On this episode of Industry Focus, Sean O'Reilly, Tyler Crowe, and Taylor Muckerman share the stories you need to know about this week in energy.
We've spent a year seeing the market rally in preparation for an interest-rate increase, and with not much year left to go, the Federal Reserve just increased rates -- by 0.25%. In other news, solar's got a good thing coming in the years ahead, after a bill went through that significantly increases the industry's subsidies. Meanwhile, in the oil industry, Magnum Hunter Resources has filed for Chapter 11 bankruptcy protection with ecstatic promises of re-emergence, and the largest Russian oil company is thinking about selling its stakes.
A full transcript follows the video.
This podcast was recorded on Dec. 17, 2015.
Sean O'Reilly: The force is strong with the solar industry, on this energy edition of Industry Focus. Greetings, Fools! I am Sean O'Reilly, joining you here from Fool headquarters in Alexandria, Virginia. It is Thursday, Dec. 17, 2015, and joining me to talk all things energy and materials are Tyler Crowe and Taylor Muckerman. What's up, guys?
Tyler Crowe: Going pretty good.
Taylor Muckerman: Interest rates, that's what's up.
Crowe: Interest rates, oh my God.
O'Reilly: That actually leads us right into our first story here. Everybody run for the hills, God help us all, the Fed just jacked up rates 0.25%.
Crowe: And then... nothing happened.
O'Reilly: Well, the market rallied, but it just gave it all back.
Muckerman: Is it down today?
O'Reilly: Yeah, it's down what it was up yesterday.
Muckerman: 1.5% today?
O'Reilly: That's right, it kept rallying.
Crowe: Yeah, it kept rallying after Yellen kept talking, and I was like, "OK, you apparently like what she's saying?"
Muckerman: Basically, the economy's strong enough, and interest rates aren't rising fast enough.
O'Reilly: Yeah, do you guys care about this?
Crowe: We were just talking about this beforehand. This is my personal opinion -- the Fed rate hike was a lot like, I think, the Y2K scare back in 1999. Everybody was panicked about it, and people were talking about all these hypothetical situations of what could happen --
O'Reilly: All the nuclear weapons are going to go off at once.
Crowe: Yeah, how it was going to be this staging point of inflation.
Muckerman: "Algorithms aren't going to know how to handle non-zero interest rates!"
Crowe: Yeah, because we've had zero interest rates for seven years, and we jacked it up 0.25%, and everyone just went, "Blah, whatever."
O'Reilly: They're saving the confetti for New Year's.
Muckerman: I mean, the only thing as I could see is, higher interest rates might lead to a stronger dollar, which could lead to more pressure on oil prices.
O'Reilly: The dollar has already rallied in anticipation all year.
Muckerman: Yeah, that, and other countries are easing monetarily. In the last seven years, we've tapered off that, but other countries are following suit, so their currencies are getting weaker. We're the strongest country in the world, so our dollar is reactive currency.
Crowe: Yeah, and it's funny, it does work to our advantage a little bit. Going to the energy sector, we've been talking a lot about the oil boom, natural gas boom in the United States. We're still a net importer of oil. So, with a really strong dollar, we're getting... well, it is denominated in dollars compared to other people, but on imports, we get a pretty big bang for the buck when we're talking about the dollar right now.
O'Reilly: Actually, on that note, first time in 40 years, U.S. producers are allowed to export oil. What's up?
Muckerman: What?
Crowe: Again, another blah moment. It's something we've been talking about for years, when's it going to happen, and then it happens right when oil prices are in the tank and we've had the narrowest spread between domestic and foreign --
Muckerman: But is that on a dollar value or on a percentage value? Because prices are low. I didn't dive in to look at the exact number of the spread.
Crowe: I don't have the numbers in front of me, but it was pretty close. I think there was actually a point last week where West Texas Intermediate sold at parity to Brent.
Muckerman: OK, then, even on a percentage basis, it's closer than normal. Because, yeah, there had been like a double-digit percentage gap there for a while.
O'Reilly: The irony is, they did this after U.S. production finally seems to be pulling back, and they're willing to list it now, I guess, because we're actually producing a decent chunk of oil here, even though we are still importing a decent amount. Is this good for us? Not necessarily just as a country.
Muckerman: I don't know. We're not the cheapest producer in the world, so I don't know if we could sell at the cheapest price on the market. We'd still have to ship it. Mexico produces its own oil, Canada produces its own oil, those are some of our biggest trading partners. I would imagine they're both in the top three or top five. So I don't know who we're going to send this oil to, necessarily.
