First Results in from USEG's Bakken Deal

U.S. Energy Corp.'s partner Brigham Exploration reports:

AUSTIN, TX--(Marketwire - 10/16/09) - Brigham Exploration Company (NASDAQ:BEXP - News) announced that its operated Brad Olson 9-16 #1H produced approximately 2,112 barrels of oil equivalent per day from the Bakken formation during an early 24 hour flow back period.

[...]

Brigham maintains an approximate 33% working interest and 26% net revenue interest in the Brad Olson 9-16 #1H. Also participating in a non-operated role in the Brad Olson 9-16 #1H is U.S. Energy Corp. (NASDAQ:USEG) with an approximate 61% working interest and 48% net revenue interest. Brigham will back in after combined payout of the six initial wells drilled under the participation agreement with U.S. Energy for 35% of their interest in the Brad Olson 9-16 #1H well.

I was waiting for a pullback to add more USEG. If Brigham keeps drilling holes in Bakken and finding oil, that may prove difficult.

USEG News

Shares of U.S. Energy Corp. (NASDAQ: USEG) rose about 32% today on about 13x average volume on the news that the company had entered into a drilling participation agreement with Brigham Exploration (NASDAQ: BEXP) in the Bakken oil field. From the release:

"We are delighted to be teaming up with one of the best and most technologically advanced operators in the Bakken oil field," stated Mark Larsen, President of U.S. Energy. "Brigham has proven itself to be one of the premier companies in the Williston Basin through the advancement of their multi-stage frac completions and their consistent improvement of production rates. We look forward to a long term relationship with Brigham and developing low cost reserves well into the future," he added.

"Our patient search for a sound investment in oil and gas has now come to light with today's announcement," stated Keith Larsen, CEO of U.S. Energy Corp. "At a time when natural gas appears to be poised for an extended period of low prices our main focus has been to expand our oil production and reserves. This agreement does just that by providing us with the potential to rapidly expand our oil production and increase our reserves by participating with an experienced operator that has a track record of lowering its finding and development costs. Furthermore, I am confident that our drilling schedule for the balance of 2009 will allow us to reach our corporate production goal of 7,000 MCFED or approximately 1,200 BOED by year end," he added.

This is a pretty large commitment by USEG -- according to the press release, USEG's "expenditures are anticipated to approximate $17.6 million for the first six initial well program." That's a little less than half of USEG's remaining cash and Treasuries, going by the company's most recent balance sheet. Judging by the relative performance of USEG and BEXP today though, without drilling down further, I'd assume this deal is on pretty favorable terms to USEG. Which would make sense, since it appears that BEXP had a more acute need for the cash than USEG had for the participation deal. I'd venture that some BEXP shareholders bought into USEG today.

I got a voice mail about this today from Reggie Larsen at USEG, but we didn't get a chacne to speak. If he and I connect tomorrow, I'll update this post accordingly. Investor relations via social media: just like in those trendy marketing books.

Reconsidering the Role of Speculation in Commodities Markets

In a post last week ("Matt Taibbi versus Goldman Sachs"), I wrote,

Taibbi takes the hedge fund manager [Michael] Masters at his word re: the commodities spike last year. Goldman is an enormous player in commodities, but one problem with blaming the commodity spike on paper speculation, or on firms such as Goldman getting pension funds to pour money into commodity index funds, is that the prices of commodities that aren't traded on futures markets or included in commodity indexes (for example, certain metals) spiked as well.

News this week lends some support to Masters's claim. From the Financial Times ("‘Rogue broker’ blamed for oil spike"):

The startling spike in oil prices to their highest level this year on Tuesday was caused by a rogue broker who placed a massive bet in the Brent oil market, triggering almost $10m (€7m) of losses for his company.

PVM Oil Associates, the world’s largest over-the-counter oil brokerage, said on Thursday it had been the “victim of unauthorised trading”. The privately owned company said that as a result of the unauthorised trades it had been forced to close substantial volumes of futures contracts at a loss.

[...]

Oil traders in London and New York said the “unauthorised trading” explained the exceptional spike in business activity and prices in the early hours of Tuesday that some initially thought must have been caused by a geopolitical event. “Trading volumes rose overnight and prices jumped more than $2 a barrel without apparent justification,” a senior oil trader in New York said.

