Agora Financial’s Rude Awakening

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Laguna Beach, California

• Rebound! 48 hours after the carnage…but what has really changed?
• The down and dirty on geothermal energy, oil majors and aluminum,
• A few companies that make the world go ’round and much more…   

Eric Fry, reporting from Laguna Beach, California…

Just 48 hours ago, investors around the world were frantically asking themselves, “What else can I sell to escape this carnage?” Now they are frantically asking themselves, “What else can I buy to cash in on the stock market’s rebound?”

Our guess – and its only a guess – is that investors should keep on selling the lousy stocks they were selling two days ago, and keep on buying the good stocks they were too afraid to buy two days ago. In other words, the shares of finance companies might bounce a bit – they might even bounce a lot – but investors would probably fare much better to buy the shares of companies that are GROWING, not those that are SHRINKING. The only thing growing at most finance companies is the share count, as these desperate, near-bankrupt enterprises issue gobs of new shares in exchange for cash infusions.

Meanwhile, many of the “heavy industry” companies that make the world go ’round are producing robust growth. Therefore, as our resident heavy industry expert, Byron King, muses in today’s edition of the Rude Awakening, why not invest in the companies that make the world go ’round, rather than those that make the world go into a tailspin?

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It’s “Buy Low” Time
By Byron King

A reader named Jean sent this question from Miami:

“You have not discussed Ormat in while. What’s going on with Ormat and the geothermal power industry?”

The short answer is that I love geothermal, and I love Ormat (ORA: NYSE).
 
Geothermal power is based on the idea of “mining heat” from within the Earth. You drill a well and inject water, or pump out steam from deep down. Then you use the hot water or steam to spin a turbine and generate electricity. Then you re-inject the water or the condensed steam. There is usually NO carbon dioxide involved at any step. It’s “clean and green” energy production.

The geothermal power industry is underappreciated in the U.S. A lot of people, and most politicians, don’t know what geothermal is. But this means just that geothermal power production has plenty of room to grow over the coming years. Eventually, people will start coming around to the benefits of “free” energy with almost zero pollution from the depths of the Earth. Eventually.

Ormat is a great company with a pricey stock. But that’s because Ormat is arguably the very best pure-play on geothermal energy. There are several smaller firms, of course. And there are also large, diversified energy companies that are doing geothermal developments. Chevron, for example, is the largest private producer of geothermal power in the world.

But Ormat is one of the leading geothermal firms in the U.S., and is rapidly expanding its operations around the world. Ormat recently received a $42 million contract to set up a geothermal plant in New Zealand. And in June, Ormat announced a $16 million contract to supply geothermal systems to a plant in Turkey.

The recent contract with Turkey was the fourth major deal just within that country. The Turks are impressed with Ormat’s world-leading technology. In particular, Ormat offers a high-performance, high-efficiency organic turbine for geothermal and recovered-energy applications.

When the new Turkish plant is up and running, in 2011, Ormat will be able to lay claim to supplying 950 megawatts of geothermal electrical power in 20 countries. So Ormat is a key player in the geothermal field, and that field is growing worldwide. I expect great things from Ormat over the long term.
An email from a reader named Arthur who asks:

“What’s going on with Alcoa? When you recommended it, you said that you thought aluminum pricing would strengthen. But Alcoa has been drifting down lately.”

Outstanding Investments has a long-term investment horizon. We look for great long-term opportunities. So I recommended Alcoa (AA: NYSE) for a lot of reasons - looking to the long term.

Alcoa is among the world’s leading makers of aluminum. And the world needs aluminum. The company has a long history of innovation, as well as a library of patents and other intellectual property. Management has moved production to areas of lower-cost energy, such as Iceland. The company is profitable, and the stock even pays a dividend of about 2%.

But when the overall stock market is tumbling, the good and the bad suffer side-by-side. So Alcoa’s share price has been slumping lately. The stock dipped down to $31 and change (just last week, in fact). I think we will eventually look back on current prices as a buying opportunity. Long term, I
still expect to see great things from Alcoa.

Some of the fiercest competition for Alcoa comes from the Chinese marketplace. China has built out a large aluminum production capability over the past decade or so. But China’s Achilles’ heel (to mix cultural metaphors) is its inability to provide large amounts of cheap electric power to its aluminum plants.

In 2007, China added a new electric plant to its national grid about every four days or so. But Chinese demand for electricity is growing by leaps and bounds. So back in January 2008, I forecast that China would encounter shortfalls in electricity production.

I also forecast that Chinese power shortages would lead to shutdowns of energy-intensive industries, like aluminum production.

