Want to Avoid Oil's Gloom? Turn to the Sun, Says Outsider Nick Hodge

The Energy Report: You call yourself an "outsider," and have founded an investment club of that name. In what sense are you an outsider?

Nick Hodge: Being an outsider stems from my upbringing. Both my parents were middle to lower middle class, and I never had anything given to me. I've always had to work for what I have, starting with a lawn-service business when I was 12 and working my way through college as a butcher. I look at the "mainstream" with a skeptical eye. I'm a contrarian. I'm not on the inside of big business, big banking and politics, and don't want to be.

The Outsider Club has been around for about a year now. I founded it after writing for several newsletters over the past decade about energy and speculative investments.

TER: What does being an outsider mean with regard to your views on energy?

NH: I'll give two examples. First is my belief in the peak oil theory. Second is my early adoption of a belief in renewable technologies, such as solar and smart-grid technologies.

TER: It would be safe to say you're not an admirer of our financial elite?

NH: That would be fair. I think it's a corrupt cabal: back-scratching, closed-door and manipulative. Until recently, one could call this a "conspiracy theory," but now I can point to the LIBOR and FOREX riggings, and to the laundering of money for terrorists and drug cartels by HSBC, as proof.

"Fission Uranium Corp.'s PLS project is the best unmined deposit of uranium in the world."

I'm not opposed to greed at the individual level per se, but when institutions and corporations are colluding to take the lion's share of the world's wealthwhen only the 1% have gained since 2008, with the middle-class failingI think that's wrong.

TER: Future energy needs are obviously dependent on the growth of the world economy. Do you think that we are going to muddle through our present difficulties, or is a reckoning in the cards?

NH: I think muddle is a good word. It's hard to forecast a reckoning, but there certainly are difficulties ahead. The World Bank has cut its forecast for global GDP growth to 3% for 2015 and 3.3% for 2016. Most of that growth will come from the U.S., while Europe's growth is forecast to be a mere 1%. Energy supply and demand is trying to find a balance. It's not going to come quickly.

TER: What are the causes of the oil price collapse?

NH: I would attribute 50 percent to a decline in growth and 50 percent to the quick ramp-up of U.S. shale production, which has reached 8.59 million barrels per day (8.59 MMbbl/d). That's getting close to our early 1970s peak of 10 MMbbl/d. A huge increase in production coupled with struggling economies is a perfect recipe for lower oil prices.

TER: What is the role of Saudi Arabia here?

NH: The Saudis are playing a long game. They know that continued production above their OPEC target of 30 MMbbl/d will shake out the shale industry, which they regard as a flea on the back. Their plan is working. We've already seen a couple of shale producers go into receivership.

TER: You've described the shale boom as a Ponzi scheme. Could you elaborate?

NH: From 20082012, four of the biggest shale producers, Chesapeake Energy Corp. (CHK:NYSE), Southwestern Energy Co. (SWN:NYSE), Devon Energy Corp. (DVN:NYSE) and EOG Resources Inc. (EOG:NYSE), actually lost money. This was at the peak of the boom. From 20082012, these companies expended $133 billion ($133B) in capital to buy equipment and drill holes, but they've regained only $80B in cash flow from operating activity. That's a $53M loss. These companies have taken on exorbitant amounts of debt to extract an unproven resource.

Then we have the production decline rates. An existing conventional oil field has a decline rate of 45 percent per year. By contrast, the typical Bakken well declines at 40 percent per year10 times faster. By the end of 2013, the typical Bakken well was losing 63 thousand barrels per day (63 Mbbl/d). That's an escalator to nowhere, the classic definition of a Ponzi scheme.

"The Saudis know that continued production above their OPEC target of 30 MMbbl/d will shake out the U.S. shale industry."

Third and last would be marginal cost of production. According to Bernstein Research, the marginal cost of producing a barrel of shale oil in 2012 was $114 per barrel ($114/bbl). And the price of oil hasn't been at $114 for three years. Here's a quotation on shale from Rex Tillerson, CEO of Exxon Mobil Corp. (XOM:NYSE): "We are all losing our shirts today. We're making no money. It's all in the red."

