Love Hurts

My portfolio is down 4% in a month.  It hurts:

Its a 7% drawdown from its all time high at the end of Jan.  Gold fell 16% in the same period.  Even in a gold bull market, it can historically be expected to correct 20-35%, so I expect more pain to come. 

I'm up 10% YTD while gold is up 4%.  So I'm "outperforming": rode the upside, missed most of the downside.

The market is choppy: 3-5 days up, then 3-5 days down.   I hate it, but we trade the market we have not the market we want:

• Started covering some shorts early tonight,
• Sold platinum and silver in the last two days, trailing stop-loss.
• Bought a little more gold (RGLD), bad timing.
• Sold my oil trading positions (XOP and BNO).  Still have Var Energi as a longer term holding. 

I don't know if we get a real correction: VIX > 30 with markets crashing from oversold levels and correlations going to one.  I think we should, as the market prices in inflation and a real (not nominal) recession.  But no sign of it yet.  So I'll probably cover more shorts in the next few days.  The war can last for months or could be over tomorrow.

This is the first time I've been able to short the market successfully over a few months.  And the first time being able to trade the chop.  At least reducing the effect of falling gold on my portfolio.  I should be happy about that.

When would I sell Var Energi?  Even through its a long term fundamental play, oil is cyclical.  Prices can't stay triple digits forever else they'll reduce demand with a recession.  Back-of-the-envelope, from 2025 numbers:

• 5.2bn revenue from crude @ 68.3 USD/bbl.  At 120 Brent it would be 9.1bn, or an extra 3.9bn  At 150 Brent it would be 11.4bn, or an extra 6.2bn.
• 2.4bn revenue from gas @ USD 74.4/boe.  Around 15% of their gas price was fixed in Q4, but I'll ignore this cuz its usually only one or 2 years out.  TTF now is EUR 59/Mwh, or roughly USD 106 per boe.  Selling gas at USD 106 would give 3.4bn revenue, which is an extra 1bn.
• Apply Norway's 78% O&G tax to this: At 120 Brent & 59 TTF, its an extra 1.07bn profit.  Or profit goes up 2.26 times.  At 150 Brent & 59 TTF, its an extra 1.58bn profit.  Or profit up 2.8 times.
• At 10 times earnings, that would be a stock price of USD 7 (NOK 67) for Brent 120 and TTF 59.   Or USD 8.7 (NOK 83) for Brent 150 and TTF 59.

The stock doesn't have to get there or could go further, but these would be unsustainably high stock prices.

Fundamentally, its not yet time to begin value investing.  Some stocks in the UAE ETF might be value buys later, but need to get cheaper.  Stocks in general are still too expensive, there's nothing yet where I'd stick my hand out to catch a falling knife.  Need to see real fear of a recession.  And if this war continues long enough we'll get it.

Sold Canadian Natural Resources (CNQ)

I've held Canadian Natural Resources (CNQ) since late 2022 based on excellent fundamentals.  Its an efficient low-cost producer in a safe jurisdiction, with effectively infinite reserves, that pays dividends and buys back shares.

But there's now political risk.  The upcoming July USMCA negotiations were already looking shaky:

• USMCA expires on July 1st.  In preparation, the USTR January report has listed areas of contention: lumber subsidies, diary protection, the digital services tax, imports rerouted from China, and fentanyl.
• 70-75% of Canada's exports go to the US.  Canada has no choice but to bend.  The issues can probably be worked through.  For example, the Digital Services tax has not been collected, and there are efforts underway to remove it from the books.  It depends on the support Carney can get.
• If the USMCA is not renewed by 1st July, it enters a 10-year "zombie state", whereby the three countries have to meet once a year for a "rolling renewal".  CNQ will be effectively licensed to sell 3/4th of their output to the US on a year-by-year basis.

Quick numbers on Canada's oil exports.  Most of their exports go straight to the US through the Mainline and Keystone pipelines.  Canada's total production is 4+m bbl/day.   The only way for them to bypass the US is through the TMX pipeline (890k bbl/day), and that is constrained as the port can only take up to Aframax sized tankers. So for long distances, they usually shuttle the oil to California to load onto VLCCs to China.   They may be able to dredge the port by 2027 to allow slightly larger Aframaxes in.  New pipelines are at least 8-10 years out.

Now Carney has gone to China and lowered tariffs on China EVs.  This is a slap in the face for Trump.  The US cannot tolerate Chinese influence on their neighbour.

I still think the USMCA is going to work out, but there'll be fireworks beforehand.  In between today and July, Trump will unleash tweets about destroying Canada's economy.  Canada is going to get bitch-slapped, then ass-fucked.  I may look to buy CNQ again when Canada rolls over or Alberta becomes the 51st state.

Bought Oil, Sold Gold

A few hours after my previous post, Hedgeye's trading signal on oil changed to bullish trend. I've been waiting for months for this, so I bought a whole lot of oil stocks.  From 5% to 15%.  Risky, because its overbought and the signal can always flip back, but now is as good a time as any.

