SharperDingaan

Politicians will readily take contributions from all ME players, OPEC, and the US oil industry; their sponsors in turn - back both parties to ensure a win. Comes payday it will simply be cheapest to throw the House of Saud under the bus; & collect on the promises from the rest of the ME, OPEC, & the US oil industry. States don't have friends, they have 'interests' - and 'interests' have limited shelf lives. SD

We put it to you that within the next 12-18 months the existing House of Saud is gone; the current leadership either assasinated, or replaced by elder statesmen – to ensure that the house survives. Beheading a cleric was an incredibly stupid and incendiary action. Everywhere else, there would have been a simple - but permanent slip and fall. US support will expire within the next 12 months as Obama exits. The region will also be a lot safer for all with the war over, and materially higher crude prices. Record global inventory awash with low cost crude, will minimize supply disruption. It is pretty hard to find a better time. SD

Look at Anglo Plats http://www.angloplatinum.com/ They are being backstopped by the RSA government pension plan. SD

-19% TWRR Primarily from hedging too late on PWT. Absent PWT & we're more or less flat with fixed income gains offsetting equity losses. Not a big deal for us, as we withdrew all of our original capital long ago - & this is all house money. We are accumulating at rock bottom prices, & should do very well 5 years out. Were we not expecting such ridiculous pricing over the next 1-2 years, we would be in floating rate FI & targeting an overall 8%+ cash yield. But if you have the structure, & can tolerate the risk, it is pretty hard to see why you would not have significant weightings to the Glencore's/Plats/Anglo Americans of the world right now. Again, the long term view. SD

Re PWE. At some point there is going to be a royalty sale; clearing off some more debt & raising the % of production hedged. They are also highly likely to increase the number of farm-ins, to reduce the capex needed to hold their land positions. Re o/g in general. We expect Iran to flood the market, & SA to either cut back or experience a regime change; no idea as to timing, but the clock is ticking. Confidence because it is far easier to change Emirs than depose Khomeini; been there already, tried that, and failed. SD

"Why would you say PDH is your best 2016 idea? its a large position in my portfolio but overvalued at the current price and we need to wait for fundamentals to catch-up to the stock price - it could take years." We're long time PD shareholders & are accumulating, not selling. If the dividend continues we get a very good cash yield; should it get cut we will see a buying opportunity. We are also not measuring over a 1 year timeframe, & are quite OK with a one-year 25% loss - if it results in a doubling of our share count. SD

Cash, FTP.DB PWT, PD ALS, ADV Cash & FTP to lower our risk, & bar-bell the portfolio. Commodities for their long term volatility. Hedging & opportunistic buying to produce large commodity holdings at nominal cost, net of house money investment. 5 years out each commodity position becomes a house. SD

We've many better things to do; so - reduce the time we spend on investing by 75%+ Probably a long-term commodity/T-Bill bar-bell portfolio; & a step away for months at a time. SD

Keep in mind … • There is no need to buy in an entire position on day 1. This may well be with us for a while, & there will be more opportunities. We have no idea if we’re at bottom yet. • Year-end results will not start getting reported until late Feb at the earliest. We know that many firms will experience material reserve write-downs; bankers are forcing equipment sales, & calling in loans. A prospective sea of deteriating head-line news. http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/oil-patch-pain-drives-bargain-hunters-to-equipment-auctions/article27891480/ • We know the tide is going out, & lowering all boats. Post reporting season, we will also know which boats have holes in them; & it is highly likely that all boat prices will be lower. There is no rush. • We know this is not globally sustainable, & that a solution will eventually be imposed. History indicates these things are sudden, & that the longer it takes to occurr – the more sustainable the solution. Bias to longer versus earlier. • In this game - it is the number of shares owned that matter, not the $ allocation. IE: If you want a CAD 1M valuation, & expect PWT to eventually trade at CAD 8, you need 125K shares. Reduce average cost to CAD 1/share, & it will only cost 125K – not the 200K as per $ allocation. Alternatively invest the CAD $200K allocation in 200K shares - & sell 75K shares at CAD 2.67 to recover the CAD 200K outlay. Gain CAD 1M on the remaining 125K shares @ CAD 8/share. Good luck. SD

