President's Message
To the Shareholders
Humboldt is pleased to report continued growth for the first quarter of 2011. At the quarter end, shareholders’ equity had increased to $62.8 million or $5.04/share, fully diluted, compared with $47.3 million or $3.86/share reported in Q1 2010.
Humboldt closed the quarter with $7.5 million of working capital, equivalent to 12% of its asset value.
At the time of writing, the market is going through a normal early spring corrective phase with continued debt issues in Europe increasing general concern. In addition, China may be entering a slower growth phase, which negatively impacts the outlook for commodity prices.
However, the overall trend for economic growth is intact, with a steadily improving outlook virtually worldwide. Prevailing low interest rates, policies promoting economic stimulus, as well as improving confidence in key economic jurisdictions should lead to continued economic growth. Economic policies in the United States should also be relatively accommodative due to 2011 being a key, pre-election year.
The Economy and the Markets
International stock markets have now completed the second year of a significant recovery, from the lows reached during the first quarter of 2009. The market recovery has been particularly strong in relation to commodity stocks, principally due to the rebounding prices related to the rapid growth of Far Eastern economies.
The current business cycle, while very severe, seems to be following a similar pattern of previous stock market and economic downturns, whereby a year of financial crisis is followed by a lengthy period of declining economic fundamentals. Ironically, by the time the worst of most economic recessions is reached, the stock market usually has already discounted economic problems and has commenced a recovery phase. This pattern appears to be unfolding at present, with very strong stock market recoveries since the market capitulation early in 2009, continuing into the first quarter of 2011.
Furthermore, the fundamental seeds of the current global economic recovery have been in place for some time. These comprise very low interest rates, a highly positive yield curve, reasonable energy and metal prices, and the availability of inexpensive labour. In addition, in the US there is an abundance of inexpensive homes and commercial properties. While the problems resulting from steady debt liquidation will hang over the Western economies for the next several years, most of the serious concerns now seem to be known and will gradually be eliminated.
However, in the long term, the normal progression of this economic and stock market cycle should result in a steady weakening US dollar, increasing inflation fears and a steady increase in interest rates. The first signs of this trend are evident, but economic growth should continue for a number of years until interrupted by a significant spike in the cost of funds.
Commodities – General
Since early 2009, Humboldt focused on purchasing shares in companies in the oil, copper and precious metals businesses. The pricing of these three commodities have been positively impacted by the worldwide economic growth and US dollar concerns.
Firstly, OPEC production curtailments and increased demand have shored up the price of oil. In the case of copper, the resumption of rapid growth, principally in the Far East led to an early rebound in the price of this metal. Lastly the pricing of precious metals have principally been driven upwards by a fear of a major financial implosion and concerns regarding the over issuance of fiat currencies.
Commodities – Oil & Gas
Due to rapid demand destruction, oil prices collapsed to the $40 per barrel level in early 2009. Only the strenuous efforts by OPEC to constrain production brought supply back into line with demand and resulted in the gradual recovery of oil prices to approximately $90 per barrel at year end. However, increasing political unrest and the outbreak of civil war in Libya has now pushed oil to over $100 per barrel. This pricing level is dangerous in that renewed demand destruction could reoccur; however baring this outcome, steady worldwide industrial growth should hold prices at a satisfactory level for producers.
The recent natural gas cycle has been quite different, with greatly increased supply resulting from a boom in drilling of long reach horizontal wells, targeting fractured shale gas deposits. These wells actually increased the supply of gas during the economic downturn! This excess supply has now moved the BTU equivalent of gas to oil from a historic ratio in the 6:1 range, to an hitherto unheard of ratio of over 25:1.
The only bright note regarding the future balance of gas supply and demand in North America is the recognition that many of the horizontal gas wells have much lower estimated ultimate recoveries per well than the operators originally hoped for. Indeed some large fractured gas fields may be sub-economic as a result of very high capital costs, rapid production declines and low prevailing gas prices. However, a great number of major energy companies are now entering this field, incurring very high acquisition costs in the hope that gas development on these projects is simply a “manufacturing process” in which they can lower the cost of production. While many of these acquisitions may turn out to be ill timed, the size and staying power of these companies may prolong the gas surplus for a substantial period.
Commodities - Mining
The mining sector has had an excellent 24 months of growth since the market capitulation of May 2009, for two fundamentally different reasons.