I still think we are in a decade of inflation.  I expect oil to maintain its price for one or two years, then explode in 2025 or 2026.  Like Uranium now.  Meanwhile, I'm paid to wait as oil companies gush cash (at 2023 oil prices) with generous dividends or buybacks.  For context, after peaking in 2022, the oil price hovered between $70-90 last year:

CNQ is a Canadian oil sands producer with long-life reserves, profitable, with generous dividends and share buybacks:

In 1Q24 they target to reduce net debt to 10 billion, after which they'll return 100% of free cashflow to shareholders.  I estimate either doubling dividends, or more than doubling share-buybacks.  Annualising their 9M23 profits, they are trading at a PE of 13.

Acker BP is a Norwegian O&G producer, that is still paying down debt but still also pays dividends:

Its trading at 12X 2023 earnings.

Var Energy is a smaller Norwegian producer, from Modern Investing Substack.  Although they pay dividends, they are a growth story, aiming to increase production by 50% by 2025.  Its trading 8 times 2023 earnings.  This company has more operational risk. 

The risks are politics and ESG.  Norway's district court overturned approval for several oil projects. While Canada will introduce a carbon tax.

Also sold my gold I'm as no longer expecting a recession.  And I need cash to buy stocks.

Aker BP

A quick look at the second largest Norwegian oil & gas producer.  They operate purely on the Norwegian Continental Shelf (NCS).

Cashflows

They pay taxes every two months, so even quarters have higher taxes.  The current quarter has one tax payment, the next has two: however they made an additional $500m tax payment this quarter (p6) to smooth it out.

For each calendar year, their percent of FCF (CFO-CFI) paid out as dividends is:

The payout ratio increased after the Lundin acquisition.  Maybe they are transitioning from a growth company to a cash cow, or maybe its because of lower energy prices.  Their dividend policy is to payout 20-30% of CFO.  Negligible share buybacks.

Lundin Acquisition

They acquired Lundin Petroleum's NCS assets (excluding renewables), in a deal announced Dec 2021 and completed June 2022.

Debt increased 60%, shares outstanding 75%:

Production and reserves doubled:

Source: Acker BP 2022 Q4 presentation (p9)

With hindsight, the acquisition may have been timed wrong: 2Q22 was the peak of the energy market.  But there are a only a handful of listed players on the NCS so opportunities like this are infrequent.  They did not stretch themselves financially.

Balance sheet

Debt is a bit high, but all fixed and long drawn out.  I think we are at the peak of the interest rate cycle anyway.  93% of their debt is fixed-rate long term bonds:

                                                        Source: Company Website

The 6% bonds were issued June 2023, so their interest payments will have been included in the current quarter.  Total interest expense this quarter was 41m, easily covered by 300-500m quarterly profits.

Future growth

Production is expected to decline from 2023 to 2026, before picking up with new projects in 2027/28.

Source: Q3 2023 Presentation (p11)

"Between now and 2028, this will require the investments of approximately $20 billion pre-tax, corresponding to around $3 billion after-tax. This CapEx estimate has remained unchanged since we submitted the PDOs to the Norwegian authorities approximately a year ago" (p4)

ESG

Their climate transition plan is less ambitious (more realistic) than Equinor's:

By 2030:

• Reduce scope 1 (energy consumed on rigs and spills/flares) and scope 2 (energy purchased) emissions by 50%
• Net zero (scope 1 and scope 2) emissions.  Offset emissions by carbon capture.

By 2050:

• Reduce scope 1 and scope  2 emissions to zero.  By electrification: using renewable energy produced onshore to power rigs.

They are not making investments in "renewables" (outside of their own use).

Valuation

TTM EPS is USD 2.04 (which contains $1/share impairments in 4Q22).  At a price of NOK 300, the PE is 14.3 (counting impairments) or 9.5 (not counting impairments).

Misc

• They Hedge commodity and currency exposures.  They hedge energy by buying Brent puts.  They may hedge up to 100% of next 12 months anticipated oil production, up to 75% for the subsequent 6 months, and up to 50% for the subsequent 6 months.  I could not find the amount of oil hedged (Only the current P&L of the hedges).
• Presentations/reports are not as well-presented as Equinors.  But I thought relevant numbers were easier to find.

Conclusion

The numbers and business plans look good.  Similar to Equinor but without the ESG risk.  Short term I bearish energy, but I think it'll be worth buying sometime.

Equinor Update

Update and Review of Equinor.  I may buy some more energy producers in a few months if we get a downturn.  Here I look at their latest numbers and their ESG plans.

Segments

Equinor is primarily an Norwegian energy play, with 90% of 2022 Net Operating Income from E&P, and three quarters of that from Norway.  

