Who Makes the MOST Money if Oil Now Runs to $65

By
Keith Schaefer
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Heavy oil stocks will be The Top Investment in Energy if oil keeps gaining past the $45/barrel mark.

The secret is in the numbers.  Let me show you how and why using Baytex Energy (BTE-NYSE/TSX) as a perfect example—because they have both light shale oil in the Eagle Ford and heavy oil up in Canada.

The stocks of light oil producers soared as global oil prices rose from $26-$46 in February and March.  But for investors, the leverage in the next $20 upward move in oil belongs to heavy oil stocks.

That’s because heavy oil has higher fixed costs, but lower variable costs than light oil.  Don’t worry, I’ll keep this simple:

High Operating Costs And A Pricing Differential

 

Below is a table from Baytex’s most recent corporate presentation.  It depicts the company’s operating netbacks in Q4 2015.

The left column is Canadian heavy oil.  The right column is the Eagle Ford.

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“Netback” is the industry term for “profit per barrel”.

The textbook definition would be that an operating netback is net sales revenue generated from selling oil production less the cost of royalties (fee to the mineral rights owner), lifting costs and transportation cost.

It has nothing to do with any of the capital costs of drilling, building pipelines or fracking.  This is the cash flow a company generates from production.

In Q4 2015, Baytex’s heavy oil operation was making a measly $5.73 per barrel of production.   And remember that doesn’t include the expenses related to running the office, paying salaries or making interest payments.

The Eagle Ford did considerably better as it was able to generate netbacks of $18.77–more than three times what the heavy oil business made.

(That’s still not great, but a lot better than heavy oil.)

You’ll notice in the above chart that heavy oil sells for a much lower price than light crude, because it costs more to get the ‘heavy’ stuff out, like the asphalt.

That heavy oil price is called Western Canadian Select (WCS), and its price is often quoted as a discount to the light oil benchmark price, West Texas Intermediate (WTI).

In Q4 2015 the chart shows that difference (or differential) was roughly $13 per barrel.

Secondly, look at the royalty expenses in the chart above.  Notice how the royalty expense in the Eagle Ford is much higher on both a dollar basis and a percentage of revenue basis than it is on the heavy oil in Canada.

These royalty expenses are variable costs.  As oil sales revenue increases these royalty expenses increase on nearly directly proportional basis.

For the Eagle Ford this means that nearly 60% of the operating costs in Q4 2015 are royalties and thus variable.  For Baytex’s heavy oil production only 15% of its Q4 operating costs are royalties/variable.

As revenues rise the majority of Eagle Ford operating expense rises.  But that’s not the case for heavy oil.

The higher fixed operating costs for heavy oil make it uneconomic at low prices. But as oil prices rise, these costs stay constant—the price of oil really has no bearing on the cost of bringing it to the surface.

In Q4 2015 only 40% of the cost for Eagle Ford production are these fixed operating costs while the vast majority (close to 85%) of the operating expense for heavy oil are fixed in nature.

That’s why you see the IRR of heavy oil surpass that of the light Eagle Ford oil as oil prices rise.  Baytex’s corporate presentation shows how the full cycle economics (which DOES include drilling cost) are actually better at $65 and $70 oil for heavy oil than they are for the Eagle Ford.

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Having a high percentage of your costs fixed is a real stinker when your revenues are dropping.  It creates an ever-tightening margin squeeze until there are no margins at all.

When the majority of your costs are variable you will make less money as revenue declines—but at least your costs will decline in a manner that allows you to maintain profitability.

If You Are An Oil Bull – You Should Get Heavy

 

When oil prices are absurdly low like in Q1 2016, heavy oil production just isn’t profitable; this oil should stay in the ground at those prices.  Baytex actually did shut in 7500 bopd of heavy oil production.

The earlier table above showed that Baytex was making only $5.73 for every barrel of production the fourth quarter of last year.  In Q1 2016 Baytex likely won’t even have a positive netback from its heavy oil operations.

That is pretty ugly, and as long as oil prices remain sub $50 it is going to remain ugly.

On the other hand, things get a lot better for heavy oil producers very quickly when oil prices rebound.  You might be surprised just how much better and at what price.

In 2015 WCS averaged roughly a $15 discount to WTI.  If WTI were to get to $75 per barrel and that discount remained at $15, Baytex’s heavy oil netback would look something like this:

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These are Baytex’s actual netbacks from 2012/2013 when the company was pretty much a pure-play on heavy oil (before the Eagle Ford acreage was acquired in 2014).

With a sales price of $60 per barrel Baytex’s netbacks were $30 per barrel.  That is a lot better than the $5.73 of Q4 2015 or the negative number Q1 2016 is going to generate.

THE INVESTORS’ LEVERAGE

 

Think back to my lead for this story—investors’ leverage is with the heavy oil producers if/when oil goes from $45-$65.  That prices heavy oil—at a constant $13/barrel discount—moving from $32-$52.  And that moves the netback for Baytex’ heavy oil from $14 – $34—that’s almost a 250% move, when the light oil price has only moved 45%!

Everything about heavy oil production makes it leveraged to oil prices.  The low variable costs, the high fixed operating costs and the discount to WTI all mean that more of every incremental dollar of revenue turns into cash flow.

At really low oil prices these heavy oil wells don’t look to good.  At higher oil prices (and $70 per barrel wasn’t considered high all that long ago) these wells look really good.

Throw in the fact that heavy oil production declines at less than half the rate that young shale production does and you can really see why an oil bull should be taking a hard look at heavy oil producers.

Heavy oil is an awful business at depressed oil prices.  But it’s highly levered to oil prices between $45-$65/barrel WTI.

 

 

EDITORS NOTE—Hey, I hope the oil price goes up and investors make bundles of money.  But what if it doesn’t?  Then you’ve got to know THIS STOCK—with the lowest costs, it can still grow—A LOT—at $45 oil.  CLICK HERE to get this best-of-breed company name and symbol.

 

How To Beat The Saudis At Their Own Game

By
Keith Schaefer
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0

We are now into Round 2 of the Global Oil War—where the Saudis maximize their revenue, and keep US shale producers—and their lenders—under the Saudi thumb.