Prices rose in one hour from $71 to $73.5, the highest level for the year, according to Reuters data. In total, futures contracts for more than 16m barrels of oil changed hands in that hour – equivalent to double the daily production of Saudi Arabia, the world’s largest oil producer, and far more than the traditional 500,000 barrels for that time of the day.

Traders said the broker implicated had allegedly accounted for at least half of the unusual activity, with the rest the result of others chasing the rally. Oil prices on Thursday fell to $66.5 a barrel, down almost 10 per cent from Tuesday’s peak.

The Financial Times has identified the PVM broker as Steve Perkins. PVM declined to comment and Mr Perkins could not be reached. Fellow traders said Mr Perkins was considered an experienced broker, well-regarded in the market.

This is the second episode of rogue trading in the oil market this year. In May, an oil trader at Morgan Stanley was banned by the City watchdog after he hid from his bosses potential losses on trades made under the influence of alcohol.

The incidents come as regulators are considering tougher oversight of the commodities markets after policymakers complained that speculators fuelled last year’s surge in oil and agriculture prices.

The involvement of PVM is ironic considering the company’s head, David Hufton, has been an outspoken critic of speculators in the oil market, calling some of the exchanges “electronic oil casinos”. In 2006, he said that “if futures exchanges did not exist, oil prices would be a lot lower”.

Matt Simmons on the Outlook for Oil and Natural Gas Prices

Hat tip to Aaron Edelheit for this PDF of Matt Simmons's PowerPoint presentation to the Commercial Club of Boston last month: "The Oil and Gas System is Sick". I hope it won't ruin any surprise if I tell you that Simmons, the author of the book Twilight in the Desert, thinks oil and natural gas prices are heading much higher. I happen to agree, but I'd feel surer if Simmons offered a compelling explanation for the massive correction in oil and natural gas prices last fall. On p.33 of the PDF he lists three common explanations,

–Speculators left the game that created spike
–Unraveling economy killed off demand
–Gluts are now endemic:

~Tank farms brimming with oil
~Super-tankers now floating oil gluts

■But, none of these “facts” were true.
■Only clear fact: “Crude oil fell 74% in 12 weeks” (September 22nd–December 22nd).

And then on P.34 Simmons offers this,

Are We Missing “The Black Swan?”

■Credit default swap index soared as crude oil plunged.
■Credit freeze began when oil collapsed.
■This had to hurt traders’ ability to own oil contracts.
■If any traders ever had to liquidate contracts, this would cause oil prices to temporarily fall.
■Glencore(aka Marc Rich & Co AG) Energy Trading credit default swaps illustrate the squeeze.

Which seems to contradict his point on the previous slide that the collapse wasn't the result of speculators leaving the game. Perhaps Simmons explicated this during a Q&A.

The image above, of the cover of Simmons's book, comes from Barnes & Noble's website.

Berkshire Hathaway's Annual Shareholder Letter

Berkshire Hathaway's annual shareholder letter (PDF) was released today. Berkshire's decline in book value in 2008 was less than I would have expected, 9.6%. Below are a few brief excerpts.

Buffett On Some of his Mistakes in 2008:

I told you in an earlier part of this report that last year I made a major mistake of commission (and maybe more; this one sticks out). Without urging from Charlie or anyone else, I bought a large amount of ConocoPhillips stock when oil and gas prices were near their peak. I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year. I still believe the odds are good that oil sells far higher in the future than the current $40-$50 price. But so far I have been dead wrong. Even if prices should rise, moreover, the terrible timing of my purchase has cost Berkshire several billion dollars.

I made some other already-recognizable errors as well. They were smaller, but unfortunately not that small. During 2008, I spent $244 million for shares of two Irish banks that appeared cheap to me. At yearend we wrote these holdings down to market: $27 million, for an 89% loss. Since then, the two stocks have declined even further. The tennis crowd would call my mistakes “unforced errors.”

On Why Berkshire Sold Some of its Stakes in JNJ, PG, and COP:

On the plus side last year, we made purchases totaling $14.5 billion in fixed-income securities issued by Wrigley, Goldman Sachs and General Electric. We very much like these commitments, which carry high current yields that, in themselves, make the investments more than satisfactory. But in each of these three
purchases, we also acquired a substantial equity participation as a bonus. To fund these large purchases, I had to sell portions of some holdings that I would have preferred to keep (primarily Johnson & Johnson, Procter & Gamble and ConocoPhillips). However, I have pledged – to you, the rating agencies and myself – to always run Berkshire with more than ample cash. We never want to count on the kindness of strangers in order to meet tomorrow’s obligations.

