To celebrate the energy sector's 18th month of endemic misery, this Industry Focus episode is all about the most ominous shadows looming on energy's horizon.
Listen in to hear Sean O'Reilly, Tyler Crowe, and Taylor Muckerman talk about which three oil companies have done the worst over the past few months; how a new court ruling in Nevada has put a serious wrench in SolarCity's (NASDAQ: SCTY) business model; how an upcoming filing by two defunct companies could set a seriously nasty precedent for the pipeline space; and, what may be oil's biggest upcoming threat.
A full transcript follows the video.
This podcast was recorded on Feb. 25, 2016.
Sean O'Reilly: It's doom and gloom week on this energy and materials edition of Industry Focus.
Greetings, Fools! Sean O'Reilly here from Fool headquarters in Alexandria, Virginia. It is February 25th, 2016, and joining me to talk all things energy and materials is Tyler Crowe and Taylor Muckerman. What's up guys?
Tyler Crowe: Howdy howdy howdy!
Taylor Muckerman: (singing) We're back!
Sean O'Reilly: So, diving right in here--
Crowe: You're making it sound really bad, doom and gloom. I mean, could we have actually -
O'Reilly: What else are we supposed to do in our sector?! What else are we supposed to do?! (laughs)
Crowe: I was going to say, we probably could have called any week for the past 18 months "doom and gloom week," but ...
O'Reilly: I could have alluded to that guy who's always on Yahoo, that Faber guy or whatever, it's Dr. Doom. It's Dr. Doom day, or ... whatever, I don't know.
Crowe: It just seems like, for the past 18 months, all we've talked about is the bad news, doom and gloom. It seems like, why don't we just call it the doom and gloom show, because it's all--
Muckerman: Gone are the days of our own energy show, "Digging for Value."
O'Reilly: It's always darkest just before the dawn, Mr. Crowe.
Muckerman: Digging for value is all fluff pieces about how great energy was doing.
O'Reilly: Yeah. Okay, to your point, literally everybody is not doing so well right now. What we wanted to do was dive in and, not pick out the whole sector for stinking up the joint, but who got particularly pummeled in the last couple of months? Who did so badly that they stand out and probably deserve to go bankrupt? Or something. Who goes first?
Crowe: I hate saying that somebody deserves to go bankrupt. It's just--
O'Reilly: Nobody deserves to go bankrupt.
Crowe: It sounds so, so harsh.
Muckerman: Well, some people deserve to go bankrupt!
Crowe: Taylor's a little harsh.
O'Reilly: If you believe what Saudi Arabia said the other day, it was like--what did he say at that conference? He was in Houston, he was like--
Crowe: He said, lower costs or--
O'Reilly: Or leave.
Crowe: --get out. Yeah, basically.
O'Reilly: Thank you so much for that sound economic principle. Anyways. Alright, who's up first?
Crowe: I guess I'll start. One company that did really ... it's been kind of one that we've talked about in The Motley Fool universe for a while. I know it was a Motley Fool recommendation--
Muckerman: Yeah, a while ago.
Crowe: --for a little while, it's Ultra Petroleum (NYSE: UPL).
O'Reilly: They're nat gas mostly.
Muckerman: Don't let the name fool you.
O'Reilly: Don't let the name fool you, yeah.
Crowe: They're nat gas, yeah. Mostly involved in what's called the Pinedale Powder River Basin area up in Wyoming. It's a very low-cost, low-decline, kind of conventional natural gas area.
O'Reilly: Well, this is why they were a Fool pick. They were the lowest-cost natural gas producer.
Muckerman: It sounds like a country club, Pinedale.
O'Reilly: Yeah. (laughs)
Crowe: But, the reason that they have struggled so much is that they were levered out the nose. They just had a debt load that was, even 3 or 4 years ago, looking unsustainable. Even when gas prices were doing pretty well, everyone was like, "You know, you guys have a pretty high amount of debt on the balance sheet, what are you going to do about that?" And as we've seen over the past, I think actually, this was a quote for management that basically gives you an idea of what's happened. He says, "We had net debt of about $3.4 billion, which has been fairly consistent since 2014. However, we have had EBITDA of approximately $800 million in 2014, $600 million in 2015, and forecast $300 million in 2016."
O'Reilly: (shuddering) Oooh!
Crowe: So, basically, they're saying that, "We're kind of losing it."
O'Reilly: Off the top of your head, do you know what their cost is? Because nat gas is at $2 or something. Do any numbers come to mind?
Crowe: They're right around there, actually. Here is the issue, though, is, we've talked about them being the lowest cost, lowest cost, lowest cost. Which is great. Here's the other problem with it: its all the way up in the mountains of Wyoming.
