Energy Defaults Are Coming, But This Time We’re Serious *** INDUSTRY FOCUS ***
Sean O’Reilly: We’ve talked about defaults
before, but we mean it this time… on this energy edition of Industry Focus. Greetings Fools, I am Sean O’Reilly joining you here from Fool headquarters in Alexandria
Virginia. It is Thursday, November 12, 2015 and joining me to talk about all things energy
and materials is Tyler Crowe and Taylor Muckerman. What is the good word, boys?
Tyler Crowe: Almost all things. O’Reilly: Almost all things.
Crowe: There’s some things we just can’t talk about.
O’Reilly: We’re going to talk about all the things in 20 minutes.
Taylor Muckerman: Solve everyone’s portfolio issues in 20 minutes.
O’Reilly: All from this 20 X 20 room in Alexandria, Virginia. So first segment that
I wanted to touch upon with you guys was, and David Gardner of course.
Muckerman: Yeah he’s decided to join us. O’Reilly: Yeah he’s here too. Oil’s
still in the 40s, things are not looking good for 2016. We talked about defaults before
but is every company but Exxon and Chevron going to go under before this is over?
Crowe: That might be pushing it. Muckerman: Just a little bit.
O’Reilly: I like to speak in hyperbole for comedic affect.
Crowe: That is quite the hyperbole. But one of the things …
Muckerman: That would solve everyone’s problems in 20 minutes or less.
O’Reilly: It would. Cure for low prices is low prices, baby.
Crowe: You know, we talked about this, when was it?
O’Reilly: Two months ago. Crowe: January. Well we’ve talked about
it a lot. We’ve talked about it in November, we’ve talked about it in January, we’ve
talked about it in March. O’Reilly: But we mean it this time, darn
it. Crowe: I think one of the reasons that we
haven’t seen that reaction of defaults and people getting in financial trouble is, well
in all honesty two things: One, I think a lot of people expected oil prices to be a
little bit more robust than they are right now. I mean if we go back to November-December
you hear all these wildcatter-style CEOs and guys like Pickens and stuff like that. We’ll
be at 70 by, in 6 months or … O’Reilly: End of the year.
Crowe: End of the year we’re back at 70 and you know, everybody kind of hung on to
that and be like, “Okay, we’ll get through this. This sucks but we’ll get there.”
And we’re what, 45 … O’Reilly: It’s almost Thanksgiving.
Crowe: 45-50 days from the end of the year and we’re still below 50. It’s starting
to really weigh on a lot of these people who thought they could weather a short-term storm
and well, that storm is a little bit longer than they expected.
In so many of these players that we had talked about, we knew they were going to be in trouble
when oil prices were low. You looked at their balance sheets, you saw they had taken out
a ton of debt, but at the same time I guess they just held on for a little bit longer
and everybody expected it. I guess people are more resilient in that fact where they
want to say, “We’ll hang on. We’ll hang on. We can make it through.”
O’Reilly: Well and the other reason that pain hasn’t been quite felt is hedges of
course. Crowe: That has helped to a certain degree.
There’s a lot of companies that have that in place especially when you look at let’s
say Master Limited Partnerships that are in production. They have those hedges to kind
of steady out their cash flows, but at the same time there’s a lot of people who didn’t
have that have just had to slash their capital budgets, their operating expenses down to
the absolute floor to make it as profitable as possible.
Some have been able to achieve some marginal level of profitability which is quite commendable,
but at the same time when you, again going back to their ability to pay off debts, it’s
getting a little bit harder. Muckerman: I think some of the people that
are facing these defaults probably didn’t utilize hedges that much because they were
those guys that were just saying, “Why are we going to forgo profits now with these silly
hedges. This is going to crimp our returns now. Who knows the future holds? What if oil
prices stay at $150? These hedges are going to just, they’re going to ruin our stock
price.” O’Reilly: Was it Harold Hamm that cashed
in his hedges a year ago now? Crowe: Yeah, right about.
