Big Mike's Contrarian Investing Blog

I sold all of my oil and gas stocks

Today I sold off nearly all of my oil and gas stocks. I still have a few shares of HEC and a pink sheet stock that's hard to unwind, but that's it. (This is sure going to be painful a year from now when I have to pay capital gains taxes on everything.)

People who followed my recent advice to buy HEC and EPEX lost money. Sorry.

This was a pretty tough decision, because I've been bullish on oil and natural gas since 2000. That's seven years of bullishness. But I suddenly realized that the oil and gas sector has been in a bear market for a year and a half now. I don't want to ride a sinking ship down further.

Some might think "ah ha, here is the final capitulation of a long time bull, and that means the market has bottomed." I sure hope that's not the case. I saw Phil Flynn on CNBC this morning being bullish on oil, so I would think that means I'm not the last person to capitulate. Phil admitted that oil will tank if the economy goes into recession.

The unraveling of the subprime mortgage lending market ought to be a clear signal that a recession is coming. Alan Greenspan said recently that there was a one third chance of a recession. And he has been an eternal optimist for ages. So while, in the long run, oil and gas are great investments because of the Peak Oil theory, in the short run it's a bad investment because of the coming recession.

That's my take. If there is now a huge surge in the oil and gas sector, I surely know that my investing magic is completely gone.

Natural gas storage report

102 bcf draw.

This is less than the 5-year-average draw of 117 bcf for the same time period.

Next week the draw will be way above average because it's damn cold here in the northeast. But the next draw will also most likely be winter's last hurrah.

Meanwhile, my recent stock recommendations of Edge Petroleum (NASDAQ: EPEX) and Harken Energy (AMEX: HEC) have not performed well since I recommended them. No wonder why no one reads this blog.

Thoughts on TXU

I think there's someting just a little bit humorous about the $45 billion leveraged buyout of TXU Corp (NYSE: TXU). The new owners say they are going to help the environment buy canceling plans to build eight of 11 new coal-fired electricity plants. As if anyone would spend $45 billion in order to help the environment. Obviously it's just about pretending to be green, and at the same time, with fewer electricity plants they can charge more money for the electricity. A win for the new owners of TXU. A win for the current shareholders. Who gets screwed? Consumers of electricity.

Natural gas followup

The astute will observe that my recent investments in Edge Petroleum and Harken Energy have already lost money. what happened?

We have had good natural gas withdrawals, and the temperature in the northeast, the main gas using region of the country, remains below average for this time of year although no longer super-below average. The market just isn't excited about it.

For those who didn't buy two weeks ago, this is a good time to get in. There is still a long term bull market for natural gas, and eventually we will have cold winter that really sucks the gas out of storage. Furthermore, increasing reliance on natural gas for electricity bodes well for prices.

Buying Edge

Today I purchased Edge Petroleum (NASDAQ: EPEX). In celebration of the accuweather.com forecast:

While temperatures may improve slightly over the weekend and early next week, it'll continue to stay below normal. By the middle of the next week, another round of harsh cold may be around once again because yet another arctic blast is headed down the pipeline.

After my worst year ever in the stock market, things are finally looking up. The prices of gas stocks hasn't risen yet in response to the coming big gas withdrawals.

You would think that if the market were efficient, this would already all be factored into the stock prices. But somehow they aren't.

Go gas

I haven't posted here in a while, so probably no one is reading, but I was so excited to see that for the first time in a long while there is less natural gas in storage than there was a year ago.

And next week's storage report will probably show the biggest natural gas withdrawal ever. And the weather forecast shows the temperature staying colder than average for the next two weeks.

I'm so excited I bought another 40,000 shares of Harken Energy (AMEX: HEC). At 48 cents it's such a bargain.

Dow 12,000: big deal

The media is making too big a deal about Dow 12,000, a mark which may soon be hit. Or maybe not.

The Dow is a legacy index (technically an average and not even an index) which goes back to the days before computers when a market weighted index of 500 stocks, like the S&P 500, would have been impossible to calculate in a timely manner.

Yes, the Dow has passed it's previous all time high from 2000, but the S&P 500 better represents what Americans actually hold in their investment portfolios. The S&P has also been doing pretty well recently, closing on Friday at 1331.32. But that's still quite a bit off its all time high on September 1, 2000 of 1530.09. The S&P has to climb another 14.9% to return to where it was six years ago.

Harken Energy Corporation

One of my favorite oil and gas plays is Harken Energy Corporation (AMEX: HEC). I have to confess that one of the attractions is the low share price (only $0.60) compared to its all-time high price of $70. Sure, it isn’t going back there, but maybe it could go back to its January 2004 peak of $1.30, which would be a nice doubling of its current share price.

Harken’s market cap is $134 million. This market cap has three components:

(1) $33.3 million net cash value.
(2) 11.9 million shares of Global Energy Development PLC (LSE: GED), which is worth $40.3 million based on Friday’s closing price.
(3) The rest of Harken’s assets, which we will call its enterprise value, is valued at $60.4 million. I believe that this stuff is worth more than $60.4 million.

Harken had $11.767 million of revenue for the first half of 2006. If we double that, we arrive at an expected $23.5 million revenue for the year, giving HEC an enterprise value/sales ratio of 2.57.

How does this compare to other oil and gas companies? Let's compare Harken Energy to Apache Corporation (NYSE: APA). I chose Apache because well known value investor David Dreman has been buying Apache. Apache has a market cap of $21.87 billion and $7.98 billion of net debt for an enterprise value of $29.85 billion. Apache reported $4.035 billion of revenue for the first six months, so we expect $8.07 billion for the year. This gives Apache an enterprise value/sales ratio of 3.7. Thus we see that Harken Energy is undervalued compared to Apache before we even look at production growth!

Harken has been rapidly increasing its production. Harken reported a 42% production growth since December, 2005. Small companies can grow a lot faster than big companies like Apache.

Ernesto, you disappoint me

Heading for Florida instead of the oil and gas rich Gulf of Mexico. Oil and gas prices have taken a dive. How disappointing.

The case for natural gas

Big Mike is back!

This week I’ve been thinking about natural gas. Two factors are probably scaring away a lot of investors from natural gas stocks: (1) record high storage; and (2) the XNG (AMEX Natural Gas Index) is only slightly off its all time high price.

The record high storage masks the coming natural gas crisis. Production of natural gas has actually been declining, and the hurricanes from last year permanently took some natural gas production off line. However last winter was ridiculously warm, and the high domestic gas prices have caused demand destruction; natural gas intensive industries have moved to other countries with lower gas prices, never to return. Because of the warm winter and the demand destruction, it looks like the U.S. is well supplied with natural gas, but it’s really not.

But the sign of the coming gas shortage can be seen in the storage withdrawals of this summer. This is the first time there has ever been a draw from storage during the summer. The increasing reliance on natural gas-fired electric plants has finally revealed itself in the storage reports.

The increasing U.S. population means that the square footage of buildings that need to be heated in the winter (as well as cooled in the summer) will also be increasing.

Where will the new production come from to meet future demand? Look at the U.S. E.I.A. production data and you will see that production has been nearly flat since 1996 despite rising prices.

Increasing demand with no corresponding increase in production guarantees higher natural gas prices in the future. Another bad hurricane season or a cold winter would result in a very quick return on investments in natural gas companies.