How much is oil vs gas?  In dollar terms, usually more oil, but it varies with prices.  In the first 9 of months 2023, they sold more oil than gas, but in the same period of the previous year, more gas than oil (page 29).  Due to the massive spike in European gas prices in 3Q2022:

Source: Equinor 2023 3Q Financial Statements and Review (p51)

Cashflows

They've been printing money in the past 2 years due to high oil/gas prices.  2022 was a bumper year, 2021 more normal:

Quarterly cash-inflows vs cash-outflows:

Notes:

• Quarterly CFO does not correlate with oil/gas prices, because taxes (payable) seem to be accumulated in Q1 and paid out in other quarters.
• Since quarterly data is noisy, calculate the payout ratio (CFO divided by dividends plus buybacks) for each calendar year: in 2021 it was 35%, 2022 was 48%, YTD 2023 is 94%.  In 2022, they spend almost all their generated cash on dividends/buybacks.

Balance Sheet and Capital Allocation

They've paid off their debt in 2021, accumulated cash in 2022, and have been returning capital in 2023:

But not all their cash and financial investments can be counted:

• Their 28bn financial investments "mainly relate to investment portfolios held by Equinor’s captive insurance company and other listed and non-listed equities held for longterm strategic purposes" (p177).  We don't know how much is required for insurance.  2020's annual report says the same thing for 12bn of financial investments.  I'll take a wild guess that 12bn is required for insurance, leaving 16bn as long term investments.
• For their 15bn cash, 6bn is required for hedging (p179).  Lets deduct another 2bn in case oil volatility increases. Leaving us with 8bn excess cash.
• With debt of 25bn, net debt would be ~ 1bn.

Long term liabilities are 13bn provisions, mostly asset (rig) retirements.  Plus 3bn pensions.

There is no fixed policies for dividends or buybacks - appropriate for a cyclical industry.

The company previously mentioned they would like to return to a 10-15% leverage ratio (p10) - they count all cash and financial investments in this ratio - so that would entail a massive capital distribution.  I'm skeptical about this in today's world: any leverage is too much when you have 5% interest rates and a product whose price can go negative when people catch a cold.

Their main form of capital distribution is dividends.  Not tax efficient, but better than stupid acquisitions.  Overall I think their capital allocation is quite good.

Reserves 

They had 7 years remaining based on 2022 production.  The reserve replacement ratio has averaged 62% in the past 3 years.  Meaning replacement was below production.

Reserves in Norway have remained steady over the past 3 years (p7).

By boe, over half of the reserves are gas:

Source: 2022 Oil and Gas Reserves Report (p6)

Business and Political Risks

Very few risks, which makes it a rarity for an energy producer:

• Norway is a developed, democratic country with rule of law.  Most resource rich countries are shitholes (eg: DRC, Saudi Arabia) or simply poor & corrupt (eg: Indonesia).
• Seabourne oil can be shipped anywhere.  The production areas and outbound shipping lanes are not in a potential war zone, like the Persian Gulf.
• Norway's oil tax is 78%, though investments can be deducted over a few years.  This high rate is already priced in, and is actually an advantage, because: 1) Its safe and predictable, they have not changed it eg: like the UK did, and 2) the government is already getting 78% of profits, they're unlikely to take shares away from minority shareholders.
• Norway is an net energy exporter, so they are unlikely to put a windfall tax on energy producers or restrict energy exports.
• Offshore oil has low decline rates, unlike American shale.
• Norway's oil is less carbon intensive to produce compared to Canadian oil sands.

Valuation

Getting a reasonable valuation for energy companies is hard because energy prices have been so volatile.  Lets base it on 2021 and 9M2023 results.  2022 was too much of an exceptional year.

"Cash generated" is CFO minus "capex and investments".

Based on the current stock price of USD 32, the PE would be 8 or 12.  Reasonable, but not dirt cheap,

ESG Risk 

Equinor has an Energy Transition Plan, which I think is the biggest risk to its business:

The first item (reducing carbon use when producing oil) and third item (CO2 storage) are OK.  The second one (spending lots of money on renewable production) worries me:

• Equinor aims to direct "30 of gross capex to renewables and low carbon solutions by 2025" and " more than 50% of our annual gross investments in 2030 towards renewables and low-carbon solutions" (p21).  It was 14% in 2022 and 11% in 2021:

Source: Material Topics, Equinor Website.

• They had to write down their US wind power projects this quarter.  Their UK wind farms are OK because prices are inflation adjusted.
• In negotiations, they said they "would like to see 4% to 8% real unlevered return from our businesses in -- within renewables" (p12)

Lets do some numbers.  Based on 2021 and 2022 capex:

• 2021 capex was 8bn, 2022 was 8.7bn.  Of that, 0.9bn and 1.2bn was spent on renewables and low-carbon (11% and 14% respectively).  
• To bring it up to 30%, we need to spend an additional ~2.3bn by 2025.  To bring it up to 50%, we need to spend an additional 5.3bn by 2030.  They don't need to just bring it up to 50% of current 8bn capex, they need to bring it up to 50% of new ~12bn capex....after they spend more for renewables.
• These additional sum could make low returns (4-8% real returns) in a much more risky investment.  Essentially we can see FCF (and therefore dividends/buybacks) reduced by this amount.
• Based on 2021and annualised 9M2022 estimates, the 2030 aim would reduce the cash generated (CFO minus "capex and investments" by 15-17%).  It could wipe out their Net Operating Income (before tax)....though they could now claim back the new investments over several years at a 78% tax rate.

