Brief notes from the Grant's conference

let's go make money in oil & gas stocks?

Jack-up rig

I was able to attend the Grant’s Fall Conference virtually and several of the presenters centered their thoughts on the oil & gas space, including Leigh Goehring and Adam Rozencwajg. G&R do great work, have solid numbers, and I would personally hire their company to do investment work in the hydrocarbon space.

G&R gave their thoughts on the virtues of hydrocarbons and the impediments to renewables. We’re running out of O&G, we can’t replace it fast enough, the gas in the Haynesville and Marcellus has peaked and are on their respective decline curves. Renewables suck right now and simply won’t be able to make more than a toehold in our lifetimes if the world wants to continue growing. More macro-history-ASMR style information on wood-burning vs. coal vs. O&G vs. nuclear. Short answer to all of our woes as a society is truly nuclear power.

Darren Maupin of Pilgrim Global, possibly the greatest living public markets investor (not joking- look up his numbers), also presented more pointedly and gave his thesis on the offshore drilling industry. Technology has pushed jack-ups and floaters down the cost curve; bankruptcies have taken the industry from 13 listed businesses to 5. Clean balance sheets, limited competition, pricing power and restricted supply have created businesses that trade at comically low free cash flow multiples and fractions of replacement cost. Noble Corp (symbol: NE) fits this bill pretty well. Theses like these are generally in my wheelhouse: high current earnings that could go away (but in this case it really is a service business, not a directional commodity bet nor an operating leverage story) buttressed by compelling asset value.

Similarly, there have been other O&G businesses that I’ve looked at and tried to evaluate: Laredo Petroleum, Chord Energy, Civitas Resources, among others that have tangential connections to O&G.

“Don’t buy cyclical companies on a low-current-P/E-ratio thesis” is sound investment advice. Peak-cycle earnings are hard to see through, especially with promotional management teams and bad balance sheets that can’t handle cycle troughs. Despite this truism, it’s also a tautology. If current earnings are peak earnings, of course they’re unlikely to replicate and forward numbers will surprise to the downside. But if they aren’t peak earnings then what’s the problem? There have been no major O&G transactions, IPOs, credit issuances or any other major capital flows into the industry. G&R have done some great work on this- the industry is self-cannibalizing, with capital returns taking precedence over drilling, and environment activists joining the board of the former Standard Oil(s) to discourage production:

From G&R’s Q2 commentary page

I can’t find the precise chart but capital returns are either currently exceeding or on their way to exceeding exploration capex industry-wide. It seems that a prudently hedged production-based business in the O&G space could rationally trade to at least its PV-10 and possibly to a double-digit earnings multiple if capital were returned in a utility-like manner. Margin visibility is what analysts crave with input costs rising so if management can prove they can manage that, you could see an industry-wide re-rating.

Of course, no O&G management team is to be trusted whatsoever to put capital into the ground (i.e. exploration). If these businesses can prove that they’ve kowtowed to public markets demand for buybacks and dividends, I’m interested in investing. The offshore guys, the E&P guys, virtually all of it looks interesting, even accounting for product demand destruction or spot price drawdown (I’ve skillfully couched this by saying “prudently hedged” as the futures curve remains in backwardation).

The rest of Grant’s was mostly macro oriented, with some interesting anecdata coming out of Japan. Seemed more like an FX trade than anything but the presenter, Andrew McDermott, referenced Buffett being interested in the trading businesses there. China is a mess and no one knows what’s going on there either. COVID zero is a terrible headwind and I don’t think there’s a lot of good ways to make money on country bets or FX bets. I do enjoy Jim Grant quite a bit (“he’s ASMR for finance bros”- a close friend) so it’s always a treat to listen in to the conference. Strong recommend for next year/Fall/Spring/whenever he runs the next one.