The reality is that we measure relative to our home country; FX change is material, & a fact of life. All a Canadian resident need do is open a USD account; make a deposit when the rate is favourable, & withdraw it when the rate is unfavourable. Invest CAD 10,000 @ 1.05 to deposit USD 10,500; withdraw the USD 10,500 @ 0.65 & repatriate CAD 16,154 (10,500/.65). Net gain of CAD 6,154 (61%). But what to do with the USD 10,500? Least risky is to simply buy a discounted long treasury, & sell it into the liquid market when the money is to be repatriated. At the other extreme, buy a USD denominated 3-5 year distressed bond at 0.45-0.50 - & wait for improvement/recovery. A twist on the same theme is to simply hold a liquid but distressed inter-listed equity (ie: a TSX listed PWT/PWE:US). Obviously not for everybody, but it has to be in the tool kit. SD

We do hedge, & typically between CAD, USD, & Pounds Sterling. We take the view that over the long-term, CAD should be roughly 63-67c to the USD, & 2.30-2.50 to the pound. Move $ out at 1.00-1.05, & back at < .60-.65. The $ themselves, invested in high quality local opportunities. It works very well, & is consistent with value investing; as one is always selling the desired asset & buying the despised one. It works better if one can also speak/read the foreign language, & has a network of contacts in those locations. As much of the gain results from picking up on the moods of the times, language/culture sensitivity is important. Leave the firms themselves to optimize their product sales in the most desirable locations; it is what they do best, & they are far better at it than you are. SD

The 1940-1970’s petroleum industry was the creation of the seven sisters. Each of them was backed by their respective states; & many of the current ME states (SA, Iraq, Iran) owe their existence to this global agreement drawn up in the concluding days of WWII. We also know from other industries (sugar, fruit, chemicals, arms, drugs, etc.) that this was the standard global industry practice of the time. It is common, & routine. https://en.wikipedia.org/wiki/Seven_Sisters_(oil_companies) We know the new sisters are suffering under the current pricing regime (scan their financials). Many of them are also sitting on higher cost reserves that will be developed for strategic interests, not economic ones. It is in no sister’s interests to acquiesce to an extended pissing match; & their state backers have a history of routinely changing opposing governments. Environmentalism is an industry built on opposition; take away the opposition, & you destroy the shtick https://en.wikipedia.org/wiki/Shtick. Opponents do not disagree with the basic argument, they disagree on how to get there. Carbon credits are a way forward, & in our version – would be controlled by the petroleum industry. Support it, & you can claim your legacy is done; oppose it, & you risk coming across as an aged hippy – unable to move with the times. Two can play the PR game. There have been private rumblings in various parts of the world for quite some time; some of which were quite probably climate conference related trial balloons. We will not wake up to a market solution tomorrow morning, but it seems pretty clear there will eventually be one; by the grace of the new sisters - & their supporting states. We floated a trial balloon. We think it has potential, we know this is a public board, & we are pretty sure it is going to be picked up. If it privately gets fleshed out later; I’m sure I will get a PM. If nothing occurs; nothing ventured, nothing gained. O&G is a strategic investment. We think the Tar Sands are essentially in the wrong industry, & that they would be far better off in the ‘saviour’ business. SD

A little more complex, but same end result 1. Global industry notionally pays to a ‘fund’. (Mkt price – MC) x production 2. ‘Fund’ pays X% of notional collection to lowest cost producers to shut-in production 3. ‘Fund’ pays (100-X)% to buy carbon credits – on central bank credit 4. Industry sequester injects CO2, & Methane for carbon credits – on central bank credit 5. Carbon credit, central bank cash settlement process Whole process becomes very sensitive to (mkt price – MC) spread, & much more stable. Those on the bubble are essentially paying others to stay out, & receiving the most benefit. Market price still set by market, producers incentivized to lower MC as much as possible. Cap & Trade is effectively global regulatory carbon emmission control. Cheating is expected; governmental oversight is the standard solution. Broadly similar cooperation examples already exist – global AML/ATF tracking & enforcement. Why Tar Sands? The size rivals SA, & at full production would be profitable at USD 55-60/bbl. It is essentially a price cap, & comes at the cost of high pollution. Use it as a carbon sink & the global industry simultaneously removes the price cap, cleans up the environment, & gets some help restructuring itself. Location in one of the more honest parts of the world is bonus. The seven sisters, & their now big nieces, are state enterprises dressed in corporate clothing. Hence, less difficult to implement that initially meets the eye. Suncor became a state enterprise when it was allowed to acquire Petro Can (the people’s oil company). SD

