also hold a charge for a long time and could be utilized to store energy from alternate sources, such as wind and solar, as the electricity production from these sources is variable.
TER: What else can we look forward to from Fundamental Research?
SR: Another company that is worth tracking is Mesa Exploration (TSX.V:MSA). It’s exploring for lithium, potash and uranium in Utah and Arizona. All the projects are in proven mining districts with accessibility and infrastructure. The company recently released an NI 43-101 technical report for its flagship Green Energy Lithium Project in Utah, where drilling is expected to begin this spring once the permits are received. Mesa also has a joint venture (JV) partnership with Passport Potash Inc. (TSX.V:PPI, OTCQX:PPRTF) on its Holbrook Basin Potash Project.
We recently picked Plains Creek Phosphate Corp. (TSX.V:PCP) and will be initiating coverage on the company shortly. It has an advanced-stage phosphate project in Guinea-Bissau in West Africa. A bankable feasibility study is expected in Q411. The company has already received a production license, and production is expected to commence in 2013. Our recommendation and rating on the company should follow in the next few weeks.
TER: Do you believe a phosphate company can grow due to the success in potash, and that it might be time for phosphate to catch up?
SR: Exactly, phosphate has the same drivers as potash. The main idea behind phosphate and potash is increasing demand for food, increasing population and diet improvement in developing economies. Also, meat consumption in developing countries is expected to significantly increase in the future, which would drive up demand for grains to be used as livestock feed. All this requires fertilizers, and that’s where potash and phosphate come in.
TER: Got it. I’ve enjoyed meeting you very much Sid. Thank you for your time today.
At Fundamental Research Corp., Sid Rajeev heads the research department, which covers over 150 small- and micro-cap companies and 15 exempt market/private issues from a broad array of industries including energy, mining, real estate and technology. He also manages the FRC list of Top Picks, which are the stocks under coverage that he has the highest conviction level about. These picks have historically helped the firm finish strong in various third party analyst performance rankings.
Sid holds a bachelor of technology degree in electronics engineering from Cochin University of Science & Technology and an MBA in finance from the University of British Columbia. He is a CFA Charterholder and has completed studies in exploration and prospecting at the British Columbia Institute of Technology.
By The Energy Report, on May 6th, 2011
 With rising global demand for food comes escalating cash flows that enable farmers to purchase additional fertilizers to further boost yields. Dundee Securities Senior Analyst Richard Kelertas follows junior potash explorers that have been red hot for much of the past six months. In this exclusive interview with The Energy Report, Richard shares some names that he believes could develop into bumper-crop multiples for investors.
Companies Mentioned: Agrium Inc. Aguia Resources Ltd. Allana Potash Intrepid Potash, Inc. Karnalyte Resources Inc. Passport Potash Inc. PotashCorp The Mosaic Company
The Energy Report: Are we at the beginning of a global bull market in food, Richard?
Richard Kelertas: Yes. We believe the upward price pressure started after the economic crisis in 2009, and it could remain a substantial bull market until stocks:use ratios (carryover:total use) in most major food stocks—grains, corn, soy beans—can be brought back up to 10-year averages. Currently, the ratios are well below those averages. There doesn’t seem to be any reprieve in sight, unless we have two to three years of bumper harvests in all grains around the world.
TER: Rising food prices usually mean increased demand for fertilizer, but that hasn’t necessarily been the case this time around. Do you believe the share prices of potash equities have exceeded potential growth rates?
RK: No, not at all. In retrospect, 2009 was a tough year for a lot of fertilizer producers. Farmers had to delay applications, even though they started to see crop shortages followed by slowly rising crop prices. We didn’t really see fertilizer-price recovery until 2010. Around March/April, or mid 2010, we started to see a pickup in fertilizer stock prices. It was slow at first and, in some cases, it has been muted; but at the beginning of 2011, it started to surge dramatically. Now it’s come off again on the expectation that all commodity prices, including that of oil, will come off as the global economy slows down (especially in China). But our view is that this is just temporary, and that these stock prices don’t really reflect anywhere near the fertilizer prices we are looking at in 18–24 months. So, these current stock prices are only reflecting mid-cycle, but nothing near peak, prices.
TER: What is the real driver for fertilizer stocks? China, India?