Crowe: And because of that, and all of those gas hubs like the Barnett Shale in East Texas, and you've got Anadarko basin right in Oklahoma, those are much closer to the demand sources, so the transportation costs down at the Gulf Coast, where most of our natural gas is consumed--
O'Reilly: Every pipeline winds up in Houston, so yeah.
Crowe: --it's a lot less expensive. So, the differential price that Ultra Petroleum is going to get because of that high transportation cost, their realized cost for actually selling it, or realized price, is already baked in lower. So you can say that you're the low-cost producer, but then you also have to accept the fact that you're not going to get as robust of prices as everybody else.
O'Reilly: Got it. Man. Alright, Taylor, who had an unfairly rough last couple months?
Muckerman: I don't think they're going to go bankrupt. I'll go ahead and prequel my--
O'Reilly: Is Ultra bankrupt?
Crowe: No, not yet. But they're talking about restructuring.
Muckerman: They're talking bankruptcy as an option.
Crowe: There was a lot of talk on the conference call about--
O'Reilly: Strategic alternatives. (laughs)
Crowe: Strategic alternatives and negotiating with their creditors.
O'Reilly: "I'm going to make it ... " Anyways. (laughs)
Muckerman: Marathon Oil (NYSE:MRO). According to MarketWatch, first time in 20 years that it failed to turn a profit. So, not that great for the full year of 2015.
O'Reilly: No, because a lot of the other big name oil companies are still profitable.
Muckerman: They're still profitable based on their metrics, yeah. They're also cutting spending this year, 2016, by a little over 50%. So, they're still feeling the pain. Cutting workforce by 20%. But the big thing here is that, of that money that they're spending in 2016, 70% is going toward shale. So they're leaving very little room to spend on long-tail projects, which is going to be the growth that you're going to see in 5 to 10 years. So, I think, they're short-changing themselves by spending all this money on -- well, because they need to, they need these upfront cash flows in order to sustain capital, because they're already spending more than double their cash flow under capital expenditures in 2015.
They're expected to spend more than they're going to bring in in 2016. So they need these immediate cash flows. And that's unfortunate, because in 5 to 10 years, what are shareholders going to have to hold on to? They're not going to continue to drive huge growth from shale for 15 more years. They're going to need these deepwater projects, they're going to need these projects that don't require fracking and CO2 injections and waterflooding. They need big projects, and they're not spending on it right now.
Crowe: It's kind of interesting, because ConocoPhillips did the exact same thing when they announced their earnings a little while ago, they are moving very far away from their deepwater exploration and deepwater development projects--
O'Reilly: Those are the low-cost long-tail things you kind of want.
Crowe: I wouldn't say deepwater is necessarily lower cost ...
O'Reilly: Well, it's big upfront costs, but later down the line ...
Crowe: Right. You've lowered your decline rates, so you ...
Muckerman: You lower your production per barrel.
Crowe: So you have a more consistent cash flow.
O'Reilly: What's the decline? It's 2-3% on those things.
Crowe: A little higher than that.
Muckerman: But it's not 70%.
Crowe: It's not shale.
O'Reilly: Cool. So, my company is not an oil-related company at all, but it is your friend and mine, SolarCity.
Crowe: Yeah, I think the two of us are going to look at you very attentively here, because you have two shareholders in SolarCity looking at you--
Muckerman: (groans loudly)
O'Reilly: I swear, I did not do this just to ...
Muckerman: "Doom and gloom!"
Crowe: He's doing it just to troll.
O'Reilly: I'm sorry. Anyways, you guys know full well, I just couldn't believe that this happened. But basically, I'm referring to the Nevada ruling that changes the rules for net metering within the state. It basically made rooftop solar on economic, and they did it retroactively. As I understand it, this is not a permanent decision, could get changed in the future. SolarCity obviously just bet the wrong way on this. And (laughs) they just did not need this right now.
Crowe: I mean, not only did they ... I wouldn't say bet the wrong way, but, the minute that ...
O'Reilly: The ruling came out.
Crowe: The ruling came out, they basically fired everybody.
O'Reilly: It's like, "Alright, we're leaving!" (laughs)
Crowe: I mean, that's it, they left.
O'Reilly: When I heard that, I was just like, "Wow, this is really a big deal."
Muckerman: Well, it shows you that they're nimble, right?
Crowe: Right. (laughs)
O'Reilly: If there's a state in the United States of America that's perfect for solar ... (laughs) it's them and Florida.
Muckerman: You would imagine.
O'Reilly: Anyways. Moving on to our next segment.