2016 prices are unlikely to look any better than 2015. The pending 1H-2016 US Shale collapse will not be enough to remove the current inventory glut before the end of 2H-2016. http://www.msn.com/en-ca/money/inside-the-ticker/billions-of-oil-barrels-vanish-in-a-puff-of-accounting-smoke/ar-AAgdMGi?ocid=spartandhp The industry is going to be restructured. We think ultimately a combination of (1) & (2). All players agree to maintain a price in the US 55-60/bbl range, pay a carbon tax, & the funds go to permanent shut-in of Tar Sands. Could be via outright purchase of Tar Sands, or via their repurposing to sequester CO2 & Methane emissions on behalf of the industry. In broad terms, petro $ re-cycling, via the use of carbon credits. Choose not to participate, & you risk the loss of some of your production facility. Your choice, but the ultimately the result will be the same; stabilized prices in the US 55-60/bbl range. SD

Assume 1. All producers are producing flat out. The get everything you can now mentality, or the new regime (political, new owners, etc.) will do it for you. They have to pay for the overthrow. 2. Average maintenance CAPEX at 75% of depletion/depreciation/amortization. Bankers need to reduce their exposure, and want their money back as the assets deplete or get used up. 3. Higher net demand (from low prices) and lower supply (from depletion) will take at least a year to restore total global inventory to ‘normal’ levels Any significant price change has to come from the existing players, & a re-ordering of the market Economics posits that to achieve stability, the price of the good must approximate its long run marginal cost (LRMC) of production. Reduce supply via shut-in of production. Raise demand by holding price lower for longer; or implement global protectionism. There are a number of possibilities 1. Pay the low cost producer to shut-in. Other participants collectively pay the shut-in producer (desired market price –their LRMC) x their shut-in production. A short-term extortion rent for cornering the market. 2. Tax the low cost producers to collectively raise their LRMC to the desired market price, & use the $ to permanently shut-in market production; via the purchase of stranded fields from those with a LRMC moderately above the desired market price. Permanently remove the competition, repurpose the assets to sequestation under the name of environmenalism, & create a new business. Alberta Tar Sands. 3. Remove a good chunk of the lowest LRMC production for a sustained period. The ME is a dangerous place, & it may be as simple as allowing bad things to happen to select facilities. Obviously (1) & (2) are the preferable outcomes. The seven sisters are not known for their gentility, and have proved very adept at re-arranging deck-chairs. There is a limit to how much they are going to tolerate. SD

Pricing reflects local, not global, conditions. The global commodity price forecast x change in ability to deliver the goods – over the intended time horizon. Most would argue that in today’s world, QE would be better delivered through paying for the building of new nation building megaproject infrastructure (ie: FE, or Fiscal Easing). For Canada, the modern day equivalent of the CPR rail road would be a high capacity cross country West-North-East gas trunk pipeline – connecting all of Canada’s major o/g fields. Not possible without vision, federal help, and provincial cooperation. The Alberta Tar-Sands are essentially a tilted, exposed oil field; where the volatiles have long since evaporated off. As a source of conventional oil, it is a high cost stranded asset that is extremely harmful to the environment. But think of it as a giant sized carbon filter (ie: odour eater) – capable of sequestering enormous quantities of CO2 and methane, & we have a global sized chemical lung; rivaling the size of the rain forests. A different vision, that is not possible without global & federal help. A whole nation using the least damaging fossil fuel to combat climate change, as necessary; acting as one of the major lungs of the world, & getting paid for it – as a generator of carbon credits. Essentially, petro $ recycling, but in a different way. The US & Russia did the space race, but this is really not Canada’s style. The ‘green’ race is, and it is perhaps THE greatest legacy, today’s leadership can pass on to the future generations. If you want to rank up there with the founding fathers, this is quite possibly THE best shot at it. Vision. Obviously there are many possible visions; but if you think something like this may have legs, then the WCSB has to be high on the list. SD