TER: Despite these numbers, American politicians and other boosters continue to talk about the U.S. becoming the new Saudi Arabia.

NH: I don't think the U.S. will ever be energy independent. We're not producing more oil than we did in 1971, despite the U.S. having almost half the world's oil rigs. We don't produce half the world's oil, only 9%. That doesn't say "boom" to me.

TER: Assuming there isn't a tremendous recovery in the oil price soon, what are the prospects over the next two or three years for shale companies and for Alberta's oil sands?

NH: The oil sands are potentially in even more trouble than shale. Oil companies that have taken on new debt to jump into shale have a big problem. We could see a 3035% correction in the share prices of the majors. Only the companies with economies of scale, best practices and lowest production costs are going to make it.

Over the longer term, we're still believers in peak oil. That doesn't mean we're running out of oil; it means we're running out of cheap oil. We will increasingly be left with oil that is neither economic nor technologically recoverable.

TER: How long will the oil price slump last?

NH: Until we see a meaningful global economic recoverysomething much higher than 3% per yearor a lot of production comes offline. Goldman Sachs said, on Jan. 12, that we could test $30/bbl before we see $70/bbl. Let's take that as a range for the next 1824 months.

TER: Which oil majors will come out of this crisis best?

NH: Those that aren't so exposed to the shale industrycompanies such as Statoil ASA (STO:NYSE; STL:OSE), Total S.A. (TOT:NYSE) and BP Plc (BP:NYSE; BP:LSE). But it depends on how fast they react; how fast they draw down the rigs and how fast they turn their sights and their resources to economic projects. I wouldn't be a buyer of American majors now. I would wait until an uptrend has been reestablished.

"I don't think the U.S. will ever be energy independent."

When it comes to Statoil, I like the Norwegian model of blocking off its oil reserves and only going after so much at one time. I like the sovereign fund the company has set up. I just like the way Statoil does business. It has a 10% dividend compared to Exxon's 3%. Total pays a 6% dividend. Statoil and BP have been unfairly punished. Exxon is down something like 10%, but Statoil and BP are down anywhere from 2535% in the past year. That's an overreaction. I think there's value there.

TER: Moving on to nuclear, China is engaged in the greatest nuclear power expansion the world has ever seen, despite the Fukushima disaster. Does it know something the rest of the world doesn't?

NH: No, it knows what the rest of the world also knows: Nuclear energy is by far the safest form of baseload energy, and it is carbon free. China has a big pollution problem, so the country has made a big commitment to clean energy. China has 22 reactors in operation right now, 26 under construction, and 28 planned to start by 2017. It is looking for threefold nuclear growth by 2020 to 50 gigawatts (GW), and then tripling that again by 2030 to more than 150 GW.

And it's not just China betting on nuclear. Saudi Arabia has committed to 16 nuclear reactors over the next 20 years at a cost of $80B. The United Arab Emirates is building four reactors at a cost of $20B, with the help of a South Korean consortium. India has six reactors under construction and is planning on building 35. Germany has said it plans to phase out its reactors, but the reality is the country will have those reactors until 2022. Meanwhile Japan, where Fukushima took place, is restarting its reactor fleet.

TER: You've described uranium as a "good contrarian bet." Why?

NH: Long term, we have the generation of new reactors I've just discussed. Short term, we've seen utilities enter the spot market. Specifically, Exelon Corp. (EXC:NYSE), the largest nuclear utility in America (the largest nuclear market in the world), stepped in when the U3O8 price fell to $28/lb. That led other utilities to move to secure uranium supply for the 20172018 cycle. That's one of the catalysts that got the spot price up to over $40/lb late last year.

TER: Where do you see the spot price going?

NH: I expect a $5055 range by the end of 2015dependent, of course, on Japan's timeline.

TER: What's your favorite uranium project?