Conclusion

Everything looks good except for the ESG risk.  Time to explore other companies.

Bought Vermillion Energy (VET)

Hedgeye's oil price Risk Range went to bullish trend on the 17th July after being bearish for a year.

Looking for something to trade, I came across Vermillion Energy:

• Half its 1Q22 revenue is from oil (2/3rds of that from Canada, 1/3rd from Europe), and half from gas (70% of this half is priced in AECO (Canada), 30% from Europe.  in Q2, we expect 40% from Europe).
• Leverage on the high side, they are concentrating on reducing it.  Mostly fixed rate.  Negligible dividend.  Some buybacks.
• 2P reserves of 14 years, not great.  Read somewhere there are some questions about how they depreciate their reserves.  No breakdown by oil and gas.
• Its a high beta stock: it dropped 60% from the peak last July's peak to the trough.  Could be due to Canada's oil and gas pricing varying more than WTI (due to lack of transportation from Canada) and the wild variations in European gas pricing.
• 1Q22 Annualised EPS is $8, trading at CAD 18, thats less than 3X a year's earnings.  Not a lot has to go right.
• European Windfall taxes end in Dec 2023....if they are not renewed.  Pro forma, removal of the windfall tax would have added another 5% to their 1Q22 earnings.

Its a trade - not a Buffet-like stock to pass to your grandkids.  Hopefully the trend lasts a few months or quarters.  I'll sell it when Hedgeye's oil trend changes.  Would not hold a stock this volatile thru a downturn.

Bought a 1% position last night @ USD 13.25, after the stock dipped for 4 days.  I would go up to 3%.  The problem is it rarely dips enough to take a big position.

My positions haven't changed much:

• The portfolio is quite oily, and has started to go up with oil.
• Removed some shorts that changed to bullish trend.
• Added some long term index puts.
• Have VET and Silver in an "Inflation Trades" basket.  2% total.

Update 6th Aug 2023:

• Increased VET position to 2.5%.  It wont go down enough to buy a big position.
• Silver position increased to 1.5%.
• SPX looking bearish, may buy more puts (June 24) if we get a bounce next week.  If things work out this could be my last chance to buy.

Update: 8th Aug 2023 morning: Increased VET to 3% last night.  Last night's rebound was weak.  SPX is no longer oversold, AAPL has broken down and VIX has broken out.  Look to press shorts, probably tonight.

Sold Petrobras and Getting Shorter

Sold by Petrobras 1% position at a 20% loss, too much political risk.  We've had Biden question why Exxon is making 'more money than God', the UK apply a North Sea tax, and Queensland apply a coal tax.  There's a risk of a diesel shortage in Brazil in the coming weeks/months, and energy companies are a good scapegoat.  Sell it while its worth something.

Now 96% invested.  Most of the new cash is from dividends and salary.

Increased my short position like a broken record, now 37% short.

I think the market bounces here into the start of July.  The same as its done every other month:

Chart from: The Market Dog.  Its actually Q's not SPY, but close enough.

A 'normal' bear market rally can be 20% - we haven't had one yet.  'SPY is almost up 5% from previous lows last night, I'll add 4% to my shorts next week if it reaches that (3817).  Then another 4% again if it goes up 5% more (3999).  And again (4181).  Then stop.  If it follows the past pattern, the market rallies into Independence Day, before selling off again. Its as good a guess as any.

Sold 1/3rd of my CNQ position

 I bought a 2% position in CNQ 3 months ago, in the last month its up 20%.  Its starting to look parabolic:

I like this company and want to hold it for the next few years.

But I expect a correction around 2Q, which would hit oil.  CNQ is a high beta oil stock.   Short term, its way, way overbought.  And 2Q is only 10 weeks away, while the market is forward looking.

Sold 1/3rd of my position, @ CAD 64.44, profit 1.9K CAD or 29%.  Will sell more if it goes higher and my outlook stays the same.

Hope to buy it back cheaper later.

Total Energies

Though I've avoided the oil majors so far, Total Energies looks like the best of them.

Business

Excluding 2020, half to 2/3rds of their profits come from oil and gas production:

E&P includes gas production.  The "Gas" in "Gas, Renewables and Power" is midstream/upstream.

As I'm expecting higher oil prices, I want companies with high exposure to oil and gas production.  50-66% is a bit on the low side, but still OK

Reserves

I want to see reserves not depleting over time.  I also split reserves between oil and gas because oil is worth more (in BOEs):

Source: Total Energies' Universal Registration Documents. Search for "Proved Reserves for"

Looks good.

Geopolitical Risk

Their reserves and production are spread around the world:

Source: 2020 Universal Registration Document p68

30% of their gas in from Russia - there's a risk the Russians kick them out (for whatever reason), or they are forced to stop trading with them from US pressure if Russia invades Ukraine.  Even if France did not obey, Total would lose access to swift, and I don't think thats an option today.

Not much dependence on the Persian Gulf, which is always a potential warzone.

