Thoughts on Denver EnerCom 2022-Let the Good Times Roll

I’ve been attending an annual oil and gas conference in Denver for several years and 2022 was unlike any event I’ve been to. I’m sure it was unlike any event EnerCom has seen in its 37 years as well. You have to remember that under the Trump administration the U.S. oil and gas industry got a flood of private and public capital thrown at it. It was overproducing, even when they were losing money on it.  When you’re losing money drilling for oil, the only solution was to drill for more of it.  The lower the price got, the more you had to produce, the more you had to drill. The irony was perfect. The oil and gas execs loved Trump but the outcome was predictable.  He was terrible for the companies.  Everyone likes low prices except for the oil and gas companies producing it.

It was just a couple of years ago that oil traded in the futures markets in negative numbers. The price of a barrel of crude was quoted in minus numbers. The Pandemic shut down the world. Oil producers ran out of storage and were paying just to park crude. Smart hedge fund managers, in hindsight, were chartering oil tankers to store the excess crude, parking them at sea. There was no EnerCom that year. It was already a boom-bust industry but I was certain that this was the bust that would end it for many of them. This year’s event pretty much proved it.  The four-day event was pretty much over the first day as there were not as many companies left to enjoy the fortunes the survivors are enjoying today.

Many of the companies attending EnerCom are small E&P producers. You are probably not familiar with most of them but you could have gotten rich off their stocks.  Some of the small-cap companies’ stocks were up 200-300% in the last year. That’s not a typo. Many of the people attending the show are vendors, suppliers, and generally economically tied to the industry. The rest of the attendees are investors, analysts, and people with time on their hands. The conference is free for me to attend as I imagine it is for most. The people that pay get up on the stage and have something to say.

Denver, itself, is the oil and gas capital in the U.S. outside of Houston. In fact, the keynote luncheon speaker on the first day was the head of BPX, which is the spinoff of the oil and gas giant, BP’s, U.S land-based assets in the lower 48 states. They moved their headquarters to Denver from Houston, in part because Colorado is a progressive state.  The words, “progressive” slipped off his tongue as the overturning of Roe B Wade must be reverberating in the HR recruiting department of Texas-based companies.

I booked one on one meetings with a few of the survivors. It’s not often you get to sit down with CEO, CFOs, and their teams, so I was determined to put it to good use. I wanted to ask the questions you don’t hear at typical earnings calls where the Q&A s monopolized by Wall Street analysts who ask deep in the weeds type of things so they can tune their models. I was going to ask the questions analysts DON’T ASK, like how are my investors going to make money buying your stock? If it’s a good buy, if so why aren’t you buying it? For the most part, I tried to meet with those companies that have insiders buying.

The night before I was scheduled to meet with the various executives, I did a quick review of the latest earnings calls.

Sandridge SD has a storied past like no others. It went bankrupt, maybe more than once. It was founded by the legendary Tom Ward. If you don’t know who he was, he’s the geology guy behind the juggernaut that Aubrey McLendon built, Chesapeake Energy.  Aubrey was the natural gas evangelist that opened the country’s eyes to the abundant wealth of natural gas that could be extracted from horizontal drilling and fracking. Before him, Alan Greenspan, the famous Federal Reserve Chairman for many years, warned the country that we would run out of affordable gas.  LNG regassification import plants were built at enormous cost in a few spots along the east cost and Gulf of Mexico. They are now converted or being converted into exporting LNG facilities as the U.S. has turned from being an importer of natural gas to the world’s largest exporter, right up there with Qatar.

Aubrey went bust in 2008 as the market collapsed and much of the cash he used to buy up Chesapeake Energy came from hypothecated stock. Margining your own stock to buy more of it is a pretty risky gambit. But then Aubrey was one of the original wildcatters, going around the country with Tom Ward buying up promising natural gas leaseholds and the land containing them. They leveraged the company to the hilt and were incredibly successful. Then the Great Recession of 2008 swept through the country wiping out many investors, including them. I remember asking the company’s IR, “Where does Aubrey get all the money to buy his company’s stock? He never sells,” I said.  The answer they gave me was hogwash. I believe the SEC changed the laws because of that.  Aubrey died in a fiery crash underneath an underpass in Oklahoma while under investigation from the Feds and others. It was a tragic end to a legend. I lost a lot of money betting on Chesapeake so I wasn’t one of the mourners.

