oil, easy money and the reach for yield presented on 5 26 2016 to cfa la
TRANSCRIPT
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Steve Worthington
“Oil, easy money and the reach for yield” Presented by Steve Worthington A Santa Barbara Group Sponsored Event Thursday, May 26th 2016 Evolutionary technology advances in the last 60 years, much of it economically perfected in the last 10 years have led to an increase in the supply of global oil and gas as well as a doubling of oil production in the US over the past decade. Growth in the demand for energy has been a large driver of the “Commodities Super Cycle”. The Federal Reserve’s easy money policy has also contributed to the increase in energy supply and this has had world wide consequences. Some of these consequences have been good, such as US energy Independence; the downside has been instability in many energy–exporting countries.
Legal Disclaimer
This presentation is not a solicitation or an offering; is for research purposes only. The past performance information contained herein is not necessarily indicative of future results and there can be no assurance that an investor will achieve comparable results or will be able to implement any investment strategy indicated herein. The research information contained herein was obtained from public and third party data sources which are believed to be reliable. There is no representation or warranty as to the accuracy, completeness or reliability of such information. This is neither an offer to sell nor a solicitation of any offer to buy any securities. This research presentation is not an advertisement and is not intended for public use or distribution.
[email protected] 805 965 8820
Steve Worthington
Overview • How Did We Get Here?
o Fed’s overly accommodative monetary stimulus. o Aggressive Banking, Investors want to believe o Oil Commodity Cycle
• Result? o Excess debt: Defaults in HY Oil & Gas: 21% E&P. 26% o Increased Risk—House of Cards Economy o Low/No ROE o US energy has already corrected: fall off in production
Steve Worthington [email protected] 805 965 8820
2008-Present: Too easy for too long
Steve Worthington Source: St. Louis Fed
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Fed Driven Asset Inflation The link between equities and GDP has changed
Steve Worthington Source: WSJ, Jack Bogle [email protected] 805 965 8820
US Monetary Base & SP500
Steve Worthington Source: Andrew Smithers, St Louis Fed & GMO [email protected] 805 965 8820
Geopolitical Aspects of Energy Supply
• Stop/Crush additional energy technology gains & infrastructure build out. Keep US relatively addicted.
• Slow Iran’s return to economic and regional power; keep a lid on internal pressures.
• Dissuade Russia from aiding Syria; give Europe alternative and secure oil and gas supplies.
• Short term nationalist behavior: A shortfall of Forex- Russia, Iran and Iraq.
Steve Worthington [email protected] 805 965 8820
Energy Supply Side Evolution • “New” technologies in oil & gas exploration & production • Directional Drilling, Fracking and 3D Seismic all evolved over decades • 1934 Directional Drilling, 1985-91 Horizontal Drilling; Naval Facilities
Engineering Service Center (NFESC) at Port Hueneme • 1949 Hydraulic Fracking; 1981-1997 George Mitchell Schumpeterian:
fracking cost reduction ca. 100x via slick water fracking - Barnett Shale • 1973 3D Seismic; a matter of cost & computational horsepower • In 2000, shale gas represented just 1% of American natural gas
supplies; by 2012 it was 30% and rising • Similar tale for oil, but later: 2009-14 oil fracking: US oil output ~2X
from 5.5 million barrels per day to 9.6 million at a time when oil frequently traded for more than $100 a barrel
Steve Worthington Source: EIA, NFESC, The Economist [email protected] 805 965 8820
ECON 2 – Supply Side Competitive response to lower prices:
Produce until marginal cost is equal to marginal revenue.
Steve Worthington Source: Schlumberger, EIA, Arthur Berman [email protected] 805 965 8820
Econ 2: Response of a firm to lower costs.
