Last week was a busy, busy week for energy. On this episode of Industry Focus, Sean O'Reilly, Taylor Muckerman, and Tyler Crowe go over the news highlights -- from former Chesapeake Energy CEO Audrey McClendon's indictment and untimely death, to ExxonMobil's (NYSE:XOM) and Royal Dutch Shell's (NYSE:RDS-A) (NYSE:RDS-B) offshore leases in Brazil that have run out at just about the worst time, and more in between.
Then, a dip into the listener mailbag: What should investors make of Continental Resources' (NYSE:CLR) not writing down the value of its properties this past quarter, while so many other energy companies have?
A full transcript follows the video.
This podcast was recorded on March 3, 2016.
Sean O'Reilly: Buffett's thoughts on energy and more, on this energy and materials edition of Industry Focus.
Greetings, Fools! Sean O'Reilly joining you here from Fool headquarters in Alexandria, Virginia. It is Thursday, March 3, 2016, and joining me to talk Buffett, Brazil, and Greek tragedies are Tyler Crowe and Taylor Muckerman. How's everybody doing this morning?
Taylor Muckerman: My God, what a show we have in store.
Tyler Crowe: Sounds like we have a really busy day ahead of us.
O'Reilly: We've got, what, five stories, Tyler?
Crowe: We've got a lot to talk about today.
O'Reilly: We've got a lot, yeah. Before we jump into Buffett's thoughts on energy from his annual report and ExxonMobil's troubles in Brazil, we would be remiss if we didn't talk about the recent indictment and demise of former Chesapeake Energy CEO Aubrey McClendon. Any thoughts come to mind, guys?
Crowe: When I heard the story yesterday, if anybody has not heard, and I'm sure they have because it was plastered over any financial news, top of everything yesterday, Aubrey McClendon passed away in a car accident one day after being indicted on charges of rigging land leases in Oklahoma, basically colluding with another company to say, "We won't bid on this one if you give us a little bit of a lease price, and then we don't have to try to outbid each other on these leases." That was the basic premise that they were going on for the court case.
When I heard the story that he had passed in a car accident, which, I think all of us have said sounds pretty suspect in the first place anyway, it kind of felt like the personification of a modern Greek tragedy. The idea of somebody just rising so high as a superstar in the shale boom in 2011, 2012. Everybody, at least in the energy patch, knew who Chesapeake Energy was, and the monstrous amount of work that they were doing is going and getting out land. They were just trying to own everything on the shale patch. Like Icarus, he kind of flew a little too high, and everybody wanted to take a hack at him.
O'Reilly: What'd you think, Taylor?
Muckerman: It sucks. Anybody dying that soon.
Muckerman: Unfortunate timing.
O'Reilly: He was what, late 50s, right?
Muckerman: He's a big reason why we are doing what we're doing in the oil and gas industry in America right now, and around the world, even, because the technology is spreading pretty rapidly. A pioneer that -- whether it's true or not, all these allegations, it's unfortunate that he won't be able to at least defend his name.
O'Reilly: Yeah. Cool. Well, moving on. Everybody's favorite 80-something-year-old billionaire investor, Warren Buffett, just came out with his latest annual letter. I know when I was a teenager and first getting exposed to investing, this was like... I don't know, it's kind of like Christmas for long-term investors or something.
Crowe: He's like the uncle that you want to have advice from, you know what I mean?
O'Reilly: Right, as opposed to the uncle that you avoid at Christmas parties.
Crowe: Yeah, the one that you avoid at Christmas parties and Thanksgiving.
O'Reilly: Not a huge portion of his comments in the letter and everything. He did have a few interesting thoughts on electric utilities. Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) Energy is obviously a big part of his operations. In fact, I think he says it's the second biggest part, outside of insurance. Correct me if I'm wrong here. He said, I actually wanted to get your thoughts first on this: "In its electric utility business, our Berkshire Hathaway Energy operates within a changing economic model. Historically, the survival of a local electric company did not depend on its sufficiency. In fact, a sloppy operation could do just fine financially," and the reason being basically the local government guaranteed them a certain return on investment. That is changing, and he goes on to note that, "Today, society has decided that federally subsidized wind and solar generation is in our country's long-term interest." He goes on to talk about federal tax credits, the investments they're making to take advantage of these.
Did you guys have any particular thoughts on what might be useful for our Foolish listeners, given Buffett's insights?
Muckerman: It shows the advantages of running a utility like a business, rather than like a company that's guaranteed income.
Muckerman: All of his utilities that he's picked up and transmission assets that he's picked up have become more profitable, safer, reduced head counts. It's showing that, if utilities do want to get serious about their profitability and the business metrics that investors can focus on, you can change the game.
Then, with renewables, they own an astounding amount of wind and --
O'Reilly: They're the largest.
Muckerman: I think 6 times the second competitor in terms of wind and solar power generation, 7% of the U.S.' wind, and 6% of the U.S.' solar electricity generation, comes from some Berkshire Hathaway holding, which is pretty impressive and, I think, a little bit under the radar for most people. When you think about Berkshire, you think of the railways, you think about some of the oil services companies that he owns in terms of equipment that they provide, and then obviously the insurance businesses. To be that big of a player in renewable energy kind of under the radar is a big surprise.