The earnings call I listened to the night before, literally blew my mind.  This company was printing money, something like $48 million in the quarter and had NO debt. here are the highlights from their press release. There was only one analyst question on the call. Out of the blue, he sat down next to me at the keynote luncheon the 2nday of the event.  The speaker that day was some fund obscure fund manager railing against the tyranny of ESG. I walked out on his speech.

Sandridge’s last quarter was a thing of beauty. From their press release:

Generated Adjusted EBITDA(1) of $53.7 million in the second quarter compared to $39.4 million in
the prior quarter
• Second quarter net income was $48.5 million, or $1.32 per basic share. Adjusted net income(1)
was $48.9 million, or $1.33 per basic share.
• Second quarter 2022 production of 17.8 MBoed was consistent with first quarter 2022, despite no
new completion activity
• Successfully drilled the first two wells of its previously announced 2022 capital development
program during the second quarter with completions and first production commencing during the
third quarter
• As of June 30, 2022, the Company returned 29 wells to production in the first half of 2022 that
were previously curtailed due to the 2020 commodity price downturn. The Company has returned
a total of 158 wells to production since the beginning of 2021
• Second quarter adjusted G&A(1) of $1.8 million, or $1.09 per Boe, compared to $2.2 million, or
$1.35 per Boe in the prior quarter
• Updated 2022 operational and capital expenditure guidance to include the addition of three new
wells to the Company’s drilling and completion program in addition to expanded well reactivation
activity
• The Company had no open hedge positions as of June 30, 2022

They were barely even drilling new wells. It was all from existing long lived wells that were gushing gas.  The best yet, they had zero hedges. Every company I’ve researched hasn’t been able to fully exploit this amazing surge in the price of Henry Hub natural gas because they’d hedged their production.  Even the largest natural gas producer in the U.S., EQT hedged 65% of 2022 prices at a fraction of what it’s currently at.  Mind you it is something like 8-10 x the cost in Europe.

The stock was so cheap I bought a large amount even before meeting management, figuring I could unload it without much risk of losing money if there was something at the meeting that bugged me.  What I heard did anything but that. I apologized for not having business cards. I left without them somehow. They were ok with that.  They didn’t have any either. They’re board was too tight pursed to buy them. That’s interesting, I thought. Who’s your board?” Icahn”, they answered.

Carl Icahn knows the oil and gas industry very well and has arguably made more of his fortune in this industry than any other single industry. There is no better insider than him. Then I brought up the lone analyst who on the call asked why there weren’t buying back their stock. It’s ridiculously cheap. I asked them why “They weren’t buying it,” Apparently they are involved in lots of M&A talks. They have a $1.7Billion NOL. They can avoid paying a lot of taxes, maybe forever unless they buy some income. If someone buys them, they lose the NOL. That’s the way the tax law operates. I’m sure Icahn and his team of tax experts and lawyers have it figured six ways to Sunday.

Comstock Resources– The prime speaker  here was your consummate Texas good ‘ole boy. He was quick to share that he was on the phone with Jerry Jones every day, hours at at time sometimes. Jerry Jones is the owner of the Dallas Cowboys. He talked and looked like someone Jerry would pal around with. He said Jerry felt this was the best investment he ever made, even better than the Cowboys bet.  Jerry Jones was just on CNBC touting his investment in Comstock.

If it’s so great, why aren’t you buying the stock ,I asked its team. He said he had bought a bunch of it.  The following day it was announced that VP McGough had purchased 28,800 shares at $14.86. We bought some then.  I went back and looked up the trading.  Management was buying it in May of 2020 when you couldn’t give it away at $4.75 per share.  Its more than tripled since then.

Apache I met with Gary Black, head of IR. Gary is a former analyst and CFA. He’s obviously a very smart guy. I shared with him that one of my interns was Pete Lannie, their long time chief legal counsel and once interim CFO’s son. Pete is a character. He was fresh out of U. of U’s Master of Finance program so I knew he was not a dumb kid. He was in the Marines before going to school in Utah, he told me because he said, “I like to blow up things and lifting heavy objects.

