A strange moment at PowerGen 2012...

A strange moment at PowerGen 2012... Two power-generation themes... A trip to Cane Island... Chinese homebuilders in the U.S.... Bullish on biotech...

 I'm in Orlando, Florida, attending the 2012 PowerGen conference with my research partner, Mike Barrett.

PowerGen is a massive event devoted solely to all aspects of the business of generating electricity. This year, it's accommodating more than 21,000 attendees from all over the world and more than 1,300 exhibitors.

The conference started yesterday with four keynote speakers. The first was a retired Navy admiral. He spoke for 10 minutes about the brave men and women of the U.S. military. That was odd enough at an event focused on power generation... He added to the slight awkwardness toward the end of his rambling paean when he said, "Our democracy is powered by the brave men and women of our military."

It was a weird moment, conjuring images of tanks and ranks of troops marching through Red Square in Moscow or perhaps Tiananmen Square in China. If he'd been in a flamboyant military uniform with a pair of Ray-Bans on (instead of a suit), it would have been right out of the banana-republic playbook. It wasn't until he almost finished his talk that he mentioned there was a Wall of Heroes on display in the exhibition hall... which still failed to explain the connection between power generation and the military.

My brother spent decades in the Marines. Nobody has anything to tell me about respecting those people willing to put their lives in harm's way to defend me. So don't bother filling our inbox with those kinds of e-mails. But this felt really weird... Although maybe it's what we should expect from a country that spends way, way too much on "defense."

 After that, I heard two other speakers and five presentations in smaller sessions. Throughout, two themes emerged for U.S. power supply and demand.

First, natural-gas usage for power generation will continue to grow. It's expected that 60% of new power plants constructed through 2035 will be natural-gas-fired. An executive from Florida utility company TECO said when he started a few decades ago, TECO had 99% coal-fired plants. Now, it has 60% natural gas.

Large numbers of new coal and nuclear plants will be built in Asia, but not in the U.S. The CEO of engineering and construction firm Babcock & Wilcox said his company is building no new coal plants in the U.S., and several in China and India.

The second common theme was slowing demand growth in the United States. In the 1950s, U.S. power demand was growing 8% a year. That rate slowed steadily, finally hitting a wall in the wake of the 2008 financial crisis. The TECO executive says since then, 1.5% annual growth is more realistic for his territory in Florida.

One reason for slower power-demand growth: New, popular technologies require far less power than the devices they are replacing. A regular laptop computer uses about $25 in energy per year, according to one presenter. Meanwhile, an iPad uses just one-tenth that amount. Likewise, LED television sets use about one-tenth the power of plasma TVs.

 On Monday, before the conference kicked off, Mike and I traveled to the nearby Cane Island power plant. It's got four natural-gas-fired turbines and, according to the control-room monitors, it was generating 320 megawatts while we were there. (One megawatt is enough to power about 1,000 homes for a year.)

Three of those turbines can also run on petroleum distillate fuel oil. The newest and largest turbine is gas-run only. The plant's vice president told us natural gas would have to hit $10 or $11 per thousand cubic feet before he'd switch to oil. It's been as low as $2 this year and sits at less than $4 today.

The newest plant engineer at Cane Island told us he's been there almost two years, and the plant never switched fuels once in that time. The biggest problem with fuel oil? It has to be kept "fresh" by adding chemicals, which kill biological critters that consume the oil. We walked by huge storage tanks full of the stuff. It's unlikely to do anything but sit there, with all the cheap natural gas being produced these days.

 Following up on Monday's discussion of the Chinese buying loads of U.S. property...

Lennar, a leading U.S. homebuilder, secured a $1.7 billion loan from state-run China Development Bank (CDB) for two massive housing projects in San Francisco. This is CDB's first major infrastructure financing in the U.S... It has focused on Africa, South America, and Asia in recent years. As part of the deal, a Chinese contractor will likely be involved in the project... State-run China Railway Construction Corp. is the frontrunner for the role.

Lennar's proposed Treasure Island and Hunters Point Shipyard developments would provide nearly 20,000 new homes, in addition to an arena and office buildings.