We have no idea what the next 5 years will bring, but we do know that time is a great healer; as whether one bets right or wrong - the longer one stays with the investment, the greater the odds of mean reversal. For some this is a good thing; for others, not so much. In today’s climate, zero o/g exposure makes little sense. It’s really about how much exposure, where & what kind, & having a strategy as circumstance change. Some folks prefer to be prepared, others are content to jump the train as it pulls out the station. Obviously, some will miss. Our view is that the oil world is a lot more dangerous than it was; even 6 months ago. Global supply outputs are declining at an accelerating rate as water/gas cuts increases, & wellhead pressures decline. It is also increasingly clear that a global warming solution – will be the permanent shut-in of a good chunk of the globes existing (higher cost) proven o/g reserves. Alberta Tar Sands may well become more valuable as a ‘green’ CO2 sequester sink, than as a ‘dirty’ oil. It is also becoming highly likely that global energy policy will bias towards a higher consumer price for non-renewable energy, and a lower one for renewable energy as scale & technology improves. Today’s low crude price offset with higher pump taxes, & the $ subsidizing ‘cleaner’ industry. Have a strategy as circumstance change. SD

Focus on the business, payback period, & dilution risk; not the BK risk. And keep in mind the typical institutional IP constraints when the instrument is close to a break-point. An over leveraged good business, can easily be fixed through either a debt/equity swap, or asset sales; a bad business, not so much. These FI investments are long term (5-10yr) workouts, with a sweet-spot around 45-50c on the dollar. A 16% cash yield will usually repay the outlay < 3 yrs, and leave 2-6 years of future potential recovery. By itself this is still a risky proposition; bundle it with an equal investment in a treasury yielding 1% - & you get a more respectable risk reducing barbell producing around an 8.5% cash yield, comparable to a pfd. But in this game - the preference is bonds, as there can be no restructuring without a sweetener going to bondholders. There is a similar game in blue chip equities, right after deep dividend cuts have been announced. It has worked very well for us. FTP, TA, PDS being some of our better examples. SD

It is useful to think in terms of the engineering model of Input => Process => Output. Substitute business parameters to arrive at Management (Input) => Operations (Process) => Sales (Output). From the marketing perspective; Operations is the target, Management the target market, Sales are unaffected. Block chain does not change the end product, it just produces it differently. Much of the dissonance is because there is no change to end product; including no price reduction as a result of block chain cost saving. The gain is captured entirely by management & shareholders –through higher profitability, & lower operational break even points. In a sales driven organization (V/MC), you might expect much of that saving to ultimately get passed on to the end buyer. Not going to happen in a bank - to anywhere near the same extent. SD

We don’t have a Barron’s subscription, but some related comment. A fundamental re-plumbing of financial services is coming; & it’s not just automation of existing processes. The technologies themselves are disruptive, there are no direct comparatives, & the established interests have most to lose. Those that can adapt will thrive, they will have far smaller workforces, & they will emerge with far easier to operate businesses. It is not going to happen tomorrow; but it will not take 10 years either. http://www.coindesk.com/deutsche-bank-letter-touts-expertise-in-blockchain-tech/ The investment angst is because historic metrics are rapidly becoming obsolete. If the future is likely to resemble the past, valuation based on historic multiple makes sense. Not so much, if the future could well look very different. V/MC does not have to lose much market share, for their Year-on-Year growth to either stop dead, or reverse. The best & nearest practical example is derivatives. When first introduced to financial services, very few understood what they did. You pretty much had to be a PhD, & maybe a handful of people even perceived the overall industry ramifications. Yet - whatever ones opinion of them, derivatives have fundamentally changed the industry; & done it very rapidly. If you believe V/MC will successfully adapt, it probably means lower earnings for quite some time; & an eventual smaller more nimble, & more valuable business. Higher tech spend, & market share loss to P2P being the main culprits. Whether they remain independent businesses, is an open question. SD

Just for comparative. • Customer logs onto smart phone • Customer pulls up Google Pay app. Logs into their account • Customer keys in amount, details, & account number of Google Pay recipient. • Google pay confirms existence of the recipient Google Pay account • Google confirms via a yes/no ask if you are sure. • Click yes. Google debits your wallet, credits the recipients And as this is essentially the equivalent of a debit card transaction; the cost is 6 cents versus the $1.50 you would have paid had you used VISA. Customer complains because the restaurant doesn’t have a Google Pay account. Customer is now forced to pay by cash, debit card, or even by V/MC. Customer is not coming back until the restaurant/bar gets it act together; so next weekend the restaurant/bar either has a Google Pay account, or does less business. The average restaurant/bar might open a handful of P2P accounts; GooglePay, ApplePay, Paypal, etc – but there’s a limit. Top of wallet just became redundant, & turned into a P2P popularity contest. Next time you go to a coffee shop, supermarket, or higher end bar – look at how many people are paying via their phone. They are easy to identify, because they are the ones slowing the line down. Count how many, & estimate their ages. SD