On Treasury Securities:

When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary.

On the limits of Regulation:

For a case study on regulatory effectiveness, let’s look harder at the Freddie and Fannie example. These giant institutions were created by Congress, which retained control over them, dictating what they could and could not do. To aid its oversight, Congress created OFHEO in 1992, admonishing it to make sure the two behemoths were behaving themselves. With that move, Fannie and Freddie became the most intensely-regulated companies of which I am aware, as measured by manpower assigned to the task.

On June 15, 2003, OFHEO (whose annual reports are available on the Internet) sent its 2002 report to Congress – specifically to its four bosses in the Senate and House, among them none other than Messrs. Sarbanes and Oxley. The report’s 127 pages included a self-congratulatory cover-line: “Celebrating 10 Years of Excellence.” The transmittal letter and report were delivered nine days after the CEO and CFO of Freddie had resigned in disgrace and the COO had been fired. No mention of their departures was made in the letter, even while the report concluded, as it always did, that “Both Enterprises were financially sound and well managed.”

In truth, both enterprises had engaged in massive accounting shenanigans for some time. Finally, in 2006, OFHEO issued a 340-page scathing chronicle of the sins of Fannie that, more or less, blamed the fiasco on every party but – you guessed it – Congress and OFHEO.

"Why Gasoline is Still King"

Another interesting article from the American re fossil fuels, this one by Ralph Bennett: "Why Gasoline is Still King: Electric roadsters are the darlings of the press, but it is likely that gasoline will continue to dominate personal transportation." Bennett's short answer comes down to the energy density of gasoline. Below is a relevant excerpt:

We may expatiate on the latest developments in electric cars and the delicious prospects of hydrogen fuel cells and various biofuels made with everything from switch grass to garbage; we may earnestly speculate about flywheels and compressed air and various gases, natural and unnatural—but we go with gasoline.

A gallon of gas weighs about 6.3 pounds and produces roughly 35 kilowatt hours of energy. That’s enough to burn a 100-watt light bulb continuously for more than two weeks. A lead-acid battery could do the same thing without needing a recharge—if it were the size of a desk and weighed a ton. Energy density is the point. We just haven’t come up with a fuel or a device that will safely and economically offer the same calorific value in such a small space as an automobile’s gasoline tank. Compressed natural gas (CNG) and liquefied natural gas (LNG) intrigue us, but the problems of storing them (or hydrogen) in a car in sufficient quantity to approach gasoline’s range and performance continues to be a sticking point. We always come back to density.

The photo above, from the article, is of the Tesla Roadster

Update on Local Gas Prices

The photo above was taken at the Valero in Hasbrouck Heights, NJ on Saturday. The prices may be slightly lower today. Regular unleaded is down about a third from where it was when we last posted a photo from this station at the end of August ("Gas Prices, Tipping Points, and Demand Destruction").

A Conversation with the CEO of Vaalco Energy

The CEO of Vaalco Energy (NYSE: EGY), Robert L. Gerry III, was kind enough to spend a few minutes on the phone with me today. A few notes from our conversation:

- He estimates that the per-barrel cost of production of any oil produced by Vaalco's current exploration projects will be similar to the cost of the company's current production, i.e., about $10 per barrel.

- No predictions on oil prices, but given Vaalco's low cost of production, Gerry was unconcerned. "We can make money on $20 oil," he mentioned.

- Regarding the political environment in West Africa, he said the government of Gabon had been great to deal with, and Vaalco hasn't had any problems there. He noted that Gabon is one of the more stable countries in Africa (as we mentioned in a previous post, "Vaalco Energy Reports"). Vaalco currently has an office in Angola as well, in support of its exploration there.

- Gerry estimated that the company would be able to maintain daily production rates of about 25,000 barrels through '09, but noted that its FPSO¹ would be about maxed-out at these levels. He mentioned that the rates to lease an FPSO currently average about $70,000 per day, but given the current correction in crude, these might start coming down at some point. If they do, he'd consider locking in low rates on one in advance.

¹Floating Production, Storage, and Offloading vessel -- see the image above, which comes from Vaalco's website.

