The average company’s stock presenting at Enercom plummeted 4% today. Presenter after presenter referred to the normal world where prices of oil would return to $50-60$ per barrel although there is no real evidence that this is about to happen anytime soon. My market experience tells me that until the last wildcatter gives up on this fantasy, the price of oil will probably continue to drift lower. My experience tell me bottoms occur when everyone gives up talking about it much less calling it. We are not there yet.
The lunchtime presenter was Cheniere Energy’s (LNG) CEO, Charif Souki. Cheniere pioneered the move to export LNG (liquified natural gas) from the U.S. The main market for their LNG is Europe. He said the U.S. is the lowest cost producer in the world for natural gas. Souki also stated that Cheniere will be the biggest customer on KMI and ETE pipelines is securing natural gas supply from all the major basins. I’ve heard him say with authority that his Company will export 15% of the entire U.S gas production. Charif is a very composed relaxed CEO/Founder having successfully pivoted from being a near broke LNG importer to the largest and first to market LNG exporter. Probably the most successful pivot in modern business history. Charif told a story how a decade ago, he told the Africans and Qatar that there were too greedy with their LNG gas and would create their own competitors. He said little did he know then it would be him. Charif was the highest paid CEO last year mostly from exercising enormous quantities of options granted The enormous pay check paid to himself hasn’t dissuaded Carl Icahn who is a major investor. When asked what he thought about that, Charif he said he was flattered.
I came to Intercom with an open mind, not wanting my preconceptions to dictate my experience.
Conclusions:
The economic price of oil, the world’s most important commodity, is not an easily understood concept. What I mean by that is that the price where it is economic to get oil out of the ground is not the price that will produce a sustainable amount of reserves. Oil needs to be replenished and that means more drilling. Nor is it the price of some high pressure wells versus lower pressure ones that need more work to coax the oil out of the ground. The bottom line is that several producers said they could get the oil out of the ground for $12-14 cash costs also referred to as lifting costs. On the other hand the President of Continental Resources, the largest acreage holder and pioneer of the Bakken said their breakeven cost as a company was $50 barrel of oil.
Pipeline companies are preferred creditors according to Crestwood Midstream President There is something known as The doctrine of necessity that allowed Crestwood to get paid by the creditors 100% of the money owed to them by bankrupt customer QuickSilver. Why this is so important is that the best oil and gas MLPs are trading like high yield junk bonds even though they are mostly fee based. If they are all likely to get paid 100% in bankruptcy of their customers, these stocks should be trading a lot higher, triple the price or more as in the case of Crestwood.
On the other hand many companies are going to get a serious review by their bank lenders after the September quarter. We learned this by talking to a geologist who works for U.S. Bank. The banks have a strict line they will not cross and that’s the debt/EBITDA ratio. That needs to be below 4 or your revolver is going to get pulled. If you owe them money, you are triggering their covenants and the bank is going to force you to sell something.
Selling producing assets may stay the wolf at the door but it won’t right the house. Companies operating in bankruptcy can overnight be low cost producers freed from some SG&A expense that ongoing operations entails. More supply into a weak market only begets more supply as what is missing in price is made up for in volume causing an ongoing death spiral until someone cuts off the spigot. During the depression, the Governor of Texas had to send troops out to stop the oil men from drilling.
Oil is likely to be depressed for a long while. Many if not most of the presenters are sill in denial. Their slide decks still reflect $50 oil. We are compiling a list of high debt to capital companies with credit lines that need to be rolled over or notes coming due in the next six months. These could be good short candidates but bear in mind many of these prices already reflect very dire outcomes.
The trade idea that I am walking away with is short the E&P producers and buy the MLPs.If oil makes an unexpected rally in price, we will lose money on the E&P side but make up for it on the MLPs. They are heavily leveraged companies but gas and crude will flow through the pipes at some price.