Muckerman: So like I said, looking at these companies, you’re talking about some names
that were really popular names among investors, among the energy inner circles during the
last 4 to 5 years of the boom leading up to the November of last year. And now all of
a sudden their debt is essentially worthless. At least that’s what they’re predicting
in the next few months. Penn Virginia I think is coming up on some
covenants, Magnum Hunter Resources, they mentioned in the report that Tyler sent around is basically
already defaulting. And those two companies, while they’re not huge, they’re only domestic
EMPs, but those are some hot stocks. Those were very, very popular and now they’re
reaching … O’Reilly: So it was a little at 45 just
because everybody’s been holding on. Muckerman: It’s below 45 right now. It’s
almost 42. O’Reilly: Oh yeah, it’s 42, 43. Is it
just holding on? I mean you see inventories continuing to creep up, but production is
falling. Is it just people putting it there because they don’t want to sell it at 45?
Crowe: Well I mean again, to these companies they have to generate cash to pay these loans
off to a certain event. So they can’t just shut off the taps. Especially like you said
Penn Virginia, and Magnum Hunter … Muckerman: Magnum Hunter, the article said
that they have debt coming up this month that they can’t pay.
Crowe: So these companies, they can’t turn off. They can’t just stop producing because
they need cash now. It’s like those dumb annuity commercials. They always say, “I
need cash now.” But right now there’s just too many of them out there.
O’Reilly: If only there was a payday lender for oil companies.
Crowe: There were and now … O’Reilly: Oh yeah it’s called Wall Street.
Muckerman: There were. Now it’s gotten to the point where not even payday lenders won’t
toss them a bone. Crowe: And so, with those people that aren’t
in that flexibility to say, “Well we just can’t stop drilling.” Or, “We can’t
stop producing.” It kind of has compounded the issues that we have seen so far.
I mean obviously you’ve got some of the larger, more well-capitalized companies, the
EOG Resources, Conoco Phillips people like that, who have scaled back and said, “We
can…” Even though some of them are more profitable at much lower prices today, they’re
still scaling back and saying, “You know, we can take our foot off the accelerator for
a little while.” Muckerman: And that’s not because they’re
smart now, it’s because they were smart before. They weren’t taking on these crazy
amounts of debt. They weren’t drilling out of control. It’s kind of a dominoes affect
here with these companies that they’re able to do this because they were smart 5-10 years
ago when they were first realizing that this is a gold mine, but it’s not going to last
forever. Because hey, the energy industry is …
Crowe: It’s a cyclical business. Muckerman: Yeah. They got it and some companies
that didn’t, it’s evident every time the bottom hits or comes close. Some companies
just didn’t have the experience or the wherewithal to pace themselves.
Crowe: And certainly as investors and people like us that couple years before, it was kind
of one of those starry eyed sort of moments where we looked at it and said, “We can
take control of the market back where we can produce all of what our own oil.”
Muckerman: Energy independence. Crowe: Energy independence. And seeing these
companies that were just growing at gangbuster-like levels, almost doubling production every year,
it sweeps you up. It really does as an investor, and you see all these companies that are just
growing so fast and you want a piece of that. But at the same time again going back to the
fact that it’s a cyclical business, if you’re an investor in this space, certainly a lesson
I learned, in some ways the hard way from this one, is that we have to be measured in
our approach throughout this entire — through the down market and through the up markets.
That last one? We all got caught up in it and it probably burned quite a few people.
And today at the same time don’t overlook the fact that there’s a lot of value in
buying solid energy companies today. Don’t just get burned back then and now today completely
go away from energy. Because there are some opportunities out there. And when this market
does turn, it will eventually, when it does you’ll have some, I think there’s a great
opportunity for some long-term rewards. O’Reilly: So before we move on to this bottom
line, it seems like some companies got to die for production to really drop. I mean
is that basically what we’re saying here? Muckerman: The crematories are firing up their
furnaces. O’Reilly: Okay that’s dark, but true.