NH: Fission Uranium Corp.'s (FCU:TSX) Patterson Lake South (PLS) project in Saskatchewan's Athabasca Basin. It's the best unmined deposit of uranium in the world. The company announced its initial NI 43-101 resource on Jan. 9: 79.6 Mlbs Indicated and 25.9 Mlbs Inferred. Nobody expected the maiden to come in this high; the expected range was 5080 Mlb. And that's only for two of the four mineralized zones Fission has found so far.

At 100 Mlb, taking the recent uranium acquisition price of projects in the area at $10/lb, PLS is a $1B deposit. Fission's market cap is only $359M. I anticipate the company increasing its resource to 150-200 Mlb once the other zones are included.

"China knows what the rest of the world also knows: Nuclear energy is by far the safest form of baseload energy, and it is carbon free."

This deposit is absolutely going to be bought by a major. This year? I don't know. But it's a better deposit than Hathor Exploration Ltd.'s Roughrider, which was ultimately sold to Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK) for $642M. It's purer, and it's shallower. It's open-pittable. I'm bullish on Fission. As Rick Rule says, I'm going to own it until it's not called Fission anymore.

TER: Ever since the first oil shock of 1973, we have been informed that fossils fuels are on the way out and that alternative energy is the way of the future. Yet 40 years later, oil, coal and gas continue to power the world. Will alternative energy triumph?

NH: I don't know that "triumph" is the right word. Will it make inroads? Yes. Will it gain generation share? Yes. Will it ever be the lion's share of generation? I don't know, because there are so many technologies: wind, geothermal, concentrated solar, rooftop solar. Alternative energies are already growing faster than conventional sources.

The U.S. solar market became an $800M industry in 20072008. Now it's a $15B industry. U.S. solar installations for 2014 are projected to be 70 times more than in 2006. The U.S. installed 20 GW of solar power over the past 40 years. We're now doing 20 GW every two years.

TER: Skeptics claim that solar power has been too dependent on government subsidies. How do you respond?

NH: These subsidies were training wheels. Germany has installed a huge base of distributed solar because of its generous feed-in tariff during 20072008. But the training wheels are nearly ready to come off. Costs have come almost straight down, to $0.80/watt, and that's projected to be reduced another 6070%. Solar proceeds toward grid parity, the point at which it costs the same as an installed, baseload, natural gas plant. We're already there in many places, such as Hawaii, California and the Mediterranean. Once that threshold is crossed, solar's success will be compounded all the more quickly.

TER: What is the biggest technical problem that solar faces?

NH: Solar has been commoditized, especially as it relates to the silicon cell. The industry is really all about the polysilicon, which is cheap right now, so that all solar panels are more or less alike. However, because no blanket quality-control measures were ever adopted for solar cell production, currently 5% or more of the solar cells coming off the line aren't up to snuff. This presents a big growth opportunity for companies that can solve this problem.

TER: You follow one such company, correct?

NH: Yes, ACT Aurora Control Technologies Corp. (ACU:TSX.V). Its CEO, Michael Heaven, solved a similar quality control problem in the paper industry, and then sold that company to Honeywell International Inc. (HON:NYSE). ACT Aurora has developed what it calls the Decima, which is bolted onto solar-cell fabrication plants and laser scans each cell when it comes from the furnace. Defective cells are rejected in real time. This technology pays for itself within six months.

TER: ACT's market cap is only $7M. A company such as this, if successful, would give investors enormous leverage, correct?

NH: That's one of the reasons I'm interested. ACT plans to publish a variability index report ranking the cells of the solar cell manufacturers. These data have previously been secret. This publication will bring the furnace suppliers to the table. I know for a fact they're already meeting with ACT management. There is even talk of bundling the Decima into the furnaces when they are delivered to solar cell manufacturers.

TER: What other solar companies do you follow?

NH: I'll discuss three. The first is Yingli Green Energy Holding Co. Ltd. (YGE:NYSE). It is a Chinese company and the largest cell manufacturer in the world. It has the first-mover advantage, but is troubled by issues following the collapse of the solar sector in 2008. The company took on a lot of debt and made some missteps. But it has the volume and the customers to succeed. It is merging into vertical channels downstream to help increase margins. Looking at a three- to five-year time frame, buying Yingli at under $2/share is a pretty good bet.