O'Reilly: With the amount that he's still plowing into it today.
Muckerman: Oh, it's billions, yeah.
Crowe: Billions of dollars, maybe not annually, but pretty darn close to that. When you look at those investments, obviously with those federal tax credits, we don't know how much longer they're going to last. I mean, there are certainly, there's some plans, at least with residential and things like that where we're going to push it out for another five to six years. We could see, certainly, Buffett making large investments over the next four or five years, because it is such a lucrative investment with tax credits.
O'Reilly: It's kind of a sure thing.
Crowe: Right. With the amount of cash that Berkshire Hathaway is generating today, it's a pretty lucrative investment.
In an interview that he actually did following up the shareholder letter, they kind of got into the argument that they've been having lately because one of his utilities, NV Energy, which is part of that utility group is in a bit of a spat with --
O'Reilly: This is in Nevada, of course.
Crowe: In Nevada, with SolarCity (NASDAQ:SCTY) and other residentials, basically on the premise of net metering and who gets to sell back and forth. You can kind of go both ways with it. From the individual standpoint, it's like, "I have to buy energy at 10.8 cents per kilowatt hour. Why can't I sell it back at the exact same price?" On the utility side, it says, "Well, why do we have to buy energy back at the utility price when we have to transmit it, we have to basically upkeep everything, when we basically get zero profit on anything that happens there?"
I haven't quite found my final verdict on this yet. Being both a Berkshire Hathaway and a SolarCity investor, I kind of have conflicting interests on this one.
O'Reilly: You've got the devil on one shoulder and the angel on the other shoulder.
Crowe: Exactly. They both make very valid points, and it's certainly something I'm going to be digging into over the next several months trying to figure out how to get my head around it.
O'Reilly: Taylor, before we move on here, I did want to get your thoughts. Berkshire Hathaway's energies, the energy segment, its earnings weren't up a lot. In 2014, it generated just under $2.1 billion in net earnings, and this past year, they generated $2.37 billion, so just over a $270 million increase, but $170 million of it came from a Canadian transmission utility that they bought in late 2014, so not much of an increase. One, why aren't their earnings going up much, and two, what the heck is this Canadian transmission utility?
Muckerman: Basically, AltaLink is the name of the company that they purchased; it still remains under that name. Big player in Alberta. They've been completing some transmission lines to bring wind energy to greater areas of Canada, so you're seeing that renewable energy portfolio carry over to this company as well. Several billion dollars in assets, looks like almost $6 billion at the end of 2013. Berkshire paid almost $3 billion for it. A little bit of a discount to what their assets were worth then. You're looking at this company continuing to grow and pour back into the business and its transmission. They're not generating anything, so it's just moving power from area to area. I wouldn't be surprised to see them get into the power generation game, given their assets.
O'Reilly: Cool. OK. Moving on, at what point does an oil company say no? As noted in a recent Bloomberg piece, Big Oil moves to drill in Brazil not because things have improved, but Royal Dutch Shell, by its likely BG Group acquisition, and ExxonMobil are being forced to drill offshore of Brazil, where they risk losing leases that they have already bought. Guys, is this fair? Could this be good in the long term because these projects take such a long time to get going and produce and everything?
Crowe: This is one of those weird situations where, like you said, when does a company say no? It's almost kind of like the gambler's dilemma. It's like, when you're down, can you recover, when do you walk away, because of the concept of a sunk cost. Basically, when all these companies went into the Brazilian black oil rush that happened, what, 10, 12 years ago, when the pre-salt fields were found and Petrobras (NYSE:PBR), everyone, was really excited about what's going on down there, and they spent a ton of money on lease holds, basically saying, "We're going to go drill these, and we want to own the rights to them." Nowadays, they're 10 years up, we're in the middle of a major oil price crash, and the due date to start these projects is starting to happen. It kind of gets to the point, it's like, they could do it. Certainly, they have the resources if they really wanted to, but they don't want to spend the kind of money. When do those lease holds basically become a sunk cost and they have to walk away?
That's one of the things that I'm not certain as to whether it's the right idea, because as we've seen with shale and some of the other faster development cycle things, perhaps it's going to take a long, long time for deepwater projects to get the economics that they're looking for.
Muckerman: Yeah. Some of the fees that these companies will have to pay equal the amount that it'd cost to drill a well anyway, so that kind of helps the decision-making process. It is unfortunate for these energy exploration and production companies, because their hands are kind of tied. You saw a lot of it happen in the U.S. during the shale-boom early days, when leases were starting to come up for renewal or expiration, and 2012, when shale gas prices were less than $2 per million BTU, or right around that $2 mark after being north of $10. Companies were forced to drill, otherwise they would lose these leases. Similar situation here. Unfortunately, prices are still low so they're being forced into it, but I think the big beneficiary here could be, if they do decide to drill would be offshore oil-rig companies, because they've seen a lot of contracts be shortened or completely written off by Petrobras and other companies down in the Brazilian waters.