Two court cases that could kill pipeline companies' cash machine. Our listeners are probably aware, if they've been paying attention to a lot of our picks, but all three of us have been saying that a lot of these pipeline players like Spectra Energy and Enterprise Products Partners and all those guys, they're kind of the babies that got thrown out with the bathwater in this huge market energy sell-off. Currently, and this is an article that was put out by the New York Times, two defunct companies, Sabine Oil & Gas and Quicksilver Resources are, among other things, seeking to get rid of long-term contracts the two have with several mainstream pipeline operators who count on the rates on these long-term distribution contracts to ... pay the dividends!
Worse yet, in the article that was put out by the New York Times detailing the situation, an unnamed judge is inclined to allow Sabine to end its contract with the Cheniere Energy subsidiary that operates the pipelines. Are you guys scared about this, and should we be selling all of our pipeline stocks now?
Crowe: This ... I'm not completely certain how to fully digest this one yet. It's one of those things, when you read it, it does certainly throw up the red flag. One of the biggest things that they're talking about in this is, throwing out minimum volume commitments, which is something that has kind of made hay for a lot of pipeline companies.
Muckerman: It's absolutely guaranteed money.
O'Reilly: So the contractors, for our listeners, between Sabine and the Cheniere Energy subsidiary, it was guaranteed volumes for through 2023. So, this is not small potatoes.
Crowe: Exactly. And so, for some of these things, you're talking about small, piddling companies. Sabine Oil & Gas and Quicksilver Resources weren't exactly the largest names when it came to selling oil and gas and using pipeline space. The bigger fear is, say you've got a large company--
Muckerman: Ultra Petroleum, for instance.
Crowe: Ultra Petroleum, or a Chesapeake Energy (NYSE:CHK) ...
O'Reilly: Every lawyer's favorite word is "precedent." (laughs)
Crowe: Exactly. Somebody like a Chesapeake Energy or something like that. Then, what if one of those companies goes to a larger pipeline company and says, "We can't meet these volume commitments anymore, we're going to take you to court on it." We've seen the effects of that over the past year. One company in particular, Williams Partners, I believe it's more than 20%, it might be as high as 30% of the revenue stream comes specifically from Chesapeake Energy.
Crowe: And with Chesapeake Energy in the financial straits that it is right now, if ...
O'Reilly: Although, they did just have an asset sale. Yay! $700 million! (laughs)
Crowe: But if this minimum volume commitment contract ...
O'Reilly: Goes out, yeah.
Crowe: ... can get torn up, then you're looking at a pipeline company who's kind of left hat in hand, "How am I going to fill these pipes?"
O'Reilly: Taylor, I don't know how to word this, so I'm probably going to butcher it, but I was curious to get your thoughts. Isn't there an argument, if you're the Cheniere Energy subsidiary or one of the pipeline companies, isn't there an argument to be made between, "Okay, listen, we've got these contracts with these guys, they're continuing to operate, our contract isn't structurally the problem, they just got over leveraged and they just need to talk with the bondholders." Isn't ...
Muckerman: Yeah, that's absolutely the case. It's like, what the hell? You signed this contract.
O'Reilly: You're still using it, probably.
Muckerman: There's always going to be a point where, you're in a contract for 15 years, that there's going to be a better opportunity out there. You can't just jump ship. The comments they made, arguing that they could save $35 million by ending the contract, and then save millions more by building an entirely new system?
Muckerman: Yeah, exactly. I could sell my gas guzzling car that's under-leased, and just cancel the lease, and go get an EV and save tons of money on gas! But I'd have to pay a fee to get out of my lease--
Crowe: And when you're bankrupt, it's kind of hard to do that.
Muckerman: Yeah, exactly. So, that's the thing.
O'Reilly: Yeah, and where's the money coming from to build this magical pipeline from the sky? (laughs)
Muckerman: This Cheniere company's obviously operating properly, because they're not going bankrupt. Why are you going to save a company that operated itself out of funds if they're just probably going to do it again if they get bailed out? I mean ... I don't understand it. You're going to let this contagion spread to a sector that has largely been absolved from it, and ... I mean ... it's just totally bonkers.
Crowe: It seems to me ... let's put in the hypothetical situation as an investor. If this is something that is legitimately an issue ... one of the ways that I think you can maybe skirt or help yourself as an investor avoid as much of this issue is to look further down the stream of the pipe. So, when you have, a lot of the things they're talking about here, it's mostly, like, gathering assets. So, that's like taking an individual well and taking it to a bigger pipe. Those are going to be the ones that are at the most risk here, because Quicksilver Resources isn't going to keep drilling at that specific well to keep that pipe filled. However, if you're to go from maybe, a refiner to a distributor sort of pipeline network, or larger pipe lines that have consolidated all that gathering, then you're looking at somebody who's probably going to be a little bit more stable, because despite, you could see 60-70% reduction on a gathering pipe, we're not going to see 10-20-30% production declines across the United States on large pipeline transportation networks.