Muckerman: Using oil to fire up their furnaces. Crowe: Cheap, cheap oil.
O’Reilly: No, no, no, natural gas. Crowe: Either way, they’re both cheap.
O’Reilly: Well before we move on, I wanted to point our listeners to a newly redesigned
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And moving on to our second segment I’m here with Tyler Crowe and Taylor Muckerman.
Oil majors have, you’re talking about the balance sheet of Exxon is like least cash,
but they have $40 billion or something. Crowe: That and then all the stock that they
have of their own. O’Reilly: Yeah, the treasury stock.
Crowe: Yeah the treasury stock, yeah. O’Reilly: So oil majors have cash to spend
but they haven’t been making a ton of acquisitions and then the devastation in the oil industry
has been going on for over a year now. Do you guys think they’ll actually start shopping
at some point? Muckerman: Well I think we talked about it
a little while ago as well when we were talking about Exxon’s cash balance, that they kind
of need that cash in order to sustain dividends. Because if not, the cash for operations isn’t
going to sustain that if oil is the in $40 range. And Exxon is addicted to the share
buybacks, so they’ll have to cut that even more if so. So the cash has kind of been held
as a necessity. Obviously if these companies start going bankrupt
like we’ve talked about in the previous segment, there’s going to be some opportunities.
And these companies that are failing, aren’t necessarily failing because they have terrible
assets. They’re failing because they were run terribly. So they’re going to be out
there for the cheap and yeah, there will come a point where Exxon and the like decide, “I
think we have enough to sustain our dividend for the next year or so. Let’s go ahead
and spend.” Not at like $10-20 billion, but let’s go
out and spend $500 million, a billion here and there, to go ahead and pick up some lucrative
assets in Texas or where the Utica base center, something along those lines. They’re not
going to reach with this cash. They’re going to be safer bets that are very cheaply valued
in my mind. Crowe: Yeah and I mean I think this is on
everybody’s minds again now because we just heard the recent talks of, there was a story
came out on Bloomberg that Apache had been courted by somebody.
Muckerman: No small company, mind you. Crowe: Yeah, they’re pretty formidable size
company. So when we heard, when you hear somebody of the size of Apache getting acquired, everybody’s
fingers immediately play, “Oh it’s going to be Chevron. Oh it’s going to be Exxon.
It has to be one of these guys because they’re the ones that have capital.”
Surprisingly it came out that it was actually Anadarko Petroleum that did it, so now that
that has happened, it just goes back to everyone talking about big oil. “Oh they’ve got
the cash, they’ve got the treasury stock, it must be those guys. When are they going
to make their move?” And we’ve been wondering that for a long time. We looked at it and
said, “Oh these companies are so cheap and some of them are really looking distressed.
They can get them on the cheap.” But at the same time, the situation hasn’t
exactly improved from back in February-March to today. And a lot of, if you listen to the
conference calls of the companies that we’re talking about; Exxon Mobil, BP, all them are
still kind of preaching that idea that, “Hey guys we could be in this for a lot longer
than some of these wildcatters. Oh we’ll be back in 6-12 months.” Big oil is like,
“Hey guys, this could, 2016-2017 might be, maybe when we start to receive recovery, but
it could take that long.” And so if you are one of the buyers or potential merger
people in these companies, why bother? Why bother with making a …
O’Reilly: You could buy some in bankruptcy court.
Crowe: Yeah you could buy something later when it’s even cheaper, or even when it’s
more distressed. Or maybe wait a little bit longer because you have some efficiency programs
you want to get through and you’re now all of a sudden starting to generate some cash
from these low oil prices, which we are starting to see from some players surprisingly. And
once that comes around, that could be a certainly, a more attractive opportunity. I mean when
the name Apache came out, what made that so attractive to a lot of people, if you look
at Apache’s assets they have a very strong presence in Permian Basin.