ESG Risk

This is the biggest long-term risk to the Oil Majors, and the hardest to predict.  I liked XOM and Chevron before minority shareholder activists Engine 1 added 3 members to XOM's board (1) (2).  Unfortunately the French Government no longer has a stake or golden share in Total, so I don't know if the same thing could happen to them.  I think the French Government have a lot more control over their corporates than the US does - more like Singapore or Norway.

Although Total has been investing more into renewable energy, 75% of their capex will still go to hydrocarbons with natural gas slowly replacing oil.  By 2030, they aim for a sales mix of 30% oil, 50% gas, 15% electricity and 5% biomass and hydrogen, with petroleum product sales decreasing by at least 30% over the period 2020-30.  

Their numbers seem realistic.  I like that they talk straight and are not pretending to be a non-petroleum company.

Valuation

At a share price of Euro 45, based on their annualised 9M21 results, its going for 9.4X earnings.  Valuations don't tell us much since they all depends on the oil price anyway.

The dividend yield is 5.8%, which is covered by their 1Q, 2Q and 3Q earnings (payout ratios of 60%, 94% and 41% respectively).  The dividend was maintained throughout 2020 (which I am not so keen on - I do not feel comfortable with a loss-making company paying dividends while pretending to be a bond).  They have no plans to raise dividends.

French witholding tax on dividends is 28% from 2020 onwards.  Singapore residents should pay only 15% (p13), but it depends on your broker and is probably too costly and time consuming.

Conclusion

This company is OK.  Its hard to find good oil producing companies, so I'll keep it on my watchlist.  The witholding tax is a killer.

US Pipeline Companies: Part #2

Williams Companies

Their business: Mostly Natural gas, they break down their segments by geographic region:

• West: Gas gathering, processing and treating in several Western US shale oil fields.  27% of 2019 EBIDTA.
• Northeast G&P: Gas gathering, processing and fractionalising in the Appalachians.  30% of 2019 EBIDTA.
• Transmission and GOM: Transport along their Transco pipeline, with a little gas/oil gathering in GOM.  42% of 2019 EBIDTA.

Transco is irreplaceable - more than one fifth of US natural gas consumption flows through it.  for Northeast G&P, Morningstar estimates that Williams collects about a third of overall gas volumes across the Appalachian region.  Their other assets are more exposed to market forces, especially declining crude.

West could be badly affected by crude oil shut-ins, as 30-40% of US natural gas production is associated with crude oil (the gas is an unwanted by product).  Northeast G&P would not be affected  and may even benefit if gas prices rise due to a falls in associated gas.  Transco would likewise be unaffected or benefit.  I believe more than half of GOM's natural gas production is associated with oil wells, so they may be hit too.

Leverage: 2019 debt was 5.4 times EBIDTA.  Very high.  They aim to reduce it to 4.2 times.

For operating leverage, 2019 CFO was 40% of revenue (excluding product sales).  ie: Service revenue would have to fall by this much before they start losing cash.

Valuation: Trading at a 7% trailing yield, with CFO at 1.8 times their dividend.

Growth: Still growing.  Capex in 2018 was 4.2bn, 2019 was 2.4bn, 2020 is expected to be 1.5bn.  For comparison, 2019's CFO was 3.6bn.  They have not announced further cutbacks to 2020 capex.

Near term they have earmarked 3.2bn:

Longer term they have other opportunities:

Management recently said they expect to have "positive free cashflow" from now.  Specifically: without any asset sales, their operating cashflows should support both their capex and dividends.

Long term or political risks: Don't see any.  Natural gas is environmentally clean and has low carbon emissions.  Oh wait...all fossil fuels are bad - one of their proposed pipelines was just killed by NY.

Worst case scenario:  Again, lets say US crude production halves. I'm going to assume that all gas production in their 'West' segment is associated with oil (1) (2).  So if gas production halves, revenue halves, and the company's CFO drops by 900m or 25%, to 2.8bn.  After the projected capex, they would have to cut their 2020 dividends to ~ $1.05,

Kinder Morgan

Their business: Mostly Natural gas:

• Natural Gas: interstate and intrastate natural gas pipeline and storage systems, gathering, NGL fractionation, and LNG liquefaction & storage.  57% of EBDA.
• Refined Pipelines: pipelines that deliver refined product, and some crude.  Including some terminals and mixing facilities.  15% of EBDA.
• Terminals: Terminals, and Jones-Act qualified tankers.  18% of EBDA.
• CO2: produces, transports and sells CO2, used for crude oil production.  8% of EBDA

KMI owns the Tennessee gas pipeline, one of three large interstate pipelines supplying Eastern US natural gas.  The company says that 40% of US gas passes through its pipelines.  They would be considered irreplaceable,

CO2 would be badly affected by crude oil demand, while natural gas gathering would be affected by oil production.  Refined pipelines would be affected by covid.

Leverage: 2019 debt was 4.8 times EBIDTA.  Pretty high.

For operating leverage, 2019 CFO was 60% of revenue (excluding product sales).  ie: Service revenue would have to fall by that much before they start losing cash.

