Miscellaneous Musings On Market Mayhem

0
1577

Oil is rocking up today, but the social fallout of the very low oil price in western Canada could deep, and for a long time.  If a lot of wells get shut in–I’m not sure people really understand what that means for rural communities.

Oftentimes, the largest two expenses for an oil and gas company is

  1. Municipal taxes
  2. Landowner payments

Small towns across western Canada rely on this resource income to help fund…everything.  In British Columbia, as the logging industry got mechanized and then mills shut down, it wasn’t just wages that went bye-bye—municipal payments did too. 

Alberta and Saskatchewan will now go through this.  Landowners would get something like $25K for the year a well was drilled on their land and then $5000 every year thereafter that the well was producing.  And if you had a pipeline go through your land, you would get a big check the year it went through and you couldn’t plant anything, and then $5000 per section (1 section = 1 sq mile) per year after that.

Farmers could work in the oilpatch for a time, and then farm for a time; keep the family farm going.  Sons would come up and do the same.  Now, unless the Saudi’s giant GHAWAR field goes dry, those days are gone. 

Truthfully, much of it is already gone as the young folk in these rural areas have  moved into the cities or another industry.

But it is sure going to exacerbate the regional differences between urban and rural across western Canada.


THE US WILL HAVE TO MAKE 
MORE PAINFUL CUTS THAN CANADA NOW

 
Down south, in the Permian basin of SW Texas, the economic impact will be much more severe than it will be here in Canada.  You see, the oil&gas industry in Canada has been dying a slow death for years.  Canadian industry has had to adapt to lower hydrocarbon prices and profit margins on a steady basis for six years.

But the Permian was booming right up until the Saudis declared an oil price war.  Production had grown and grown, and both money flow and production were going great—despite realized pricing being barely break even for the last few years. 

Remember, there is no such thing as an American oil producer.  They all have so much natgas in their production stream that almost all the US “oil” producers barely get half of the WTI price for their product on any given day.

But just like their natural gas brothers, these management teams kept pumping and spending on razor thin margins, and pipeline companies kept levering up to 3-4x debt to cash flow to install more pipe. (I have never seen a more reckless cratering of shareholder value by management teams in any other sector than US natgas production).
 
Now, oil (and therefore associated natgas) production is about to fall off a cliff—taking tens of thousands of good paying jobs (what a ripple effect that’s going to have in Texas!) away, and pipeline volumes will drop.  We will see what MVCs are really worth—Minimum Volume Commitments.

Debt is the other big issue obviously.  There is tens if not hundreds of billions of debt in the Permian alone, and it’s relatively concentrated into 20 or so entities.  What happens to them and their shareholders?  Well, these debt holders—mostly Private Equity—will do what Americans do better than anybody else in the capitalist world—they will cause a lot of deep intense pain very quickly and move on.

They will merge whatever producers or OFS (OilField Services) companies they need to, rationalize management teams, balance sheets and shareholders.  They will likely wipe out equity and recap them with preferreds that pay out dividends (20-30% of gross cash flow) and make sure that none of these companies grows for a couple years. Yeah, you know that “return-of-capital” chorus that we investors have been shouting at Energyland for 2-3 years?  The PE guys (that weren’t crushed in this last month) will get that now.



ARE NATGAS PIPELINES A PLACE FOR INVESTORS?


I was thinking natgas pipelines in the Northeast USA would be a good bet to invest now—they are not impacted by the drop in oil prices or in anticipated US oil flows.  Yet they have been slaughtered along with the rest of the energy sector, but natgas prices have been low for years.  But here’s the thing—you can buy an 11% yield right now on a company like TC Pipelines (TCP-NYSE) and think, hey, this is a safe place to hide because:

  1. natgas demand is relatively inelastic as it’s used for basic heating and other infrastructure needs, and
  2. I see Cabot Oil and Gas (COG-NYSE) going up from $15-$20/share this last week as the market prices in losing 5-7 bcf/d of associated production from the Permian and Bakken in North Dakota (today, as oil prices jump big, COG stock drops as market thinks maybe oil production–and natgas–stays up).

BUT—while TCP may not actually be impacted that much from the oil price decline (its assets are in the Marcellus natgas formation in northeast US; no oil), there is the possibility that with the new ESG investing craze going on now, fossil fuel pipeline companies might become like the tobacco sector—shunned, giving those stocks permanently high yields.

And if you’re a pipeline company, you want to be trading at 5-7% yield.  So if the Market doesn’t reward you with a small yield, you may as well transfer a big chunk of that free cash flow to your 4x debt to cash flow and improve your balance sheet. So cut that dividend by 60% to get to 5% yield and #TooBadSoSad to you retail shareholders.  Maybe that doesn’t happen.  But that’s the risk.


MLP Madness and Droopy Drops


MLPs–Master Limited Partnerships–are tax-advantaged investments that are supposed to pass through their cash flow (and their tax liabilities!) to investors.  In energy, that means pipelines. There’s a lot of paperwork involved in owning MLPs, so institutions don’t bother with them and they are almost all retail shareholder owned.  Being as retail shareholders are more skittish than institutions, these have a lot of volatility, especially in downturns like the last month

Now the general partner in these firms (in energy) is usually a producer, who, IMHO, often mistreat their MLP children by what’s doing best for the partner (lower toll fees) and not the MLP–so they have been average to poor businesses for the most part. 

For example, with the huge increase in oil and natgas production in the US in the last 10 years, these investments should have done well.  But they have horrible stock charts, as the industry used low interest rates and continual equity to overbuild pipelines and keep toll rates low. 

(Yes Canada, the US has overbuilt pipelines while funding groups up north who stir it up to make sure you can’t build even ONE.)

Kayne Anderson (KYN-NYSE) is a closed end fund full of pipeline stocks, so it’s more like the ultimate leverage on these pipeline plays–which all got hit hard post-Saudi production increase.  It dropped from $12 – $1 in 3 weeks–over 90%.  Part of it was because its constituent holdings were dropping.  Part of it was because it always carries 25-30% leverage, and the company had to get rid of that in a fast dropping tape. 

And part of it was the drop just scared its own shareholders away.  When the stock hit $1, it was trading at something like 60% lower than its NAV. It usually trades 10% lower.

KYN has led the charge up as well this week, now a triple off its $1/share bottom.  Several other midstreamers are also up 30-50% today. 


I think all these MLPs will cut distributions to match a 9-10% yield depending on where their stocks end up.
 


WHAT I’M DOING NOW


I never thought I would say this, but I was so lucky oil and gas were bad investments in the last two years.  I say that because I recognized it, and was in mostly cash for a long time.  That was really boring for subscribers and didn’t my personal cash flow being bearish and not buying anything.  But I missed a lot of the pain in the last two months.

As yet, I’m not buying traditional energy stocks right now-I mean oil or natgas, upstream,  midstream or downstream.  I see a huge increase in US COVID cases coming in the next month, and I mean HUGE doesn’t really describe it.  So more fear is coming and I’m willing to be patient. 


 

 

Keith