RK: It’s global, definitely global. China kick-started the demand increase by buying corn on a large scale, but it suffered a significant drought in the southern part of the country. That was followed by several crop failures, droughts, weather—you name it—throughout the world in different locations. However, the main driver, going 5–10 years out, is population growth and the increase of the middle class’ diet requirements. That’s the big driver.
TER: What about phosphates versus potash? Will phosphates catch up in the foreseeable future?
RK: Yes, eventually. Not much phosphate supply is coming out over the next 18 months, so it’s going to catch up. There’s no doubt about it.
TER: What about global potash and phosphates prices? They are not consistent across the world. Do you see them evening out in time?
RK: Well, it all depends. You could look at history and assume that they will, but governments’ export/import restrictions can have a dramatic effect on regional prices. So, it all depends. I suspect that small regional differences will start to coincide at some point. Prices are lower in China, India, Indonesia and the United States. In another six to nine months, we could see increases in all regions.
TER: Is there an arbitrage opportunity for investors there?
RK: Oh, yes, but not really in stock prices. You’d have to play the futures markets and the actual commodity.
TER: Do you have a price forecast for potash? And, will we ever see $1,000/ton again?
RK: No, we won’t see $1,000/ton. I don’t expect the type of hoarding experienced back in 2007 and 2008 will happen again to the same degree. We certainly will get speculation; but, typically, the amount of cash that’s available, the lending requirements and margin calls are more stringent than they were three years ago. You will probably see one-half of the speculative run-up in potash that we saw back in 2007. This time it is coming from actual supply/demand dynamics, not speculative investors gobbling up contracts. So, $1,000/ton?—I’ll never say never, but I think the next peak we’ll see is probably more in the $700–$750/ton range.
TER: Do you have a timeframe for that?
RK: Yes, about 24 months.
TER: How do you start your due-diligence process on something like a potash stock?
RK: Well, there are two different types of companies—the junior exploration plays, which are predevelopment, and the established producers. The established producers are companies like Agrium Inc. (NYSE:AGU), PotashCorp (TSX:POT; NYSE:POT), The Mosaic Company (NYSE:MOS) and Intrepid Potash, Inc. (NYSE:IPI). The due diligence you have to do on those is pretty basic, and a lot of information is available from published sources on the Internet. So, the amount of research is directly related to the amount of information available—and there’s really not much you can’t find. We sit down with management to go through the numbers, and then tour one or two of the operations. We consider the overall picture on different types of fertilizers to determine if this stock is positioned well and rank it next to its peers.
For junior developers, which are either in pre-exploration or exploration phase, it’s more difficult. We spend a lot of time with the management team, going onsite, talking to the geologist and making sure the resource is there. We also ensure that there are no outside risks—no native land claims or land lease difficulties. We want to make sure a company can secure land and exploration leases over a contiguous area, so it will be smooth sailing when drilling starts.
After that, it depends on how well the company is financed, the quality of its management team and the level of its compliance and its experience in the field. Finally, you have to ask: “What are the barriers to entry for these particular players?” It could be country, infrastructure or any of a whole list of risks. The amount of due diligence you do on the smaller companies is a lot more than you would do on the larger ones.
TER: Do you like to see smaller companies being managed, especially in the field, by people who have come from larger companies?
RK: No, not necessarily. It depends on their experience level. They may have worked and been successful at smaller companies in the past. A lot of the guys who work for larger companies haven’t had to go through the exploration phase—they’ve just gone through the production phase. So, the smaller companies don’t really need an expert in production quite yet—they need exploration experts. That’s where the difference lies.
TER: Do you consider these junior exploration companies you’re following value stories or growth stories?
RK: Well, it’s a combination; but sometimes you don’t have the value yet. Some might be growth stories only because they haven’t yet established the resource. Even if a company hasn’t started drilling yet, we look at the historical holes done 15–20 years ago. And if it shows some good concentrations of potassium chloride (KCL) or phosphorus, we’re happy to follow it along and look at the company as a growth story even though the value hasn’t been established.
TER: How long do you typically follow a company before you initiate coverage?
RK: Well, I spend a lot of time with management and going through the numbers. So, we probably spend two to three months with a company before we initiate coverage.
TER: Where are you finding your desired characteristics now?
RK: Right now, the ones that we spend a lot of time on are Allana Potash (TSX.V:AAA) and Karnalyte Resources Inc. (TSX:KRN). These two companies have tremendous potential for resource expansion, as they’ve done drilling on only a fraction of their properties. Allana is in Ethiopia, and Karnalyte is in Saskatchewan.