Valuation: Trading at a 7% trailing yield, with 2019 CFO at 2.2 times their 2019 dividend.  It would cover the newly raised dividend ($1.05/year) by 2 times.

Growth: Still growing.  They announced they were reducing 2020 capex from around ~3bn to 2.2bn.  For comparison, 2019's CFO was 5bn.

Their new projects before the announced reduction are here (slide 13).  The reduction was probably in CO2:

Long term or political risks: The usual ESG stuff.

Worst case scenario:  Again, lets pessimistically say US crude production halves.  And KMI gets corresponding reductions in revenue as customers go broke.

For Natural Gas, how much would be affected by the halving crude production?  They say that gathering and processing was only 10% of EBDA (slide 21):

I can't relate this to revenues, but assume it cashflows from this fall to zero, as revenue is halved.    Thats an 800m reduction in earnings/cashflows.

For CO2, its easier - halving 2019 revenue subtracts 600m from earnings/cashflows.

So total, we lose 1.4bn from cashflows, which is now 3.6bn.

This gives us enough to cover the 2.2bn capex, but not enough to cover the 2.4bn in dividends - the $1.05 dividend would have to be cut to 60c to be cashflow neutral in 2020.

Lets also say that their refined revenue halves over 2020, due to covid.  This is realistic - not pessimistic - but its only temporary.  KMI's refined revenue also halves, as refined fees are usually volume based.  That removes 900m from their Products revenue, they will still have 500m they could use for dividends, or around 20c per share.

Conclusion

I like Williams and KMI the best, as natural gas is not affected by covid, and is only partially affected by crude.

Although both have high leverage, I can't see any way either company fails.  The dividend is comfortably covered under normal conditions.  And both have growth potential.

KMI has slightly more short-term downside due to more refined exposure.

In general, these types of businesses are predictable and profitable.  Its the black swan risks to watch our for (like Deepwater Horizon).  Or the political ones (Green New Deal).

US Pipeline Companies: Part #1

US pipeline companies are trading at 8-10% yields.  When stocks trade at that valuation, usually it means theres something wrong with them.  But these are exceptional times.  Lets take a quick look.

All of these companies own pipelines, with most revenue from long term take-or-pay contracts that don't depend on volume.  Their revenues should hold up - unless their customers go bankrupt, which is what the market is concerned with.

I'm trying to see how badly their businesses may be affected by the plunge in crude prices.  The crude market looks terrible now, I expect US crude production to drop in a seesaw pattern for 1-2 years, then grow.

Magellan Midstream

Their business: 62% of 2019 profits are from Refined Products (pipelines from Texas/GOM, up to Wisconsin/North Dakota/Wyoming), 38% from crude (pipelines covering Permian and GOM).

Their Refined business is large enough to be irreplaceable: they provide more than 40% of refined product in 7 of the 15 states they serve, and can access nearly half of nationwide refining capacity.

Refined usage has taken a beating due to covid.  I expect it to get worse for the year - the previous outbreak hit New York, the next outbreaks will equally spread in rural/red states. Probably get a recovery in 12-18 months, as the US situation changes from lockdowns into a normal recession.  For now, refined product demand has bounced a little after falling off a cliff:

Source: Macrovoices #122 Art Brennan, slide deck

Leverage: 2019 debt was 3.1 times EBIDTA.  Pretty low.

For operating leverage, operating expenses (excluding D&A, including interest and G&A) were about half 2019 transport/terminals revenue.  ie: revenue would have to fall by half before they start bleeding cash.

Growth: Limited.  They are paying out most of their cashflows as dividends.

Valuation: Trading at a 9+ percent trailing yield, estimated payout ratio 90-100%.

Long term or political risks: Gradual decrease in fossil fuel usage, replaced with electric cars/trucks/planes.

Worst case scenario: Lets say US crude production halves, and Magellan's crude revenues (620m in 2019) halve with it (half their customers go bankrupt).  Rough guess, this removes 300m from their profits, reducing the CFO by the same amount, and dividends by 1/3rd (slide 10).   So even if you think US crude production is permanently and badly impaired - which I don't - the dividend is still 6%.

Long term, I don't see Refined dropping.  They are under long term take-or-pay contracts.  The problem is if their customers go bankrupt during the lockdown period.  I estimate lockdowns will be on/off in different states for another 18 months.

Conclusion: 
I can't see any risk to this company's long term prospects, and I think their cashflows/dividends may take a temporary hit before going back to 2019 levels.  Short term, if their dividends drop, so does the share price.  Long term, its a cyclical play where you're paid to wait.  The only downside is limited growth.

Enbridge

Their business: 2019 EBIDTA breakdown:

• Liquids Pipelines.  A series of pipelines transferring crude through Canada to the US.  Also covers most US shale basins, handling 25% of all US crude.  Tolls on the Canadian Mainline are based on volume (pp14-15), tolls on the US interstate pipelines are long term take-or-pay.  56% of 2019 EBITDA.
• Gas Transmission and Midstream.  Long continent-spanning pipelines transferring gas from Canada to the Vancouver/US, and from US producing fields (especially the Marcellus) to consuming states.  Take-or-pay.  25% of 2019 EBITDA.
• Gas Distribution and Storage.  A regulated utility consisting of last mile distribution of gas to Canadian households.  Also an unregulated storage business.  13% of 2019 EBITDA.
• Others.  7% of 2019 EBITDA.