Conversation with the CEO of USEG

U.S. Energy Corp. (Nasdaq: USEG) put out a press release on Monday announcing a deal with a private, Texas-based oil company -- U.S. Energy's third working interest partner in the oil & gas space: "U.S. Energy Corp. Signs Lease Purchase and Drilling Agreement With Private Texas-Based Company".

I spoke to U.S. Energy's CEO Keith Larsen today, and asked him if he was seeing better terms offered on these sorts of working interest deals, with the current correction in oil and natural gas prices. He said he was, and that he was also starting to look at buying proven reserves from other companies, particularly those that overextended themselves with leverage and may now be forced to sell some of their assets.

At its closing price today of $2.29 per share, USEG is trading for about $2.5 million less than its net cash.

The Commodity Correction

The commodity correction over the last few months has been brutal, across all market caps. For example, my micro cap holding Alloy Steel International¹ (OTC BB: AYSI.OB) closed at $1.16 per share today, down from its June high of about $2.80; mid cap U.S. Steel (NYSE: X) closed at $63.50 today, down from its June high of nearly $192 per share; and large cap Arcelor Mittal (NYSE: MT) closed at $44.62 today, down from its June high of $104.25. Share prices of agricultural commodity companies have posted similar drops.

A question this raises is whether this is a cyclical correction in the continuing secular bull market in commodities, or the end of that secular bull market. My view is that this is a cyclical correction and could be a great buying opportunity (for anyone who has some dry powder left). It's worth revisiting some comments Jim Rogers made to Bloomberg's Carol Massar in July ("Jim Rogers Speaks"):

[Carol Massar:]...What about this commodity boom? I think recently we talked to you and or I was reading something and it said that we are in the fourth inning of a baseball game. Still there, in your view?

ROGERS: Probably around the fourth inning, that sounds good enough. Maybe the fourth and a half, maybe the top or the bottom of the fifth, something like that. The commodities bull market has a long way to go.

There are going to be corrections along the way, Carol, there always are, but no, nobody has discovered any major oil field in over 40 years. There just aren't any supplies of anything.

MASSAR: Jim, what do you make though of the arguments out there about demand destruction, about a weakening global economy and that is going to start to bring down commodities. I know you talk about some near-term corrections.

So, anything out there though that will substantially drag down commodities, in your view?

ROGERS: Well, recession, if the world goes into recession, of course it is going to drag down the demand. But remember, Carol, in the 1970s we had one of the worst decades in a long time for the economy. And oil went up ten times, the oil commodity, we had one of the great bull markets of all time in commodities because supply went down faster than demand and that is what is happening now too.

Oil can go down - you know the bull market in oil started in 1999. Three times since 1999, oil has gone down over 40 percent. It wasn't the end of the bull market. It just scared the socks off everybody, including me. That can happen again, but it is not the end of the bull market.

MASSAR: So, any pullbacks for a buying opportunity, in your view, whether it is oil, whether it is grains, whether it is base metals?

ROGERS: Yes, of course. Everything. Base metals have already corrected a lot. Wheat has corrected a lot. Sugar has corrected a lot. Get yourself some sugar, take it home, take it home from your Bloomberg.

[snip]

MASSAR: 30 seconds left here. I know you mentioned you are kind of looking, eyeing at base metals. Anything else you think investors should be looking at, just kind of keeping on their radar, just quickly if you could?

ROGERS: Agriculture, agriculture. You should be buying agriculture. I am buying agriculture.

Update: Rogers reiterated his view that the secular bull market in commodities hasn't ended in an interview with New Delhi Television over the weekend, "Commodity bull run not over yet: Jim Rogers". Excerpt:

NDTV: Do you believe in the theory of commodity cycle cooling off?
Jim Rogers: There is no question that commodity prices have cooled off, but that is the way the market works. You always have consolidation and correction. Three times in the last nine years, oil prices have gone down by 50 per cent, and each time it was not the end of the bull market. If suddenly someone discovers huge oil reserves then the bull market is still on.

NDTV: But how long the bear market in the current commodity space will continue?
Jim Rogers: In the 1970s, gold went down 50 per cent, but after two years it turned around and went up 850 per cent. So I don’t know how long this correction is going to last. If the worldwide economic problem continues for a while then it can last for a longer period.

