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AlphaNorth Asset Management President and CEO Steve Palmer believes further
economic growth in China and the ongoing economic recovery in the U.S. will
send oil prices over $100 a barrel in the first half of 2011. But he picks
his oil equities knowing the oil price will play only a small role in
determining any share-price appreciation. For him, it's about getting in
early on companies with reasonable prospects for massive gains. In this
exclusive interview with The Energy
Report, Steve shares three of his favorite oily names with outsized
potential.
The Energy Report: Briefly tell us about AlphaNorth Asset Management.
Steve Palmer: AlphaNorth
Asset Management manages the AlphaNorth Partners
Fund, which is a long-biased, small cap-focused hedge fund that just finished
its third year in business. In 2010, we launched our first flow-through
offering—the AlphaNorth 2010 Flow-Through
Limited Partnership.
TER: Are there many flow-through funds like that
out there, or are you carving out a niche for yourselves?
SP: We're carving out a bit of a niche for
ourselves, in terms of performance. There are dozens of flow-through funds.
TER: How is that fund performing to date?
SP: Extremely well. The net asset value (NAV) per
unit was $16.42 at the end of November. The initial NAV was $10. We had two
closings—one in March, one in April. We do not pay premiums for the
flow-through shares, as flow-through funds usually pay a premium, and we
actually averaged a discount. Our lawyers have advised me not to talk about
returns because the AlphaNorth 2010 Flow-Through
Limited Partnership has not been around for at least a year. I guess people
have to figure out the difference between $16.42 and $10 on their own.
TER: You invest mostly in Canadian companies listed
on the TSX or the TSX Venture Exchange, both of which witnessed big gains in
early December. A week later, however, profit taking was dampening some of
that enthusiasm. Do you believe taking profits is the correct approach
currently, and are you doing the same?
SP: No, quite the opposite. I've been quite
confident that December will be a strong month. In my recent commentaries,
I've noted that December is typically the strongest month of the year for
Canadian small caps. If you look at the BMO Small Cap Total Return Weighted
Index over the last 25 years, on only one occasion was it down in December.
TER: To a certain extent, you believe in market
timing and the seasonality of the markets. You firmly believe the markets
usually slow down in the summer and pick up again in the winter, at least
here in Canada when the registered retirement savings plan (RRSP) cash flows
in. Could you comment on that and your approach to timing market seasonality?
SP: I'm definitely aware of seasonality, but that's
just one factor I consider when making investment decisions. When May comes
around, for example, I'm not going to sell everything in the portfolio and go
100% cash. However, I'll be much more cautious at that point.
TER: Are you buying now?
SP: I've been fully vested since August, so I'm
taking profits on some positions. I'm always buying and selling, taking
profits on some and reinvesting in others with a better risk/reward balance.
I intend to maintain a higher-than-average long position going into the new
year.
TER: In a recent research report, you said cash is
flowing out of equity mutual funds and into bond funds but you expect the
situation to reverse. What's going on there and how is that phenomenon
showing up in the market?
SP: Cash has been going out of equity mutual funds
consistently for over a year. It's been piling into bond funds. I think
investors are still focused on capital preservation as opposed to trying to
earn an investment return. Investors are still very cautious. They lost a lot
of money in the equity markets in the 2008 meltdown. A lot of people remember
it quite vividly and are scared to put money back into equities.
TER: Is that creating some buying opportunities for
you?
SP: Yes, it is. Ultimately, as the equity markets
continue to do well, those people are going to come back. I'm starting to see
that. I don't consider it much of a return when you can invest money and get
only about 2%–3% for an entire year. There's a lot of risk in that. If
you're a long-term investor, it makes no sense.
TER: I agree; 30-year Canadian bonds are selling at
about 3.5% right now. That won't even keep pace with inflation.
SP: If inflation goes up, there will be a huge loss
on those. Not a lot of people realize that you can lose money on a bond.
TER: You said investor reluctance is presenting
some buying opportunities. Where are you finding value right now?
SP: Well, there's no particular trend. Recently,
I've been focused on oil and uranium.
TER: About half of your equity positions are in
resource-based companies. You said the other half is in technology and
similar plays. How much of that 50% is in gold, oil and gas (O&G) and
base metals?
SP: Due to some pretty strong performers in the
resource space, that weighting is closer to two-thirds resources now. I will
be reducing that over the coming months; but of those two-thirds, about 40%
would be in energy, 20% base metals, 20% precious metals and 20% rare earth
elements (REEs).
TER: You've said you're short on COMEX Gold. Are
you long on oil?
SP: I'm long on a lot of junior oil equities but
not on the commodity itself.
TER: Where do you see the oil price as long as five
years out? Are we getting over $100?
SP: I think so; I think it will be over $100 in the
first half of next year.
TER: What do you base that on?
SP: Continued strength in the markets and the
economy and the fact that most forecasts are much lower.
TER: Do you believe now is a good time to buy
junior oil companies?
SP: I believe so, but I like to buy companies that
are not dependent on the oil price. I like to buy companies with attractive
odds for discovering something big. I try to take the commodity aspect out of
it because the hardest part is to predict where commodity prices will go. I
focus more on the company's specific prospects, but it's always good to have
the commodity working in your favor.
TER: Where are you with gas? Are you buying small
O&G companies because they may be undervalued right now?
SP: No, I haven't yet. The key there is timing. At
this point, what will turn the gas price around in a meaningful way is not
apparent. Buying small-cap natural gas companies hasn't been a focus; but, at
some point, opportunity will be there.
TER: Tell us about some O&G companies that have
performed well for your fund.