 In the December 5 Digest, we reviewed Steve Sjuggerud's bullish biotech stance... He recommended the sector in the February issue of True Wealth. Back then, Steve noted biotech stocks were at an 11-year high, but "nobody" was invested in the sector.

As you can see from the chart below, biotech rallied this year, then sold off after the election. But now, biotech is marching back toward its highs for the year.

 DailyWealth Trader co-editors Amber Lee Mason and Brian Hunt say the sector is still a buy. In yesterday's issue, they explained why they see triple-digit profit potential in biotech:

In the issue, Amber and Brian described their favorite way to play a biotech rally. It's a trend they expect to cover regularly… To learn more about DailyWealth Trader – and get access to their ongoing coverage – click here.

 New 52-week highs (as of 12/11/2012): iShares Australia Fund (EWA), iShares Germany Fund (EWG), iShares Singapore Fund (EWS), SPDR International Health Care Fund (IRY), Hershey (HSY), Procter & Gamble (PG), and Home Federal Bancorp (HOME).

 Please write in and tell us what's on your mind. Are you bullish on biotech? Have you bought insurance companies and World Dominators like Porter and I have been recommending? If so, let us know how you're doing. Send us your notes to feedback@stansberryresearch.com.

 "When you say buy or sell gold, are you referring to actual bullion or an etf based on gold bullion such as GLD?" – Paid-up subscriber M.F.

Ferris comment: Unless otherwise specified, we're talking about holding a certain percentage of your liquid assets in gold bullion – outside the borders of the United States, if possible. I personally don't like the exchange-traded fund because it's just a piece of paper. I recommend gold as a way to place some of your assets outside the mainstream, online, Big Brother-monitored global financial system. You can't do that with ETFs. But you can do it with bullion.

 "Here is a question I have asked every acquaintance who has expressed interest in our economy and received no insightful answer: In about 1977 at a breakfast with Alan Greenspan (both of us were much younger then), he answered my question 'Remember young man, INFLATION is GOVERNMENT SPENDING.' Why, then, with 47.3 million on food stamps (gov't spending), FEMA throwing money at every 'disaster' (gov't spending), The FED issuing hundreds of millions and billions of dollars (gov't spending) to buy Treasuries (worthless paper?) and on and on; why then have we near zero inflation?

"My thoughts: The word DEPRESSION has a lot more meaning than just an extraordinary RECESSION. The Great Depression was a lot more than just a long severe recession. It was a HOLE that put people in the dust, into suicidal mentality, into an environment where GROWTH became impossible. Perhaps this gives one an insight into my answer to this question." – Paid-up subscriber B.W.

 "I agree with Mr. Singer that significant inflation could destroy our society. But he seems to suggest that the low-velocity money the Fed and ECB and BOJ are printing (about $3 trillion each so far) would have to get back into the system (economy) and acquire some velocity before the inflation would smother us. But wouldn't that require growth in the economy followed by more bank lending in order to accelerate the velocity of all this newly-created money? If we dive off the cliff soon and get higher taxes, that would slow growth even more which would thereby slow velocity. In this perverse scenario, shouldn't we all be rooting for another recession so the bankers keep sitting on the Fed's money, or would that just embolden the central bankers to 'ease' even more? Curiouser and curiouser (cried Alice). If you drink much from a bottle marked 'poison' it is almost certain to disagree with you, sooner or later." – Paid-up subscriber LAF

Ferris comment: Inflation is money creation in excess of demand, plain and simple. How that plays out is another matter. I personally waste no time trying to guess about such things, any more than I try to figure out when I'll have a car accident or when tornado will hit my house. I just buy insurance and let the chips fall where they may.

I recommend two types of inflation insurance: gold bullion and fantastic businesses that grow dividends at inflation-beating rates and earn large returns on invested capital.

Regards,

Dan Ferris

Orlando, Florida

December 12, 2012

How Freeport-McMoRan bailed out its friends... and picked up a gem in the process...

 As we alluded on Friday... Freeport-McMoRan's decision to sink about $20 billion into energy companies – Plains Exploration (PXP) and McMoRan Exploration (MMR) – looks a lot like a "friendly bailout"...

 Remember, Freeport Chairman James "Jim Bob" Moffett is also the CEO of McMoRan Exploration (which was spun out from Freeport in 1994.)

