Ron MuhlenkampGet Positioned Now For The Next Great Natural Gas Switch

TER: So how can investors take advantage of these changes?

RM: Well, any number of ways. We hold some fracking services companies, like Halliburton Co. (HAL). We own a couple of drillers, including Rex Energy Corp. (REXX). And we invest in the people who build natural gas export facilities, such as Fluor Corp. (FLR), KBR Inc. (KBR) and Chicago Bridge & Iron Co. N.V. (CBI).

I already mentioned companies building natural gas-fired engines, including Westport, which makes a kit to modify a common diesel engine. And because natural gas will require new, larger fuel tanks, investing in companies that build natural gas tanks is another way to play it. One of the disadvantages of natural gas versus gasoline or diesel is compressed natural gas takes about three to four times the volume to get the same range. Liquefied natural gas (LNG) takes about two times the volume. Of course, compressed natural gas is stored in pressure tanks, so it takes a pressure tank of larger size. Fuel tank conversions have been almost as expensive as the engine conversions. 3M Co. (MMM) has gotten in that business, as has General Electric Co. (GE). There's another outfit called Chart Industries Inc. (GTLS), which has already run a good bit.

We want a foot in each of these camps because we're not quite sure who the ultimate winners will turn out to be, but we know what the product lines will have to be. Don't forget about the companies that own the LNG export facilities—Cheniere Energy Inc.'s (LNG) facility should be up and running in probably 2015, but, again, that stock has run up a good bit, too.

Pipelines will benefit from the switch. One of the biggest pipelines in the country is Kinder Morgan Energy Partners L.P.'s (KMP) Rockies Express Pipeline, which stretches from Northern Colorado to Eastern Ohio and ships gas east. Kinder Morgan recently filed to reverse the flow on part of the line. Right now, in Western Pennsylvania, we have a glut of gas. A few months ago, they reversed the flow of the pipeline from the Gulf Coast that used to come up to Western Pennsylvania. There's a whole lot going on.

TER: After some serious oil train derailments in recent months, pressure is building now to increase pipeline capacity, but there is also pressure on producers to reduce flaring, which is happening on a huge scale in the Bakken Shale. How will the economics and the operations of Bakken producers be affected if they can't flare and pipeline capacity is not increased?

RM: The Bakken is primarily an oilfield; the gas is a byproduct. We hear a lot about the Keystone XL Pipeline, which is meant to carry oil from the Bakken south. I can't speak specifically, but if you're going to lay an oil pipeline from the Bakken, you should lay a gas pipeline alongside it. You can ship oil by rail, but it's not economic to ship gas by rail. One way or another, the oil will be shipped.

TER: Bill Powers, the independent analyst and author of "Cold, Hungry and in the Dark: Exploding the Natural Gas Supply Myth," says gas prices are going to rise steadily to as much as $6/million British thermal units ($6/MMBtu) because U.S. gas production has peaked and now is now flat or declining. Do you agree with that?

RM: Our production of gas has not peaked and is not declining. We are using fewer rigs drilling for gas, but each well, particularly if you drill horizontally instead of just vertically, is producing so much more gas. Production is not declining and isn't likely to for at least a decade. At current rates, we can drill in Pennsylvania for another 50 years. Yes, you drill the best wells first but also, over time, you get a little bit better at timing this stuff. I'd be very surprised if the price in the next decade gets over $5/Mcf for any extended period of time because there's an awful lot of gas that's very profitable at that price. I'm willing to make that bet with Bill Powers. But even $6/Mcf gas would equate to $55/bbl crude, which is still a huge spread and wouldn't negate my general argument.

TER: What's your forecast for gas prices in 2014?

RM: My forecast is $4/Mcf, give or take $1. We just had a big cold snap on the East Coast. What used to happen is any time you had a cold winter, the price of gas jumped. For instance, in 2005, when crude was selling about $50/barrel ($50/bbl), gas began the year at about $7/Mcf, which was on par with crude, but in the wintertime, it doubled and ran up to $14/Mcf. The recent cold snap took gas all the way up to ~$4.20/Mcf. Gas is going to be in that range for a long time.

TER: Your advice to investors in natural gas is to get exposure to exploration and production companies, service companies and even LNG plant constructors. What about the LNG plant owners, the pipelines and the railroads?

RM: The pipelines will do well. They've already been bid up. The railroads will benefit from oil and gas, but they're getting hurt because coal tonnage is way down, CSX Corp. (CSX) just reported. So for the railroads, it's going to be a wash. They'll haul less coal and more oil. The railroads won't haul gas. How much oil they haul is an open question. We're about to tighten restrictions on how tank cars are built.

TER: What did well in the Muhlenkamp Fund last year?

RM: The fund was up 34.4%. We did very well in biotech stocks. We did very well in financial stocks. We also did well in some energy stocks. Airlines did well for us. Incidentally, airlines benefit big time from cheaper energy, as you know. So it's fairly diverse.

TER: How are you adjusting your portfolio this year?

RM: Not too much has changed. We're no longer finding many good companies that are cheap. So we're monitoring and adjusting a little bit around the edges. We do think banks have further to go. We think the economy will grow somewhere between 2.5–3% this year. We've owned no bonds for the past couple of years, but with the Treasuries now, the interest rates on the longer end are high enough so that savers can get a little bit of return.

TER: I was surprised to see a really sharp drop in November for Fuel Systems Solutions Inc. (FSYS). Why did that happen?