O'Reilly: Well, Tyler, what were you telling me six months ago about how refineries --
Crowe: It's got to do with quality of oil and our refinery capabilities.
Muckerman: Yeah, because we were built for Middle East oil.
Crowe: Middle East oil, heavy, nasty crude that we could actually turn into ultra-low-sulfur diesel and gasoline. The theory now is, we're producing a ton of light, sweet, very easy-to-refine, high-yield-on-gasoline crude oil. And outside of the United States, refinery complexity, it's a measure of people's ability to take crude and turn it into high-yield products. Outside of the United States, refinery complexity is quite low.
You look in a place like India, on what is called the Nelson complexity index, they have refineries in the three to four range, which is quite low, versus a majority of American refineries are in the nine, 10, 11 range for refinery complexity, which means that we can take that heavier oil --
O'Reilly: There's a little bit of an arbitrage here, is what you're saying.
Crowe: A little bit, yeah. Because that heavier oil normally sells at a discount, because there's not a lot of people who can refine it. So, the idea is, we can take that really bad oil, turn it into refined products here, and sell it at a market rate --
Muckerman: Which is largely Canadian and Mexican oil.
Crowe: Exactly, and then take our nice premium oil and sell it somewhere else at a higher rate than we can take in cheaper --
Muckerman: You said that with a jig, by the way.
O'Reilly: Oh, yeah, for those of you who can't see. Tyler, you have some moves there.
Crowe: I know, right?
Muckerman: It's the interest-rate dance.
Crowe: Speaking of that -- I don't know if you guys saw this, but there's another news site called Quartz. I feel we should have gotten this: There were actually commemorative T-shirts that said, "I survived the Fed rake hike of December 2015," and it had the chart of federal interest rates.
O'Reilly: Yellen was talking about, by the end of 2016, being up just over 1%. So I want to have a "1% or bust," or something.
Muckerman: What year?
O'Reilly: End of 2016, a year from now.
Muckerman: OK. We'll see.
O'Reilly: "1.25% or bust."
Well, before we move on to discussing the Christmas present that Congress gave the U.S. solar industry, I wanted to point our listeners to the newly redesigned focus.fool.com. There, you'll discover a special offer to join the Motley Fool Stock Advisor newsletter for all Industry Focus listeners. All loyal IF listeners have access to a special discount on Stock Advisor that works out to $129 for a full two-year subscription. And if you join, as part of your Stock Advisor subscription, you can check out exclusive content from Tyler Crowe's and my recent trip to Houston, Texas, where we interviewed executives from National Oilwell Varco and DistributionNOW. I don't know if you want to add anything there, Tyler. It was a good time?
Crowe: Great interviews. I sat down with CEO Clay Williams for over an hour, just talking about the business in general. A lot of the things that you think about as a long-term investor, not just, what are the margins and that stuff, but stuff like leadership, corporate culture, what has allowed them to blossom as a corporate leader in the oil and gas space, beyond just "They've got a good balance sheet." So if somebody's looking to get into the people end of the business, it certainly was a great talk.
O'Reilly: And DistributionNOW, I interviewed the CEO, Workman, and he noted how he and his team, they have leadership classes once a month or something, they hand out books and stuff. So it's definitely in their DNA to focus on culture and stuff.
Crowe: Yeah, it was really fun to see in contrast with some of the stuff that we talked about on an everyday basis.
Muckerman: Probably thank Pete Miller for that.
Crowe: Oh, it totally was, because when we went to go do [the interview], Robert Workman actually did mention, "Well, we weren't planning on doing this, but I sat down with a beer with Pete Miller." And he was like, "Oh, I got this interview request from over at The Motley Fool --"
O'Reilly: "These jokers over at The Motley Fool."
Crowe: "I don't wanna do it." And Pete Miller was like, "You go on, and you do that."
Muckerman: Respect my authority!
O'Reilly: So, guys, I don't know if you've noticed, but solar's got a little bit of a pop.
Crowe: Something like that.
Muckerman: A little bit. As hot as the surface of the sun, those stocks.
O'Reilly: Congress gave them a Christmas season.
Crowe: It's the season of giving.
O'Reilly: They extended the tax credits, God bless us, every one.
Crowe: They gave the oil industry an export lift.
O'Reilly: The Republicans had to give something to the Democrats.
Crowe: "You get a subsidy! And you get a subsidy!"
O'Reilly: The extension actually went further out than I thought. It goes into the 2020s or something?