O'Reilly: Got it. Before we move on, I wanted to point our listeners to a newly redesigned focus.fool.com. There, you'll discover an offer to join The Motley Fool's Stock Advisor newsletter at a special discounted rate of $129 for a full two-year subscription. Once again, that is focus.fool.com.
Moving on, this is a speculative story, but we have to talk about it.
Crowe: Do we have to?
O'Reilly: We do, because it's a big deal.
Crowe: Aw man, dad! (laughs)
O'Reilly: It's a big deal! This could destroy all of oil forever!
Crowe: Aw, OK, fine. Whatever.
O'Reilly: Basically, how fast could electric cars disrupt the the oil industry? Bloomberg just put out an interesting piece and a companion video under the headline, "Another Oil Crash is Coming, and There May Be No Recovery." It goes on to talk about how peak oil was clearly a myth, we can also talk about that, because I have some thoughts; that once electric cars become increasingly popular via mass adoption, which is not far away, according to them, it could be as early as 2023, oil is screwed, basically, pardon my French, in not so many terms. How seriously should we take this, what are the potential holes in this analysis, and is anybody at this table selling their oil shares because of Tesla right now?
O'Reilly: We can leave now. (laughs)
Crowe: We're done.
Muckerman: This is, like, a pause for thought. It's definitely going to be a big deal. I don't think in the next 3-5 years, which, generally, I'm looking at stocks to invest in for. You want the stocks that are going to be around in 10-15 years, but you have to imagine, with most companies, in five years, you're going to have to reevaluate your investment thesis anyways. But this is definitely something that I think energy investors need to be worried about, because they're projecting decades of cash flows. OPEC and Exxon seem to--
O'Reilly: Well, they had that projection--
Muckerman: --downplaying it to 1% of overall--
O'Reilly: They had that video, and OPEC is reporting, by 2040, 1% of the vehicles in the world will be electric? That seems really low to me.
Muckerman: Whereas, Bloomberg says 35% will be electric. So, there's a lot more room for error from OPEC's point of view, because it's not going to be less than what they expect, which would be good for them. It's most likely going to be more than they expect, which would be a bad thing for them. The thing here, I think, you look at the increase in electricity needs when you have that many cars on the road--
O'Reilly: Well, and, do we have enough lithium? I wanted to get your guys' thoughts on ...
Muckerman: There's plenty of lithium out there. It's one of the most abundant resources in the ground.
O'Reilly: Okay, that's good.
Crowe: It's really not an issue.
Muckerman: So, you have that and cobalt. So maybe you look at some of these miners. But right now, because it is so abundant, these miners haven't been doing all that well. And then, maybe some renewable utilities out there, because they're talking about needing 8% of current electricity use, if this Bloomberg projection is correct, in 2040. 8% of current production of electricity will be needed for electric vehicles.
Crowe: So, I thought it was a very interesting thought piece. One of the nice things about this is, it makes you think about your thesis, and anybody who's a long-term investor, it really gets your mind flowing in trying to wrap your mind around some of the things that are going on that could totally transform industries. The points they make certainly have a case. One of the things they talked about mostly is what's called the S-curve, the rate of adoption of a new technology. And what they were saying is that we're going to see a rapid acceleration of the S-curve in the adoption of the electric vehicles, mostly with companies like Tesla Motors, Chevrolet, and I believe Nissan, they're all, within the next couple of years, looking to bring out an electric vehicle, in the $30,000 range, which makes it certainly much more affordable than what we've seen in the past couple years.
And then, they made the comparison of rapid adoption of certain technologies. They mention things like refrigerators, microwaves, cell phones, things like that. So, there was the case to be made. Here are some of my counter points, where I'm looking at it and going, "Okay, here's some of the things that I feel like don't quite jive with that idea." Let's start with the purchase and adoption rate. Going to buy a refrigerator, a cell phone, something like that, is a much more discretionary purchase. $500 for a cell phone, it's may be a few weeks' paycheck or something like that, but it's not a $30,000 purchase. You're not going to immediately go turn in your car just because there's a cheap EV to be had out there.
Muckerman: You are if you're Sabine.
O'Reilly: Well ...
Crowe: You are.
Muckerman: You're just cashing it in.
