The Energy Report: The year started with a very volatile
Chinese stock market. Are we in crisis mode?
Chen Lin: That was actually mostly related to the Chinese currency.
Every Chinese citizen is "entitled" to exchange $50,000 per year.
At the end of last year and the beginning of this year, people rushed to use
their quotas. I heard reports that the banks were crowded, the website was
too busy, and people couldn't get their exchanges completed in time to catch
the trend before it went down further. Yes, there was a little bit of panic
in China that likely led to the stock market drop. Also, you need money to
exchange for the U.S. dollar, so some investors may have sold stock. All this
led to a very volatile Chinese market.
Are we in a crisis mode? That's hard to say. It's really up to the Chinese
government and how it handles this situation. Right now, my view is as long
as the Chinese renminbi goes down in an orderly fashion, we should view it as
a positive for the rest of the world.
China is in the very same situation Japan was in the early 1990s. There is
a housing bubble and overcapacity. It took Japan about 20 years to slowly
deflate its bubble. China probably needs to go through the same process. The
only thing going for China is that the Chinese renminbi is depreciating.
Japan didn't have that luxury. Japan's currency was appreciating when the
bubble deflated, and it actually made it much worse. As I said, as long as
it's orderly, it should be helpful for everybody.
TER: Let's talk about the impact on some of the commodities. You
recently shared with your readers an upward-climbing Chinese industrial
lithium price chart. Do you still believe that China's prices will lead to
stimulus activity that will further boost lithium prices?
CL: I believe there will be more stimulus coming. Rumor is that
China's president, Xi Jinping, wants to be the Reagan of the East. He's going
to work on the supply side. There will be a huge deficit in spending coming
this year and reduced taxes, supposedly. Hopefully, he stimulates free
enterprise. We will see.
One of the most burning issues when you talk to Chinese citizens is
pollution. How do you reduce pollution? Electric cars are probably the only
logical solution and the government could focus on that as an area for
stimulus. Even today, lithium production cannot meet the demand. If more
demand for lithium batteries is created, the supply problem could get much
worse.
TER: There are two types of lithium. We talked about the industrial
lithium, but how about battery-grade lithium? Is there even more upside for
that in China and the U.S.?
CL: The spot price in China for battery-grade lithium already
jumped, even with the weakness of the Chinese yuan. If you put it back in
U.S. dollars, it quadrupled in a few weeks. It's a classic supply/demand
imbalance issue. Industrial lithium didn't go up as much, but it has more
than doubled. So it's still very strong. For those companies that can sell
lithium at the spot price, their margin probably will lift to $10,000/ton or
more. That is dramatic. Lithium has been trading around $6,000/ton for many
years, and suddenly it quadrupled. Many of these lithium miners and producers
are producing for costs of something like $5,000/ton. That means if their
margin was $1,000/ton before, suddenly it becomes $10,000/ton or more. It's a
dramatic increase.
TER: Is the imbalance coming more from the demand side-the need for
lithium for electric car batteries-or the supply side-due to the shutdowns of
some of the mines in Chile and changes in seller policies?
CL: It's both. There was flooding in Chile, so brine mines there
had some interruptions. New mines have been having difficulty starting up.
The breaking point was when FMC Lithium
Corp. (FMC:NYSE), one of the top three lithium producers, announced an
increase in the lithium price by 15% in September. Other lithium producers,
namely Albemarle
Corp. (ALB:NYSE), refused to sell the cheap lithium anymore, and instead
paid a small cut to have the lithium processed and kept the profits. The
whole market changed dramatically in the past few months.
TER: If prices continue to go up, are auto manufacturers going to
find an alternative? Is there a demand-destruction challenge looming?
CL: No other technology is as compelling as lithium. Plus, the
lithium itself is only 2% of the cost of manufacturing lithium batteries.
Even if lithium prices go up tenfold, it will only increase the input cost
from 2% to 20%. Battery users have to absorb it because there's no other
alternative. That is why lithium producers are in happy land. Even if it's
triple or quadruple, it's very, very profitable. However, there are other
products such as lubricants and paint where some demand destruction is a
concern.
Eventually, the market will find equilibrium so we have enough lithium for
all uses. As you know, it takes a few years to build a new mine. Until then,
we may have to pay a little bit more.
TER: Some of the biggest lithium producers are polymetallic
conglomerates. Can rising lithium prices make a difference in the bottom
lines of these companies?
CL: The lithium part of their business will change dramatically.
Albemarle, the largest lithium producer in the world, is also a chemical
producer. Lithium is about 15% of its revenue. But if the margin on that 15%
revenue suddenly increases by a few hundred percent, you can see it will
impact the bottom line, though it won't be as big as for pure lithium
players.
TER: What are some of the pure lithium players you're watching?
CL: There are many pure lithium players. I'm trying to cherry-pick
after watching the recent mining crash. I try to pick either producers or
very near-term producers with financing already lined up, so they don't need
to come back to the market over and over again and dilute shareholders. I own
Orocobre
Ltd. (ORL:TSX; ORE:ASX) and Western
Lithium USA Corp. (WLC:TSX; WLCDF:OTCQX).