Lead times to bring production online have
fallen by an order of magnitude
• 1967 Prudhoe Bay discovered – full production 1981 14 years • 1970: North Sea – full production 5+ years • Saudis as swing producers delivered oil below full cost of ROW • 2007 fall in worldwide demand f(super-cycle, financial recession) • Technology solutions become economic: 3D seismic, fracking
and directional drilling • Schumpeterian Economics: Fed, Fools and their Money • Initially shale economics were unknown, questionable • US shale oil & gas appear to be the new swing producer
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Shale Decline Rates~6X Conventional
Steve Worthington Source: Schlumberger [email protected] 805 965 8820
• Dividend Yield & Growth: bankers offered up, investors bought it
Industry Debt Spree: OPM
Steve Worthington Source: FT [email protected] 805 965 8820
KMI: The largest energy infrastructure Co in North America
Steve Worthington Source: KMI [email protected]
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KMI a brief history • A merger/roll up of 4 segments natural gas, refined products & CO2
transport/storage Cos. (29 total). Orig. asset sale SFPL1997->KMI • MLP to merged Common stock co 2014 • Capital markets idea of growth of divs.- funding dries up • Management deal oriented; OPM capture. • October, 2015: KMI issues 10% Conv. Pref. • Dec 8, 2015: AMC, KMI cuts common div 75% • Top priority: Maintain credit rating aligned with shareholders: 19 years • Cash flows 5 categories: O&M, Capex, Debt Paydown & Divs, M&A • No free lunch yield: hedged position needs a baby sitter & tradeoffs • Debt covenant key to watch 6.5 x vs. • Take or pay? Plenty of BKs; converts to pay now contract
Steve Worthington Source: KMI, SEC & Wikipedia [email protected] 805 965 8820
Lots of choices: risk v. return • Heavily regulated: FERC, CPUC, NEB, SEC, CFTC, Jones Act,
EPA • Key variable: DCF distributable cash flow
• Hedges- Street has forgotten: 97% Take or Pay/Hedged.
o 2016, $1 WTI/bbl crude oil price =$6.5 million o $0.10 per MMBtu natural gas = $0.6 million, o 1% change NGL/bbl /WTI/bbl= $2.0 million. o 100 basis point shift in interest rates = $100 m op income o $11 of $41 billion of debt subject to variable interest rates
Steve Worthington Source: KMI, SEC [email protected] 805 965 8820
KMI Positives • Management owns 14% of common shares out. (V) R Kinder 11% • 38% of all natural gas handled by KMI, 84,000 miles of pipelines and
approximately 180 terminals, 8 Jones Act tankers • Near 100% capacity utilization vs. competition • GM 71%, G&A 16%, EBDA 40%, 16% DDA, 14% Int. Exp. (2015) • Stable DCF: 4.6 (2014), 4.7 (2015) 4.7 (2016 E) • $3.6 B of Distributable Cash Flow (DCF) in excess of divs. for 2016E • Prior Funding: 50 Debt/50 Equity, Now: 100% excess cashflow • Oil was down 31% below budget, gas down 45% DCF: $1.233 1Q16
vs 1.242 1Q15: Very Hedged • 10-15% Project by Project ROI (pre Co. overhead)
Steve Worthington Source: KMI [email protected] 805 965 8820
KMI Long Com. vs. Long Pref. Post Com. Div. Cut.
Steve Worthington Source: SunGard Data [email protected] 805 965 8820
Please see page 2: Legal Disclaimer
KMI Return Scenarios 2 ½ year Equity Hedged T note: Conv. Pref. vs. Common – Returns to date:
Steve Worthington Source: KMI, SEC, AA Research [email protected] 805 965 8820
Please see page 2: Legal Disclaimer
THE END
Energy Economics
• What does this mean for investors? Pay attention to leverage, ROEs & where cash is going: expl, prod, debt, share buybacks.
• Cyclical businesses don't become secular. • Lifecycle economics important- geology & reservoir engineering. • Oil is likely capped at ~$60 for the foreseeable future.
Steve Worthington [email protected] 805 965 8820
The following eight slides provide additional detail
regarding various aspects of this presentation.
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Steve Worthington
Never quite a free market • Standard Oil Trust 1882-1911 (Sherman Anti Trust 1890) • Achnacarry Agreement 1928 Three then Seven Sisters • Texas Railroad Commission 1930s • Venezuela, Aramco 1950 artificially low transfer pricing (50/50), • Embargoes: 1967 Six Days War, Yom Kippur War 1973 25%
production cut, 1979 Iranian Revolution, then Iran/Iraq war. • Saudi ownership Aramco: 1973 (25%), 1974 (60%), 1980 (100%) • Later Political Motivation: Influence Russian gas & oil pipelines. • Today, Political Proxy Wars: Dangerous Neighbors. Short term
nationalist behavior: A shortfall of Forex- Russia, Iran and Iraq.
Steve Worthington [email protected] 805 965 8820
Steve Worthington Source: EIA [email protected] 805 965 8820