Crowe: And even beyond.
O'Reilly: Give us the primer.
Crowe: This is the proposed bill that's on the omnibus spending, what's been added. Basically, instead of the investment tax credit at 30% basically getting chopped for all residential in 2017, and down to 10% of commercial, it's being extended all the way out to 2019 at that 30% rate for both. And then, in 2020, it goes down a few percentage points, 2021, it goes down a little further, and then at 2021, it goes down to 10%.
Muckerman: Which is what it should have done in 2016, right?
Crowe: Right, but that's for both residential and commercial -- 10% for what appears to be perpetuity. They don't seem to have a real limit on when that 10% subsidy goes down.
O'Reilly: Taylor, did this throw off any Excel spreadsheets for any businesses?
Muckerman: It sure seems so, if you saw SolarCity (SCTY +0.00%) sell off about 50% just a few weeks ago, and now it's up 100% back to where it was. So, yeah, some people didn't see this coming. This tax credit cut was looming over everybody's head. Now, they're getting it back for a heck of a lot longer than I think anybody would have expected. It's amazing what they can stuff inside a bill that has to pass Congress before it shuts down.
O'Reilly: Because that was a $1.1 trillion spending bill.
Crowe: It was a big one, yeah. Just give everybody enough to sweeten the pot a little bit to keep it going. But one of the interesting things, like you were saying, the big sell-off in SolarCity, one of the reasons it did have that sell-off was, on its most recent earnings, they were talking about scaling back gross and working within their cash flows.
Muckerman: It was actually making a profit, but it sold off.
O'Reilly: Well, they lowered their growth profiles. But it was like, "We're only going to grow at 60% per year, or something."
Crowe: It was kind of an admission that the federal tax credit in 2017 was going to have a pretty large impact, and we're going to try to adjust our business model before it got there. Not driving to the edge of the cliff at 60 mph and then trying to hit the brakes. They were trying to tap it before it actually happened.
O'Reilly: You guys may or may not know the answer to this --
Muckerman: Thanks for the confidence.
O'Reilly: I feel like I'm about to get a "Congress isn't that smart" comment, but did anybody look -- when picking the year that these would drop to the 10% or 0% that they were going to drop to next year -- just about efficiencies of solar cells and everything, by the end of the decade, we think these will actually be competitive to where we don't need to subsidize them?
Crowe: I really doubt somebody in Congress did that.
Muckerman: Not because they're stupid, but because this is not their avenue of expertise. Solar experts could have predicted that.
Crowe: Yeah, maybe a solar lobbyist would have been able to chirp something in somebody's ear, but I have a hard time thinking members of Congress are looking --
O'Reilly: So they picked these years out of a hat.
Crowe: -- really intensely looking at cost per kilowatts of installation of the solar panel, and saying, "Yeah, if we start to taper at this rate, we'll be good."
O'Reilly: I'm giving them too much credit, I'm sorry.
Muckerman: It was pretty interesting at the Paris conference, and another speech recently, Elon Musk was talking about, if you just took a small corner of Nevada and covered it completely in solar panels, you could power the entire United States.
O'Reilly: What about transmission lines?
Crowe: That's the problem, right?
Muckerman: Yes. If you imagine breaking that up and putting it in four corners of the United States, the same acreage --
O'Reilly: Maine is not a good place to put solar panels.
Muckerman: Well, New Jersey is one of the biggest solar states in the country in terms of growth over the last five to 10 years. So, clearly, somewhere in the Northeast, we could do it. And then, this other article I read said if you just covered the entirety of Spain in solar panels --
O'Reilly: Europe's good to go?
Muckerman: No, you power the entire world.
O'Reilly: Oh. Wow. Spain. Wow.
Muckerman: That's all it takes at the efficiency we're at now, so imagine if we get more efficient.
O'Reilly: Which is, I don't know, at best 23%?
Muckerman: Something like that.
O'Reilly: Cool. Moving on to -- another one bites the dust. Magnum Hunter Resources files for Chapter 11. I think this company was a penny stock?
Crowe: It was close.
Muckerman: There's a few of those penny stocks out there in energy parts.
Crowe: They're not the only one, yeah.
Muckerman: It was a $2.5 billion company in 2014, at its peak.
O'Reilly: Yeah, so, was this just, was their cash flow that bad? A lot of people are doing a lot of finagling right now, and these guys just couldn't? Was it that bad?