TER: Orocobre just opened a mine in Argentina with help from Toyota
Tsusho Group (TYHOF:OTCPK). Are you worried about political problems in that
country?
CL: Argentina has a new president, Mauricio Macri, who removed
repatriation rules so companies can ship money out of Argentina freely again.
He removed the 5% tax on lithium exports as well. The new government seems to
be quite pro-business. That is why it s a perfect opportunity for Orocobre to
ramp up production. Orocobre has been ramping up production in the past year
at what could be one of the largest lithium mines on earth, but it has been
quite slow. The slowness of this ramp-up actually contributed to the current
lithium shortage.
TER: Will the company be able to raise money in this market for
operating capital? When will it be profitable?
CL: Orocobre was saying it planned to break even in December. It
just announced that the break-even is delayed to January 2016 due to some
technical issues. Some of its production has already pre-sold, but if the
company can sell some on the spot market, it could be very profitable.
Orocobre has a history of raising money every year. If it reaches breakeven
and starts generating cash flow, I see that the company has a very great
future. Remember, in a recent transaction, Albemarle bought Rockwood Holdings
Inc. (ROC:NYSE) for over $6 billion. That's one of the largest lithium
producers on earth. This can be one of the largest lithium mines on earth.
Its market cap is less than 10% of that. If this mine goes into production
and everything is on track, its upside is huge.
TER: How soon could Western Lithium be in production in Argentina
and Nevada?
CL: It has the Argentina mine shovel-ready. It is finalizing
financing with a Korean partner that has already committed to providing 100%
financing for the mine and the production. The recent rise in the lithium
price probably gave the Koreans more urgency to start the lithium mine as
soon as possible because, unlike China, Korea cannot produce any lithium. All
its lithium has to be imported, so it was probably hurt the most from the
recent lithium squeeze. That means Western Lithium is in a very good position
to negotiate the best terms, enabling it to move into production as soon as
next year, 2017.
TER: What about Western Lithium's Nevada project? What is holding
that up?
CL: That one is two to three years behind the Argentina one. The
company is probably focused right now on getting Argentina into production,
and then it will focus on Nevada again. It's a little bit behind, but again,
it's a nice property and it's in the same state as the new Tesla Motors Inc.
(TSLA:NASDAQ) battery gigafactory. Tesla last year was looking for partners
to supply lithium for its gigafactory. It already signed some memos of
understanding with a number of companies, including Pure Energy Minerals Ltd.
(PE:TSX.V). I wouldn't be surprised if Tesla is interested in this property
as well.
TER: Do you also own Texas Rare
Earth Resources Corp. (TRER:OTCQX)? It has lithium.
CL: Texas Rare Earth is a very interesting company. It has almost
everything. It has uranium and rare earths. It's located in a very good place
in Texas. It's easy to get permits. It's on the mountain. The strip ratio is
zero. It can heap leach. It's a property that eventually will shine. But in
this market, nobody cares and the share price is very low. One day, it will
show the value. It's just a little further away from production.
TER: You recently released your 2016 outlook. How can you be
excited about the oil and gas space when experts are predicting $20/barrel
($20/bbl) oil?
CL: As an energy investor, frankly I love to ride the boom and bust
of the cycle. Twenty-dollar oil actually is a dream situation for energy
investors because it is not sustainable unless the world is really going into
a very deep recession and we don't need to drive our cars and there's no need
for energy. What $20/bbl oil will do is kill the U.S. fracking industry.
That's a 9 million barrel per year industry that will be gone. It may not
take a year. It may take a few years. But nobody will be drilling, and all
the wells will decline and it will be gone.
In the commodity business, the lower you go, the higher you bounce. So
commodity investors want to see it go as low as it can to really push the
boundary, and then you will have a very pleasant ride on the upside.
TER: You have written about taking advantage of opportunities
opening up with the legalization of exporting U.S. petroleum products,
particularly natural gas. How big of a game changer is that?
CL: Exports of U.S. petroleum products, both oil and gas, are
negative for refiners. Refiners are taking advantage of cheap oil and cheap
gas in the U.S., so opening up exports is hurting them. I shorted a few
refiners last year, with limited success. Some did very well. Some I didn't
sell fast enough for a profit, so I got caught a little bit. That was my
thesis, to short refiners.
TER: What about select stocks that could do well in a situation
where natural gas sells for a lot more in other countries than in the U.S.?
CL: It is very expensive to ship natural gas overseas. You need to
liquefy it, use a special boat and then de-liquefy it, so the cost is over
$4/thousand cubic feet ($4/Mcf). That actually supports a $6/Mcf natural gas price
in any area where there's a natural gas shortage. That is why I am focusing
on three companies in high natural gas price areas.
One is Canacol Energy Ltd. (CNE:TSX; CNNEF:OTCQX) in Colombia.
