Oil: Shooting Fish in a Barrel.......or Not

[kilroy04]

Seems there could be a ton of opportunity and or a ton of risk....  Some of this has been discussed but thought it might be worth revisiting in various ways.

 

Macro – Tide Out

 

Tide in tide out investing vs finding a needle in a haystack (as mention by Brian Spectre outgoing Baupost exec).  It is likely we are going through a tide out situation.

 

Supply: It appears that excess supply is not more than 1.5mm boe/day (about 1.5-2% and not the severe excess of the 1980’s).  There is risk for further increased production in Libya, Iran, Iraq, Canadian Oil Sands, Gulf of Mexico……and perhaps others.  Current excess oil in storage in the OECD. – about 250mm barrels according to the IEA (essentially 33 days of supply vs the usual 30 days globally).

 

Consumption: Growth has been healthy at > 1.8mm boe this year.  If there were a global slowdown – that would obviously be important. So far the China “slowdown” with respect to oil has actually been a substantial increase daily consumption

 

Long Term Green Energy:  At some point unknown (but I’d guess very incremental for at least 10 years) fossil fuel will be a less dominant form of transportation energy.  Though the IEA number still show similar usage as today out for 25-30 yrs.

 

Marginal cost of production is 50-60?  Coming down further?  Cash lifting costs?

Full cycle cost of production is thought to be a bit higher

 

Core Question:  Who can survive a few years at ongoing spot prices – whatever they are – including in the 20’s?  (without the benefit of hedges that are coming to an end)

 

Some broad ideas below

 

Low Cost Producers and or low debt

Survive with oil in the 20’s - 30’s for 2-3 yrs

Upside 1.5-3x

 

Bonterra (can be cash positive at WTI 35)

Surge Energy(low debt)

Peyto ( mostly gas - long history of doing well through cycle)

 

Low to medium cost with debt or other issues

Survive with oil in the 40 -50s for 2-3 yrs

Upside 5x +

 

Bellatrix?

PennWest  (requires further asset sales- if possible)

Gear (maybe) (netback getting close to zero at these prices)

 

Survive with oil 60-70 - need it soon!

Lottery ticket

 

Sandridge (trading for debt at discount)

Twin Butte (pennies and a junior)

Lightstream (Trading for debt at discount)

 

Thoughts?

 

[goldfinger]

For pwe and asset sales, look at the metrics of the recent raging river Viking asset deal to figure out if good metrics can still be obtained at current oil prices...

[Uccmal]

To your low risk lower return add:

 

Arc Resources:arx - more gas than oil - gas hedged 2-4 years out

Whitecap: cutting capex this year to stay within cash flow. 

 

Mtl: service provider - just cut dividend 20% to stay below 100 % payout ratio

Rus: supply provider to energy industry - very low debt.  Paying out over 100% of cash flow as dividends - I expect a possible cut to stay within cash flow.  Maybe so, maybe not,  Anyway, they operate as an inventory turn and more expensive inventory is out the door at a loss by now.

[kilroy04]

Some metrics on the lower risk side

 

Bonterra - 71% oil/liquids - 29% gas

Production about 13000 boe/d

Shares  33.1.m

Market cap  500m  cdn

Debt 336m of 425m bank line (last approved 9/15)

EV  840m

Netback (last quarter ) = $24 at sales price of 43

Dividend =  just cut from 0.15 to 0.1/mo  (payout 56% last q)  yield about 8%

EV/flowing barrel = 64k

 

More than doubled debt with 170m Cardium purchase (at mid 97k or more/flowing) in the spring (maybe a bit early on that)

Comment – focused on per share metrics – near 15 year record of improvement.  I like that per share focus

 

 

Surge Energy - 76% oil/liquids -

Production about 14500 boe/d

Shares  220.8m

Market cap  413m  cdn

Debt 143m  (400m bank revolver last approved 9/15)

EV  556m

Netback (last quarter ) = $14

Dividend = 0.15/yr  (8-9%)

EV/flowing barrel = 38k

Debt to cash flow

 

21% annual decline rate  -  50m capex will maintain at 14k boe next year. More a conventional play than tight oil play. No Drip

 

 

Happy to see rationale for or against any particular plays with the caveat, I don't think one can yet enter this space without risk.  There may be a time when you can see through things that others don't (ala Fairfax with the cds) but it doesn't seem we're there yet.

 

 

 

 

 

[Uccmal]

 

 

 

Happy to see rationale for or against any particular plays with the caveat, I don't think one can yet enter this space without risk.  There may be a time when you can see through things that others don't (ala Fairfax with the cds) but it doesn't seem we're there yet.

 

 

Isn't there always risk?  I am not sure where your going with the Fairfax comment but the biggest money I made on FFH was in the summer of 2006 a year ahead of the CDS bet.  Or are you just referring to the Fairfax CD bet itself?

 

The situation is of course risky.  There is the risk that oil prices will drop further and every one of my holdings mentioned above goes to zero.  That its never happened before, and all but one existed during the 1990s, and the other, WCP is a top notch company, should be of no relevance.  They really could all go to zero and close their doors.  So could Apple. 

