Saturday, July 12, 2008

A Conversation with the CEO of U.S. Energy Corp. (USEG)

Keith Larsen, the CEO of U.S. Energy Corp. (USEG), was nice enough to spend 40 minutes on the phone with me Friday answering my questions about his company, and sharing his insights about the natural resources industry. Here are a few notes from our conversation.

- Alternative Energy: T. Boone Pickens's plan came up in our conversation, and Keith Larsen mentioned that he had just seen Pickens speak at an event in Denver. Larsen noted that USEG is considering investments in alternative energy, including wind.

- The Gillette, WY project: Currently, it's half built, and the half that is built is 100% occupied and generating $120k in monthly revenue. The other half will be completed by October 1st, and Larsen expects this half to be fully occupied as well, so the completed project should be generating about $240k in monthly revenue for USEG. Gillette has a population of about 50,000, but is growing at about 7% per year and has been benefiting from the secular bull market in commodities -- 40% of America's coal comes from this area (and of course about half of America's electricity is generated by coal-fired power plants).

- Real estate in general: USEG's board has decided not to pursue additional developments, despite the success of the Gillette project, and plans to sell off piecemeal another property it owns -- 25 acres of undeveloped land adjacent to its headquarters. Mr. Larsen expects they will be able to do so at a profit.

- Oil & Gas exploration: The first of three wells being drilled in partnership with Petroquest Energy (NYSE: PQ) is about to be spudded, and the next two are scheduled to be completed this fall. Although Petroquest's website touts an 89% success rate on its wells, Larsen says that figure includes its shale projects, and the more relevant success rate for Petroquest with these sorts of exploratory wells is 70%. If these wells are successful, Larsen estimates they could generate $150k-$250k in monthly revenue per well for USEG. Combined with the revenue from the Gillette, WY development, this could total $1 million in revenue per month, which would be enough to give USEG consistent, positive earnings.

- The Lucky Jack Molybdenum project: Keith Larsen is confident that this project will eventually get completed. He noted that, although our current high energy prices are bad for America unfortunately, they are at least finally increasing public support for natural resource projects such as Lucky Jack (and, of course, oil & gas drilling). Larsen says that despite a small, vocal, minority of environmentalists (who remain unsatisfied by USEG's plans to develop the mine in an environmentally responsible way), the feedback USEG is getting from most locals in the Crested Butte area is that they want the project to go forward, and they are looking forward to the jobs it will create. Larsen also clarified his earlier $10 per pound cost estimate, saying they are working on getting a current engineering cost estimate, and that his $10 figure was a ballpark estimate derived by more than doubling a previous engineering cost estimate. Ten years ago, when molybdenum was trading for about $5 per pound, a previous engineering study estimated that this molybdenum deposit could be mined profitably, at a cost of about $4.50 per pound. Larsen used $10 per pound as a ballpark estimate to take into account the increased cost of mining equipment and labor today.

- Uranium: Larsen explained that the end of our reprocessing treaty with the Russians should put pressure on uranium prices over the next few years. Although Uranium One is not required to give USEG updates on its plans, he estimates that USEG will receive at least $20 million of its $40 million in contingent deferred compensation from Uranium One by 2011. Larsen also noted that USEG also has a 4% interest in any net profits from the Green Mountain uranium deposit, which is estimated to contain 50 million pounds of uranium (uranium currently trades for about $60 per pound). That deposit is currently owned by Rio Tinto which is shopping it around to other mining companies.

- Insider sales: I mentioned the three ~300,000 insider sales listed on Nasdaq in January, and Larsen explained that those were actually shares of a subsidiary that were canceled, and that they are reported as insider sales although they actually aren't. He said that no insider in USEG has sold shares in 10 years.

- Three accounting firms used in the last few years: Larsen said that one of USEG's accounting firms was bought by another, and that also Sarbox required them to change accountants periodically. He noted also that, since they were now actively involved in oil & gas exploration, they might need to switch accountants to a firm more experienced in this area.

U.S. Energy Corp. also recently announced that it has applied for a listing on the Toronto Stock Exchange (TSX), and it expects that application to be approved and that U.S. Energy will start trading on the TSX by the end of October. Since many natural resources companies are listed on the TSX, a listing there should expose U.S. Energy Corp. to a new audience of natural resources investors.

At the current quote ($2.81 per share), USEG trades at less than 60% of its book value. I may add more at these levels.


Daniel said...

Great post.

Operating costs for Lucky Jack are one thing but how about the up-front costs before they even get that far? That is crucially important.

Environmental groups, however small, can ruin the NPV of projects. Something to keep an eye on. These schmucks are the best friends of high commodity prices and the worst enemies of people who need commodities to live.