RM: Fuel Systems makes conversion kits for cars to burn compressed natural gas. In places like Pakistan, 40% of the cars run on natural gas; this is not new technology. A number of its customers decided to make these kits in-house. Fuel Systems is a small position of ours, but, yes, it got hit in Q4/13 when it announced that a number of its customers decided to produce their own kits. One of the nice things about this is there's no new technology involved. We've been using natural gas as a power source for generations. What has changed is the amount that's available reliably at a cheap price.

TER: There was another sharp drop in Clean Energy Fuels in October. What happened there?

RM: Clean Energy, so far, doesn't make a profit because it has been shelling out all the money to build all these filling stations. It's just taking a little longer than people expected. The stock is compelling at these levels. A number of these companies ran. Westport doubled, and we took some profits. It's now back down, and we should do a Buy rerating. There is volatility in this stuff, but the economics are undeniable. We still managed a 34.4% gain this year, which isn't bad.

Clean Energy has signed a joint venture with Pilot Flying J to build natural gas fueling stations at Flying J truck stops coast to coast. Royal Dutch Shell Plc (RDS.A) is doing a similar thing in concert with another truck stop operator. For instance, the Port of Long Beach, Calif., passed a rule several years ago that the trucks on the port need to burn natural gas. The Port of Hamburg, Germany, has contracted to put a natural gas-fired power unit on a barge so that when cruise ships come into the harbor, instead of running their own power off their diesel engines and generators, they'll use this barge to supply power to the cruise ship because natural gas exhaust is cleaner than diesel exhaust.

TER: A couple of other companies had surprising drops— Rex Energy and Westport Innovations. Rex rose all year until October or November, when it suddenly dropped. Westport also dropped suddenly. You had a wild ride in your portfolio, didn't you?

RM: We bought Rex at $13/share, and it went to $22 or $23, and it's now $19. I can live with that. The dips give you a chance to load up again. That volatility is why we have a diversified portfolio. That's why you don't just bet on three stocks.

As an investor, most of the time what you're looking for is to find a difference between perception and reality. Today, we have two realities: One is the price of crude oil, and the other is the price of natural gas. So it's literally an arbitrage if you can buy energy either at the equivalent of $100/bbl or at a third of that. Four-dollar gas is equivalent in energy content to about $35/bbl crude. So I can buy my energy either at $100/bbl or $35/bbl. Economics says that spread is too wide. It won't necessarily close, but it sure as heck will narrow a good bit. For instance, I own no conventional oil companies. I think the price of oil will be coming down.

TER: So what companies in your portfolio look most promising?

RM: If you really want to get me excited, we can talk about natural gas, which we've been talking about. We could talk about biotechnology, which is exciting but I don't understand it as well. We can talk about U.S. manufacturing, but that's basically based on cheaper energy. I just bought more Rex. At these prices, I'm buying Westport. I just bought Chicago Bridge. I just bought KBR.

TER: What is your main motivation in buying these companies? Is it just the stock price or is there something about the management of the company or the technology?

RM: We're in the investment business. What we rely on is good companies, and we look to buy them when they're selling cheaply. Our first measure of how well a company is run is we start with return on shareholder equity. So we like companies that are at least above average in return on shareholder equity. I cannot yet say that about Clean Energy, but we do think Clean Energy is at the forefront of something that's needed for this transition. We're always looking for good companies. Then the question is whether you can buy them at a decent price.

My phrase is: I want to buy Pontiacs and Buicks when they go on sale. I don't want a Yugo at any price. I would like to buy Cadillacs, but they don't go on sale very often. But if I can get Buicks when they're on sale, I'll make good money for my clientele. We think that the companies we have are at least Buicks. If we can get them at Chevy prices, that's when we buy them. I will not pay an unlimited amount for any company.

I've never seen a company that was so good it didn't matter what you paid for the stock. To us, value is a good company at a cheap price. Some people bottom fish. They look to see when they can steal companies, and there are times when you can make money that way. But at that point it's not often a very good business, and there aren't too many well-run companies at bargain basement prices. So it's very unusual for us to buy a weak company or a weak industry.

TER: Ron, this has been a good conversation. I appreciate your time, and good luck with your Money-Show presentation.

RM: Thanks; it'll be fun.

Ron Muhlenkamp is the founder and portfolio manager of Muhlenkamp & Co. Inc., established in 1977 to manage private accounts for individuals and institutions. In 1988, the company launched a no-load mutual fund as an investment vehicle for all investors, large or small. Muhlenkamp is an award-winning investment manager, frequent guest of the media, and featured speaker at investment shows nationwide. His work since 1968 has been focused on extensive studies of investment management philosophies, both fundamental and technical. As a result of this research, he developed a proprietary method of evaluating both equity and fixed-income securities, which continues to be employed by Muhlenkamp & Co. In addition to publishing his quarterly newsletter, Muhlenkamp Memorandum, he is the author of "Ron's Road to Wealth: Insights for the Curious Investor." Muhlenkamp received a Bachelor of Science degree in engineering from M.I.T. in 1966, and a Master of Business Administration degree from the Harvard Business School in 1968. He holds a Chartered Financial Analyst (CFA) designation.

DISCLOSURE:
1) Tom Armistead conducted this interview for The Energy Report and provides services to The Energy Report as an independent contractor. He or his family owns shares of the following companies mentioned in this interview: None.

2) The following companies mentioned in the interview are sponsors of The Energy Report: Royal Dutch Shell Plc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.

3) Ron Muhlenkamp: I or my family own shares of the following companies mentioned in this interview: General Motors Co., Clean Energy Fuels Corp., Westport Innovations Inc., Halliburton Co., Rex Energy Corp., KBR Inc., Chicago Bridge & Iron Co. N.V. and General Electric. 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 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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Written By: The Energy Report