Another one that we’re looking at is Passport Potash Inc. (TSX.V:PPI, OTCQX:PPRTF) in Arizona near Holbrook. It has a lot of potential based on exploration work conducted there about 25 years ago. Passport’s management team has done a lot of advance work, and drilling is just starting now. But the history indicates, to us, that there will be some fairly large deposits.
We’re looking at another one called Aguia Resources Ltd. (ASX:AGR), which is a Brazilian phosphorus and potash play—a combination play which is fairly unique. We’re doing more work on it, but we think it’s going to an interesting value-and-growth story there also.
TER: The first two you mentioned, Allana and Karnalyte, seem to have a tremendous sense of urgency. Drilling is faster than expected.
RK: Right.
TER: Allana has 105 million tons (Mt.) potassium chloride in the inferred category. Ultimately, how large could this resource be?
RK: The company is looking at the first 11 drill holes and some of the 3-D seismic data, but it has not made anything public yet. The NI 43-101 will be out in mid May. From our experience, we believe that we could be looking at 500 million to 1 billion tons of potash—mineable potash.
TER: Let’s just take the low end of that, 500 Mt. of mineable potash. You’ve got a target price of $2.50 here, which represents 50% upside from where Allana is right now. But, at 1 billion tons of mineable potash, where could that take this stock?
RK: Well, if you put the sensitivity on the mineable potash, it could take AAA’s price well over $10–$12/share quite easily. It depends on the grade; so, there are a lot of ‘ifs.’ That’s why we make a sensitivity table, just to get an idea. If the grade is about 35%, which seems to be the case with the last four or five drill holes, it could be a 25% average grade. That would take us north of $10/share.
TER: Well, grades seem to be high, so far, from what I’ve seen.
RK: Very, very high—and Allana can do open-pit mining.
TER: There are some near-term catalysts; do you believe these catalysts are priced in or discounted to the stock?
RK: No, not at all. But I would say that many unanswered questions remain. There are still some risks and issues having to do with the country, location, infrastructure and things of that nature. There’s also a continuing view that commodity prices, potentially, have topped off here for the short term. We’ll probably see other commodities pull back; but, essentially, the farmer is sitting with lots of money in his pocket and is starting to apply more fertilizer.
TER: Karnalyte was the second company you mentioned, I noted that it was up just 2% over the last three months while Allana was up 79%. Does that give an investor something of a relative-value play here in Karnalyte?
RK: Yes; but, you also have to remember that Karnalyte surged from $8–$13 very quickly after its IPO. So, it put on a lot of its capital appreciation early in the process. Right now, the resource is based on just 7% of its total land holdings. The CEO thinks that the potash deposit is extremely contiguous, very deep and very large. So, if you extrapolate to 100% of Karnalyte’s property and add its newly added exploration rights, you’ll start to see the stock catch up.
TER: Ok, you have a $20 target price on Karnalyte. That’s an implied 60% upside from where KRN is now.
RK: Correct.
TER: And, the next catalyst could move it to there?
RK: Well, I don’t know if it’ll move it to there. It may take a couple more catalysts to get it there. But that’s my 12-month target, and I have no doubt that KRN will blow through that number.
TER: What is your target on Passport Potash?
RK: I don’t have a target yet. The company hasn’t made any resource information public, at least not to the extent that we can infer a net asset value (NAV); but that information will be out shortly. Passport is working on its NI 43-101 now, which will be ready by June. The company’s drilling as we speak and will release its first drill results in the next couple of weeks. Then, after two or three holes, we’ll be able to come out with a valuation.
TER: You mentioned Aguia. Is it formally under your coverage?
RK: Not yet. Like Passport, it’s an item of interest. We will be getting drill results from the company over the next couple of months.
TER: Richard, thank you and best wishes.
RK: Best wishes. Thank you very much.
Richard Kelertas has 25 years experience as a research analyst covering the forest products sector. He has been one of the top-ranked analysts in the sector over the years consistently, and was most recently ranked No. 1 by Brendan Woods. Richard has worked for a number of well-known brokerage firms, including Scotia McLeod, Deutsche Morgan Grenfell, UBS Warburg, and Desjardins Securities. He has a bachelor’s degree in forestry and a master’s degree in forestry and economics from the University of Toronto. Richard is also a Registered Professional Forester.
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