The Commodity Investor Q&A
With Matt Badiali
Q: You recently said refiners are the most undervalued assets in North America. Would you recommend buying shares in a refiner? – F.
A: It sure looks like a good time to buy them. According to the Energy Information Agency, the price of gasoline is up 6% in 2008. The price of diesel is up 12% over the same period. However, while gas prices have spiked, refiners are trading essentially flat.
I think that means the potential for profits is building. Refiners make money on the spread between the price of oil and the price of refined products, like diesel and gasoline. (You can read more about that here.)
If gas prices are rising while oil prices are falling, refiners are making more money. The same is true as long as gas prices are rising faster than oil prices, which is the situation we're in now. But refiners' share prices are down considerably...
Refiner |
Fall Since
December 31 |
Western Refining |
-33% |
Tesoro |
-31% |
Valero |
-25% |
Hess |
-9% |
Sunoco |
-7% |
|
Rising gas prices should eventually cause the refiners' share prices to rebound. I think this could result in quick, double-digit returns.
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Q: What are your thoughts on investing in uranium producers and explorers? – W.S.
A: In general, I think the uranium sector is a good investment. This industry grew lean selling uranium for $12 per pound – the average price in the U.S. over the last 14 years. Today, uranium's selling for $72, a 525% gain.
However, many of these companies sold contracts for their production. We call that hedging, and it means the miners don't get market price for their uranium... They get whatever the agreed price was.
Even so, as the price rose from the teens up above $100 per pound, investors drove the price of uranium companies way up. For example, Cameco, the premier uranium producer, sells for 34 times earnings... As the price of uranium falls, so will Cameco.
Typically, big metal miners (like copper and aluminum producers) trade for 10 to 12 times earnings. I wouldn't pay more than 10 times earnings for a uranium producer.
On the other hand, a couple weeks back, Hathor Exploration announced the discovery of nearly 40 feet of ore grading 5% uranium per ton.
At 5% per ton, the miners are pulling out 100 pounds of uranium with every ton of rock they mine. That's an incredibly rich find, and the market appreciated it. The share has just about quadrupled since.
Q: What fills the void after oil is removed? – K.P.
A: Usually water fills the space, sometimes naturally, as ground water seeps on, other times pumped in on purpose...
When oil reservoirs age, engineers pump in water to help push the remaining oil up. So older reservoirs often produce more water than oil (called the water cut). This is a big problem in Ghawar, Saudi Arabia's massive oil field.
However, sometimes nothing fills the space in the reservoirs, which causes the land to sink. Geologists noticed this phenomenon at the Goose Creek Oil Field outside Houston not long after the field began pumping in 1917.
Another famous man-made sinkhole occurred in Long Beach, California. The Wilmington field sits smack dab in the middle of Long Beach harbor. In 1942, 1,000 wells pumped oil and gas from the field.
As the field emptied, the land above it began to sink. In fact, the land level fell more than four feet by 1945 and continued to sink nearly a foot per year. By 1951, the land over the field began to sink at a rate of two feet per year. By 1958, about 25 square miles subsided at least two feet due to oil and gas extraction. In the center of the field, the land sunk 27 feet.
The subsidence damaged infrastructure like roads, bridges, and port facilities. Some areas sank so far they needed protective levees and breakwaters.
Good investing,
Matt
P.S. Every Wednesday, I answer reader questions about commodities. Got a question? E-mail me here. 