NDTV: But everybody is talking about global slowdown, so if there is no demand then how will commodity price rise?
Jim Rogers: They will have a consolidation but if you are suggesting the world in a perpetual economic decline, then we will never have any bull market.

¹Alloy Steel occupies a different niche than traditional steel companies: it manufactures alloy steel wear plates for mining equipment.

USEG Update

U.S. Energy Corp. (Nasdaq: USEG) announced the spudding of the second of the three planned wells with PetroQuest Energy (NYSE: PQ). Excerpt from the press release:

``With drilling completed at the Bluffs prospect, our oil and gas program continues to expand as our partner, PetroQuest, has redeployed the rig to begin drilling at the second of three projects where we have an interest,'' stated Keith Larsen, CEO of U.S. Energy Corp. ``As we advance our oil and gas program through the balance of 2008, we expect to report initial production rates at the Bluffs and additional drilling at our other prospects. With approximately $70 million held in U.S. Treasuries and cash, we are well positioned to take advantage of any additional opportunities identified in the year ahead,'' he added.

According to Yahoo! Finance, USEG currently has a market cap of about $60 million and, after adding in its debt and subtracting its cash, an enterprise value of about $1.5 million.

Trouble in Russia

With all the excitement in the U.S. markets this week, the crash in the Russian stock markets, and the subsequent suspension of trading Tuesday (The Financial Times: "Russia halts trading after 17% share price fall") didn't get as much attention as they might have otherwise. Now Forbes reports that the Russian stock markets are set to reopen tomorrow ("Inside Russians Stock Market Panic").

A couple of months ago, I mentioned an e-mail I received from friend who worked for a Moscow-based brokerage. I've sent him an e-mail to see what his thoughts are on the current situation there.

Sarah Palin, Todd Palin, and the benefits of Increasing Domestic Energy Production

Alaska Governor Sarah Palin, John McCain's surprise VP pick, is in at least one sense a refreshing change from the usual sort of politician we've seen on a national ticket: someone who has done some blue collar work in her life, when she worked in commercial fishing. Her husband has gotten his hands dirty as well, both as a fisherman and while working in the oil fields for BP (NYSE: BP) on Alaska's North Slope¹. According to this article in the Anchorage Daily News from last year, "Todd Palin Unique Among Nation's 5 First Husbands" (hat tip to Atlantic blogger Jeffrey Goldberg),

Until recently, he earned hourly wages as a production operator in a BP-run facility that separates oil from gas and water. Palin was making between $100,000 and $120,000 a year before he went on leave in December to make more time for his family and avoid potential conflicts of interest. London-based BP is heavily involved in the gas pipeline negotiations with his wife's administration.

That's good money for honest work, and, as I've pointed out in comments on some political blogs, it's another benefit of increasing domestic energy production: more high-paying blue collar jobs for Americans². To his credit, Mr. Palin has encouraged young Alaskans to consider the same line of work. From the article,

Like other first spouses around the country, Palin has been asked to champion an array of causes or institutions since his wife took office in December.

His favorite is steering young Alaskans toward stable jobs in the oil and gas industry. It's a singular choice among his counterparts, whose pet issues include schools, public health, domestic violence, poverty or the arts.

That's the sort of pragmatic career advice you don't hear much of from many politicians, particularly those on the left, many of whom seem to consider access to a college education to be a panacea for economic advancement. In reality, a lot of Americans don't have the interest or aptitude for college (hence the high dropout rates), or the sorts of jobs a college degree often leads to, and there are plenty of Americans with college degrees sitting in cubicles making a third of what Palin was making for BP, or serving lattes for $8 per hour.

Regarding the politics of the Palin pick, a flurry of comments on the Atlantic blogs argue that this is an attempt by McCain to woo women voters. I doubt that. Most single women vote for Democrats, and most married women vote for Republicans; I don't see this pick changing those trends much. If anything, McCain's selection of Sarah Palin is an appeal to the sort of Reagan Democrats that Barack Obama had difficulty winning over in states like Pennsylvania. While Republican politicians generally feel compelled to be seen hunting or clearing brush or otherwise acting as if they enjoy outdoorsy activities, Sarah Palin seems to be the real deal on that score, having grown up hunting moose with her father. She and her husband ought to be able to connect more easily with rural voters than, say, Mitt Romney. Louisiana's impressive young governor, Bobby Jindal, might have contributed more in policy terms, but Palin probably gives McCain a better shot of winning in November.