Colombia has a natural gas shortage. It actually asked Venezuela for gas, but
that country doesn't have the capital to export. So Colombia is short. It is
an extreme situation. In the meantime, Canacol is starting its new natural
gas pipeline in the next few weeks. So it can quadruple its natural gas
production and can sell the gas for $5-6/Mcf. Its cost is only about $1/Mcf.
So that's a dream situation because nobody on earth is making money these
days at the current energy price, but this company can make a killing. The
company can generate a lot of cash flow and use the money to pay back loans
and/or buy a company out of bankruptcy. Last year, it bought bankrupt Orinoco
energy assets for a penny on the dollar.
Pan
Orient Energy Corp. (POE:TSX.V) is another company with a unique
situation. It is trading at below cash. It is going to pay a dividend very
soon, in a month or so, a $0.40/share dividend, which is very nice. After
that, it is still trading at below cash. So it's a company with very limited
downside. It is selling its business piece by piece. It recently just let go
of its chief operating officer to further cut costs. It has properties in
Canada, Thailand and Indonesia. If I'm right, by the end of 2016, most of its
properties will be gone, and the company will have even more cash to
distribute back to its shareholders.
In the meantime, Pan Orient's partner, Talisman
Energy Inc. (TLM:TSX), is going to drill a very high-impact well in
Indonesia. It is going to be fully paid for by Talisman for the first $10
million ($10M), which covers the initial drilling. So even in this market
environment, it still is going to go ahead and drill the well. That's how
exciting it is, even to Talisman. It's a very important well. Currently, it's
not reflected in any way in Pan Orient's stock price, and it's a free option.
Pan Orient is a company you can hold and collect a dividend from. There is
only one way to go-up. Even in the worst situation, Talisman misses the well,
and everything goes bust. You can see Pan Orient's probably going to
distribute more money than its current market cap.
TER: What's the third one?
CL: The third one is Cub Energy
Inc. (KUB:TSX.V), a tiny company in Ukraine. It's a natural gas company.
Ukraine relies on importing natural gas from Russia, so its natural gas is priced
very high. Recently, the Ukraine government cut the Ukraine royalty almost in
half, so that opened up new opportunities. If you look at Cub's financial
statement, it was cash flow positive even before the royalty cut. In this
environment, Cub will be making a lot of money and it's not priced into the
share price in any way. That's a very good opportunity for the company.
Also, Cub has another opportunity with a private company where Joe Biden's
son's partner is the director. It tried to buy out Cub Energy's partner for
$30M. That was last year, before the royalty cut. My understanding was that
after the royalty cut, the price it paid was too low. It was at least 50%
below the fair value, so it exercised a first right of refusal. We should
know very soon what that means. It may be able to profit handsomely from this
deal.
TER: Are you worried about more conflict in Ukraine?
CL: Yes, I am. I do worry about that, but that's life. Iran and
Saudi Arabia are killing each other. There are a lot of risks in this
business, but the fact that Joe Biden's son's company bought out Cub's
partner for $30M means it sees strong opportunities in Ukraine. Cub's
property has one eastern part and one western part. The western part, which
it owns 100%, is very far away from the conflict zone. The eastern part,
which it owns 30% of, is not. The partner of Joe Biden's son wants to buy the
other 70%. That adds confidence for me to this investment thesis.
TER: Give us some final words of wisdom for investors who might be
a little jittery from the start of the year.
CL: Commodities always go through the boom/bust cycle. Investors in
the commodity business should expect this kind of cycle. It's always like
that. However, each bust creates opportunity for the next boom. Right now,
"commodity" is a bad word because the U.S. dollar is strong. So are
all the mining companies going to go under? Are all the energy companies
going to go under? Are we going to live without any minerals or oil? No.
Obviously, that's not the case.
There is a lot of exploration everywhere in the mining business, a lot of
exploration everywhere in the oil business. Demand will pick up. Lithium is a
perfect example. Lithium has been in the $6,000/ton range for a long time,
and a lot of lithium companies went bust. They tried to start new mines, and
it was too difficult with so little margin. But then the demand overran
supply, and we had lithium quadruple in the spot price in China. That's
similar to copper. Remember, copper was $0.70 a pound ($0.70/lb) for a long
time, and then suddenly it ran all the way to $4/lb. That was sevenfold. I
think the quadruple in the lithium price was just the beginning. There is
more upside to come. That is why I feel there are a lot of opportunities in
the commodity business, especially for those investors who are willing to
take a little bit of risk.
TGR: Thank you, Chen.
Chen Lin manages a family fund and writes about it in the
popular stock newsletter What Is Chen Buying? What Is Chen Selling?, published
and distributed by Taylor Hard Money Advisors, Inc. While a doctoral
candidate in aeronautical engineering at Princeton, Chen found his investment
strategies were so profitable that he put his Ph.D. on the back burner. He
employs a value-oriented approach and often demonstrates excellent market
timing due to his exceptional technical analysis.