But there are a few very smart men—and I’ll tell you about a few of them in a minute—who think the price war will be over within weeks.

They think global oil prices are on the verge of a huge run up.

If that happens, my #1 Oil Stock will make me rich…in a hurry.  But I’m not counting on any big rise in oil prices because this company beat the Saudis at their own game!

How can anyone do that—beat the Saudis? 

1. By drilling the same kind of reservoir the Saudis have.
2. By having the lowest cost production—possibly in the entire world.  Yes, they may even have lower cost production than Saudi Arabia.  I can prove it to you.  It’s not just me saying this—it’s independent reservoir engineers.
3. And by having no debt.  In fact, this company has a mountain of cash.

They don’t have to slow down production at all if they don’t want to.  With no debt, every dollar of cash flow can grow the company.

No debt repayments.  No interest payments.  Just keep making more money.

It’s my #1 Oil Stock, and now that the global oil price has bottomed and is moving up, the profits are rolling in.  Get the name and symbol—RISK-FREE—right HERE.

Big Profits Can Come in This (Very) Small Package

By
Keith Schaefer
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0

How do you get a golf ball out of a Coke bottle?

It’s a puzzle that Ken Gerbino and his team at Titan Oil Recovery solved years ago, but have yet to commercialize on a grand scale.

He’s hoping a new business model will find some entrepreneurs willing to fund this proven technology.  Titan has had several producers use the technology on field-wide basis.

Titan breaks down oil droplets into smaller ones, so they can escape out of the “Coke bottle”—the analogy of the microscopic pore spaces where the oil is in a conventional oil field.

“The Titan process makes that golf ball into little BB’s and so it can flow through the reservoir a lot easier,” Gerbino said in an interview recently.

Titan’s process uses naturally occurring microbes in the reservoir to break down the oil so it will flow through the pores in the reservoir rock.  This process is what’s called “tertiary recovery”.

The industry calls whatever oil comes out of a well naturally “primary recovery”.  Secondary recovery would be processes like a water-flood or gas flood.  Titan’s microbial technology works with a waterflood, and is considered a tertiary process.  The all-encompassing name for all these secondary and tertiary processes is called Enhanced Oil Recovery, or EOR.

EOR is a $100 billion industry, because it is estimated that 65% of the oil in already discovered fields is left behind.  That’s right—when an oil field finally goes dry, there is still WAY more than half the oil in the reservoir.  The Recovery Factor (RF) is rarely more than 35%, and in tight/shale oil it’s often only 5-10%.

The Titan Process is designed to increase the RF—at a very low cost per barrel.

The process involves feeding microbes, which are single cell organisms so tiny that you could fit millions of them through the eye of a needle.

Titan analyzes a sample of the reservoir for the microbes, and then injects a custom food for them down the wellbore, usually in one day.

These nutrients create a dramatic response in the microbes that are already in the reservoir.

The microbes multiply by 100 million to a billion times, grow larger and then shrink dramatically.  The microbes also have a change in the skin structure which results in them seeking to move away from water and rock and attach themselves to droplets of oil left in the reservoir.

The oil price is rising again, and the lowest cost producer in the world is ready to open the taps.
Low costs = high profit margins, and this company’s stock will reap the rewards.
And with no debt—every dollar goes right to the bottom line!

Click HERE for the ticker symbol of my #1 Oil Stock

With billions of microbes pushing themselves up against the oil droplets—they, deform and break apart, making them into smaller micro-droplets. The microbes also create a more slippery surface for the oil droplets to squeeze through the pore spaces in the rocks as they now are between the rock grains, water and oil interface.

Imagine a golf ball being stuck inside a Coke bottle.  The oil droplet is the golf ball and microbes break it into smaller pieces that fit through the neck of the bottle.

 
 

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The feedings should take place every 4-6 months.

The process works best on conventional fields where a waterflood program has been applied.  Gerbino and Titan believes that up to 25% of the oilfields in the United States and 17,000 to 20,000 fields in total around the world would be suitable for the Titan Process.

Now, everybody does waterfloods—even in tight oil.  But only one producer in the world–Pertamina, Indonesia’s National Oil Company (NOC)–is now using The Titan Process—even though Titan has had some success convincing companies to give the process a try.  Three of them (Husky Energy, Venoco and Atinum) each published SPE (Society of Petroleum Engineers) papers detailing their results.

All of which were very positive.  But even after positive results those same companies have not adopted the Titan Process in any sweeping manner.

In total the Titan Process has been applied over 300 times to over 100 different wells in almost 50 fields—and the average result has been a 92% increase in production.

1

The company says their process costs only $6-$10 per barrel of incremental oil recovered and I verified that figure last week when I spoke with a field manager who used the process successfully when they worked at a major oil producer.

I asked them—and they wished to remain anonymous—why they chose the process:

“It’s low startup capital for mature water flooded areas, and you don’t need a lot of surface equipment like with a polymer flood where you need something to carry a base (like water or alkaline) and it’s a lot of facility upgrades and pipeline work required beforehand; whereas with a Titan process it’s just the nutrients…… its lower risk with higher reward.”

Gerbino says there are obvious financial rewards for producers, even at today’s low prices.

“Our numbers we have are, if:

1) an oil field is declining at 10%
2) and the oil price is $40
3) and the Titan process can increase production by 30% for the first 2 years only
4) and with feeding the microbes every 6 months
and then you go back down to that decline slowly and it’s a $20 per barrel lifting cost, the NPV of that field doubles after 2 years. It’s pretty cool. This would be at current rates.”

But the producer mentioned above did not continue using the process. Now PERTAMINA the world’s 23rd largest oil company is using the process.  I asked Gerbino why the slow adoption rates from oil customers.

“It was our fault. We didn’t have advertising or a marketing budget or any salesmen.

“And a lot (of engineers) were trying this on 1-2 barrels a day wells to see if they could get a miracle out of it. When they didn’t they didn’t want to go any further.”

Another issue for Gerbino is that it’s mostly large, conservative, staid producers who own the big conventional fields are very slow to adopt any form of new technology.

