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Harry Koza

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Call me Moloch

Harry Koza


Moloch whose love is endless oil and stone! Moloch whose soul is electricity and banks!

— Allen Ginsberg, Howl, Collected Poems 1947-1980

Oil is like a wild animal. Whoever captures it has it.

— J. Paul Getty, quoted by Robert Lenzner, The Great Getty

In one way, an oil boom is a mighty bad thing, because it gets into your blood and almost becomes an obsession. Booms are filled with excitement, adventure, and drama, but sometimes the exit from the scene must be made between suns on a pair of mighty weary feet

— Sue Sanders, U.S. oil producer, Our Common Herd (1940)

TORONTO (GlobeinvestorGOLD) — Back in my days in the “awl bidness,” where I earned the unfortunate sobriquet “Dry-Hole Harry,” I often felt frustrated by the strange Canadian notion that being a nation of hewers of wood and drawers of water, a nation of drillers and miners and fishermen, was somehow something to be ashamed of, that if only we were a nation of car and aerospace and shoe manufacturers, we would somehow have reason to be proud of ourselves.

Oddly enough, back then, you never seemed to see Saudi Arabian Oil Minister Sheikh Yamani wringing his hands and moaning about having the world’s largest oil reserves while wishing fervently that his country’s economy could somehow instead be based on manufacturing running shoes.

Because of our National Identity Deficit Disorder, we always had — or at least our ruling elites did — the philosophy that extraction of natural resources was something to be ashamed of, a necessary evil, tolerated only as a means to generate the capital to build the mansions in Rosedale and Mount Royal and Rockcliffe Park. It wasn’t anything that modern people did, it was a holdover from our colourful post-colonial past, like fur trading or building railroads.

This may go some way to explaining the perverse treatment of our extractive industries by government for so many years, while so many billions were frittered away on subsidies to failing businesses, or to build “national champions,” in whatever industry was favoured by the government of the day (Bombardier Inc. and Nortel Networks Corp., for instance). Once the 1970s oil shocks rolled around, of course, and oil suddenly became valuable again, we had to have a national champion in the oil patch, too — which led to Petro-Canada and the National Energy Pogrom, er, program (the NEP being little more than a strategy by Ottawa for capturing the economic rent generated by soaring oil prices, in order to delay the inevitable need to put its fiscal house in order, but I digress).

Now oil is hot again. In real terms, adjusted for inflation, oil at $50 (U.S.) a barrel today is still cheaper than it was at $30 back in the 1970s, although oil prices have been hanging in for a long time now above $40, compared with the sharp but short price spikes in the 1970s. Besides which, I subscribe to the theory that official oil reserves in the Middle East are generously inflated. Back in the mid-1980s, OPEC switched from calculating production quotas based on lifting capacity, to calculating them based on “official” reserves.

Miraculously, official OPEC reserves overnight increased by orders of magnitude. Abu Dhabi’s reported reserves, for example, tripled between 1987 and 1988 (from 31.0 Giga-bbl to 92.2 Giga-bbl). They’ve been pumping full-tilt ever since, and I wonder if anyone’s ever bothered to check the dipstick? OPEC made noises this week about not increasing output despite the high prices, which sounds to me like they just don’t have the excess capacity to crank out much more. With oil likely to continue trading above $40, there is still mucho dinero to be made in the oil patch. And nowadays, Canada — counting the Athabasca Tar Sands — has bigger oil reserves than Saudi Arabia, which the world is rapidly beginning to appreciate, even if Ottawa would still rather pump money into bird Cuisinarts (wind-power projects, as they are more commonly known).

Oil and gas income trusts have had a helluva run on the market for several years now. Pop up a chart of just about any one of them, and it looks like David Suzuki’s famous climate hockey stick graph. I’ve been solidly in the sector since I read a story in Wired back in 1999 or so about these giant server farms in California that used so much power (and California’s electrical system was so Ontario Hydrolyzed) that they were building their own gas-fired co-generation plants to assure themselves of a secure, steady power supply. Natural gas, I told myself, is the fuel of the new millennium. Forget tech stocks: buy oil and gas. Which I did — I loaded up on oil and gas trusts and electric power trusts, and E & P (exploration and production) companies, most of which I still own — and it has worked out very well for my portfolio indeed.

My main problem now is that most of the energy trusts aren’t yielding nearly enough to get me excited about buying them at current high levels. I’m happy enough with ones I bought back when they were trading at nine or 10 bucks and yielding 15 or 16 per cent, and which are now trading at $20 or $25, but I can’t get too excited about buying more at current yields. And I recently read a very bearish research report about oil and gas trusts that suggests that many of them will be forced to cut distributions over the next few years, even if oil prices stay at current levels, which will cause way more price volatility than I’m comfortable with.

With the RRSP seasonal rush for yield, there’s been a ton of cash flooding into trusts, and hopefully they’ll pull back a touch after the first of March, brining better buying opportunities. I’ve been trimming back my energy trust holdings, taking some profits and raising some cash. I still hold eight oil and gas trusts, including Canadian Oil Sands Trust, which I bought at $32 and plan to leave to my grandchildren’s children. You can still find some attractive yields on some of the oil and gas trusts: just remember the mantra — long reserve life, conservative payout ratio, large land positions, and good stability ratings.