¹A royalty trust that pays out distributions based on production from BP's Prudhoe Bay field on the north slope is a holding of mine I've mentioned here before, BP Prudhoe Bay Royalty Trust (NYSE: BPT)

²There are other benefits, of course. Every barrel of foreign oil that we can replace with a barrel of domestic oil helps reduce our trade deficit and our fiscal deficit as well (by the increased tax and royalty revenues domestic energy production generates). No, increasing domestic energy production will not make us energy independent -- we will still need to import oil from Canada, Saudi Arabia, etc. But the more energy we can produce here, the better off we will be.

Gas Prices, Tipping Points, and Demand Destruction

The Valero station above is where I usually fill up, since most of the time it has the lowest prices in the area. Gas prices peaked here a couple of months ago at $3.93⁹, so to see them drop to $3.39⁹ this week was a relief. Last year, when gas prices peaked here at around $3.15⁹, I remember how high that seemed at the time, and that I tried to drive less. Now, after paying $3.93⁹ per gallon two months ago, paying $3.39⁹ seems like a deal. I don't think about gas prices much now when I decide whether or not to drive somewhere.

Thinking about this, I recalled recent columns claiming that $4 per gallon gas was the tipping point into demand destruction, so the corresponding oil price (~$149 per barrel) was the peak (some columnists went further, and claimed that oil was on its way back to $70 or less per barrel). A problem with the tipping point concept, as my reaction above demonstrates, is that the mind adjusts, so tipping points are a moving target. $4 gas may have been the tipping point that caused Americans to drive less this year, but next year that tipping point might be $4.30, and the next year $4.50, and so on.

That's just us, of course. The rest of the world has plenty of drivers, and many of them in developing and oil-producing countries have gasoline subsidies that insulate them from the effects of higher oil prices.

How Unusual is a 20+% Correction in Oil?

Interesting post by Tim Iacono, "How Unusual is a 'Bear Market' in Oil?":

A story in USA Today today began "Finally, investors have a bear to get excited about. Oil now is in unofficial bear market territory, with the price of a barrel of crude falling to $115.20, down 21% from its July 3 peak."

A good question to have asked prior to writing an article such as this, something that apparently doesn't occur to the new "oil bear market" enthusiasts, is whether a 20 percent decline in the price of crude oil is unusual or statistically significant in any way.

More on Electric Cars and Plug-in Hybrids

From Joe Nocera's column in yesterday's New York Times (Talking Business: "Costly Toys, or a New Era for Drivers?").

In the documentary “Who Killed the Electric Car?” — about the EV1, an all-electric car General Motors began making in 1996 and killed once and for all in 2003 — the filmmakers posit the theory that the vehicle was done in by a grand conspiracy involving the oil industry, the Bush administration and the car industry. But that’s not what happened. Gas was cheap when the EV1 was on the market; auto buyers preferred S.U.V.’s. And the technology didn’t exist to allow the EV1 to become a viable mass-market automobile. Among its flaws, the EV1 used a nickel metal hydride battery that couldn’t get more than 75 miles before needing a charge.


“My daily commute was 37 miles one way,” wrote a man named Michael Posner on a Web site called The Truth About Cars, who drove an EV1 for several weeks back in 1997. “Every trip was loaded with drama,” he added. “If I went to lunch, I gave up a few precious miles. That could mean disaster.” At General Motors, they took to calling this problem “range anxiety.” Is it any wonder the car didn’t catch on?

So far so good, although from reading the rest of the column, I get the sense that Joe Nocera doesn't seem to actually understand how the plug-in hybrid Chevy Volt works (it doesn't "switch back" to electric; it only runs on electric -- the gas motor is just there to recharge the battery). The salient point that he gets right is that it has mainly been technological challenges (primarily with the batteries), and not a grand conspiracy, that has delayed the mass-market introduction of electric cars. Nocera concludes by doubting the ability of Tesla Motors to field an all-electric mass-market sedan (the company's next project after the Roadster), and claims that GM's Chevy Volt is the "the one to root for".

For a more cynical take on the Chevy Volt, check out Holman Jenkins's column in the Wall Street Journal from earlier this month, Business World: "What is GM Thinking?". From that column:

GM executives are not nuts. They justify the costs and risks of the Volt as a way of changing GM's image in the minds of consumers and politicians. To commit a pun, the Volt is GM's vehicle for making a bailout of GM politically acceptable.