That has caused Gerbino to now set his sights on Titan acquiring its own oil fields and getting all the upside themselves.  Their balance sheet doesn’t allow them to go bid on assets immediately, so the company is now in the process of arranging  external capital to help finance this plan.

Gerbino says this way Titan can make sure that the process is directed at exactly the right types of oilfields applied correctly.  With the oil industry in disarray he believes there is great potential to pick up unwanted, high cost oil fields for very reasonable prices.

Then Gerbino and his team can start turning golf balls into bbs and get the oil flowing—for $10/barrel or less.

www.titanoilrecovery.com

Keith Schaefer

You’ll Never Guess Who is the Lowest Cost Producer in the World

By
Keith Schaefer
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0

The Saudis want control of the oil market back, and they are lowering prices to weed out the high cost producers.

But I found a western producer with even lower costs per barrel than the Saudis.

That’s right—someone who beat them at their own game.  Just like the Saudis, this company can turn on the taps and start raking in big profits whenever they want.

I’ll prove it to you in these two charts.  The first one, from the Wall Street Journal, estimates the cost of production of major oil producing countries:

1

Here’s a chart from the financials of my #1 Oil Stock—these numbers are verified by independent reservoir engineers:

2

You are reading that right—for their proven (IP) reserves, they can get those out of the ground for TWO dollars a barrel.

That’s less than half what the WSJ says it costs the Saudis.

This Company Beat The Saudis at their own game.

And as the global oil market rebalances now, prices are going higher.  With the lowest cost production, this company will have the fattest profit margins of any producer in the world.

I just bought more stock this week.  This is a stunning play, and the profits are just starting to roll in.

If I could only buy ONE oil stock, this is it.  Get the name and symbol—RISK-FREE—right HERE.

Is There A Perfect Storm Coming for Natural Gas Prices?

By
Keith Schaefer
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0

Even before Tuesday’s big jump in natural gas prices, I was intrigued to see some of the leading natgas stocks in the US hold up or go up on days natgas was down this week, like EQT, Southwestern, and Rice Energy, (which my colleague Bill Powers profiled at $9.47/share on Feb. 9 and is now up 80% in two months)…I thought traded quite bullishly last week week.

Fundamentally, there is a very bearish 1 Tcf (TRILLION cubic feet) YoY surplus of natgas inventories in the US.  But investors have to remember that bloated inventories are today’s news, and the Market tries to price in what it thinks will happen in the future, 6-9 months from now.

The Street is seeing natgas production almost flatten in the US so far in 2016, after jumping 4-5 bcf/d each of the last two years.  That is somewhat bullish, though production flattened in 2013 as well before making those big jumps in ’14 and ’15.

Overall natgas demand has steadily kept up (mostly) with production, and is really the untold story of this market over the last few years.

And now the Weather Gods could co-operate with the bulls.  This summer is expected to be hot–like 2012 hot–which saw corn yields shrivel and corn prices soar.   Natgas prices also doubled off the lows from April 2012 to December 2012.

A hot summer isn’t near as bullish as a cold winter (3-4 bcf/d more demand for hot summer but up to 10 bcf/d for a cold winter), but we may get a cold winter coming (2016/2017) as the National Oceanic and Atmospheric Administration’s (NOAA) Climate Prediction Centre came out on April 14 saying there was a good chance of a La Nina weather system for next winter.

La Nina is kind of the opposite of El Nino (not 100% different), especially along the heavily populated and high natgas-consuming region of Chicago to the NE US coast.

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A colder winter can mean up to 10 bcf/d difference in overall natgas usage from Nov-Mar, which is what the natgas analysts mean when they say “winter”.  That’s a lot; over a 10% swing at 90 bcf/d.

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La Nina means the Pacific Ocean is getting warmer.  El Nino means eastern Pacific waters are colder (just off Mexico).

And in the Atlantic, a huge mass of cold arctic water the northern part has kept the Gulf Stream quite far south, so there is a build-up of warm—very warm—waters there.

That could mean storms and hurricanes.  Hurricanes used to be a big deal for natgas prices because the Gulf of Mexico (GOM) used to provide a higher percentage of overall US production.  Now it’s just a hair over 4%.

GOM natural gas production is down about 50% since 2000.  That will increase in the coming years as there was a dearth of new production after the Macondo/BP oil spill in April 2010—but several new projects are coming online in the coming two years.

So if there is a really warm summer this year, that could mean 4 bcf/d extra demand, and over 150 days that would more than half the current 1 Tcf YoY storage surplus—and allow low cost producers to lock in some great profits.

Costs for natgas producers have come down a lot—more than people expected.  I see sub $1/mcf all in costs for some producers now.  I saw how Canadian Montney producer Painted Pony (PPY-TSX) hedged like mad at $2/mcf recently because they make good money there.

So between warm Atlantic waters this summer and La Nina this coming winter from the Pacific, natgas investments in the coming 1-3 months could be very lucrative.  Does that create The Perfect Storm for natgas stocks?

As in oil, leading US natgas stocks have had a big jump in the last four weeks.  As an investor I wonder how much of that is the Dow pulling everything up and how much is really natgas related.  But charts of leading stocks in both commodities are surprisingly similar—strong bounce off mid-February lows through the short and mid term moving averages all the way up to the 200 dma.

Now the moving averages are narrowing quickly—and that usually presages a big move of some kind.  If I had to guess now, I would say that it would be up.

But fundamentally, very little if anything has changed recently.  Perhaps the Market is saying that any month that US natgas production is only up 1 bcf/d YoY is bullish.

The stocks of Canadian natgas producers will rise in some sympathy, but Alberta and B.C. are at the back of the pipe so to speak, far from major markets.  That means higher transportation costs, which means lower realized prices for producers to stay competitive.  Lower realized prices=lower stock prices.

And the Pacific Northwest got buckets of rain this winter, about 130-150% of normal, so hydro-electric supply should be a lot more this year, and Canadian natgas filled that demand the last couple years. This is a bit bearish for Canadian natgas.