TER: What's the second company?

NH: Natcore Technology (NXT:TSX.V). We were just talking about furnaces. Natcore, through a process licensed from the National Renewable Energy Laboratory, can help eliminate some costly steps in cell manufacturing. Instead of baking cells at high temperatures with dangerous chemicals like silane gas, they can be etched and coated in an aqueous solutionbasically a water bath containing nanoparticles.

"The oil sands are potentially in even more trouble than shale. . .Only the companies with economies of scale, best practices and lowest production costs are going to make it."

Natcore's technology also uses a laser to dope the cells to a hundredth of a micron, reducing cost, reducing the time to make the cells, and, ultimately, increasing efficiency. The company's model is to license this process to any solar cell manufacturer. It has been in discussions with Costa Rica, which would prefer to make its own cells and not be dependent on the Chinese. Natcore would not only license its technology, but would also act as consultant to customers building their own fabrication facilities.

TER: Natcore also has a small market cap, less than $20M.

NH: The solar manufacturers are already established. We know who they areSunPower Corp. (SPWR:NASDAQ), Yingli, First Solar Inc. (FSLR:NYSE), if you're looking for thin film. But the technology is still young. Solar supplies less than 1% of global energy, so there will be advances and disruptions. The young technology companies can be more nimble because they are in the research stage. They are pre-revenue, and aren't yet producing a commoditized product.

TER: And the third solar company you wanted to discuss?

NH: SolarCity Corp. (SCTY:NASDAQ). This is not a micro capit has a market cap of $4.5B. I like SolarCity because it's not a producer and doesn't have to fight over pennies and percentage points. It's an installer. It was cofounded by Elon Musk of Tesla Motors Inc. (TSLA:NASDAQ) and Space Exploration Technologies Corp. (SpaceX) fame. There aren't many public installers, and none on the scale of SolarCity. Its customer is just "Bob Homeowner," who maybe doesn't have $2025K to put a brand-new solar array on his house. SolarCity is developing interesting financing mechanisms whereby Bob can lease the panels. He can sell the electricity back to SolarCity or back to the grid; he can pay off those panels over time; or he can split the cost of the savings. This model enables more customers to adopt solar more quickly, which means bigger business for SolarCity.

TER: To what extent does the adoption of solar power require a significant level of economic growth? Putting solar panels on new houses and retrofitting old ones is not cheap.

NH: Solar will be offered as an upgrade for new houses, just like marble countertops. Yes, the post-2008 recession has resulted in homeowners tightening their belts. SolarCity has cracked that nut, and that's why it is gaining traction. It can go to homeowners and explain how solar installation can pay for itself over time through electricity savings.

TER: You haven't mentioned wind power. Is that because you deprecate it compared to solar?

NH: In my heart of hearts, yes. One, the costs haven't come down as fast. Two, there are greater hurdles to installation. And three, people don't want to look out their windows and see turbines. We don't know how long turbines will last, how much service they need and how much power they add to the grid.

TER: Would you advise people to choose nuclear and solar investment vehicles rather than fossil fuels?

NH: I think investors have to be diversified. I would advise investors to make safe, long-term, yield-producing investments in conventional forms of energy, and then to invest in medium- to long-term plays in quality midsize and small-cap renewable companies. The International Energy Agency says solar will be the world's largest source of electricity by 2050. Given that, I would want the best-of-breed solar companies in my portfolio for the next 30 years.

TER: Nick, thank you for your insights.

Nick Hodge

Nick Hodge is founder and president of the Outsider Club, and investment director of Early Advantage. He is the author of Energy Investing for Dummies, appears regularly at investment conferences, including the Cambridge House Vancouver Resource Investment Conference, and is frequently interviewed by major media outlets. He is a graduate of Loyola University, Maryland.

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1) Kevin Michael Grace conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
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3) Nick Hodge: I own, or my family owns, shares of the following companies mentioned in this interview: Fission Uranium Corp., ACT Aurora Control Technologies Corp. and Statoil ASA. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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