Oil and Gas Curious 🛢 ⛽️ 🤯
Oil and Gas Curious 🛢 ⛽️ 🤯
Adventures in the world of O&G, a thesis, and an opportunistic smell
WARNING: Before we get into this “rough dive” of Oil and Gas, I want to make one thing really really clear. I am not an oil and gas expert by a long shot so please read all of this with a grain of salt. I do have a small position in CNX and OXY but understand that these are commodity-based companies so there is an inherent risk that comes along with this. Please do your own work and bring a skeptical eye to the words that follow.
This post is one of a few where I am going to highlight my thoughts on why I got interested in the space and write ups on the companies in the inudstry I own and why.
Commodities have always made me skeptical. There are risks that come along with these types of companies that are not inherent in others. The biggest, of course, is based on the fact that the price of your product is determined by a market of supply and demand constantly pushing one another out of the way to somehow get to equilibrium. Achieving this “middle” state never happens. It is all a cycle of boom and bust. When you decide to wade in the waters of investing in companies with commodity exposure a smooth ride should be the last thing you expect. But it isn’t all scary.
The reality is we live in a world that runs on Oil and Gas. The roots of this industry find their way into so many others that trying to displace it would be almost close to impossible. When you take a step back and look at it from 10,000-foot view the world needs these commodities and the world needs companies to go out and bring them to market.
I didn’t wake up one day and say, “today is the day I want to look at oil and gas”. In fact, it took a little bit of a nudge. I first began to look at the space right around the spring of 2021 when Oil began to recover from going negative and we were seeing the price come back to a “normal” level. During the same time, I listened to a podcast with Bill Brewster and Arnold Van Denberg. Towards the end of the episode, Arnold makes a pitch for a “commodity boom” (boy did he call it).
This was interesting to me. I had followed Arnold for quite some time and rarely do you hear a superstar value investor blatantly come out and pitch oil stocks. I should also note this was the time when Buffett began to build a stake in Chevron. Because I thought this was unusual, curiosity led me to do a deeper dive into the world of oil stocks and I started with the big guys, Exxon, Chevron, and Occidental. At the time they were all still recovering from being obliterated during COVID.
The research began with just reading all of the 10ks and a ton of Googling. I also bought a book called Oil 101 which helped give me a nice little primer on the words used in the industry and brought my understanding up enough to feel like when I read the annual reports I could understand what I was looking at.
When I first took a look at the space I was more drawn to the names that were really taken behind the woodshed. There is a certain smell to extremes and fishing in those ponds seem to be the ones where I feel more comfortable, as odd as it might seem. At the time, OXY seemed to be swimming in that pond.
During this time they were coming out of a major crisis. They loaded the balance sheet with debt and a $10 Bil deal with Berkshire for preferred stock to fund the acquisition of the Anadarko. They won the bid and what seemed like immediately after the close of the deal bombs started to go off. Fast forward to March of 2020, they have a massive debt load and their “product” was priced in the negatives. It was grim span of time and there was a serious question as to whether they were going to be able to weather the storm or end up going the route of many other O&G companies who seemed to get greedy and file for bankruptcy.
My ears perked up when they did a warrants offering. These warrants were available to convert into shares in 2027 at a price of $22 a share. The warrants themselves were $10 a piece so $32 was the break-even. In my mind it was simple, I’ll know long before 2027 whether OXY will be alive or not and if they are alive, these new Permian assets are going to be incredibly valuable. The only question was the price of oil. If it stayed below their ~$40 break-even price they would be in big trouble, if not, there would be a lot of cash. And if there was a lot of cash I didn’t see how the share price wouldn’t climb back to what it was before the pandemic.
In April 2021, I bought warrants for around $10 a piece and some shares of CVX, then a few months later I concinved myself I wasn’t smart enough to understand the market, sold the warrants and the shares in August, and put the money in Alibaba. On a dollar basis, this was the biggest mistake I have ever made as an investor.
Chart of the OXY.WS price
I kept up with the companies during the year because I wanted to make sure I saw the real opportunity cost of switching investments. Each time they kept going up and up I felt dumber and dumber but mistakes like these are part of the game.
As investors, we rarely get to really choose the investments we are interested in. The investments, to a certain extent, choose us. There can be a million opportunities but if we are not interested or curious the research doesn’t go deep enough to warrant a postion and so there is a certain element of “interest luck” when looking for ideas. They have to come to you when you are ready for them and the tipping point occurs where curiosity drives intense action. One could say the investment ideas don’t achieve critical mass until there is a mixture of “this doesn’t makes sense” followed by “The could be a pool of opportunity here” and then an unquenched thirst to figure it out.
The Here and Now
Fast forward to today and we have seen a run in oil prices with the WTI hitting $120 twice this year and for the first time in my life I paid $5 a gallon to fill my car. Everyone is calling for green fuel but I am skeptical of our ability to really get to a net zero world. It sounds good but is it really doable? I don’t know. I just know the world runs on 88 million barrels of oil a day and consumes around 4 trillion BCFE of natural gas a year, which has been steadily increasing over the past 10 years. To replace all of that is going to take a LONG time.
O&G 10,000 Foot Thesis
We have a good idea as to what the consumption of Oil and Gas all be for the short term (3 to 5 years), there won’t be any large movements to one side or the other in terms of electricity generation from renewables and there are some large underlying trends in the world today such as the increase in energy demand. I am skeptical to believe we can build enough renewable energy to get infront of the curve.
We are much more reliant on the Oil and Gas industry than we would like to believe. Policy and social dilemmas have put a collar around our ability to produce these fuels for consumption, choking supply, and thus we are seeing higher prices relative to the close past which I think will stay around long enough to become a new norm.
If this is the new norm, Oil and Gas companies are at the beginning of a solid runway of serious cash generation and given the political and social environment, they are less likely to use this cash to increase production so they will be returning it to shareholders in the form of dividends and buybacks. There are a handful of companies that have come out and stated they will be generating their entire market in cash over the next 5 years.
When I reverse engineer the share prices I think the market is skeptical about the current environment and that some of these companies have little terminal value past 5 years. Which, if you think it’s going to take longer than 5 years to transition away from Oil could present a significant opportunity. Then we layer on shareholder-friendly management that is using all the excess cash for shareholder benefit. Looking down the road, 5 years from you can get your market cap back in cash, a larger stake in the enterprise which is probably not worth $0, and it’s probable management continues to hammer down share counts and send dividend checks well after the 5-year mark.
I am speculating but this change in capital allocation mindset from “growing” to “returning” is what I think was the catalyst for Berkshire to buy massive stakes in CVX and OXY. The even more interesting part is the stocks haven’t moved since the news.
I AM NOT AN ENERGY EXPERT. JUST WHAT I THINK.
This curiosity is what led me to go back and take a look again at the industry. After seeing the initial run-up in market price it would have been easy to think, “I missed it” but then after a deeper analysis I think a lot of risks were taken off the table during the past two years when the companies used the run up in price to strengthen their balance sheet and now we are entering into a stretch of time when the returns won’t be 4x in a year but they could be above average with much less risk. I think the sector is worth a look. I say this all with a dose of humility.
Peace and Love,
Michael
Please be advised, Wall St Gunslinger is not an investment advisor and does not give personal investment advice. All content is for educational and entertainment purposes only. Investing entails a lot of risks and should be managed appropriately. Please do your own research and consult with an investment professional before making any investing decisions. Thank you.