The value of an unfunded business plan.

To continue an unintended series about value, herewith some musings on cost of capital. About 6 months ago I wrote a post (“Financing “Oil 2.0″ will be more expensive. What is the WACC for your next Frac?”) commenting on how Shale 2.0 would be more expensive (and thus probably slower) than Shale 1.0

This theme of changing cost-of-capital – which should now be applied to the whole industry – results from a complex combination of factors. Most of the industry is suffering from a lack of interest in the sector, from public equity (both retail and money managers), as well as private equity. The latter, whilst well poised to take advantage of the downturn, is very selective, and becoming increasingly restricted by the views of their LPs and indeed the stakeholders of those LPs (typically students when the LP is a university endowment, or voters when it is a SWF). Big Oil is fast turning into Big Tobacco in the minds of consumers, albeit with a less obvious cost/benefit analysis. Climate Change, BigOil=Evil Empire, Pollution, and historically very poor returns on investments…. combine into a cliched “perfect storm”.

Whilst the equity story is tough, the real damage is being done in the debt sector. Many of the big name O&G lenders have gone (and here I am talking essentially about the non-US banking market, although the US has had similar trends), and those that remain don’t have anything like the appetite or balance sheet to step up to fill the gap. If we are, in addition, talking about Emerging Market lending; well it is very definitely “risk-off”, and there are rarely any local banks to turn to. Where local banks had started building a presence, irrational exuberance coupled with our wonderfully fickle oil price has resulted in them imploding on excessively overweight O&G loan books and now scary NPL numbers. Don’t hold your breath for a rapid return.

The only “bright spot” is that debt is still stupidly cheap (at least the base-rates). Whilst this is a macro economic theme well beyond the scope of this post (or of me), it does beg the question of how bad things will look if/when base rates start going up again… Maybe interest rate hedges should be on a CFO’s watch list.

So whilst thinking about this I have tried to plot the evolution of the O&G sector financing since I left the industry and went to the dark-side in 2001.

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The real value of oil

In an early 1990s British TV series called GBH, the main protagonist – a Machiavellian local council leader is seen at one point trying to shred large numbers of documents with a tiny paper shredder as the police close in… and famously says something like “Bloody typical… I always know the cost of everything and the value of nothing… agggahhh” – (and my apologies if that isn’t exact, or even attributed to the correct TV show.. all from memory).

The point is, we know the cost of oil, we know the price (even if we don’t know where it is heading…) but do we know the real value?

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The Emperor’s new IPO

Four years ago, in mid-May 2012, Mark Zuckerberg and colleagues IPO’d Facebook.   Rather unusually the IPO didn’t have a clear use of proceeds:

The company says it plans to use the proceeds for working capital and general corporate purposes, but adds: “We do not have any specific uses of the net proceeds planned.”  WSJ

Imagine my version, he instead says that  “we will be using the proceeds to create a fund so that we and our current stakeholders can build a future for ourselves that does not rely on social media or advertising…”   

His advisors and bankers would have gone into meltdown…  Predicting the demise of your core industry and planning for an alternative future doesn’t sound like the stuff that pre-IPO prospectuses are made of.

But from a certain distance this looks rather like what Saudi Aramco is doing.  Bankers are, of course, killing each other to get a piece of the action – it will undoubtedly generate massive fees (for the bankers).  But what of the use of proceeds?

“What is left now is to diversify investments. So within 20 years, we will be an economy or state that doesn’t depend mainly on oil.”

As long  ago as 2000 Sheik Yamani famously said:

The Stone Age came to an end not for a lack of stones and the oil age will end, but not for a lack of oil. –  Ahmed Zaki Yamani

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Bonjour Volatility – Reasons to be Cheerful 1 2 3…

More musings on the oil price, I know, I know – it’s a mug’s game…

Part 1: Short Term

Somehow, oil is holding above $40.   Notwithstanding the details, the US continues adding oil into storage (+3mmbbls yesterday) – and we have several ephemeral events taking production offline and propping up the price (Kuwait strike, Forcados down and now issues at Escravos, Libya, etc)…  But fundamentals are really no different now than they were in February (albeit with even more in storage).  Now, I fully buy into the narrative around the coming rebalancing – and am more and more convinced it will result in a big overshoot in the other direction (hence a recent public utterance of mine of $85-90 in Sept 2017).  But today (and in the next few months) I don’t see that rebalancing happening in this time span… so am back to fundamentals and scratching my head why we are at $45 today…  
That being said, the whole situation is becoming pretty unstable – the outages in Nigeria don’t look like random events.  