Firstly, gold and silver prices have steadily trended upwards as a result of the “safe haven” aspect of these metals. Indeed they appear now not to be an inflation hedge but, a catastrophe hedge as an investment medium, in case of significant sovereign debt defaults.
Secondly base metals which are easier to evaluate on a supply/demand basis, have been impacted positively by Far Eastern, principally Chinese, buying especially affecting copper and nickel prices. The continued rapid expansion of
Asian economies has provided steady price increases in these metals, and should spill over into related metals such as molybdenum and tungsten in 2011. Tungsten has recently shown substantial price increases and Humboldt is adding some new positions in this sector.
Related Energy Companies
During the past year Humboldt’s management has spent a considerable effort to assist in financing and planning issues related to a number of its principal holdings. The operations of some of these companies were adversely affected by the decline of natural gas prices. The resulting reduced capital to invest in maintaining production volumes has magnified the problem. A process was set in motion in these companies early in 2009, resulting in a total switch from natural gas targets to the development of heavy oil prospects on the Alberta/Saskatchewan border.
Diaz Financing
Diaz was particularly hard hit by the low gas price. The resulting decline in cash flow made it difficult for Diaz to invest the necessary capital to increase oil production and reduce its dependence on gas. As a consequence, in the second quarter of 2011, Diaz’s lender indicated its intention to reduce the credit facility by $3 million.
Humboldt’s analysis of the Diaz financial situation is as follows:
• Diaz has a significant asset in its undeveloped oil properties but lacks the working capital to realize this value;
• Diaz requires $4.0 million to satisfy reduction in bank line and its short-term working capital shortfall;
• Diaz requires a further $4.0 million to allow it to commence its development drilling program at Lloydminster, and
• The results of its initial drilling program should provide Diaz with the cash flow to continue to develop its oil properties.
Therefore, Humboldt has agreed to backstop a Diaz $8.0 million 10.5% convertible secured subordinated debenture financing. The debenture will have a term of five years and will be convertible into Diaz common shares at $0.075 per share. Humboldt has agreed to purchase a minimum of $4.0 million and up to $7.8 million of the Issue.
Tuscany and Sharon Merger
On May 31, 2011 the shareholders of two of Humboldt’s principal holdings, Tuscany and Sharon, will be asked to approve a business combination (the "Transaction") whereby Tuscany will acquire, subject to certain conditions, all of Sharon's issued and outstanding common shares on the basis of 0.84 common shares of Tuscany for each Sharon common share. Following completion of the Transaction, Tuscany will have approximately 125 million common shares outstanding. The combined entity will have total proved plus probable reserves of approximately 1,345,000 BOE, current estimated production of 190 BOE/d approximately 17,000 net acres of undeveloped land, and marketable securities of $4.0 million. The combined entity will also have working capital of approximately $4.2 million and an unused bank line of $4.6 million. Humboldt has indicated its intention to vote in favor of the business combination.
Humboldt believes this will significantly benefit the shareholders of both companies as the merger will result in a much stronger company with a large inventory of drilling locations, new exploration prospects and the necessary working capital to develop the properties.
International Energy Focus
Humboldt commenced to rebuild and expand upon its international energy holdings during 2010 as a result of the potential increase in share prices especially when compared with gas or Alberta focused energy companies. In addition, Humboldt believed that exposure to large energy projects in favorable jurisdictions, would lead to significant gains as a result of careful risk assessment. Hence, Humboldt has increased its exposure to exploration companies operating in Europe, Australia, Africa, and the Far East while maintaining a substantial exposure to North Sea oil stocks.
Outlook
The stock market capitulation in Q1 09, clearly indicated the panic bottom for this market cycle and with the steady increase in worldwide indices since, bodes well for a sustained, but choppy, upward move. Since the commencement of the economic recovery, many of Humboldt’s holdings have shown significant gains. This has resulted from higher commodity prices, companies focusing on their best projects, increased access to capital for substantial exploration targets and to general sector rotation back into high impact energy exploration.
Humboldt is in an enviable position, with a substantial cash balance originally built up during 2007 and early 2008, to allow it to weather any significant economic and stock market set back. From this position of strength Humboldt plans to continue to upgrade the quality of its holdings while reducing its portfolio diversity over the next year.
On behalf of the Board,
"R.W. Lamond"
Chairman of the Board
May 27, 2011