SP: One company that has performed very well for us
is Primary Petroleum (TSX.V:PIE)—a land
play that's developing in Montana. We bought it at $0.08 and it's trading at
around $0.84 now. One of the most attractive formations that companies are
going after now is the Bakken. And the Bakken has been identified in Alberta. The theory is that
it extends south into Montana.
Over the last several months, large companies have done a
lot more work in that area and seem to be having some success in proving that
theory. Primary was very early to assemble a large position there in Montana.
Companies like Rosetta Resources Inc.
(NASDAQ:ROSE) and Newfield Exploration Company
(NYSE:NFX) have acquired significant
land positions in Montana not far north of Primary's land. They've been
drilling wells and one of the wells is in production now. They're in the
process of acquiring more land, so the evidence continues to build that
Primary's land could be very valuable.
TER: Primary has not yet tested its land but
neighboring land is coming on at high production levels. Is that correct?
SP: We don't yet know the production capabilities.
What neighboring companies are achieving has all been very secretive up to
this point; but actions are telling the story. They're acquiring more land
and expanding their drill programs. They wouldn't be doing that if they
weren't getting good results from the initial wells.
TER: Has that theory led you to increase your
position in Primary?
SP: Initially, I bought in at $0.08 in a private
placement. It wasn't as much as I would have liked, so I began buying it
aggressively in the market at $0.10–$0.15. I bought stock all the way
up to $0.60.
TER: And you're just holding it now. I guess that
means you believe there could still be some appreciation ahead.
SP: Yes. If it's proven that the Bakken extends onto Primary's property, the company is
worth several dollars a share. That's the minimum.
TER: Steve, what are some other oil and gas
companies that excite you?
SP: Canadian
Overseas Petroleum Ltd. (TSX.V:XOP).
I'm excited about that one; it's one we purchased in a recent private
placement.
TER: Tell us about the company's projects.
SP: Canadian Overseas raised $130 million when it
was valued at only $12 million, pre-financing. Its projects are all in the
North Sea, where companies have been operating for decades. So, it's all a
very well-known process—no different from western Canada, really. XOP
will begin drilling those projects in March. The management team has a good
track record of finding oil in the area; it has drilled five exploration
wells before, four of which were successful. The P50 number for recoverable
oil on its prospects is more than 100 million barrels (Mbbls.).
TER: Please explain to our readers what P50 means.
SP: The 'P' stands for probable and '50' represents
the odds percentage. So, for Canadian Overseas, it means there is a 50%
probability that 100 Mbbls. are there. If the
company were to find 100 million barrels, it would be worth more than $1
billion. Right now, it has a market value of roughly $180M.
TER: What are the risks?
SP: XOP could be unsuccessful in its drill programs
and/or the oil price could decline making its projects less economic.
TER: Are there any other oil plays you like?
SP: There's Simba
Energy Inc. (TSX.V:SMB),
which is a very early stage company that's assembled some land that's highly
prospective for oil on Africa's west coast. Oil seeps all over the land,
indicating that oil is there somewhere. A couple of major oil companies are
drilling very nearby offshore.
TER: What's Simba trading
at right now?
SP: It's trading at $0.08 a share; I got in at
roughly the same level. Currently, the market cap is around $7 million.
TER: What will be the next catalyst there?
SP: The company is working to attain a
production-sharing agreement from the government to drill on its property.
That should come sooner than later but it's very hard to predict with African
governments, particularly those where Simba is
operating—Mali, Liberia and Ghana. It may get done, but it may never
come—that's why it's a $7 million company.
TER: You must like either the thesis or the
management?
SP: The thesis makes sense. Another company with a
similar business plan is Centric
Energy Corp. (TSX.V:CTE),
which was pursuing oil in Africa also. Africa Oil
Corp. (TSX.V:AOI)
offered to buy Centric for $60 million on November 29.
TER: Do you have some parting thoughts on the
O&G sector currently? What investors can expect over the next five or six
months?
SP: Well, my market call on oil is that it will
trend higher over the next five to six months. Gas is much more uncertain, so
I don't particularly have a view on gas at this time. But the risk to the oil
price is Asian growth rates.
TER: And to a certain extent a continued recovery
in the U.S.
SP: A continued recovery, yes; but obviously it's
going to be a slow recovery.
TER: How do you recommend people play oil and gas?
SP: Find good companies and get in at good
valuations or through our fund. A lot of people don't have time or the
expertise to identify the best prospects in the energy space.
TER: But the minimum investment in your fund is
$150,000, right?
SP: I can waive that amount, and I have been
accepting lesser amounts.
TER: Thank you for talking with us today, Steve.
SP: You're welcome.
Steven Palmer, with 15 years of experience in the
investment industry, has been the president, CEO and a director of AlphaNorth Asset Management (AlphaNorth) since founding the firm in the
fall of 2007. The company currently manages a long-biased, small-cap hedge
fund. Prior to founding AlphaNorth, Mr. Palmer was
employed at one of the world's largest financial institutions as VP of
Canadian equities, where he managed assets of approximately $350 million. He
managed a small-cap pooled fund from its inception in August 1998 to August
2007, achieving returns that Morningstar Canada ranked #1 in performance
(35.8% over nine years versus 10.0% for S&P/TSX Composite Index and 13.0%
for the BMO Weighted Small Cap Total Return Index) over the same period. Mr.
Palmer also managed a large-cap fund that ranked in the first quartile of
performance for years 1–5 and 10 at the time of his departure in August
2007. Prior to this, he worked as a portfolio manager at a high net-worth
investment boutique. Starting his career as a research associate in January
1995, Mr. Palmer quickly progressed to research analyst. He has a BA in
economics from the University of Western Ontario and is a CFA.
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