Um Google has 1.4B? I assume you mean Android has 1.4B != Google. Google Play has 1B. Google does not control all Android users. We just used this; & assumed that ultimately 1 in 2 of those on the company’s Android mobile operating system maintains an active Google Pay account. Used once/day or once/year; don’t much care. Point was, a free cash float in the billions. http://www.wsj.com/articles/google-says-android-has-1-4-billion-active-users-1443546856 Sept. 29, 2015 1:14 p.m. ET. Incoming Google Inc. Chief Executive Sundar Pichai said Tuesday that the company’s Android mobile operating system had added 400 million users since May 2014, for a total of 1.4 billion. Make your own estimate. SD

I think we are just talking past each other. Some minor rebuttal, and we will call it done. If you are content to always borrow from V/MC, & repay by the card due date; it doesn’t affect you. Pay your annual $100-$150 card fee for the convenience, & be happy. If you are OK with paying the 24% rate on those occasions when you do not repay on time, V/MC is a great deal. If cachet is worth more to you than cost, V/MC remains a great deal. So long as the overpaying is reasonable, & you like the rewards; treat it as simpy another cost of doing business. If you are young and poor, you cannot be so charitable. You want the lowest possible interest rate , no annual fee, lower prices (because merchants don’t have to recover the 2-3% fee), rewards that you will actually use (concert tickets/access), and societal change. P2P does all of it. Google Pay would charge a nominal cost/transaction because of the large zero-cost float. Google has 1.4B users; if just 50% of their users sign-up to a Google Pay wallet, and the average balance is $30 – they obtain 21B of float (1.4B users x 50% x 30). Invested at 1.5%, they would earn 315M. Google is also a distribution platform; very similar to your grocery store. The more popular it is the higher the stocking fee it can charge suppliers. Ultimately it will be the incremental advertising revenue that pays for it. SD

V/MC already works closely with P2P players – as loan provision, & the payment process; are complementary products. To pay/receive from someone outside your P2P network – it is cheapest to run on the existing V/MC rails. But you can significantly reduce the amount of traffic, if you can make Google Pay/Apple Pay exchange payments directly with each other through a P2P clearing/interchange mechanism. Make it attractive to stay within the V/MC rails, & there is no need to go the direct P2P clearing/interchange route; hence the close workings. To get cash back, you have to overpay for your purchase; pay me $4 so that I can give you back $3 - & make us both happy. You also do not have to have saved first before you buy something, you just need someone to loan you the money. It is still the same loan as today, made on the same lending criteria, and paid in the same digital currency. A mortgaging bank does not give you a sack of cash, it simply credits your account (digital currency) by the amount of the mortgage. Music is priced by the song; it is essentially given away to drive network effect – that is scalped at the touring concert. P2P payment within the same network (ie: settlement via crosses), follows a similar business model. And the bigger the network effect, the more attractive it becomes to both payer & receiver. Agreed V/MC has a great business model, but it is no longer the ONLY great business model in the space. It also has the disadvantage that its demographic is older; todays V/MC dad is tomorrow’s lower spending grandpa, & that P2P kid is tomorrow’s higher spending dad. SD

Gio, you are missing the point; consider a very simple back-of-the envelope Imagine tbere is currently $200 of total business. Asia expands the total business by 25% to 250. XYZ Credit Card Company currently has a 50% total market share, & expects it to remain that way with the addition of Asia; XYZ business goes from $100 (50% x $200) to $125 (50% x $250). Shareholders anticipate higher earnings from the additional business, and everybody is happy. Now imagine that P2P shows up, & collectively reduces the XYZ Credit Card Company to a 40% total market share. Total business (including Asia) is still $250, but that 40% share is now only worth $100. Same as it was before the Asian addition, but zero growth. Assume we have no idea why folks chose to use P2P; they just do. What happened? The equivalent of that anticipated Asian growth in the total business went to our P2P friends; XYZ Credit Card Company just trod water. Obviously the numbers are manufactured, but it’s pretty clear that it will not take much of a collective market share loss to materially erase much of the Asian expansion benefit. SD