They are heavily exposed to crude oil volume:

• Its 56% of EBITDA.  
• Canadian Mainline pricing is volume based, so lower volumes will be felt immediately. Morningstar estimates that Mainline accounts for 30% of EBITDA.
• It will have new competitors: TCE's new Keystone Phase 4 is expected to be operating in 2023 (unless Trump loses) and will compete with them.  Same with the Trans Mountain pipeline.
• Meanwhile, Canadian crude output has fallen due to low prices.  Canadian crude usually trades at a large discount to WTI, because it is landlocked, and must go to the US for refining.
• Canada's crude production is also energy intensive (like using steam to melt bitumen), so have high fixed costs, despite unlimited reserves.
• So I think Canadian crude producers are marginal producers.  They may do very badly during this crude crisis.

Enbridge's US interstate gas pipelines (TETCO) distributes gas from the Marcellus down to the Southern US, and is irreplaceable. It would also be unaffected by crude.

So we have 30% of EBIDTA serving marginal (ie: Canadian) producers on volume contracts, in a market crunch, with long term competition coming up.  And another 26% on the US side under take-or-pay (where we would only be worried about customer bankruptcies).  With the 38% of EBIDTA being stable.

Conclusion:

I don't see this as a dividend stock, but more cyclical, levered to WTI (actually to the WTI and WCS differential).  If I want to play an oil price recovery, its probably better to buy Enbridge's customers (CNQ & Suncor).  Right now I'm looking for steady dividend stocks.

Enterprise Products

Their business: Their business segments by 2019 Gross Operating Margin (similar to EBITDA - p83) is 49% NGLs, 25% crude, 13% Natural Gas, 13% petrochemical & refined.

What are NGLs?  Natural Gas Liquids extracted from natural gas at the wellhead.  Different NGLs have different uses, in industrial, heating and transportation:

Source: EIA

In general, the 'wetter' the gas, the more NGL's it has.  So dry gas (from the Marcellus) has less NGLs than associated gas (from shale oil):

Source: IHRDC training course: Gas Processing and Fractionation.

EPP's NLG pipeline covers most shale (oil and gas) in the west and south US:

Source: EPP System Map

EPP's NGL processing revenue is currently mostly fee based (top of p5)... ie: based on volume, with contracts lasting one to ten years.  Their NGL pipeline revenue is also volume based (p7).  Their NGL fractionation revenue is a mix of volume, and commodity prices (bottom p11).

Given these, their EPP's NGL earnings are dependent on crude prices.  First, as associated gas production falls, NGL production falls with it, affecting their volume based payments.  Second, associated gas has more NGLs than dry gas.  The effect on falling crude on NGL supply/demand is very complex.

Lets look at crude (13% of Gross Operating Margin).  Their crude pipelines cover the Permian, Eagle Ford, Haynessville and GOM, with pipes running to Cushing.

I'm guessing that most of their crude is from shale, and will decrease as prices drop.  Their crude pipeline profits are volume-based (bottom p15).  So dependent on crude oil prices.

Their Natural Gas assets (13% of Gross Operating Margin) seem to be around shale oil fields (except for GOM):

And profits are volume-based (bottom p20), so this is again dependent on crude prices.

For Petrochemical and Refined (13% of Gross Operating Margin), they do not say specifically, but I guess they are dependent on the economy.

Conclusion:
I like EPP's long term track record, but all their business segments could be exposed to falling crude production.  I can't estimate how much.  Too risky now.  I may look at them later as a cyclical play if they are hit by falling crude production.

Oil Prices

Two MacroVoices interviews with Dr Annas Alhajji and Art Berman give an optimistic long term view on the crude oil market.

 Dr Annas Alhajji (22 June 2020):

• The surplus is now 180m barrels in inventories in OECD (excludes China), Saudi Arabia is trying to eliminate it.
• Comparing now and 2017: in 2017, oil inventories decreased 152m bbl in 10 months,.  This was done by the Saudis cutting production, US oil production increased by 1.2m barrels per day in that period.
• This time, the rest of the world is cutting production.  US production is down by 1.8m/day compared to 2017.  Libya is at 30-40,000 barrels/day, down from 1m in 2017.  Venezuela now 600k down from 1.9m.  Iraq exports are half of 2017.  Brazil, Norway, Ghana have increased, but small amounts.  Overall, we will get serious supply side issues in the future.
• Estimates the rebalance of the oil market will take a year.  Picture is way brighter in the next few months than people believe.
• Shale: only 25% of oil has being brought back, (due to price differentials between WTI and oil areas), once the differentials improve, will see major comeback.  Expects all major companies shale wells to come back online, but there is a problem due to lack of new drilling, needed to offset rapid shale declines.  Major decline may last for 2 years.  Thinks will bottom around 9.8-10m US production, then see a recovery.