And the Permian has historically been a huge oil and gas producer for us in the United
States and with shale starting to take hold, everyone started to say well, with all that
acreage there, somebody that has a decent position in the Permian like Chevron, that
could really compound that and become one of the key drivers for them pull in this,
in their next wave of development. You know, 2017 a lot of the things that they’ve been
working are starting to wrap up and everyone’s starting to wonder what are they going to
do next. And somebody like Apache could be a big lever for them to pull later on.
O’Reilly: Now you guys may or may not be able to answer this so it’s totally fine,
but maybe you just take a stab. At what point, and to Taylor’s point, he’s talking about
Exxon’s committed the dividend, they want to hold […], they also need to balance that
I assume with just reserve declines. At what point do they need to be like, “Yeah we
should probably buy one of the smaller guys just to up our reserves or something?”
Muckerman: Most of these guys are generally breaking even or just barely growing reserves
year over year. The recapitalization, is that …?
Crowe: Yeah the replacement rate. Muckerman: Replacement ratio they generally
want to keep that like 100 so that they’re right there. You see it fluctuate between
95 to 105. So some years they’ll be a little less, some years will be a little more, but
generally these companies are big enough to where they’re just trying to stay steady,
right? And if the price of oil, which is what they
kind of base their reserves on, on their balance sheets, going to stay this low, then it will
continue to decline. And yeah the only way to really boost that is through acquisitions
because they would have to drill a heck of a lot to move the needle in terms of how much
they’re producing and selling. Crowe: And at least in terms of again big
oil they’re not in a huge rush. I mean somebody could say there’s a panic because Exxon
Mobil doesn’t completely replace its reserves in a single year. They have if not just proof
but if you look at their kind of pipeline that they talk about, of potential reserve,
they have 90 billion barrels of potential reserve.
O’Reilly: Just hanging out. Crowe: Just, they’re working through that
they haven’t, you know it’s like it’s not in our prove reserve because we haven’t
dropped them into our balance sheet. But it’s like, we’re working on 90 billion barrels
of potential oil. So they’re not in a huge rush in any way to go do this. And I think
one of the important things that they’re going to look for is not just cheap, not just
you know grow reserves, but fit. What is going to be a company when they bring
them on that is going to be a good strategic fit? Royal Dutch Shell has been looking to
make their purchase of BG Group, because they’re like, “We’re going to make a big splash
into LNG.” And so with the BG Group, they’re kind of pushing more towards LNG.
So if you have somebody like Exxon Mobil or Chevron who may be making some big move in
the future, they’re going to want to find something that really fits within their development
portfolio that they can not only develop, but kind of combined with what they have and
get a lot of cost savings and things like that.
I certainly, after Exxon Mobil made that XTO purchase in 2011, it took them a few years
to figure it out. And I think they learned a lesson from that.
O’Reilly: Cool. Well last little thing before we go, we have a mailbag question, guys.
Crowe: It’s been awhile. O’Reilly: It has been awhile. And actually
on that note, if you have a question or comment for Tyler or Taylor please email us at [email protected]
Crowe: Or Sean, if you want to ask Sean a question.
O’Reilly: Or me. Muckerman: Tweet us @TMFEnergy.
Crowe: Any way you can get in communication with us, we’ll find a way to answer your
question. Muckerman: What was that email address, Sean?
O’Reilly: [email protected] Crowe: Sorry, I interrupted you.
O’Reilly: Anyway, that’s fine. Crowe: Stop playing on your phone Taylor.
O’Reilly: So Jonathan … Crowe: Rossignol.
O’Reilly: Rossignol, thank you. Crowe: It’s a skier? I don’t know.
Muckerman: I don’t know. O’Reilly: Maybe. Writes, “I would like
to hear you guys’ opinion on midstream energy limited partnerships. Do you have past experience
with them? Are they too risky under the current market conditions? How reliable are the dividend
yields for the long-term? This is particularly pertinent because those yields are 10-20%
right now? Crowe: Well depending on where you look at
in the space. It is a rather broad stroke question in the fact that are they risky?