Despite Canadian producers like Painted Pony doing an excellent job reducing costs down to sub $1/mcf costs, I see the first Big Move in natgas stocks being in the US.  Or has it already happened?

EDITORS NOTE–Who would have thought in January 2016 that Tier 1 oil and gas stocks would double from February to April?  What happens now?  Lucky for me, I know the one western producer that has lower costs than the Saudis.  Nobody else can grow like this company at $45 oil.  And if oil goes to $70, it will have the largest profit margins of any producer I know.  Get Ready.

The 2 Questions You Should Ask About Oil Stocks Now

By
Keith Schaefer
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0

Oil is up.  Consensus has changed from a supply glut to a more balanced market by the end of this year—but the Market is in full swing pricing that in now.

Energy producers across the board have had a good run in the last month, and it could continue—both Brent and WTI prices rose above their 200 day moving average (dma) for the first time since November last year.

So now you want to buy some oil stocks.

But which ones?

To introduce some discipline into this process, here are a couple questions you should ask about any oil stock your broker pitches you, or an idea you come up with yourself:

1. Could this company get a “bought deal” financing done tomorrow? A “bought deal” is where the stock broker firms guarantee the producer/public company their money and then try to sell said financing to their retail and institutional clients.  If the market views the company as undervalued, or having great growth prospects, and the answer is yes, then that means there is good demand for the stock and it’s likely going higher.

2. This second question is more geared to savvy oil investors—Would you take this company private today at its current valuation?  Would you buy the entire company for what it’s trading at today (and don’t forget about the debt!)?

It’s an interesting question because of a couple factors.  One is that many of the high quality names are trading at all-time high multiples of cash flow—because right now there isn’t much cash flow, even after oil has jumped 50% since February.

The share prices of high quality oil stocks didn’t go down much over the last two years, as energy investors high-graded their exposure to the sector.

That means they sold all the Tier 2 and Tier 3 producers—ones with higher debt, or just with management teams that they knew would not be able to raise money if needed in a prolonged downturn (which we got)—and bought more of the high quality, leading oil stocks.

In the US, think of a company like Synergy (SYRG-NYSE).  The stock held up incredibly well through 2015, only falling in early 2016 when new CEO Lynn Peterson (formerly of Kodiak, bought out by Whiting for $3.8 billion at the top in 2014) said he was going to do lots of M&A at the bottom of the market—a smart idea but scared the daylights out of investors.

Two equity raises totaling 30 million shares later, the stock has recovered, and they have no debt, a proven CEO but trade at 18x cash flow.  Great company—but is it worth that?

 

syrg

Another example would be Cabot Oil and Gas (COG-NYSE).  It’s considered one of the top US gas producers—but at 22x cash flow would you buy it here? Twenty-two. Its large production gives it good leverage to rising natgas prices.  Would the Market finance it here?

Equity raises are another thing investors need to be aware of now (besides the oil price ;-)). Many of these leading junior and intermediates have diluted their shareholders with new equity raises—and it could be awhile before that larger share count figures into their per-share production and cash flow. The Market pays for per-share growth; not absolute growth.

The Market could see stagnant to lower per share cash flow in the coming 2-3 months than a year ago because these equity raises have diluted shareholders so much—despite rising commodity prices.

In Canada, look at Spartan Energy (SPE-TSX) or Raging River (RRX-TSX).  In Rick McHardy and Neil Roszell respectively, you have two proven Tier 1 CEOs who have built their companies into the lowest cost oil producers amongst all the junior and intermediate oils in Canada.

But Spartan’s recent 40 million share issue took the company to more than 300 million shares out—for only 9300 boepd production.

spartan
The issue for investors buying The Best is…the share prices of Tier 3 companies have been dramatically outperforming, and will continue to do so as oil prices rise.
But has the Market given them too much credit too soon?This is especially true of large, debt laden producers in both Canada and the US. Natgas producer Chesapeake (CHK-NYSE) and Canadian oil producer Baytex (BTE-TSX/NYSE) has quadrupled off their lows of $1.56.  Oil producer Halcon (HK-NYSE) is up 500% and Encana (ECA-TSX/NYSE) has more than doubled.
chesapeake

But if you could afford to (hey, I get we’re talking tens of billions of dollars), would you take any of them private—along with all their debt—and make them your own at today’s stock prices?

These are companies that are former darlings with tens of thousands—sometimes over 100,000 boepd—and massive debt.  In most instances, it was because of big acquisitions in 2014, mere months before oil started its decline.(This goes to show that senior management of big producers—in all commodities—often have no clue where the underlying price of their production is going.

The same thing happened to copper producers in 2004 and uranium producers in 2007.)

The share prices of these (now) Tier 3 companies have been crushed some 80-95% from their highs just two years ago.But if oil does stay in the $40-$50/barrel range, cash flow will remain very tight, and these companies will give investors massive losses at some point later this year.

Just this week, the Energy Information Agency (EIA) in the US said it expected the oversupply in the global oil market to come down to 500,000 bopd, from what it says is the current 1.5 million bopd.

That will give a lot of the highly levered, debt laden producers a boost.  Investors love them, judging by the charts. But the Market is not rushing out to finance these companies—yet.

But would you bet your net worth on that happening?  Just asking.  And you should ask that too.

EDITORS NOTE–I’m just finishing an updated report on—The Company That Beat OPEC.  It’s an oil producer with as low or lower costs than the Saudis.  They are ready to turn on the taps as well–and with such low costs, theirs is the most profitable production in the western world.  If you want any exposure to oil, this company gives incredible leverage–with NO debt.  It’s my #1 Oil Stock. Stay tuned.

Keith Schaefer

How Many Beers Needed To Believe Tesla?

By
Keith Schaefer
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0

tesla

INTRODUCTION

Short Tesla (TSLA-NASD: $250).  Target Price = $12.  Twelve Dollars.  That would be a 95% drop from its share price today.  There is a lot of emotion and hype around the company and stock right now, with its cheap electric car model, the Tesla 3, getting banner headlines every day on surging sales.

But Nathan Weiss, an institutional newsletter writer out of Rhode Island, runs the unit economics on the production costs of Tesla–and finds the stock wanting.  He presented his vews at our Toronto Subscriber Investment Summit.  The entire transcript of his speech is below, or you can click on the video.

