Monthly Archives: April 2012

UK shale gas industry set to boom – how to profit from it

The UK's energy future?

As I wrote a couple of weeks ago, the US is benefiting from a booming shale gas industry. So much has been invested in the drilling of shale that the US now faces a glut of natural gas and depressed prices. But if we were to look at the other side of the Atlantic, the UK has barely touched its shale resources. There are two main visible players in Britain, and those are Cuadrilla Resources and IGas – but IGas is the only one publicly traded.

Recently IGas upped its estimates of recoverable shale gas at their Ince Marshes site to 10TCF (Trillion Cubic Feet). To put that in perspective, the UK uses 3.3TCF every year (Source: NoHotAir). That means that IGas owns fields which have the potential to power the UK’s gas needs for 3 years. No North Sea resources, no tankers coming from dodgy Middle-East states, no pipelines from Norway… for 3 years!

My question then was: why is this company only trading at roughly £100M?

My first thoughts were the controversy surrounding shale drilling and the misunderstandings about it. Will nimbyism and local politics get in the way? Concerns were raised about earthquakes caused by fracking operations near Blackpool and the government had suspended Cuadrilla’s drilling, pending an investigation. That DECC investigation last week concluded that Cuadrilla should continue, so this bodes well for IGas’ holdings.

Secondly I wondered if that because it is a small company and barely discussed in the newspapers… it has garnered little attention. Its low market capitalisation could be due to this.

Thirdly, I wondered whether the fact that they are not planning to develop their shale gas resources was weighing on its valuation. Instead of drilling themselves, IGas announced that they would be looking for partners to exploit the gas for them.

After attempting to contact the CEO this morning, I was sent towards their PR department who told me very little beyond what I already knew. Except that the woman who I spoke to implied that they would be looking to sell their shale gas acreage, as opposed to other options.

According to their recent investor report IGas own 384,249 acres. In the US, where commercial production has taken off, transactions in 2010/11 valued each acre at $7,468 (according to the same report). Now correct me on my back of the envelope maths, but that makes an estimate of their shale assets worth $2.9 billion or £1.76 billion at today’s exchange rates. Even if only a fraction of those assets are retrievable, exploitable and sellable – IGas’ share price should be a multiple of where it is today.

What also gave me faith in the company is the fact that its management own a significant portion of it. Francis Gugen, the chairman, owns 17.03% of the company, whilst Andrew Austin, the CEO, owns 6.57%. Those two will know more about the company than any freelance researcher like myself can find out – so that should be a strong signal to buy in.

Significant Shareholders (Source: IGas website) No of Shares Percent
NEXEN 39,714,290 24.48%
FRANCIS GUGEN (Chairman) 27,615,764 17.03%
BRENT CHESHIRE 11,429,253 7.05%
ANDREW AUSTIN (CEO) 10,659,253 6.57%
BAILLIE GIFFORD 8,088,217 4.99%

The only risks I do see are political obstacles. Many people are uninformed about the risks and unaware of the potential which shale gas holds in the UK.

But the way I see it – the market is not expecting IGas to make much money from shale. Once they do make an announcement, however, regarding a shale drilling partner or selling off land parcels – we will see the company’s valuation reflect this.

All in all, the company owns shale gas fields which may be worth several times more its current market value. As the company appears to have had minimal attention paid to it, it is trading at low prices and furthermore the management have put several million pounds of their own money into the business. Although there are risks, the company does have a strong portfolio of CBM (Coal Bed Methane) and oil assets which limits the potential downside. This is a strong buy, if ever I saw one.


Posted by on April 30, 2012 in Trading Ideas


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How democracy will triumph over the EU – and take down the Euro with it

"Madame Merkel, 'ave your fiskalpact et la France will 'ave zees baguettes!"

As I write, voters in France are casting their ballot papers in the first round of the presidential elections. Francois Hollande’s Partie Socialiste and Sarkozy’s right-wing UMP party are expected to proceed to the second round, where many predict that Hollande will win. What this means is that Sarkozy, who has been a bastion of saving the Euro with a big bazooka, or a firewall, (or perhaps his stool) – will be out of office. Instead, Hollande will be in power and he wants to renegotiate the Fiskalpact that Merkel and the EU have imposed on the Eurozone.