I think when you say that, it really depends on who you’re looking at. And so …
O’Reilly: So who are the risky people? Just a couple names for the …
Crowe: Well I would say I think one of the general things that you should look for, when
you’re looking to purchase a midstream limited partnership, I wouldn’t say that it is a
risky environment now. I think of all the investments you can make in the oil and gas
space that is one of the lower risk opportunities. And one of the reasons for that is that when
it comes infrastructure most of the stuff And I think you can see some of the dividend
yields of those companies showing that as of late. So if for Jonathan I wouldn’t completely
avoid the sector in that broad stroke sort of way. Look at the structure of the company,
how do they generate their revenue, and make O’Reilly: Taylor, are there any names that
come to mind that you like right now? Muckerman: Right now probably the bigger the
better. Kinder Morgan. Kinder Morgan’s taking a big hit lately. Personally we recommend
… O’Reilly: What’s the yield on that? Is
it like, 6, 7-1/2? Muckerman: I don’t know off the top of my
head. Crowe: It’s 7 right now.
Muckerman: Yeah, it took a hit over the last month or so. I know it’s a Fool favorite
and a lot of services, Spectra Energy’s a recommendation in Stock Advisor Canada on
our U.S. side of the score card. That’s probably one of my favorites. I personally
own that as well. O’Reilly: Now they’re mostly natural gas,
right? Muckerman: Correct and they’re not nationwide
or even in Canada. They have a small presence in Canada along the Great Lakes, but predominantly
East Coast all the way down to the Gulf. And yeah like you mentioned, natural gas is the
bulk, and natural gas liquids are the bulk of their business.
And then one thing obviously you want to find a good company, but then you have to take
into account the tax implications, the K-1 form you have to file, long-term this could
be advantageous because you’re kind of deferring some taxes. But when you sell it there’s
tax implications on the units that you own. So you definitely want to kind of understand
that a little bit more. I guess Spectra Energy isn’t really an MLP is it? They own MLPs
… Crowe: Neither is Kinder Morgan […]. We
just recommended two C-corps when talking about limited partnerships.
Muckerman: I guess that gives you my feeling on it.
O’Reilly: Enterprise Products Partners? Crowe: Enterprise Products Partners.
O’Reilly: Yeah there we go, yay! Muckerman: … I give you my opinion on MLPs,
I don’t personally care for them all that much just because the added tax structure.
But there are companies like Spectra. O’Reilly: Don’t be lazy Taylor.
Muckerman: Choose Spectra Energy or Kinder Morgan if you want an infrastructure company
without having to deal with the MLPs. Crowe: As somebody who owns them, one of the
things I would recommend is you buy to own. You don’t buy to trade in any way because
of the weird tax things in terms of dividend recaptures and like you said, the K-1. If
you’re buying it and just holding it forever, yeah you have to fill out an extra form come
tax time. It’s not a huge deal. Muckerman: Not the biggest …
Crowe: But if you’re moving in and out of these positions, they can be a pain in the
butt. O’Reilly: These are definitely things you
give your grandkids kind of stuff. Muckerman: Yeah that sort of thing.
O’Reilly: Cool. Very good. Well thanks for your thoughts boys.
Muckerman: Well maybe you could look at Spectra Energy Partners, or DCP Midstream.
Crowe: Here he goes just throw it, oh I’ve got to find something.
Muckerman: Obviously I like them if I like Spectra because Spectra owns them both, they’re
general partners. So, take a look if you like MLPs, maybe they’re worth it.
Crowe: Trying to keep it together. or comments we’d love to hear from you.
Just email us at [email protected] Again interests in the stocks they talk about and
they may hate filling out K-1 forms. The Motley Fool may have recommendations for or against
those stocks as well. So don’t buy or sell anything based solely on what you hear on
this program. For Taylor Muckerman and Tyler Crowe, I’m Sean O’Reilly. Thanks for listening
and Fool on!