Freeport is paying a 74% premium to bring McMoRan Exploration back into the fold. Meanwhile, Freeport shares fell around 20% following the announcement (handing shareholders a $6 billion paper loss).

But Jim Bob's gains on his McMoRan holdings outweighed his losses on Freeport stock by around $15 million.

 James Flores, the CEO of Plains Exploration (which Freeport bought at a 39% premium), had the biggest windfall... He made $130 million from the deal, including accelerated vesting of stock options. And he got a salary raise to $2.5 million to match Moffett and Freeport CEO Richard Adkerson.

In addition to being the CEO of Plains, Flores is also a director at McMoRan Exploration.

 On a conference call, Moffett couldn't say how buying McMoRan Exploration at a 74% premium would help Freeport... He only said the company was "cheap."

And on that point... we agree.

In short, we saw the value in the assets Freeport bought... especially McMoRan Exploration...

 As part of the Stansberry Data weekly supplement to Stansberry's Investment Advisory... we run a proprietary screen on more than 70 oil and gas production and exploration companies. We call it the "Global Oil Value Monitor" (GOVM).

We're watching for stocks whose enterprise value (market cap plus debt minus cash) is less than the total value of its assets. By tracking the sector this way... we expect over the next 12-24 months to find opportunities to invest in oil companies at steep discounts to the value of their reserves... In some cases, the market may even assign no value at all to the reserves. In those cases, we'd essentially be buying the oil for free.

And until Freeport's offer... McMoRan Exploration was one of the cheapest stocks we found on the GOVM.

 Of course, the announced acquisition effort drove shares of PXP and MMR up. PXP now trades right at the value of its assets (a 1% premium) and MMR is trading for a 31% premium to the value of its assets.

 It's worth noting that despite Plains Exploration's stake in Texas' Eagle Ford shale basin... we believe McMoRan's offshore assets will eventually prove to be the real gem in this acquisition...

 That may surprise some readers, as we've written volumes (literally) about how new "unconventional" drilling technologies at work in shale regions around the country are tapping vast resources we could not reach before...

The key is... offshore oil reserves are extracted using conventional drilling methods... And the ongoing operating costs on offshore wells are lower once the initial investment is made...

Here's why...

 Total development costs in the Eagle Ford run about $5.5 million. That looks tiny compared with the costs of developing an offshore Gulf of Mexico well, which can run about $100 million to develop. McMoRan Exploration's engineers have estimated it will cost about $200 million to drill and complete one of its offshore wells.

 Offshore oil reserves are huge... so the wells last a long time. More important... the vast majority of the development costs come up front. In contrast, shale wells are relatively inexpensive to establish... but cost more to keep operating over the years.

You see, offshore oilfields use "conventional" drilling techniques. Essentially, you spend the bulk of your money getting the "straw" stuck in the ground. Once you've tapped the reservoir, the oil flows freely.

With onshore, unconventional reserves, drilling is an ongoing process of fracturing the rock and propping the fissure open with sand or ceramic pellets, known as "proppant." It's a more expensive operation over the long term.

 So go back to McMoRan Exploration's estimated $200 million cost to develop its offshore gas wells. Over the life of a well... that works out to a finding and development cost of $1.50 per thousand cubic feet (mcf) and sets the well's breakeven price at $2.20 per mcf... which is lower than even the best gas shale economics from the Marcellus and parts of the Eagle Ford (which run around $2.50 per mcf).

That's why McMoRan will eventually become a more valuable asset for Freeport.

 We'd like to clarify one point... The fact that offshore wells will eventually have lower operating costs than shale oil does not change our bearish stance on Brazil's state-run oil company Petrobras.

Petrobras is a different beast... The company's oil is in extremely deep water. The company has to drill even further into the earth to extract the oil. That's why the company plans to spend $225 billion in capital expenditures between 2011 and 2015. (And our guess is the actual numbers will be even higher.)

No other company is trying this kind of exploration. And there are enormous risks involved.

How Freeport-McMoRan bailed out its friends... and picked up a gem in the process...

In today's Digest Premium, we took a closer look at Freeport-McMoRan's re-entry into the energy sector... and you may be surprised where we see the real value.

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