Hollande wants the agreement to have more focus on growth and jobs, as opposed to cutting budget deficits and national debt. This could raise hackles in Germany and Brussels, as George Magnus of UBS notes (quoted from Zerohedge)

If Hollande, as leader of the Eurozone’s second economy, were to try and stand up to the German government, he would not only feel he had a popular mandate to do so, but doubtless act as a lightning rod for a wave of sympathy and Euro-angst from other Eurozone countries, such as Italy, which are becoming increasingly worried about the character and consequences of the current German-dominated approach to the Eurosystem crisis.

This “German-dominated approach” which Magnus talks about, involves bailing out the “fiscally-irresponsible” countries and then impose swinging austerity on them – at whatever cost. But since this is not easy to do in a democratic country – the EU has implanted their ‘technocrats’ to enforce the fiskalpact.

In Athens riots are almost a daily occurrence, unemployment is over 50% among young people, and at 22% among the overall population, according to official (and probably untrustworthy) figures – I suspect it is much higher. The Bank of Greece scandalously embezzled funds from universities and hospitals to pay off the Eurocrats. In Italy, Burlesconi was ousted to make way for Monti and the EU elites are putting pressure on Spain. The EU is forcing these countries to destroy their economies with austerity – with non-elected rulers.

The contempt held towards its citizens by the EU has led to the rise of popularist, nationalist parties. If we look towards Greece, the main parties are struggling to hold power in the upcoming elections, whilst fringe parties are garnering votes. Rajoy in Spain is trying to insist that his country will not need a bailout because he does not want to suggest Greek-style austerity. Even in Germany, where Merkel is not up for re-election until next October, her political support is slipping because many Germans do not want to throw good money after bad to the European periphery.

The question is: how much longer can this continue? The EU was established to prevent another war in Europe, but its actions seem to do little but provoke one.

The Eurozone’s underlying problem is its currency. In the past if a country was struggling it would devalue its currency, exports would become cheaper, imports would become dearer and the domestic economy would naturally recover. However, the Euro puts a straight jacket on these economically challenged countries because  fixed currency rates prevent them from devaluation. If the likes of Italy and Greece want their economies to recover, then they will need free-floating exchange rates, not austerity.

National politicians will realise this in due course, once the pressure from their people becomes too great. Once one country sets a precedent about leaving the Euro, or attacking the EU, then others will quickly follow. Hollande may be the start of it – maybe he won’t be. Greek elections in the next fortnight may be the catalyst, where the likely result is an eclectic mix of parties opposing austerity, maybe they won’t be. But however you look at the Eurozone crisis, democracy has to triumph over the EU, and consequently rip the Euro to shreds.

To trade on this, I would get out of stocks (and short-sell them) right now, and buy German Bunds and gold. The equity markets have recently undergone a rally – totally ignoring the fact that the West is in a dire economic state – reality will reassert itself soon enough. Shorting the FTSE 100, I would put a stop loss at 6000, I think there is a good risk/reward ratio there, and I do not expect it to reach that state.

German Bunds are not a perfect hedge, as a Euro collapse would lead to the Germans accepting a large part of the ECB’s losses. However, if you are a Eurozone bank, the safest place to park your money is in German bonds as their budget is fairly balanced, and if the Euro broke up your bonds would become denominated in New Deutsche Marks – which would appreciate greatly against other currencies. So I would recommend buying these for their safe haven status.

As for gold, if the world does go into an Armageddon type scenario due to Europe, gold will be one of the few safe places for your money. It has been trading in a fairly cheap range by recent standards and I expect it to climb much further. I would put a stop at $1600 an ounce if I were trading today.

I currently hold all three positions, and got into them at an earlier stage. Since then, all three positions have been profitable.

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Posted by on April 22, 2012 in Trading Ideas


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America’s Natural Gas Glut – Opportunities ahead?

Source: US EIA

You may not be aware already but in the United States, over the past three years a huge glut of natural gas has emerged. Improvements in ‘fracking’ technology have allowed companies to exploit shale gas fields which were previously considered uneconomical – since then natural gas production has boomed. Every producer was expecting to get rich but that has lead to the US overproducing natural gas, and prices are at a 13 year low.

As The Oil Drum points out

U.S. shale plays share many characteristics with the gold rushes of the nineteenth and early twentieth centuries. Both phenomena result from extreme promotion. Anyone can join. Every participant believes that they will get rich. Great amounts of capital are destroyed as entrants try to get a position. The bonanza is exhausted sooner than most expected (Andreoli, 2011) and few profit in the end except for the vendors that serve participants.

They conclude

The gold rush mentality taken by companies to enter shale plays has added expensive leases and new pipelines to those costs, further complicating shale gas economics.

Looking forward, however, natural gas prices are not going stay at these low levels..

