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  Still not time to roll out the barrel

BENJ GALLANDER and BEN STADELMANN

Friday, October 31, 2008

People have every right to be aghast at what is happening in the marketplace, as their savings and retirement dreams go up in smoke. Gazing at our own downtrodden portfolio is enough to put us in a sour mood as well.

But we have to laugh at how foolish those predictions of $200 (U.S.)-a-barrel oil now look. Admittedly, the jolt to nearly $150 surprised us, and was the perfect example of the pendulum swinging too far, but $200 in the short term was a forecast that we at Contra the Heard always denigrated as sheer hyperbole.

It is fun to look back and see who was so wrong on that prediction — and it gives cause to wonder about the worth of their future expectations.

Arjun Murti, an analyst at Goldman Sachs described by some as "The Oracle of Oil," predicted last May that crude would soon drive past $200 a barrel. Oops. The firm has since cut its year-end prognostication from $115 to $70. Got any other rabbits up your sleeve, Mr. Murti?

T. Boone Pickens was closer, but still off the mark (unless the next two months are more bizarre than bizarre), with his prediction of $150 by year's end. Perhaps he will be on firmer ground with his major move into alternative energy, the centrepiece of which is his Pampa Wind Project in Texas. It's expected to cost $8 billion to $10 billion, of which at least a couple billion should be his own money.

But while substitutes for oil are, undoubtedly, ultimately a necessity, many developments will be shuttled to the back burner as the case for their short-term economic practicality becomes flimsier.

CIBC's chief economist, Jeff Rubin, also predicted $200 oil, but his timeline takes in the next few years, so his prediction may yet avoid the "folly" category. He certainly did not foresee oil falling back to the $60 range.

As for his prophecy in a BusinessWeek interview last spring that the U.S economy will "recover in the second half of the year but the big surprise will be how quickly the Federal Reserve board will reverse its recent rate cuts and tighten" — well, that's one he'd probably like to take back.

With oil at $65 or so, the price has rolled back to where it was a mere 17 months ago — which isn't a long period of time. Those companies that stuck to their balance-sheet knitting instead of buying into the hype that unrealistic prices were here to stay had the opportunity to turn a short-term windfall into a long-term gain.

Those with an almost cultish belief in the mantra of Peak Oil and ever-growing demand from China and India, and who pursued takeovers and took on debt like there was no tomorrow, now face possible failure.

In our portfolio, we have one company in this sphere. Kelman Technologies, which we wrote about in 2004, specializes in seismic processing and archiving and has done nothing except hurt our results. Purchased in 2000 at 40 cents, our position was tripled in 2006 at 23 cents. Currently it can be bought for eight pennies.

Evidently, we are not always right, either, and perhaps should adhere more carefully to the advice about people in glass houses throwing rocks. Of course, a mistake on a minor-league corporation is not like a boo-boo that drastically affects the global economy.

However, hope springs eternal, and indeed, this past spring, president and CEO Rene VandenBrand announced the signing of "three large multiyear data management projects that provide a very significant backlog." To help finance these, a non-convertible debenture at 6.5 percent was issued to the chairman and largest shareholder, Seymour Epstein; 3.7 million purchase warrants were also added at 18 cents. It should be noted that Kelman then used $495,000 of the note to repay another Epstein enterprise, Video Age.

Kelman has been operating near the break-even level for some time, although it lost almost $1 million last quarter. Revenues have increased to close to $25 million on an annual basis. If these deals do not push the corporation to reasonable earnings, then at some point next year it might be time for us to give up and take a tax loss. In the interim, it remains on our Buy list, but our target price of 79 cents is looking mighty pie-in-the-skyish.

People who are looking for established names in the Canadian oil patch that have a history of success might want to consider three that, although not owned by us, are of particular interest: Encana, Nexen and Petro-Canada.

All have been crunched by the falling price of crude, but worthy of note is that, while many of their cousins in this sector will have difficulty surviving, these three have quite reasonable balance sheets and should be around for the next round of barrel-price hopping. It's also worth noting that they all made 10-figure profits in 2004, a year when the average oil price was $37.

Back in the late 1980s, when oil prices capsized, we were heavy buyers in this sector. Today, however, prices of enterprises in this field are still not cheap enough to make us jump. Given the stock market's insane gyrations, that could soon change.


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