Incidentally, the challenges of fielding viable plug-in hybrids described in both columns are consistent with what I wrote in this post, "Why Oil Prices will likely be Higher in 5 Years -- but not necessary in 10 or 15".

Tesla's Wild Ride

I meant to post a link to this Fortune article when I first read it over the weekend, but better late than never: "Tesla's Wild Ride". The subtitle gives a good summary of the rest of article:

Building the world's first electric supercar was never going to be easy - even without the hubris, infighting, and mismanagement that nearly sent Tesla spinning off the road.

Somewhat surprisingly, Tesla Motors posted a link to this article on its website.

USEG Update: Spudding of First Well with Petroquest Energy

In our conversation Friday, USEG's CEO mentioned that the first well USEG was participating in with Petroquest Energy was about to be spudded. Today USEG released this press release: "U.S. Energy Corp. Announces the Spudding of Its First Well With PetroQuest Energy".

U.S. Energy Corp. (USEG)

I started a position in U.S. Energy Corp. (USEG) last month at $2.85. Today it closed at $2.81. Below is a write-up of the company I initially posted on GuruFocus.com a few days after I bought the stock. I am re-posting it here now because I spoke with the CEO of USEG today, and before I post my notes on our conversation, I wanted to provide some background on his company, for those who may be unfamiliar with it.

---------------------------------------------------------------------------------------

U.S. Energy Corp. (USEG) is an energy and natural resources exploration and development company currently trading for a third less than its book value (it was trading for .57x book when I bought it a few days ago). The management of USEG has a demonstrated track record of acquiring natural resource assets and selling them at opportune times for significant gains; the most recent example of such a successful sale occurred last year, and was the source of most of the company’s current cash hoard. USEG is a compelling value on its discount to book value alone, but four potential catalysts present opportunities for significant additional appreciation.


Valuation


USEG has a market cap of $75,470,000 and an enterprise value of $10,687,000 (subtracting both the company’s cash and its Treasury securities from the sum of its market cap and interest-bearing debt). It currently trades with P/B ratio of .66 and an EBIT/EV ratio of 82% (using trailing twelve-month data). The reason why the company trades at such a high earnings yield is because up until now it has generated its income through occasional deals rather than through consistent earnings. The company’s strategy going forward is to invest in assets that will produce recurring revenues while still pursuing large deals with windfall potential. The catalysts I describe below include examples of both. Note that the data above do not reflect the results of U.S. Energy’s sale, announced today, June 13th, 2008, of 39,062,072 shares of Sutter Gold Mining Inc. (SGM on the TSX Venture Exchange) for approximately $5,281,200 (in U.S. dollars).



Examples of USEG Management’s Timely Sale of Natural Resources Assets


Last year, U.S. Energy sold uranium properties that it had staked claims on during the 1990s, and had held onto as uranium prices dropped from the $ mid-teens per pound to $6.40 per pound in 2001. With uranium prices at uneconomical levels, U.S. Energy turned its focus to developing prospects for coal bed methane, but held onto its uranium properties. Through a subsidiary, Rocky Mountain Gas, U.S. Energy invested $15 million in the exploration and production of coal bed methane assets. Through a series of transactions, by the end of 2005, U.S. Energy had sold these assets for a total of $27.7 million.


Last April, when uranium prices were about $110 per pound, USEG sold its uranium properties to Uranium One Inc. (which trades under the symbol UUU.TO on the TSX) in exchange for 6.6 million shares in Uranium One, plus additional consideration, which I will expand on below. Uranium prices peaked in the mid-$130s a few months later, in the summer of 2007, and around that time USEG sold all of its shares of Uranium One Inc. for an average price of $13.68. Today, uranium is trading for less than $60 per pound, and shares of Uranium One Inc. are trading at about $4.30. This is an example of near-virtuosic timing and prudence on the part of USEG management, and one that bodes well for its handling of its current and future natural resource projects.


Catalysts


USEG has four potential catalysts to unlock additional value: One in the near-term (most likely this year), two in the medium term (within the next five years), and another in the longer-term (five years from now).