He customized his powerpoint for Canada, showing–every few slides–how much beer investors would have to drink to believe each successive claim by Tesla management.

I subscribe to Nathan’s service, and his ideas over the years have made me and my OGIB subscribers more money than anyone–especially in ethanol stocks in 2013-2014.  His research and analytical skills are second to none.  The timing here could hardly be better to understand why investors should short Tesla.

As you can see we’re probably negative predisposed to Tesla Motors, this actually shows a recent fire of a car charging a (inaudible). We do like lithium and we’ll talk about it in the presentation.

A couple of quick disclaimers, this is for information only and not for investment advice, we may change our mind tomorrowplease don’t sue us.

A little bit about my background. We’re a Rhode Island based independent research firm and we try to come up with ideas and themes that we then write about and sell to our clients, which are primarily hedge funds. We just follow a few stocks at a time and we try to know them very well. We recently published a 99 page re-initiation report on Tesla Motors. We limit ourselves to 30 clients.

Today we’re going to talk about Tesla Motors and specifically some more of the controversial things surrounding the company, as well as a little bit of insight into what we do as a research process on a stock. We’re going to talk about the credibility, environmental aspects, subsidies, Tesla’s Giga Factory which is their largest lithium ion battery plant. The Model S and orders backlog and some of the financials and economics.

From the consumers point of view the Model S is a great car. Most controversial stocks and companies have a great product and it’s actually the numbers behind it that are troubling. I personally love Krispy Kreme donuts and the company went bankrupt.

So from the consumer’s point of view the Model S is a cutting edge car with a really cool UB. It’s green, it’s sexy, very high performance and the fastest models are sub 4 seconds, 0 to 60 and been billed as the safest car in America by Tesla and it’s just plain cool. People stop and take pictures and want to ride in one and it’s a really cool product.

From a stock analyst point of view…so the bullish analysts will tell you the production constraints they have more orders than they possibly can deliver, they have industry leading 25% gross margin, they’re profitable on a non GAAP basis and if you move some numbers around you can make money. There is a sustainable cost advantage and they’ll do 500,000 deliveries in 2020 up from 50,000 deliveries last year.

The bearish analysts will tell you they have zero credibility, an unreliable product, aggressive accounting and a couple use a stronger word but…heavily subsidized and they lose thousands of dollars on every car.

So if we quickly look at Tesla’s current products on the upper left we see the Model S and it’s generally $70 to $140,000 US dollar car and the average is around $92,000. As you see on the right, it’s got a massive 17” touch screen which other auto makers have been hesitant to put in for liability reasons.

They introduced the auto pilot which is basically their self driving highway mode where they can follow the lane and set the cruise control and follow the cars and kind of drive itself on the highway…again before most States are allowing it to happen.

They have auto extending handles, touch door handles and to date they’ve done 107,000 deliveries and again 50,000 last year.

The newest product they introduced on September 29th last year is the Model X SUV. The initial model came out at $137,000, which was a pretty negative surprise. Investors and buyers thought it would be about a $90,000 car. They are promising that some of the next models are being priced at about $112,000 US with a pretty good set of options.

It’s got a lot of the same features as the Model S except it has Go Wing doors, electromechanical doors that open themselves and look really cool. It has auto pilot and a windshield that actually extends over the driver’s head to compensate because of lack of sun roof because of the falcon wing doors.

They shipped just over 200 of them in the 4th quarter and we think they’re about at 2,000 deliveries today.
Then the power side of the business and given their expertise and seeing the amount of market and utility demand that they’ve got in the power business as well, they’re producing a 200 pound lithium ion battery that goes into the wall.

It’s really aggressively priced at around $3,500 or sells at $3,000 but by the time they actually install it and include the inverter and everything it’s about $7,000. So it turns out Tesla wasn’t actually as cost competitive as they thought, but that was their entry into a really rapidly growing market.

One of the first things we’re going to discuss is whether Tesla’s management team is credible. If you believe they are then you probably want this, this and this. It takes about 4 to 5 beers to think about Tesla being credible.

management tesla
So one of the first things we do when we’re looking at a company, whether it’s me or one of my analysts, I tell them to go back and look at the last few years. What happened? There are some things with permits or energy or commodity prices that’s outside the company’s control and we don’t fault management for having as bad a guidance as everybody else on that.

But there are things that are under their control. In terms of raising capital which is clearly under Tesla’s control; there have been multiple instances, 2 of the most egregious on this slide where in 2013 they promised they didn’t have any plans to raise capital right now and we spent no time on that at all and 7 days later they raised $230 million in equity and $450 million convert.

They did the same thing in August and the CFO implied on a conference call that we’re comfortable with our cash levels and 9 days later they did an equity offering that was up sized to $785 million.

They’ve done similar things in production. They’ve got a Roadster production and the time tables have been delayed. They originally said they’d build 650 Roadsters in ’08 and they built 140. The bottom bullet point, they actually missed every year’s delivery except for 2013 in terms of their initial guidance.

And the bottom of the slide shows the Model X which we showed a couple slides previously was originally to come out at the end of 2014 and came out late in 2015. At the time in late 2013 they said they were at the final brush scopes of the design and completely ended up revamping the front end and making major changes in mid 2015.

Lastly on the delivery guidance they made some ridiculous financial statements. The first one in May 2010 they said they weren’t profitable because they had Model S expenses when developing the vehicle. They did $20 million in revenue and almost $4 million of gross profit but then had $16 million of SG&A.

One of the things that I think is really important what management says on a call or conference they’re not really held accountable. If you put something in a SEC or government filing that’s actually important, it’s on the record and reviewed by lawyers.

They had guided in early 2015 that they were going to hit a 30% gross margin and deliver cars at a 100,000 vehicle annual rate at the end of 2014. They delivered 17,000 cars at a 22% gross margin, arguably we think the actual car’s gross margin is only 17%.

Is the Model S green? A lot of these things are particular to Tesla but it doesn’t mean all EV’s aren’t green but if you believe the Model S is then you probably need a few beers.