Now, only seven months later, the electrical situation in China has deteriorated badly. In fact, China is curtailing power production in plants near Beijing to try to clean up the air in time for the Olympics. But that’s a temporary issue. The plants will be back up next fall, when the crowds of foreigners and the media go home.

The real problem is that China has a severe coal shortage. In the past few years, China closed hundreds of small mines due to safety reasons. There are about 4,800 coal-mining fatalities per year in China.

Now, guess what? China cannot supply all of its coal-fired power plants. And the ports are clogged, so it’s tough to make up the shortage with imports from Australia. One traditional supplier – Vietnam – has already stopped exporting coal to China.

So China cannot meet the industrial demand for electricity, especially for manufacturing aluminum. Things have gotten worse in China’s power sector as 2008 has unfolded, with the snowstorms of last winter and the spring earthquake that damaged many hydropower units on dams. By the end of last week, Chinese aluminum producers announced they were closing nearly 10% of total Chinese capacity due to power shortages.

When China announced the aluminum cutbacks, almost instantly, the world pricing for aluminum strengthened to record levels. In fact, according to the Financial Times , aluminum is the best-performing base metal of 2008. Among the beneficiaries of all this is Alcoa.

Like all companies around the world, Alcoa is dealing with pressures from rising costs for energy, inputs and consumable products used in production. But Alcoa should continue to benefit from an increasingly tight aluminum market, as well as its investment in new projects. I foresee Alcoa climbing from its present stock price of about $35 to $50 within 18 months.
A reader named Michael from Los Angeles sent me this note:

 “I keep reading bad news about BP in Russia. Is there any good news from BP?”

Yes, you’ve read some bad news about British Petroleum, now known as BP (BP: NYSE), and its partnership in Russia. I wrote about the Russian ordeal in a previous update. It’s contentious, and we’ll just have to wait to see how things play out.

I recommended BP because it missed much of the run-up of the oil majors in the past few years. While the likes of Exxon Mobil and ConocoPhillips rose, BP missed the rising tide that lifted the other boats. But I believe that under the stewardship of current CEO Tony Hayward, BP will fare much better. So now you want some good news about BP? OK, I can give it to you.

Just this week, BP announced a major new energy investment project on the North Slope of Alaska. BP will spend about $1.5 billion to develop the 100-million-barrel Liberty field, north of Prudhoe Bay, in the Beaufort Sea.BP first drilled an exploration well that discovered commercial amounts of oil at Liberty in 1997. But it has taken 10 years to put together a development plan and obtain government permits. It also took great strides in drilling technology to make this project viable.

The BP Liberty project will be a technological leap forward in Arctic drilling. According to the president of BP Exploration (Alaska), Doug Suttles, “Liberty will set a new standard for Arctic oil field engineering and development.” And indeed, it will.

BP expects to drill six of the world’s longest wells – called “ultra-extended reach wells.” The BP wells will go down to about 10,000 feet beneath the surface, but they will extend directionally outward for about 8 miles. BP has contracted with Parker Drilling Co. to develop the necessary rig systems and perform the drilling.

These wells will reach oil deposits that will yield about 40,000 barrels per day. Two wells will inject water to maintain pressure, and four wells will produce the oil.

By drilling so far outward with directional wells, BP will not have to lay any undersea pipelines in an icy coastal environment. This is a remarkable step that will protect the fragile Arctic coastal ecosystems.

This is no ordinary drilling project. Really, there is nothing ordinary about working in the Arctic environment. In the Arctic, heavy ice conditions prevent the use of conventional platforms. So BP will utilize small man-made islands as bases for further exploration and production efforts. As of now, the Liberty field will not even require its own island. BP will drill out from drill pads that service other existing operations.

BP is already performing the final phases of seismic work to define the drilling targets. The company expects to start drilling by 2010, with the first oil production coming ashore in 2011.

The stock market might continue thrashing around for a few more weeks or months. If so, stocks like Ormats, Alcoa and BP will also continue thrashing around. But I expect all three of these stocks to deliver superior returns over the long-term.

[Joel's Note: If you’re a heavy industry kind of guy (or gal) who prefers growing companies over shrinking balance sheets, you might like to check out Byron’s new Energy & Scarcity service. In it, Byron examines the energy trends shaping our world and the companies most likely to profit from them. Here’s a link to his latest report to get you started:

Byron King’s Energy & Scarcity Investor

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[Rude Endnote: See you in Vancouver!

Until then…

Cheers,

Joel Bowman
Rude Awakening

aussiejoel@the-rude-awakening.com