Won't argue with the success they had in unloading their uranium position, nor even that the real estate position seems to have worked out, but given the history here one has to be comfortable with management's ability to continue to allocate money profitably.

They seem to be jumping from hot spot to hot spot, no? I mean real estate, uranium, oil and gas, wind. Nothing particularly wrong with that--if they are working with partners that know what they're doing--but what's your feel for their abilities after talking with the CEO?

For me, who hasn't put nearly as much time into this company as you, I think it comes down to the viability of the Lucky Jack project. If that's a great investment than this is probably an excellent one. But even here, it comes down to the confidence you have in the management team being able to develop what a FS will hopefully say is a profitable mine.

Hope these thoughts are worth something. You put a lot of thought into that post so I figured I'd offer at least something--whether useful or not.

DaveinHackensack said...

Thanks for the comments and questions, Daniel. As always, I appreciate your feedback.

Regarding the up-front costs, the M.O. is to sell a stake in the project to a mining major with that major covering 100% of the costs going forward as part of the deal.

"They seem to be jumping from hot spot to hot spot, no?"

Not exactly. They held onto their uranium properties whe uranium was a 'cold spot' in 2001 (trading at $6.40 per pound), and didn't sell most of their uranium properties until last year, when it was trading for $110 per pound. Also, most wouldn't consider real estate a "hot spot" today (and of course, broadly speaking, it isn't), but USEG was savvy to develop the Gillette project in spite of that sentiment. The project is consistent with Jim Rogers's insight in Hot Commodities that real estate in regions benefiting from the secular boom in commodities will tend to do well.

Relatedly, I caught a few minutes of CNBC's replay of their special on oil, where they interviewed a high-end real estate broker in Houston. His business was booming. Why wouldn't it be? He's in Houston, the Silicon Valley of the energy industry (as Daniel Gross has aptly called it).

I don't know much about the company's potential investments in alternative energy. I do think that this might make sense for political reasons, if nothing else, if you look at the big picture. Note -- this is just me speculating, and isn't based at all on anything the CEO said in our conversation. That said, let's consider a scenario.

You're getting flack from a vocal minority of environmentalists over your big proposed molybdenum mine. They try to paint you as some rapacious company that doesn't care about the earth, "climate change", or whatever. You point out that you're trying to build a windmill farm in the next town, to generate the electricity locals will need to charge their plug-in hybrids, and that the Johnson Rods in the windmills need to be made out of a steel alloy made with molybdenum -- and what kind of environmentalists are against plug-in hybrids anyway?

As for my sense after speaking with the CEO, this was the second time I spoke with the CEO of a natural resources company (the first was when I spoke with the CEO of Vaalco Energy), and in both cases, even as a fairly well-read layman, it's a humbling experience to speak with someone who has to throttle back a little so you can keep up. That said, USEG's CEO seems like a straight shooter to me. He answered all of my questions without any evasions, and I was impressed that he volunteered that Petroquest's success rate for the sort of wells it's drilling with USEG is lower (~70%) than PQ's overall success rate (~89%). Regarding USEG's ability to develop the molybdenum mine, remember again their M.O.: get a deep-pocketed mining major to do the heavy lifting.

There's an investor who has a lot more experience than I do, whose opinion I respect. He's been something of a devil's advocate on USEG, and I plan to run my new info by him.

Daniel Mokhtar said...

That said, USEG's CEO seems like a straight shooter to me. He answered all of my questions without any evasions, and I was impressed that he volunteered that Petroquest's success rate for the sort of wells it's drilling with USEG is lower (~70%) than PQ's overall success rate (~89%).

I'd just second that thought. After watching the CEO on a video interview I was reassured by his manor and genuineness. Those are the types of companies I like to cast my lot with. The 60 Mil of cash on the balance sheet's not bad looking either.

DaveinHackensack said...

He does seem like a genuine guy, Daniel Mokhtar, and in times of tight credit, having plenty of cash on the balance sheet is a good thing.

Denis B. Hall said...

Mr. Larsen may be a straight-shooter, but his assertion that only a small group of Crested Butte environmentalists oppose the mine is flat wrong. The town and much of Gunnison County oppose a mine. There are myriad sources of molybdenum other than smack in the middle of the town's watershed.

DaveinHackensack said...


The company seems committed to mining this resource in an environmentally careful way, and I would think the host of regulatory hurdles involved are designed partly for that purpose. From checking out your blog, it appears that you have other objections to mining, e.g., you prefer the area's current tourist economy to the additional (and, I would think, higher-paying) jobs that the mine would create. Have you proposed a referendum to see what percentage of the community shares your views?