Near-Term Catalyst

· The Completion of a 216 Unit Residential Real Estate Project in Gillette, WY. Demand for housing in this part of Wyoming has been high recently because of the natural resources boom – the Gillette area produces about 40% of America’s coal, and the town’s population is growing by 7%-10% annually. Of the 216 units, 207 have been pre-leased. If USEG holds onto this property, its CEO Keith Larsen estimates it will generate about $250,000 in monthly revenue. Although USEG management sees promise in targeted real estate developments in regions participating in the natural resources boom, they have decided not to pursue any additional real estate projects, to assuage investor demand that they focus exclusively on energy and natural resource projects.

Medium-Term Catalysts

· Oil and Gas Exploration and Production. U.S. Energy has entered into separate partnership agreements with a private Houston-based oil and gas company and with Lafayette, LA-based Petroquest Energy (PQ on the NYSE). Drilling of the first three natural gas wells with Petroquest is expected to begin in June of 2008, and the drilling program with the private company is expected to begin in 2009. According to a presentation by Petroquest management dated June 2nd, 2008, Petroquest’s drilling success rate over the last 9 years has been 89%. U.S. Energy’s CEO has estimated that his company’s interest in these three wells alone could generate $250,000 in monthly revenue (the CEO estimates that USEG may be able to generate a total of approximately $750,000 in monthly revenue between interest income, income from the Gillette real estate development, and the potential revenue from these initial wells). USEG is evaluating other oil and gas investment opportunities to pursue in partnership with exploration & production companies that have proven, successful track records.
· Additional Payments from Uranium One. The largest part of the additional consideration that USEG received from Uranium One last year was $40 million to be paid contingent on the former USEG uranium properties meeting certain production targets; USEG management expects to receive this $40 million in the next few years as these production targets are met. Since USEG is such a small, little-followed stock, these windfall payments may act as catalysts for the share price as market participants see them appear in USEG’s quarterly filings. More importantly, USEG will be able to reinvest these moneys in energy and natural resource projects with promising returns.


Long-Term Catalyst


· Molybdenum Claims in Colorado. USEG’s patented “Lucky Jack” molybdenum claims near Crested Butte, Colorado, represent its most challenging project and also potentially its most lucrative one. USEG management estimates that a mine here could produce 15-20 million lbs of high-grade molybdenum per year, at a cost of about $10 per lb, and that the mine could have a 50-year life. Molybdenum, the demand for which has been driven partly by the global infrastructure boom, currently trades at over $33 per lb, so the potential profits from a Lucky Jack mine at current prices hold would be over $345 million per year. Currently, USEG has commissioned an engineering study of the project, and intends to submit a plan of operation to the U.S. Forestry Service by the end of 2008. If all obstacles are surmounted, and USEG can build a mine here, it would first start producing molybdenum in 2013. USEG may be able to monetize part of its interest in this project before then though, since it plans to sell a stake in its claim to an established mining company and have that company help develop the project.

Two Solutions to America's Energy Crisis

In today's WSJ, Joseph Petrowski, the president of Gulf Oil, offers his solution ("A Bipartisan Fix for the Oil Crisis"). In a nutshell: Democrats need to agree to allow increased domestic exploration and production and Republicans need to agree to higher fuel efficiency standards for cars and trucks. Excerpt:

We can responsibly drill. The technology to find, drill and recover oil has evolved tremendously, and careless drillers will fear tort lawyers more than government regulators. The claim that the oil companies are sitting on leases and not drilling defies all logic. With oil at $135 per barrel and drilling rigs renting at $300,000 per day, there are no idle rigs anywhere.

In The American, Andy Grove, former CEO of Intel, offers his solution ("Our Electric Future"). Somewhat confusingly, he uses the term "dual-fuel" to refer to what most seem to call "plug-in hybrids", i.e., cars that can travel shorter distances on an electric battery but have a back-up gasoline-powered engine. Nevertheless, his general point makes sense: if cars ran primarily on electricity, the country would be less vulnerable to energy shocks because that electricity could be generated by a variety of sources: natural gas, coal, nuclear, etc. Consistent with my point in an earlier post ("Why Oil Prices will likely be Higher in 5 Years -- But not Necessarily in 10 or 15"), Grove notes,

No matter how fast the production of dual-fuel cars is ramped, replacing the bulk of the approximately 250 million cars on the roads in the United States with new cars will take a decade or more.