Muckerman: Well, if you look at their balance sheet over the last three of four years, you can see that debt-to-equity, debt-to-capital creeping up and up. It was like, 40%, 60%, 100%, 170%, and now it's just too late. They can't survive. Their income was decent; they suffered this year. But interest and coverage ratios just weren't there. This was a darling of the shale patch for quite a while.
O'Reilly: Where were they operating?
Crowe: Marcellus and Utica. In terms of an attractive place to be --
O'Reilly: Yeah. They weren't in western Pennsylvania or Michigan or something.
Crowe: No, they were.
Muckerman: Yeah.
O'Reilly: I should have guessed.
Crowe: They were in Ohio, right near my home state. You don't have one of their rigs in your backyard?
Muckerman: Not anymore. It's owned by some bank now.
Crowe: Also, on a small side note, I find, there are certain CEOs in the energy industry who are very good cheerleaders for their stock, for their industry, or whatever. And the CEO of Magnum Hunter Resources, I'm sorry, I don't have his name in front of me right now, he is an amazing cheerleader, and can find -- he can put lipstick on the ugliest pig. One of the statements that he made was, "This is going to be an unprecedented move that's going to make Magnum Hunter Resources --"
O'Reilly: Gary Evans?
Crowe: Yes. "It's going to make Magnum Hunter Resources a stronger company, they're going to re-emerge as one of the leaders in the shale patch again." And I was like, your company just filed for Chapter 11, and you're talking about how wonderful this is going to be.
Muckerman: Above all hope.
O'Reilly: It's just a reorganization, Tyler.
Muckerman: What a great organization.
O'Reilly: Did he get a golden anything?
Crowe: No, he's still there.
O'Reilly: It's just a reorganization, like I said!
Crowe: A golden opportunity to wipe out all shareholder value and turn all the bond into equity later on. Thinking about this a little more broadly, one of the things that I think is holding the industry back, we talked a lot over the year, "We need to see some bankruptcy so that production will roll off, and it'll help correct prices." But, as this says in their Chapter 11 --
O'Reilly: They're going to keep pumping, baby.
Crowe: They're still pumping. And a lot of these companies that are filing for Chapter 11 are still producing, and it's not really helping the situation, because they have to find some way to pay off all those debts, and the only way they know how to do it is pump oil. So if we're not losing production from companies going bankrupt, where are we going to lose it?
O'Reilly: Obviously, their capex will drop, because it's really hard to approve the capex budget in bankruptcy court. So, naturally, those will decline, I would hope.
Muckerman: An immediate drop isn't going to take place, but eventually.
O'Reilly: Yeah, I would think decline rates are the only saving grace there. So, we'll see. Moving on from western Pennsylvania to --
Muckerman: Where are we going next?
O'Reilly: The Russian Federation! Oh, there are so many fun jokes we're going to be able to make with this segment. Russia is for sale. Anybody at the table want to buy anything there?
Crowe: Uh...
Muckerman: Not I.
O'Reilly: No?
Muckerman: No.
O'Reilly: You don't trust Putin to not take your assets or anything?
Muckerman: Yeah, I'll stick to American shale patches.
O'Reilly: An article in The Wall Street Journal states that Russia could sell a stake in Rosneft to bolster its finances. I guess I could sell it to the mafia?
Muckerman: The shale geopolitical war is working. Russia's crumbling.
O'Reilly: I mean, I know Russia is hurting. Their currency's crashing. But we don't know too much about their budget, do we?
Muckerman: Well, we know they're not meeting it with current oil prices. Other than that, they have the reserves --
Crowe: I think it's something like 40% of their federal budget is tied to oil royalties.
Muckerman: They're producing at record levels... because prices are so low.
Crowe: We're going to make it up on volume! No, I'm just comparing them in my mind to the budget of Saudi Arabia, because it sounds crazy, but I'm pretty sure Saudi Arabia is more open and honest about their budgets than Russia.
Muckerman: They might be. Maybe. Probably because America has a little bit better relations with Saudi Arabia.
O'Reilly: Who would buy this, Tyler?
Crowe: Well, BP bought it seven years ago. BP has almost a 20% stake in Rosneft. To be honest, I would not be surprised --
Muckerman: How's that working for them? Clearly not great, if they're trying to sell --
O'Reilly: Fool me twice, shame on me.
Crowe: They get a couple hundred million dollars in dividends every years.
O'Reilly: Pay a few salaries.
Crowe: I would not be completely surprised if you did see a big oil company come in and take a small slice of the pie. BP is obviously there, so it's not like this is completely, what would you say, a fixed book or something?