 

So, we deal with what we know or think we know.  Here is what I think I know:

1) The surplus of oil on the market is razor thin and will turn on a dime to a deficit.

2) The markets aren't going to tell you when things have balanced in advance.

3) To no. 1: A huge amount of oil development has been taken off line.  It may take years to bring back. 

4) At the same time the E&P is going off line, depletion hasn't slowed down from existing wells.  Everyone in the periphery of the industry is squeezing existing wells (Russians, Canadians, Us Shale).  This to me implies a production cliff.

5) Contrary to popular belief oil and mat. gas are still the most important non ag. commodities.  We dont know when the above is going to happen.

 

Enough with the numbers.  I am by no means a technical analyst but I think we are seeing a bottom form with oil, and certainly with oil stocks.  The early bounce could be very quick leaving everyone shaking their heads, saying why didn't I buy at x price.  We already saw a mini version with PennWest, which has since became another buying opportunity for a small portion of a good future portfolio. 

 

Kilroy, I am not picking on you BTW, at least I hope it doesn't sound like it.  You have the courage to put out ideas while others whine about lack of opportunities, or try to time some sort of bottom.

 

 

[SharperDingaan]

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

 

[kilroy04]

UCC - this is precisely the type of discussion the post was meant to stimulate (not feeling picked on and mostly agree with you).  The tide out - potential tide in - nature of oil makes it hold the possibility of a material change to a portfolio. It could materially change either way and needs to be weighted as such.  In my opinion, the lower oil goes (perhaps into the 20's or even teens) the safer it becomes to invest simply because the rebound would likely happen sooner and stronger.

 

Of course we can't know a bottom for certain until after the fact.  It seems to me we are low enough below marginal costs that investing now assures good upside if you choose companies that have staying power but are still reasonably leveraged to oil price.  Buffett was early in the fall of 2008 with his NYT's editorial about buying - but he was of right.  We might be a little early now.....but keeping some dry powder can certainly help

 

I've allocated about 5-6% and will probably allocate more. Particularly if oil gets into the 20's or teens.

 

Sharper - I was a bit early on PWE but got pretty lucky employing one of the strategies you noted close to the bottom.  The swiftness of the upswing was powerful - and in the end I didn't want to sell shares due to the fact that the upswing put me in the money.  I also like your idea of the targeted exit. It shows the leverage potential of this type of opportunity.

[Cardboard]

What is different now vs a few months ago is that truly the babies have been thrown out with the bathwater.

 

While I can't identify the names since I am still accumulating some of them, there are small service companies with pretty low debt levels, strong asset backing and even some paying dividends that are available at 1/4 to 1/3 of book value. Almost zero risk of default and they are not directly dependant on the oil price. They are dependant on oilfield activity but, some even have meaningful unrelated operations. 

 

These companies will at least double on any kind of recovery since they have been sold so aggressively due fear and this insane tax loss selling which is a myth: on average, all you are doing is delaying your taxes by one year. Is that worth dumping names at any price?

 

The preferred's is another great field for research in Canada. Everything has been dumped from Aimia to Enbridge to BCE, etc. Most preferreds are not oil related but, the general decline in interest rate in Canada is related to what has happened to oil.

 

Cardboard

[krazeenyc]

What is different now vs a few months ago is that truly the babies have been thrown out with the bathwater.

 

While I can't identify the names since I am still accumulating some of them, there are small service companies with pretty low debt levels, strong asset backing and even some paying dividends that are available at 1/4 to 1/3 of book value. Almost zero risk of default and they are not directly dependant on the oil price. They are dependant on oilfield activity but, some even have meaningful unrelated operations. 

 

These companies will at least double on any kind of recovery since they have been sold so aggressively due fear and this insane tax loss selling which is a myth: on average, all you are doing is delaying your taxes by one year. Is that worth dumping names at any price?

 

The preferred's is another great field for research in Canada. Everything has been dumped from Aimia to Enbridge to BCE, etc. Most preferreds are not oil related but, the general decline in interest rate in Canada is related to what has happened to oil.

 

Cardboard

 

I do as much tax loss selling as I can -- specifically to keep capital losses short term. I often have a decent amount of short term capital gains due to special situations, event driven, and arb opportunities that are not confined to tax advantaged accounts.

 

So let's say you have $100K position that gets smashed and is worth $40K. If you sell while it's still a short term loss you "save" $30K in taxes (assuming ~50% bracket).

 

Let's say, instead, you hold the position, and in a year it rallies 40% from the lows and you sell it at that point.  Not bad. You've made back $16K.  Now you can report $44K in long term losses, but since they are now long term losses you are only "saving" (~30%) $13.2K. So... even after a pretty darn good year you are actually better off just taking the short term losses when you can.

 

I understand that everyone's tax situation can be different, but I think it generally makes sense for me to aggressively prevent short term capital losses from becoming long term capital losses. 

[Cardboard]

Meant on the Canadian side since we have only one tax rate on capital gains/losses no matter what the duration.

 

Cardboard