Pete said his dad always complained about owning Apache stock. I don’t’ know why since he just sold over $5mllion of it so he’s probably not complaining loudly.  Gary gave me the Apache story and I have to admit, it’s on my radar. The find offshore Suriname is apparently a big deal. The majors are making big plans for drilling there but I’m not a fan of crude. It’s natural gas that I am after and Apache looks like about 50% crude, the balance in natural gas and NGLs.  At any rate, Gary gave me a good income tip, Kendall Resource Partners, KRP. Its a handful of lawyers with leases in the best producing oil and gas basins around the country spinning out a current 10% dividend. From their website

• We offer our investors a compelling risk-adjusted cash yield through direct mineral ownership in over 16 million gross acres with more than 122,000 wells, without any associated operating costs or capital expenditures
• Kimbell benefits from continued development of our acreage by leading operators, at no cost to us, and continued technological advances that are driving the U.S. energy renaissance
• Kimbell has elected to be taxed as a corporation for federal income tax purposes.  Kimbell is neither a traditional Master Limited Partnership nor a Royalty Trust
• Our investors receive tax advantaged distributions via 1099-DIV without a K-1

W & T Offshore is like the name sounds. Offshore drilling and deep wells at that. They were patient with my non analysts dumb questions. They had a very sharp CFO who had all the numbers at the ready but I wasn’t interested in numbers. You can get that off the Q’s and K’s.  I wanted to get a feel for the people. I did just that. The founder of the company, Tracy Kohn told me he was just an ole’ fashioned treasure hunter. I told him I was one too, but my search was for cheap stocks not oil in the ground. WTI might just be both.

I’m saving the best for last.  Hayes Resources, Paul “Craig” Hayes and I shared some time together at the Rockies game. EnerCom has several club boxes every year for and the evening at the game is the highlight of the conference. I didn’t know anyone there and neither did Craig.  Craig goes way back to Park City. He told me he used to store his skis in Tommy Vada’s house. Tommy was a bit of a Park City legend, making a fortune in the software industry in California, and settling down in P.C, Tommy threw big parties with fire dancers and all. He flew a plane and lived a bon vivant lifestyle that. Tommy passed away from cancer recently and I’m sorry I didn’t get to know him better.  Craig lives in Greenwich, Ct and was looking for a deal. His family goes way back in the oil industry. His father told him he would buy him any kind of car if he would just graduate high school. He went to college in Durango, Colorado where he majored in skiing and partying. He was wearing a brace on his arm when I met him. He said he fell down the stairs chasing after a girl.   I’ve got a good feeling, Craig and I will cross paths again.  He’s a character like so many of the people that shape this uniquely American industry.

Conclusions:  The fossil fuel industry must feel like they are under attack. Their lenders were demanding loans due to collapsing prices in their collateral, the oil and gas proven reserves.  ESG policies of many giant asset companies like BlackRock and university endowment funds were disinvesting themselves of their fossil fuel investments. It was bad enough that environmentalists had been protesting them for years, ESG  was really hitting home. Democrats have had a target on their backs.

The surviving companies knew they couldn’t fight this.  It was better to join them than vanish altogether.  They began to try and outdo one another with their ESG chops. Giant producers were investing in solar and wind.

It all changed  Thursday, February 25th, 2022 with the invasion of Ukraine. Russia weaponized energy by threatening to cut off gas supplies to Europe and watch it freeze in the Winter.  No one doubted their heartlessness after the brutal attack on their neighbor.  The world realized in a heartbeat’s time that we weren’t ready for renewable green energy. It was a pipedream or some mix of illusion and confidence that we thought we could live without fossil fuels. After all climate change experts told us we had to. Bill Gates told said it was a certainty we had to get to Net Zero carbon. Tesla was valued more than all the auto companies in the world combined. Elon Musk said we had to move Mars as a species to survive. Most major auto makers vowed to stop making combustion engines some time in the near future.

The thinning of the herd has made the surviving companies stronger and richer.  Tanks and fighter jets will never run on batteries nor will passenger airlines connecting vast swaths of the world. I personally don’t believe we will stop using natural gas until the planet runs out of it. Exxon said that the usage of oil for transportation will level off at the level of 2016’s usage.  They mentioned noting about the price, though. Enough said, this sector is grossly underrepresented by market cap in the S&P 500. You’d think from looking at the Map of the Market that we all lived out of our phones and software. As of 12-31-2021 energy represented 2.67% of the market. You can’t go wrong investing in a sector that no one in the modern world can live without, metaverse or not.