Monday, April 11, 2016

Unleveraged Commodity Companies

The FRMO quarterly call [pdf] had some thoughts on optionality of unlevered oil producers:

"Let’s take oil as an example which, I should warn you, isn’t necessarily reflective of what we might have in this fund. Let’s say I wanted to buy an at the money call option on oil. Oil is $30 a barrel, and I want to buy a call option exercisable at $30, and I want it exercisable over the course of 20 years. The writer of the option would calculate the strike price as known, the option expiration period of 20 years, the volatility of oil and then ask some truly astronomical sum as a price for that option. But, effectively, you can buy that option in an unleveraged commodity company, and you get it for free. If you can find one that’s making some money, if you think about it, it’s actually a negative premium."

16 comments:

Unknown said...

I don't understand their argument. The option is for a fixed amount of oil, while the commodity producer's reserves are steadily depleting. And if the producer spend money to replace reserves, the replacement costs will tend to track the price of oil, offsetting the optionality.

Anonymous said...

I spent a fair bit of time thinking about these comments and building a universe of things that match their criteria.

It's a mistake to think that they're solely about oil. If you dig in to their portfolios, plus the sorts of things they've made available in their research (the stuff on their websites + the things they'll send you if you ask) you start to see that the universe they're referring to is larger than just oil trusts.

They themselves say there aren't many of these things that they like, hence the concentration.

C

Anonymous said...

In fact, I'd argue that the oil example was perhaps a little bit of creative misdirection on Murray's part.

C

CP said...

Very interesting! What else is in the universe?

Anonymous said...

The HK guys say some weird shit. I remember one of them saying they bought Sears Canada after reading about some SCC property sales in the newspaper. They took the sales price (which were for trophy properties) and applied it to SCC's entire sq footage, and therefore determined that SCC was a bargain. I pretty much quit following them after reading that.

CP said...

Right, like many value investors they fall in love with companies.

TPL was cool and all but when a chart goes parabolic you have to be getting ready to sell:

http://www.barchart.com/chart.php?sym=TPL&t=BAR&size=M&v=1&g=1&p=MO&d=X&qb=1&style=technical&template=

Anonymous said...

I think the things they're looking at include things like Royal Gold, Anglo Pacific, etc. Companies that are actively building royalty portfolios, or who are sitting on land with royalty income from said. Stahl has said in his research that he views oil trusts like call options, so they're certainly in the mix. There are oil & gas companies that aren't royalty trusts but rather just manage vast tracts of land and develop royalty portfolios from said. But IMO, the analogy is more apt for the actively managed royalty companies.

There's a decent number of smaller, more marginal companies who are actively building royalty portfolios. The key is getting to a critical mass where you have enough cash flow to reinvest into more royalties.. I guess with enough research, you might find something really interesting. But like he says, not for the faint of heart.

I'm only speculating, so caveat emptor - naturally. The more I looked at these things, the more I felt that the entire space goes straight in to the too hard basket.

C

CP said...

Have you looked at DMLP?

I know they also like SLW.

Too hard because of the commodity price variable?

eah said...

The price of oil is up, what, 50% or more in just a few weeks? Unnatural 'market' moves -- cannot see how you can do anything intelligent in that space -- too much speculation pushing the price who knows where.

Anonymous said...

I haven't look at DMLP, no. Will check it out.

Partly because of the commodity price variable. Party because - especially with the smaller companies - there's execution risk. Partly because I don't know how to assess the prospect generation side of some of their business models (Altius, Eurasian Minerals etc)

It all comes down to shrewd capital allocation, a good balance sheet and revaluation of the royalty streams with rising/falling receipts. The first is not really clear in real time, the second is generally lacking outside the bigger operators, the third is a head scratcher.

I'm no expert, so open to any thoughts you have.

C

CP said...

It seems like if you could buy these oil royalties at 1x PV-10 at $40 oil, it would probably work out well for you.

When they were trading at 1.5-2.0x PV-10 at $90 oil, not so much.

Anonymous said...

Certainly. One of the things that struck me about the way FRMO is structuring their exposure is it seems like the investment is in the general partner. If they do selectively buy beaten down oil trusts in a more general equities rout (that they seem to be expecting), the distributions will partially flow through to the GP, but with none of the volatility. The yields could be quite interesting. I could be reading that incorrectly though.

C

CP said...

I can't remember them talking about that. He's been on the subject of indexing for a while now.

Are you a new CBS reader?

Anonymous said...

They've raised a lot of cash - in FRMO, in the Kinetics Funds + Stahl has mentioned that the hedge funds are more hedged.

Have read for a while. Never really commented though.

C

CP said...

This guy's surveillance of royalty and E&P co's can be useful:

http://www.mcdep.com/

Anonymous said...

Wonderful. Thank you!

C