An Interview with Eric Sprott Of Sprott Asset Management
David Pescod's Late Edition -- Canaccord Capital Corporation
(From November 10, 2006)
David Pescod: One of the big questions out West here, is with income trusts almost as good as gone, you’ve astutely avoided that sector. And it might destroy some of the liquidity in the oil and gas sector. Any thoughts on that?
Eric Sprott: I think it will affect liquidity. One of the things I was always a little bit skeptical of with income trusts and the majority of trusts (if you will) are that you start out with a company that’s worth “X” and you dress it up in income trusts clothing and it’s worth “1.5 X”. I was always a little skeptical of that and that’s pretty tough to create that value into believing it’s sustainable and even if you do change it from “X” to “1.5 X”, you probably don’t have the growth characteristics that you might have had if you still traded like “X” because now you are paying out all your cash flows. So I haven’t been a big believer in trusts lately and I fully believe the whole unwinding process that we have to go through here (you have to go from 1.5 X back down to 1 X).
D.P: For following the oil and gas sector, we’ve certainly learned in the last year that natural gas prices are almost totally changed by weather forecasts. The gas sector has been hurt. What are your thoughts as we look forward to next year?
E.S: We are very keen on natural gas, because I see what’s going on, out in the field. And what I mean by that is we have rig counts in Canada that are way down, we’ve got a number of major producers that have said they are going to cut back on their Cap Ex. A very usual thing with the natural gas market is that the production rates of the first year are so important or the corollary of that is that the reduction after the first year is so important. If all of a sudden you stop drilling wells, your production is going to fall. In fact, I saw a piece by First Energy and it said that if we went back to let’s say drilling the same number of wells we drilled in 2000 in North America, that gas production would fall by 30%! Because the first years production becomes so important, so you are on this tread mill where you have to keep drilling just to stay still. I use the analogy in Canada that we drill 20% more wells, we spend 20% more per well, but we never get any production increase.
That’s a formula for disaster, sooner or later because you can’t keep spending 40% more on something every year and not get more output. I think we are going to see a decline in gas production which of course then affects our exports, which then will help to resolve this supposed surplus of natural gas that we have in storage.
D.P: What would your crystal ball say for oil and gas prices for Christmas of 2007?
E.S: I would just say higher. I would guess that gas has a little more in it than the oil does, simply because gas got beaten up here and maybe the whole Amaranth thing over-extended the decline. Plus of course, we had an incredibly mild winter last year. I always hope for just normal weather. If we get normal weather then these products, these hydrocarbon products will go where they all should go. We are upbeat on hydocarbons, we think we are at peak production here for oil in the world, so I suspect that prices will be higher and do I think oil could be $80 to $100? Sure it could be, by December of 2007. Could gas be in double digit numbers again? Yes, I certainly would think so.
D.P: Your Fund has been one of the top performing funds in Canada if not the world over the last while, mainly because of your faith in commodities (uranium, gold and the like). If you had to pick your favorite commodities right now, which would they be?
E.S: Obviously, we’ve been very well rewarded with gold and silver over the last six years. We still love the precious metal but for totally different reasons than we would like for example, uranium and gas and oil. There’s hardly any commodity that we are not involved in. The one I can think of is aluminum, but most of the metals we look at pretty positively on. We also think we might be in a bit of a Malthusian situation in the world where we have all these new consumers coming into the world who have more money (China and India) and the resources are limited. I would think that a lot of metals will do well here. I think everything will do well.
D.P: Regarding this boom, the question is, how much longer it can go. Jimmy Rogers is figuring about 15 years. What would be your estimate?
E.S: That’s a tough one. I define the world into two parts now. There’s North America, which is going to be in downtrend for sure. I just see the U.S. economy slowing down remarkably. If you look at what’s happening with housing and autos, even on the active retail level, it really is slowing down.
Whereas the rest of the world seems to be going to its own beat here and of course its own beat in the case of many countries is a very strong increase in GDP, whether it’s Russia or South American countries, India or China there’s a lot of growth going on. I think the trend will continue until there is some sort of collapse that goes on in the world, which we don’t foresee. We see a problem in the U.S., but I think the world might be able to deal with it and take it in stride now.