On Tesla’s website they calculate the effective CO2 emissions of the Model S sedan are about 176 grams per mile driven and that compares to a small gasoline car at 240/280 and the Jeep Grand Cherokee at 440.So when you go into EIA’s data and start to actually verify the claim there is about 572 grams of CO2 emitted nationwide in the US when you include the 7% transmission loss on average from power plant to customer.

When you multiply that by miles driven the average efficiency we get about 216 grams of CO2 per mile. That’s not bad and a little higher than what Tesla stated but pretty efficient.

However, lithium ion batteries are inefficient when they charge and you get about a 15% charging loss partially because of heat generation and then just the chemical reactions that take place. So when you add that on top of it you end up getting 255 grams per mile so it’s kind of in the range of a small passenger car.

Taking that a little further, the Model S in particular uses a lot of power when it’s idle. So they’ve taken the role of using over 7,000 small lithium ion battery cells that they then actively circulate coolant through to warm and cool it even when the car isn’t being driven.

It monitors the temperature and there’s tons of fire detection and fire suppression equipment on board. Those total units of consumption of that monitoring and temperature compensation system is about 3 ½ kilowatt hours per day more than a small refrigerator. When you divide that out over miles driven that adds another 61 grams per mile for your effective CO2 emissions and that gets us up to 316 grams.

And in the constructional lithium batteries themselves is very CO2 intensive, over 100,000 mile battery life that adds another 153 grams per mile of effective CO2 emissions and we’re not even including things like the car actually weighs over 4,000 pounds, has aluminum fenders and so it’s a very energy intensive car to build.

So we think the total effect of emissions is about 469 grams a mile, which if we go back to our Jeep Grand Cherokee is actually more than that at 443 for the Jeep Grand Cherokee.

Other emissions matter and so Nitrogen Oxides are perceived a lot (10:10 audio skips) after the Volkswagen scandal. The EPA reports it’s about .508 grams of NOX emissions per kilowatt generated by the US grid.

Based on our previous driving efficiency and power consumption calculations the Model S emits about .27 grams a mile and that’s up against the EPA’s Tier 2 standard you’re past your vehicle mile limit of .05 grams per mile.

Sulphur dioxide is also similar but roughly where it’s given approximately 30% of the US power grid’s pull you end up with sulphur dioxide emissions of about 182 times the gas powered automobile. So 20,000 Model S’s in the US emit the same sulphur dioxide as 3.6 million passenger vehicles, gas powered.

If you look at the bottom the Volkswagen Passat diesel which is one of the cars being recalled emitted .25 grams a mile of NOX, so Volkswagen took a $17 billion recall position and facing EPA fines up to $37,500 per car. The Model S we calculated emits .278 so a little bit higher and Tesla has received a $7,500 Federal tax credit, $2,500 State credit and other auto makers including Volkswagen have been forced to pay a total of $412 million in zero emission credits from Tesla.

Should Tesla be subsidized? Probably not.

I always like to use the Amtrak example here and in the US Amtrak is constantly cited as a big wasteful bloated organization losing hundreds of thousands a mile. Newspapers have gone as far as to say on some of the longer routes it would be cheaper to buy the passenger airline tickets and shutting down Amtrak. It would be lower costs.

So every year Amtrak gets drug before Congress and they testify why we need it and begrudgingly end up getting funded. The most recent fiscal year is a $289 million operating budget funding.

For 2016, we estimate and it’s actually below consensus but we estimate 35,600 Tesla vehicles will be sold in the US and for that the Federal tax credits will total $267 million, almost equal to Amtrak’s subsidy and also about $2 per household and so everybody in the US has paid a couple of bucks for the Model S over the year.

In addition, we mentioned those greenhouse gas EVD credits and so various States, particularly California, require that a certain percentage of your vehicle fleet be 0 tailpipe emissions and if you don’t hit that you have to buy credits from other auto makers. To date Tesla has received a total of $583 million credit revenue from other auto makers.

They’ve also received other nice tax subsidies such as a $1.2 billion incentive package from the State of Nevada for floating their Giga Factory. From the State of California they get a lot of tax exemptions and accelerated depreciation write off and the like.

Is the Model S reliable? We think you have to drink a lot to believe the Model S is reliable.

It doesn’t mean people don’t love the car still and people endured some incredible reliability issues and still had raving reviews about the company.  But if you look at some of the independent road tests that have been done CNN did a road test where the touch screen and the door handles refused to work and they had to call Tesla and have them send an update.

Consumer Reports initially gave the Model S a 99 rating tying the top rating of a Lexus that they ever gave and recommended to buy it. that said as they drove the car at 15,000 miles the article said they had more than their fair share of problems, including door handle problems, a blank center console, a seat belt buckle that broke, all types of noises and they replaced the 3rd row seats, a 12 volt battery, the HVAC filter and the power train coolant light.

They actually took Tesla off the recommended list and saying the 2015 model had lower quality than the previous years.
Edmund’s was even worse. In February 2013 they plunked down $105,000 for a top of the line performance version of the Model S85. They were going to do a $20,000 road test which they then extended over 30,000 miles.

In the first year of ownership the touch screen had to get replaced, the sunroof leaked, rear tires wore out prematurely which is a common problem and importantly they actually had 2 driving unit replacements which in the Model S the main battery assembly the motor, inverter and transmission effectively a 1 gear transmission all get replaced in a single unit.

They actually had a 3rd replacement at 30,000 miles on the odometer as well as right height sensor, motor mount.
Their summary was the car has 30,000 miles on it and hasn’t been out of service for 30 days. In the wrap up review, which is still available online they reported 28 total issues.

Much like Consumer Reports there is an organization called True Delta which tracks actual repair visits from repair centers and they show here the ranking of US auto makers with models available in the US and the brackets beside the names is how many cars are available by that auto maker and so Tesla shows 2 cars available. They actually rank as the least reliable car in America.

Then Plug In America which is an interesting group and it actually is a Pro EV group. It’s transformed into a California non-profit and they are quite a large organization now where EV owners submit repair data and efficiency data and form a general community about all their respective EV’s and not just Tesla but it’s for all plug in vehicles.