O'Reilly: What about, even, like, they're talking about, there's a billion cars on the road right now, blah blah, we're having a hard time, here in the United States, getting to electric cars, and we have, theoretically, or could pretty easily have, the infrastructure for all the charging stations and everything. That's going to be hard in emerging markets like India, Africa. It's going to be harder than it is here, and we're not doing it super easily.
Crowe: Right, so, the integration of not just the electricity demand itself, but also the grid demands, are going to be huge. And one of the things that I always feel like is slightly underestimated when we talk about these sort of things, they always look at the adoption rates in China, and to a lesser degree, India. But when we look at the developing world, there is a much, much wider swath that really isn't talked about a lot, when we talk about oil demand, petroleum demand, things like that.
And while we can see a decent decline of use from the developed nations such as ourselves, most of Europe, and more and more becoming China, what are considered the OECD nations, but at the same time, those developing markets are growing at such a rapid pace, and the expansion of GDP, population, I feel like the demographics of that are underestimated, and the demand for oil and energy are going to be so great from that that I don't necessarily see how robust that argument can hold up when you have that much demand coming online.
O'Reilly: The other thing that stuck out to me was the peak oil point. That's fine, I agree that peak $20 oil is gone. But I'm not so sure that peak oil always and forever at certain costs is gone.
Crowe: Please clarify, go on.
Muckerman: Do tell.
O'Reilly: Okay, so you guys remember, in 2008, the books for coming out, peak oil and all that and whatever. What they're talking about is, now that is a defunct thesis. My point is, and a lot of the analysis that I've read today is, that was correct for $20-30 oil. Saudi Arabia still produces for $10-20 per barrel. We can't. Shale's what, $50-60?
Crowe: Some people are pushing it down a little lower than that.
O'Reilly: But you see my point.
Crowe: But that's prime time acreage.
O'Reilly: And not only that, but U.S. shale production is projected to peak in 2021, and all of the sudden we're in decline again. So, I'm not so sure that ... because the first point the video made was, "Because of advanced technologies and unanticipated things, we have way more oil than we ever thought we would." But really, this seems like more of a pause in a limited resource and our ability to get it out of the ground.
Crowe: Seems like a fair enough assessment. If you look back, historically, there have been these times, a great example is the eighties, where we were awash in oil, and everybody said, "We're going to be fine forever."
O'Reilly: You had the North Sea, you had blah blah blah.
Crowe: Between the cycles of, "Oh my god, we can't find any oil!" All of the sudden, 10 years later, we're like, "Ugh, what are we going to do with all this oil?" So, that's certainly a valid point in terms of trying to take the assessment that we have today and basically projecting it out.
O'Reilly: Well, and it was just in 2008 that oil went up to $130, gave it a high five, and Goldman Sachs was talking about $200 oil. This was just 6 years ago. And all this $20 talk is funny to me.
Muckerman: They can figure out how to extract more out of the ground. I mean, we're leaving a ton of oil and natural gas in the shale. So, if you can figure out how to extract that, then--
O'Reilly: But that's expensive, which lends itself to my point.
Muckerman: It is, and it has been in the past. But it's always gotten cheaper. I'm not saying it's going to continue to get as cheap as it has been percentage-wise as quickly. But ...
Crowe: We're going really deep into this one. I like this.
O'Reilly: Today is deep philosophical ... Do we need pipes or something to be doing this?
Crowe: No, nu-uh.
Muckerman: Maybe pipelines.
O'Reilly: Maybe pipelines?
Muckerman: But yeah, that's my thought, if we really need to, there's so much more underground that we can get it.
Muckerman: Deep, way deep.
O'Reilly: The human spirit, Taylor.
Muckerman: The American spirit!
O'Reilly: Oh, god. (laughs) 'Murica!
Muckerman: 'Merica, man. We're the ones with shale, that's ours!
O'Reilly: It is ours. Although, what's-his-name, McClendon, he's going to Argentina, doing a little shale drilling.
Muckerman: But that's American technology.
O'Reilly: Oh, here we go. Anyways. Alright. Good doom and gloom show, guys?
Muckerman: Ended on an American high note.
Crowe: There we go.
O'Reilly: We need a bald eagle to fly in here.
Muckerman: (bird caw)
Crowe: That was all the money we spent on our graphics budget right there, thanks Taylor.
Muckerman: I'll collect my royalties for that later.
O'Reilly: We'll give you a $5 bill. Alright, if you're a loyal listener and have questions or comments, we would love to hear from you. Just email us at IndustryFocus@Fool.com. Again, that's IndustryFocus@Fool.com. As always, people on the program may have interests in the stocks they talk about, and 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 Taylor Muckerman and Tyler Crowe, I am Sean O'Reilly. Thanks for listening and Fool on!