O'Reilly: Actually, all joking aside, wasn't it ExxonMobil a year or two ago, when the Crimea stuff started to happen and we were all like, "Rrrr, Russia is terrible, blah blah blah." And Exxon said, "No, we're just going to keep doing business with them, it's fine."
Muckerman: Yeah, they didn't shake it off. I don't know if it was Exxon, but I remember a story about a big oil company doing that. If you want access to the Arctic, this is a pretty decent shot.
Crowe: If you want access to the multiple-billion-barrel shale oil reservoirs in the Bazhenov and things like that, you need to have some partner in Russia. And ExxonMobil has worked with Rosneft extensively over the years. I would not be completely surprised if -- and we say we wouldn't buy it, obviously, as individual investors, it would be difficult. But I can see a big oil company looking at that and being like, "Eh, it's not a bad idea."
O'Reilly: Do these companies worry about being lied to?
Muckerman: Who knows. They deal with China, they're champing at the bit to get back into Iran as soon as that was reopened back up. So, they're not pouring all of their eggs into these terrible countries. One rotten egg here, one there, one potentially rotten egg. So, they're not totally putting their company on the line with these bets.
Crowe: And you also have to give these big companies credit because oil is what you call a geopolitically critical resource. You have companies that are national oil companies, basically run by states in certain places, and all of these integrated majors work with them, in most of these places. And you almost have to give them kudos for being able to manage the political minefield that it is, actually getting through this.
O'Reilly: We've got better politicians at ExxonMobil than Congress.
Crowe: Maybe better diplomats.
O'Reilly: Yeah, diplomats.
Muckerman: Another safety blanket, though, is these countries need to produce oil, since they are mostly are state-owned.
O'Reilly: They need the technology.
Muckerman: So, like, Saudi Arabia is not going to let the oil industry fail. Iraq's not, Russia's not. So they're going to step in, and they're going to take the necessary precautions to ensure that these state-run oil companies are --
Crowe: Total signed a deal.
O'Reilly: I was going to ask you about them.
Crowe: Earlier in the year, they signed a deal with the Abu Dhabi on-shore petroleum company, and it's been a commission project. And it has some of the lowest-cost production, and it's actually been one of the reasons that Total has been successful these past few quarters, and remaining semi-profitable on its upstream production versus other companies.
O'Reilly: Well, that's it for us, guys. If you're a loyal listener and you have questions or comments, we'd love to hear from you. Just email us at [email protected]. And before we go, guys, it is book week here on Industry Focus. What are some of your favorite investing books?
Crowe: I guess I'll start. Probably two. One of them, I really doubt -- I wouldn't say go out and buy it. If you can find a copy that a friend has --
O'Reilly: A free giveaway pile.
Crowe: Don't buy it. On Amazon, it's $1,600, don't buy it. It's Seth Klarman's Margin of Safety. Great book.
Muckerman: There are PDFs online, you can find it, I have it on my Kindle.
Crowe: It's a really great read; it's kind of a more modern version of The Intelligent Investor. I think it's a really good one. Or, if you're looking for something a little bit simpler, I really like The Little Book That Builds Wealth by Pat Dorsey.
Muckerman: The author has said he doesn't mind if people use the PDF. It's expensive because it's no longer produced, so it's a collector's item. So, don't feel bad if you're going out and reading a PDF form. He put it out there for the general investing population to learn from.
My book, I'm gonna stick with energy, I'm going to say The Frackers, because if you don't understand what's going on in the shale revolution, how it came about, who were the key players that got it kick-started --
O'Reilly: Who wrote that?
Muckerman: Gregory Zuckerman.
Crowe: We actually did an interview with him last year around this time.
Muckerman: Yeah, it came out last summer, or somewhere around there. But it's not necessarily an investing book, but if you want to understand how the heck we're doing what we're doing, and what's actually going on behind the scenes, tremendous read. It's a great story, too, so you're not just sitting there, "Oh my God, this is so confusing, all this petrochemical science!" It's nothing like that. So give it a shot. It's a short read.
Crowe: A Wall Street Journal reporter went out on the oil patch to learn about it and delivered it in a way that is entertaining.
O'Reilly: Awesome. Well, that's it for us, thanks. As always, people on this program may have interests in the stocks they talk about. The Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell anything based solely on what you hear on this program. For Tyler Crowe and Taylor Muckerman, I'm Sean O'Reilly. Thanks for listening, and Fool on!