How about this for one coming out of left field: Venezuela which produces just under 2.5mmbbls/day produces roughly 70% of its electricity from hydro power.  Their dams have, along with everything else been poorly maintained and managed, and are currently drought affected – the key Guri dam is 3ft above its minimum water level – so pretty soon the lights will start to go off.  Now how many of Venzuela’s 15,000 wells have electrically driven pumps?  I don’t know the number, but I’ll bet it is a huge proportion…   and when the grid fails, Venezuela will resort to generators to power the wells and to power homes and businesses, so we can expect domestic consumption to increase and exports to decrease.  

Continue reading “Bonjour Volatility – Reasons to be Cheerful 1 2 3…”

Witnessing History Happening

On April 8th – two weeks ago, SpaceX landed the Falcon 9 rocket on their drone ship out at sea.   This is a huge landmark in space travel – probably bigger than anything since the moon landings.   It is worth watching the video also – this was no benign bit of sea either (OK so its not the North Sea in winter), but there is clearly some swell and some strong cross-wind…  (obviously this is not an easy exercise)

But why all the hyperbole about this landing – after all the space shuttle landed many times?

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Petrodollars, deflation and your pension

Low oil prices put more money in the pockets of consumers but there is a hidden cost to your savings and ultimately your retirement.

In January I attended a Fund Managers conference in Geneva – clearly not my ‘metier’, but I’d  strongly recommend (and this will be the subject of a future post) going to events outside your own industry – you’ll be surprised, always, by what you learn.

 Anatole Kaletsky of Gavkal presented a macro view and noted that the decline in oil prices is causing a massive redistribution of petrodollars from producers to consumers. He suggested that the figure is in the order of 2.2 Trillion dollars annually.  

This is a big number but the figure is quite easy to get to.  Solving for 96 million bbls/day global production, 365 days a year and oil declining from $110/bbl to $35/bbl, one gets to $2.6Tn.  Not all of the produced oil is sold, and one can argue about the price end-points used, but as an order or magnitude it looks about right.

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Why Tesla will make the Taxi vs. Uber confrontation obsolete.

I recently watched “Made in Dagenham” – a feel-good film of how a small group of women fought the Ford corporation and the male-dominated unions that were supposed to represent them.  As much as the film is good and the subject (equal pay for women) is important, you couldn’t hope but noticing that the Dagenham factory that employed 57,000 workers in 1970, now employs zero workers… (at least not in the UK, and probably not anywhere).   

Last month we saw again, Parisian taxi drivers out on road-blocking go-slows to protest the non-taxi competition.   Whilst they may have a reasonable case that it is unfair competition (licence fees, regulations, tax and social charges etc), you have to love the irony that the founding story of Uber is of Travis Kalanick not being able to get a regular taxi in Paris one evening and thinking… hmm there has to be a better way of doing this.   If you’ve ever tried to get a taxi in Paris you’ll understand his frustration.

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Financing “Oil 2.0” will be more expensive. What is the WACC for your next Frac?

Just when revenues are hitting decade old lows, the cost of financing for your favourite oil company is going up…

The oil industry is all about boom and bust.  We live with inherently long investment cycles and have global macro-cycles layered on top.   I have speculated about the ability (or rather, inability) of the financial markets to respond to a second coming of the US shale industry in a previous post.  What is significant for all players is that the cost of capital is increasing across the board.

Typically companies finance themselves with a combination of debt and equity.   We may hear all sorts of nomenclature with term loans, revolvers, RBLs, mezzanine, bonds, kickers, warrants etc, but it is all either debt or equity in some form.  The average cost of financing a company can be simplified to the Weighted Average Cost of Capital (WACC) – where the cost of each component is weighted by its relative proportion in the mix:

WACC =   (%debt  *  cost of debt)  +  (%equity  *  cost of equity)

Importantly the %equity term should be thought of as 1-%debt, because when debt is not available, equity has to make up the delta.  The obvious case of this is exploration companies who have no access to debt are 100% equity funded. 