I’ve been shifting out of oil and gas trusts into oil and gas services trusts such as Keyera Facilities Income Fund, Pembina Pipeline Income Fund, Trinidad Energy Services, Enbridge Income Fund, Inter Pipeline Fund, Fort Chicago Energy Partners, CCS Income Trust (again, I’ve had this one since $15, when it yielded 15 per cent: at today’s price of $24.50 [4.78 per cent], a 10-year Ontario bond looks almost as attractive at 4.67 per cent).

I made a nice pass last year on Esprit Energy Trust, which I bought at $2.60 a share, when it converted itself into an energy trust, spinning off an exploration and production company and a cash dividend of about 10 per cent on my cost. That has suggested a good alternative to high-priced oil and gas trusts: smaller E & P companies with good growth potential (some are also possible trust conversion candidates). Recently I’ve bought UTS Energy Corp. (the budget priced oil sands project. It’s up 83 per cent since I bought it).

I also like Burmis Energy Inc., which is up about 25 per cent since I bought it a few weeks ago. Being an inveterate reader of company press releases on the Canada Newswire and CCN Matthews services, I happened to note that they had completed a half-dozen successful wells so far in Q1 that hadn’t been hooked up to production facilities yet, had another half dozen awaiting completion, and plans to drill eight more. Last week, the company announced the results of its annual independent reserve evaluation. The good news: during 2004, Burmis increased gross proved and probable reserves by 110 per cent to 3.31 million barrels of oil equivalent compared with 1.58 million barrels of oil equivalent a year earlier.

Recently, Burmis announced it was going to raise $8.1-million (Canadian) via a bought-deal private placement of 3 million shares. The stock rose 11.5 per cent to $3.15.

Now, I figure there must be other small, fast-growing E & P companies like Burmis out there, with good management and a high drill-success ratio, and I plan to look for some more.

I also like UTS. It’s a pure oil-sands play, and I figure it can go from the $2.16 range to $4.32 a lot easier than Canadian Oil Sands can go from $82 to $164.

As always when buying a junior, I never put more into any one stock than I am prepared to kiss goodbye. That way, if one of my stocks goes Chernobyl like Nortel or Bombardier, I won’t have to get a second job at Wal-Mart. It also frees up a lot of time: if I had a big position, I’d be watching the tape all day and fretting constantly. I’ve also recently bought Midnight Oil Exploration Ltd. and Breaker Energy Ltd., and continue to hold ProspEx Resources Ltd., the spin-off from Esprit Explorations’ trust conversion. (All up nicely since I bought them, too.)

As for trusts, I still own 11 electric power trusts, and 13 “other” trusts — including Labrador Iron Ore Royalty Trust, which I bought a few years ago around $15 (it’s now $27) because it had an attractive yield, long reserve life, and might be the subject of a takeover bid. It’s been a steady cash cow ever since, and last week the price of iron ore shot up by 71 per cent. As well, there’s starting to be talk in the financial press about Rio Tinto PLC taking them over again. The current yield isn’t so hot, though, at only 3.51 per cent, so it’s not the greatest if you’re looking for income.

And here are a couple of oil and gas trusts that I’m thinking of buying. I already bought (as I wrote this) a little Harvest Energy Trust. It has a reserve life of eight years, a little short perhaps, but it is forecast to increase to 9.2 years in 2005 and 9.3 years in 2006. Harvest had a low payout ratio of 46 per cent in 2004 (72 per cent adjusted for capital expenditures), and that is expected to increase to 54 per cent in 2005 (83 per cent adjusted), still very low. The trust also plans a 25-cent-a-unit extra payment to be made to shareholders of record March 31. It should pay distributions of $2.70 in 2005, for a cash yield of about 10.9 per cent.

I also like (though I haven’t bought it yet) Ketch Resources Trust. Ketch has a low 68-per-cent payout ratio, and offsets a low reserve life of only 5.5 years with a huge land position offering lots of exploration potential. It yields about 10.2 per cent. A more risky play, perhaps, given the short reserve life, but there could be pretty good upside. I must admit that the main reason I haven’t pulled the trigger is that I almost bought the stock at much, much lower levels back before it became a trust (shoulda, coulda, woulda) and I’m having some lingering sticker shock at current levels ($15 range).

And I’ve been picking away at TransAlta Corp. TA just brought its Genesee 3 coal-fired generator on-line in Alberta, which, through the use of state-of-the-art pollution abatement technologies, is said to be as clean as gas-fired cogeneration. The stock has been getting beat up a bit on concerns over how the (mostly) coal generator will meet the Kyoto requirements — assuming, of course, that Ottawa ever manages to figure out what they might be. At current prices, TA has an attractive 5.6 per cent dividend yield.

And finally, I’ve been looking to buy miners and metal-bangers on pullbacks. I bought some Alcan Inc. down around $45 a few weeks back when it gapped down one morning: it has since traded around $49, and I fully expect it to eventually fill the gap back up to $58.

So, all in all, Allen Ginsberg be damned, you can just call me Moloch. Endless oil and stone? It works for me.

Harry Koza is Senior Analyst in Canadian markets for Thomson Financial/IFR. At various times in his career, Mr. Koza has been a prospector, metallurgist, project manager, engineer, as well as an institutional bond salesman for 15 years. His current area of expertise is in high-yield distressed securities and corporate bonds in general.

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