With the idea that they can also help promote electric cars and have some really cool data.

They show in their data set much like we’ve seen in Tesla forums a lot of driving unit replacements. So when we were looking through the forums one of the things…we go through forums not to get anecdotal information but try to gather hard data out of forums. It’s really time intensive but with the right effort sometimes you can get some really cool conclusions. So we found between 30 and 40% of Model S owners had a driving unit replacement.

Based on the Plug In America data 77% of cars over 50,000 miles had a driving unit replacement. And 13 out of 14 in the data set with over 65,000 miles had 1 or more driving unit replacements. And we categorize the data and break it up by year and mileage, so the way you read this at 25,000 miles 27% of the 2012’s had a driving unit replacement, 23% of the 2013’s and 23% of the 2014’s. The 2015’s are still too new to have that many cars in the data set with over 25,000 miles but there is a large number that are at 10,000 miles now and look to be moving in track with previous years.

The Giga Factory which is Tesla’s lithium ion battery production center is unprecedented. So EV critics pointed out a couple of years ago that Tesla’s plan to sell 20,000 EV’s in 2020 would require more than 100% of 2013’s lithium ion battery output for cells, the types you use in laptops and power electronics.

This is actually one of the interesting things about the lithium market what with Tesla’s skeptics if you look at global lithium vehicle deliveries they will grow by more than 500,000 units between now and 2020. That growth will exceed everything put into consumer electronics today. So we are actually very positive lithium and positive lithium demand. We’ve recently seen some pricing quotes that lithium is trading at 13,000 in China.

This is what Tesla promised. It’s a massive Giga Factory, the largest building in the world and a $5 billion production center. Then there were a couple of little news articles and the union that was actually working on it said the project was cut back 80%. The CO of Tesla said it was a test project. This is a recent drone photo of what’s being built.

Are they production constrained? One of the main cases is they have more orders than they can deliver today and they can produce whatever they want and no worries about backlogs. That’s even a little harder to believe.

It’s a busy slide but what we do is go through forums and find online posts from groups like Plug In America where people ordered their car and in the good old days 2 years ago Tesla used to provide sequential production numbers.

If I ordered a Model S I might get production number 13,001 and Keith orders 2 of them and he gets 13,002 and 13,003, etc. and so it was really easy to track orders.  They’ve since muddied the water and give unsequential numbers and skip thousands at a time. They do whatever they can to hide it, which to me is a very good sign they don’t want you to know something.

So when we go through their data we suggest they’ve actually been burning down backlog and we think they only have a 2,000 vehicle Model S backlog. Putting that graphic here which is a much more fun way to look at it this table shows that the red vertical bars are individual order clusters and the height represents the number of days from the time you order your Model S to the time it’s delivered.

One thing we do know with relative certainty is how many Model S’s are being produced each week. They frequently do conferences, trade shows and presentations where they talk about their current weekly production rate so we can track that pretty well.

You can see in the order cluster, so right around the middle of the chart was 2014 when they introduced all wheel drive and auto pilot. More recently production has been flattened by a low priced Model S70 and so a smaller battery but a really aggressive $70,000 price point.

And the black line shows how many days on average between the order and start of production which has been hovering around 10 to 25 days recently. So with current production rates for the Model S cars around 1,000 per week that indicates a couple thousand cars in backlog.

With the Model X they still provide sequential model numbers so we know up until September 30th anyway, we know at a hard and fast basis they have about 31,000 orders. They quit giving order guidance and quit sequential reservation numbers so they’re intentionally trying to muddy the water now that they’re in production.

The other thing is generally a company with more demand than supply raises prices and does things like cut back on SG&A and Tesla has kind of done the opposite. If you look at and in Canada you guys get a pretty good deal but in the US the dollar price of a Model S has gone from $99,000 on the far right in late 2013 for a fully loaded car to $84,000 today.

In Canadian dollars you’ve actually seen the price has gone from $104,000 Canadian to $110,000 despite the massive move in the currency. So they’re introducing a new lower price Model S.

The question is can they sell 400,000 cars a year and will that solve all their financial problems? I think that one speaks for itself.

So we’ve seen that people have been nice enough when they go through Tesla tours to take pictures even though they’re told not to. This is what we think the Model 3 looks like and that was actually a clay model seen in Tesla’s facility. It’s supposed to be a $35,000 car that does 200 miles per charge. They claim it’s going to be 400,000 in annual deliveries.

If you look at their competitors today which is the Nissan Leaf which is sort of a boxy, hopefully no one takes offense, but kind of a boxy little car and they sell 44,000 copies globally. The I3 which I’m actually a big fan of and is a cool little car that gets a battery bump this summer and goes up to 120 mile range and also has a gas engine on board to back it up. It does 28,000 cars a year.

Is Tesla profitable? No.

So the far left column shows Tesla Motors financials as the report it compared to Ford and GM and we also threw in Renault and Volkswagen. So Tesla claims in their financials that they show a 25.5% gross margin compared to 11 to 15% for other auto makers.

Within that they also showed almost 22% SG&A and so their sales and overhead are incredibly high compared to 7 to 10% for Volkswagen.

So what’s going on? GM, Ford and pretty much every other auto maker the manufacturer sells the car to an independent dealer at about a 10% discount to MSRP and the dealer bears the cost of selling the vehicle to the customer, which is generally a break even transaction and they make money on service and extras.

Tesla because they sell direct to the customer they include that as an operating line rather than part of the cost of goods sold. So if we actually re-allocate 10% of revenue from SG&A up into cost of goods sold they look like a regular auto maker. So you get 11% of sales as an SG&A expense, which is better than Volkswagen and you get a 15.5% gross margin which is kind of in line with everybody else.

The problem is according to GAAP when you do development work for a car by factory equipment if it’s for a future model or production equipment it’s going to last multiple years and so you get to capitalize it so when you spend the money you don’t put it under income statement you call it an asset and then over the useful life of the asset, generally over 5 to 20 years you depreciate it.