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Could the “Green Revolution” in energy lead to instability, real revolution and war?

OK so that is a classic LinkedIn banner headline designed as click-bait… 🙂  the original was going to be “Why oil will go to $20/bbl and why it won’t stay there..”, but since I started writing this in mid-December 2015 procrastination has now made the old headline a bit mainstream…  

Despite this, the core argument remains – not that oil will go to $20/bbl in the short-term (it may well…) but that the long-term price of oil should be $20 or below.   “Should” is only relevant from supply and demand perspective – the geopolitics of $20/bbl oil mean that it is unlikely to stay there.  Could the “Green revolution” in energy lead to war?

The conventional wisdom on oil as a resources has been that of oil as a finite resource leading to Peak Oil panic – which was widely commented in mainstream media and widely dismissed within the industry.  Probably the best antidote to Peak Oil Panic I heard (and I apologise as I don’t know the source) was “when you can talk about Peak Technology, then we can talk about Peak Oil…”.  With a bit of hindsight this has proven to be very true at the current time.  US oil shale has been a technology driven source of new supplies.

In 1968 Garrett Hardin published the influential paper in Science “The tragedy of the commons” – which was a amongst other things, a call to abandon the cold-war arms race.  Above and beyond the main argument that humans would act in a rational-but-selfish manner to the detriment of shared resources (the “commons”), he also argued that there was a class of problems that had no technological solution.  The arms race being one.

The use of finite resources may also be seen as a member of this set.   Technology in the oil industry has caused a temporary supply side excess, and indeed I think most people in the industry can see that a combination of technology and price could keep us supplied for generations, even if it does not alter the fact that fossil based hydrocarbons are a finite resource.  Technology can’t change the fact that fossil fuels are finite – although it may well render them obsolete.

The finite nature of oil has led to a generally accepted view that oil prices will inevitably rise over time as scarcity sets in and F&D costs increase.  This was very much the driver of the Peak Oil debate mid last decade.  However, it now seems likely that the opposite is becoming a reality – demand will decline before scarcity of resources becomes an issue.  In this brave new world, permanent over-supply and consequent low prices may be the main theme.

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What connects LNG to 4G and the M25…?

Having commented on oil in recent posts, the recent  announcement of a giant 30tcf gas discovery offshore Egypt by ENI is a great segue to thoughts on gas.

It will have been hard to miss the Shell-BG merger announced earlier this year.  This deal was seen by many in the immediate aftermath of the announcement as a read-across that Shell was betting on a high ($85) future oil-price.  Many took comfort from this.   This view was however generally quite short-lived, with the significant synergies in the BG and Shell gas businesses, both upstream and mid-stream; it looks much more probable that Shell have in fact taken a strategic view that gas is the fuel of the future.  More recently the Woodside-Oil Search potential merger is largely about gas also.

As if to ensure we get the picture, Shell recently suggested dropping “oil” from its usual name “Shell Oil” (admittedly from the US subsidiary only).  And the industry/finance interface The Oil Council has rebranded itself the  Oil & Gas Council.   Is there a hidden message here somewhere?

Whilst this gas-driven M&A and re-branding activity was going on, Kosmos announced a very significant gas discovery offshore Mauritania (probably spilling across the border into Senegal).  Based on the discovery well, resources were being quoted as 5 tcf, 12 tcf and in some cases 20 tcf.   Even the low end of this is a sizeable gas discovery, and it is located relatively  close to the European market.  So how did the market react?   Well, a nice 10% spike on the announcement followed by a decline to pre-discovery levels within a couple of weeks.  A huge shrug and a sigh.   Ho Hum, more gas.

So some pretty conflicting messages then.

The origin of the market apathy is actually quite easy to see; just as with oil, it looks like over-supply coupled with a stagnation in demand.   

Continue reading “What connects LNG to 4G and the M25…?”