US Active Rigs - Source: US EIA

On the supply-side, due to the aforementioned gold-rush mentality, many natural gas producers paid very highly for their land leases. At the current price of roughly $2 per million British Thermal Units, energy companies are making a loss on their gas projects. Basic economics dictate that loss-making businesses close down, and this is what we are seeing.  The number of active rigs in the US has fallen from roughly 1,000 in 2010, to approximately 600 today.

Equally on the demand-side of the equation, structural changes are taking place. For instance, many power plants are switching from coal to gas (due to the low price of gas, and environmental legislation discouraging coal). Several new cars are being fitted with engines which run on CNG (Compressed Natural Gas), and petrol stations are adding CNG to their pumps. For these two infrastructural changes to take place however, they will take time to implement and it is difficult to predict the long-term impact of these changes.

Source: Valero Corp conference March '12

What I have discussed so far however only covers the US domestic issues. If we were to take our scope further afield, we would see that elsewhere in the world there are natural gas shortages. In Europe, gas is trading at 4x the US price and in Asia, as much as 6x. So surely this is a enormous arbitrage opportunity, US prices should rise and prices outside the US should fall. So why is that not happening already?

As I found out, the US has a substantial LNG (Liquified Natural Gas) import capacity, but very limited export capacity. So regardless of that huge price differential, no one can take advantage of it. Naturally, companies have clocked onto this and have been pushing to create LNG export terminals. Cheniere Energy earlier this week were granted the rights to create one. Nevertheless, gas cannot be expected to leave the US from the terminal until late 2015. As for other terminal projects, the US government will not give the go-ahead until a study into the price impact on consumers from exporting gas, has been completed later this year. Even then, it will still be at two or three years before the projects start operating.

To summarise, US natural gas prices are expected to stay low for at least a couple of years, but perhaps rise somewhat in the medium term. Until more demand comes on tap through gas-powered cars, gas power stations and arbitrage with the world, demand will stay fairly constant and in the meantime, supply is tailing off because producers are making losses.

In terms of trading, I would buy natural gas futures because this current price cannot be sustained with producers losing money. But I do not want to be picking a bottom in the market yet, and also risk losing money through contango, not to mention that my broker has a 43 tick spread on Natural Gas as well. I think there must be good opportunities with energy-related equities and I plan to investigate in the coming weeks.

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Posted by on April 18, 2012 in Trading Ideas


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Fleeing a sinking ship – Santander

Soon to be torched

The tale of Abbey National is the archetype of what happened to Britain’s building societies. It demutualised in 1989, resulting a windfall payout of shares to all its members – Abbey was one of the first, and then many other building societies followed suit. Both of my parents received some free shares before buying a few more.

The Abbey National later merged with Santander in 2004 and their shares were converted into those of Banco Santander. It weathered the storm of 2007/8 reasonably well, and its management has had the wisdom to strengthen its balance sheet over the more benign past 2 or 3 years. Their core capital ratio (a barometer of the health of a bank’s balance sheet) increased from 6.2% in 2007 to 9.2% in 2011. Equally the bank made over 40 billion euros in that period and also acquired several ailing banks like Alliance & Leicester and Bradford & Bingley.

Faced with the the unraveling of the Euro and economic problems, however, Santander is in serious danger. According to their Q3 2011 report (the most recent I can find) 37% of their €734 billion loan portfolio is in Eurozone countries (26% Spain, 4% Portugal, 7% others) with another 29% in the UK (which would suffer badly from a Eurozone recession). Backstopping the bank is €78.3 billion of assets, but with loan writedowns on the cards, Santander is in trouble.

Relative to its European banking rivals, Santander is the best of a bad bunch. But with the upcoming shocks of recessions, falling house prices and losses from a Euro break-up – it is not something you would want to own.

So a couple of weeks ago I advised my parents to sell out. They both saw their shares as a long term investment, and over the years have received many small dividends. But after explaining the issues Santander faced to them, they agreed that they ought to get out. They hadn’t got around to it until Friday, when Dad got out at £4.16 a share at lunchtime and my Mum sold her’s in the afternoon for £4.10. At the close of play they were trading at £4.06.

The Titanic sank 100 years ago today, and I think that there is a rather ironic parallel between that liner and these shares. Santander’s shares will probably tick up tomorrow, with a typical “dead-cat-bounce”, but I would expect that we have got on the lifeboats, before everyone realises the severity of iceberg ahead.

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Posted by on April 15, 2012 in Trading Ideas


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