When you’re doing development work and refining a certain car, let’s say you have a drive unit or door problem and you need to fix it, those expenses based on the current car production get expensed. So GM and Ford actually per GAAP accounting they include those expenses in the cost of goods sold and Tesla breaks them out as a separate line item and quite surprisingly that’s actually over 17% of sales is expensed R & D.

If we re-evaluate Tesla’s accounting we still get the same operating margins and so we’re not changing operating margins at all, but we’re re-allocating part of the SG&A and all the expensed R & D into cost of goods sold.

So we think they actually generate negative gross margins and those gross margins are deteriorating not improving. Then on top of that Ford, GM and Volkswagen spend 5 to 8% of revenue on capital expenditures new equipment and new models and Tesla spends 42%.

So there is definitely some flexibility and room there in what you call capital expenditures and I think there is a reasonable possibility that they’re putting production costs and other costs into that capitalized expense line.

So quickly the blue bars are SG&A expense per vehicle sold and that’s the most important on sort of a unit economic basis. Going from the far left to the far right the green line shows how many vehicles they’ve delivered each quarter. So deliveries are going up but SG&A per vehicle is also going up and again that’s not supposed to happen.

Most companies have positive operating leverage where the cost per unit goes down as you increase production. Again we think this shows they’re not a production constraint company and they’re actually doing everything they can to try and increase production and increase demand.

The same thing on the capital expenditures and we just show a couple of charts showing capital expenditure per car is actually increasing as deliveries increase.

And a quick point on the capital intensity of auto manufacturing and instead of building one car, Ford and GM have to spend about $35,000 on the total manufacturing equipment to support a single annual unit of output and so as of today Tesla has 100,000 cars of production capacity per year.

At Tesla’s recent spending of $51,000 per car they would have to invest $11 billion to get to 200,000 deliveries per year and the company currently has a $25 billion market cap.

If they reach their goal of 500,000 deliveries in 2020, we calculate they’re going to spend more than their current market cap, so almost $26 billion on capital expenditures to do so. We argue that Tesla (26:43 – inaudible) probably don’t want them to do that.

Lastly, a quick touch point on the unit economics which should sober us up a little bit. Again we like to look at the unit economics, the per unit cost of the car and this just shows what the previous slides have shown. Revenue per car is decreasing over time and so it goes from the left to the right. SG&A expenses have increased from $9,500 per car to over $20,000 per car in the 3rd quarter.

The same with expensed R& D and they went from $11,000 per car up to $15,000 per car. So Tesla’s loss in cash flow has been increasingly negative.

And like any good promotional company does in the 4th quarter they actually introduce a new cash flow metric saying on their own adjusting cash flow metric they’re positive.

Thank you.

Six Top CEOs Tell Their Story

By
Keith Schaefer
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When you talk to management teams of public companies directly, you get a lot more colour on the company…and of course, on who the CEO is as a person. It helps you decide if the company and stock are a good fit for you.  Institutions get that luxury all the time.  Retail investors like most of my subscribers…not so much.

That’s what makes my twice-yearly Subscriber Investment Summits (SIS) so valuable–we bring out some of the best teams in the junior space to meet with my paid subscribers.  One month ago, on March 5 in Toronto, we had over 300 investors come into Toronto to go face-to-face with these CEOs.  We sprinkle in a couple hedge fund managers to give perspective from the buy side, and it makes for a highly entertaining and educational one day event.

Below you will see videos of 6 junior energy CEOs from that day telling my paid subscribers all about their public company–and why my subscribers should invest in their company.

These are all very well run companies who can survive the current low price environment, with at least one flagship asset–low cost, big size–that gives them huge upside leverage to rising oil or natgas prices.

1. Richard Thompson of Marquee Energy (MQL-TSXv; MQLXF-PINK)

Thompson showed great stealth in accumulating a huge contiguous (all-together) land package in the Michichi play just northeast of Calgary.  In a very competitive basin, this was a huge coup.  Thompson explains how he did it, and goes through the low-cost economics of Michichi.

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2. Brian Schmidt of Tamarack Valley (TVE-TSX; TNEYF-PINK)

Schmidt has done something remarkable–put together a package of wells that have 1.5 year payouts at just $35/b WTI.  His strict cost controls, strong hedges and ability to create efficiencies have made Tamarack Valley a “go-to” name for energy investors.

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3. Painted Pony Petroleum (PPY-TSX: PDPYF-PINK)

CEO Pat Ward’s foresight in developing low-cost land packages early has kept share dilution low and equity valuation high.  He was early into the Saskatchewan Bakken and sold that to Crescent Point for $100 million just before the oil price collapsed.  His all-in costs on his Montney natural gas is now under $1/mcf.  Remarkable.

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4. Renaissance Oil (ROE-TSXv; RNSFF-PINK)

CEO Craig Steinke and Chairman Ian Telfer did their homework on the recent bidding round in Mexico, and were the ONLY Canadian company to win concessions.  They instantly became a producer, and are leveraging their new “insider” status in Mexico to prepare for more acquisitions.

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5. Lithium X Energy (LIX-TSXv; LIXXF-OTC)

Chairman Paul Matysek, CEO Brian Paes Braga and financier Frank Giustra have assembled a management team and property portfolio that should develop into the largest lithium junior in the world.  I originally profiled this story at 45 cents/share, and it now trades great volume at $1.30 as investors realize the fundamental supply-demand for lithium for the next 18-24 months is very bullish.

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6. NexGen ( NXE-TSXv; NEGXF-PINK)

NexGen’s stock has more than doubled since the February Subscriber Summit.  This uranium explorer (uranium is used in energy!) has announced stellar results from their Saskatchewan property.  This shallow asset will be one of the largest and high grade uranium assets ever found.  CEO Leigh Curyer tells the story here.

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March 5 in Toronto was our best event ever.  As we build our brand, more CEOs want to bypass analyst interpretations, and take their story directly to active retail investors.  It’s all about putting retail investors on the same information level as the institutions.  It’s a very empowering day.

JOIN US–our next conference is Tuesday October 11 in Vancouver.  You can sign up now at www.subscribersummit.com.  Sign up HERE.

Keith Schaefer

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