D.P: Of your picks in the last interview we did, Delta Petroleum is up almost 66% in just a few months. We are very appreciative of that, but there hasn’t been a lot of news out on the company.
E.S: There’s a lot of chatter going on if one looks at some of the chat lines here. They are involved in three major hydrocarbon plays. The one that we invested in initially was for the Columbia River Basin in Washington. Encana has completed the first well, they are currently testing it and the beauty of the basin-centered gas plays is that if you hit on the first well, you can almost imagine that you can hit on the whole play. It’s just gas that’s in rocks, so it’s called an “unconventional play” and we will be able to jump to some conclusions very quickly as to how effective it could be for everyone. Another play is what they call the Paradox Basin and where they announced a blow out because the downhole pressure was too high. There was no damage fortunately, but it looks like they might have a pretty significant gas discovery. In the third play they are just starting to drill called the Utah Hingeline and I believe they spudded their well down there and I think it could drill in some- thing like 45 days. So we could have a lot of company-making news come out in the next three months.
D.P: Another gas story that has surprised some people that you’ve done quite well on and we are glad we followed it is Corridor. Natural gas in New Brunswick of all things! Pretty exciting well starting in about a week...
E.S: Most people think that all the oil and gas is in Western Canada, but there has been some significant plays all along the East Coast. Talisman has big operations in New York State and then you move up into New Brunswick and Corridor has some very interesting properties there. They hope to bring a new pipeline I believe in early 2007. It’s been a great win for us and I think there is a lot more gas to discover. Some have suggested they might have recoverable gas in place of around 1 Trillion cubic feet. In today’s world that is worth about $1 billion. With that kind of reserve base it would allow lots of upside from where it is. They are drilling a deeper well to a new zone called the Dawson Settlement. They could get 5 T’s of gas. Now that is huge, but these are things that can dramatically change the perception of a company with one major success.
D.P: Another story that hasn’t gone quite straight forward has been Falcon Oil and Gas, half a billion shares outstanding and not one well completed yet.
E.S: They completed the well but they haven’t tested the well yet and I gather they should begin testing probably soon, I believe the end of November. So we are not that far away. From all reports that we have been able to get, it looks like they should have some dynamite wells there. It’s a new company and people shouldn’t rush into believing all the stories, particularly because there are no official results, but I think when the official results come out, people are going to stand back and be (I hope) very impressed by the test results. Again, there were some estimates done by a group suggesting that the recoverable could be something like 40 Trillion cubic feet of gas. That would be worth a lot of money to the shareholders of Falcon Oil and Gas.
D.P: Now this is a bit of an awkward question, but it tends to focus on things...if you could buy only one stock today, what would it be?
E.S: I would probably buy Delta Petroleum. I just think there is so much upside here. I am not buying the stock today, because I bought it a couple of years ago, and I’m happily long, but I do believe they have three world-class plays going on and any one of them, could cause the share value to change quite dramatically.
D.P: Are there any other favorite stories you’ve got that you should mention?
E.S: I can tell you that we are looking into some of these strategic metals like molybdenum and tungsten and a few others, but there is nothing I can suggest that is new and exciting there yet.
D.P: Where do you think the stock market is going as a result of the recent election?
E.S: I’ve been a bear for a long time in the U.S. market and I would think with the Republicans having lost the election and watching what the dollar is doing here (it’s almost literally in free fall these last couple of days) if that continues, we should all be monitoring that dollar very carefully here. We had somebody from the Central Bank of China talking about diversifying out of the U.S. dollar – well, we all can’t diversify out of it and not have it go down a lot. So, that would be the one thing I would really be watching – the U.S. dollar and the U.S. stocks if people lose confidence in where they are going, we could have a bit of an issue.
D.P: That would be good for gold?
E.S: That should be good for gold, yes.
D.P: Thank you very much, Mr. Sprott!