Art Bernan (18th June 2020):

• US Production is down from 13.2m bpd to 10m
• Unlikely to see negative WTI again.  The govt has opened up strategic reserve space (to lease to store oil).  And the market should resolve any issues if it happens again.
• Can oil production be switched on and off immediately?  For shale (45% of US production), yes - barring occasional repairs, you can switch on/off production with a few clicks on an ipad.  For conventional, no. 
• The  current rally is just a relief rally, too many people were short oil.  There is still too much oil around (slide 11).
• Decline rates have been increasing with newer wells. 
• Time from rig to first oil production is around 10-12 months.  Estimates 16 months lag from when oil prices rise to make shale profitable, to the time the first shale can be drilled.
• So he expects the oil price to recover, longer term: "And that next down is going to be a buying opportunity. Because it sounds to me like maybe there’s a few more waves up and down along the way, but eventually we get a moon shot when there is a full economic recovery from this crisis and the industry is just not able to respond quickly enough."   [My notes: And I guess the recovery could be around 16+ months....]
• Slide 13 shows current recovery in oil consumption so far.  It has not recovered yet.  And the recovery has been mostly in gasoline.

Equinor

Crude oil trading at negative prices is not sustainable.  How do I play it when it recovers?

Equinor (formerly Statoil) is Norway's state owned oil company.  It has very low production costs, operates in stable jurisdictions, and has reasonable finances.

I got this idea from Vitaliy Katsenelson's Contrarian Edge.

All numbers are from their 20019 Annual Report ending December (pre-virus, and pr oil crash).

Business

What do they do, and where are they exposed to?

• Almost all their profit came from Norway E&P, which consists of 70% oil, 30% Natty & NGLs (by revenue).
• Next are their operations in the US (p38), which produced around 10-20% of their oil, natural gas and NGLs.   What and where do they produce?  By revenue, most should be GOM oil.  By BOE, most is Marcellus natural gas.  There is very little shale oil - there's some from the Bakken, but their Eagle Ford assets were sold off in a well-timed November sale.
• Their International E&P (including the US) made a small loss.
• This is offset by their Marketing, Midstream & Processing making a small profit.
• They have a stake in 7 wind farms.  Makes for nice ESG photos, but meaningless for profits.
• They own an insurance company!  I think it insures the parent against operational risks (eg: workmen's compensation).  Again, not meaningful for profits.

So basically: Norwegian offshore oil production, followed by US and international (mostly) offshore oil production, followed by natty.  Minimal US shale oil.

Finances

Net debt (including IFRS 16 Leases) are 22bn, of which 4bn is due this year.  Another 4.2bn is due in 2021 and 2022.  They recently raised 5bn very long term debt on good terms.  I am ignoring long-term financial investments, which are required for insurance.  2019 interest payments were 1.5 billion.  All debt is fixed rate.  Its in a mix of major currencies (p198), but "normally swapped into USD".

2019 operating profits covered interest payments by 6 and a half times.  CFO covered it 15 times.

Despite the large debt, I don't think they have to issue new shares.  I think their status with the Norwegian government allows them to issue debt cheaply.

Net Debt has dropped from 33bn in 2016 to 22bn now.

Its unclear to me how much of their production is hedged.

Production Costs

They state they have breakeven prices for different projects between $11 and $40.  Not sure if that is extraction or full cycle costs.

In March they stated they can be "organic cash flow neutral before capital distribution in 2020 with an average oil price around USD 25 per barrel for the remaining part of the year".  I interpret this to mean their overall cash breakeven is $31 Brent.

Reserves

Charting their oil (not BOE) reserves:

Relationship with oil price

EQNR's stock price seems to follow Brent:

Conclusion

Good company that meets my criteria:

• Operates in stable, lawful jurisdiction.  No geopolitical risk.
• Low cost of production
• Minimal exposure to US Shale oil.  Product priced in Brent (seaborne), not WTI (landlocked).
• Reasonable financials, although a bit too much debt.

This is not an exhaustive look, I won't buy-and-hold forever.  And the oil industry is very difficult to study.  Who really understands break-even costs, or accounting rules for reserves and E&P?  If I buy, it is just as a trade for rising oil prices.

I would prefer to buy a basket of oil companies, but am unlikely to find many (any?) that fit the above criteria.

I use Hedgeye for timing when to buy.  I am not buying now.  The economy is still shit.  Oil producers may keep overproducing for a long time because of fixed costs and hedges.  And there's a chance Brent crashes, maybe below zero, after all the oil tankers fill up.

Misc

The Norwegian government owns 2/3rds of Equinor.  Norway has the worlds largest sovereign wealth fund, so I don't think they will push Equinor to pay dividends.

If I buy, I have to buy the ADR since Interactive Brokers does not access the Oslo stock exchange.  One ADR represents one share.  There is a fee of 0.5c per ADR for each dividend distribution.  Interactive brokers has Equinor as STL (Statoil).  Witholding tax for dividends should be 15% for Singapore residents (p8).