I know a personal holding of mine, Ensco, has lost a rig or rig time to Petrobras. They have four rigs down there right now.
O'Reilly: I feel like every rig company has lost something to Petrobras one way or the other.
Muckerman: Maybe Petrobras doesn't pick them back up, but maybe BP does, maybe Total does, maybe Shell or Exxon, these companies that could be forced to make that decision. Maybe they needed an extra rig to pick up, and companies with experience down there, rigs that were originally built for the Brazilian pre-salt fields, would have a unique advantage to getting back in there earlier than maybe they had expected.
O'Reilly: Cool. Before we move on, I wanted to point our listeners to focus.fool.com, where you can take advantage of a discount on The Motley Fool's Stock Advisor newsletter that works out to $129 for a full two-year subscription. Once again, that is focus.fool.com.
All right. Guys, is ExxonMobil finally going bargain hunting? They're obviously the biggest, the baddest integrated oil major. They are not on the ropes, although the stock's seen better days. They just announced a $12 billion debt offering. What are they going to do with this money? Are they going to do a little bit of shopping? Because obviously prices are pretty low right now.
Crowe: I mean, if there was a time to do it, now would be it.
O'Reilly: Now would be it.
Crowe: You can kind of leverage the fact that ExxonMobil has a credit rating better than the United States Treasury. We can say it: $12 billion is certainly an attractive thing, and considering that this past year, this was the very first year where ExxonMobil did not 100% replace their reserves in a very, very long time, and for some, that can be concerning. At the same time, with companies that have attractive leases or attractive land holdings that could fit well into an ExxonMobil portfolio, it's kind of that quick hit. We can replace reserves very quickly at probably a price that is less than what it would take to go out and actually explore unknown reserves. The economic cost or the risk cost involved with exploration could be out there. Certainly, looking at shale across the United States right now and various other places, there's a lot of opportunities if Exxon wanted to go hunting. We're really worried about losing their reserve replacement rates.
O'Reilly: Yeah, that's a really good point that they haven't replaced 100% of their reserves. Taylor, do you think this is just to make sure that dividend stays?
Muckerman: Well, $12 billion is the dividend, so that's for one year. They could cover it and have $12 billion.
O'Reilly: What a coincidence!
Muckerman: I don't think that they're necessarily worried about that dividend this year. I don't think they're going to spend $12 billion on an acquisition, either, but if they did, there's some companies out there with a market cap under $12 billion. Granted, you're going to have to pay a premium for these companies so they won't be able to spend on a $12 billion market-cap company, because they're going to ask for a premium. You're looking at companies like Devon Energy, Marathon Oil, Continental Resources. Cheniere Energy might be an interesting deal, because they could source their own natural gas and export it. There's a few companies out there that have interesting stories behind them and have seen their stocks plummet. I doubt they'll spend all $12 billion on an acquisition, though.
O'Reilly: Well, at the same time, the last time they made a major acquisition was XTO Energy back in 2010. They did tap into their massive reserve of bought-back shares when they did that, too. We could say they have $12 billion in debt ready to pull the trigger. They have $220 billion, $230 billion in Treasury stock that they could use to go jump at somebody if they were really inclined to do so.
Muckerman: You're probably going to look at an acquisition of a company whose shares have declined further than Exxon's, though. Otherwise you might not be getting as good of a deal on your shares because Exxon shares are down as well. Yeah. That's a huge --
O'Reilly: That's a pretty big war chest right there.
Muckerman: Huge war chest.
O'Reilly: Can you guys imagine Howard Hamm selling out to Exxon?
Muckerman: Yeah. It'd be pretty interesting.
O'Reilly: I'd be surprised.
Muckerman: Probably relieve a lot of stress in his life.
Muckerman: Turn those shares that he has into actual money rather than depreciating assets.
O'Reilly: He took out a billion-dollar loan to pay off his ex-wife.
Muckerman: Yeah, because he knew his shares were in the toilet, so he didn't want to use those to pay her off.
O'Reilly: Yeah, fair enough. Cool. All right. Last segment. We've got a mailbag question from Carl in Virginia Beach, who writes, "In recent quarters, we have seen some oil and gas companies write down the value of their properties, and some have not. One company that has not is Continental Resources." Speak of the devil. "They have a huge debt load as well. Are they being honest by not writing down their properties? Sincerely, Carl."
Muckerman: I was just laughing at --
Muckerman: Billy Madison. "Carl. Nice to see you!" About writing down assets, that's a tricky game with oil prices fluctuating like they are. It's a pretty company-dependent thing. As a shareholder, obviously you're going to want to have your own opinion about how these companies are handling their assets, and especially with oil and gas companies, because asset values do fluctuate pretty frequently and Continental Resources has been, I guess, maybe one of the more bullish companies in terms of the speed of the turnaround they expect. Maybe they're not as quick to write off their assets because they think it's going to turn around, but if it doesn't, they could see those writedowns a little bit later than most and catch people off guard.
Crowe: There are certainly some accounting things that can go on when it comes to oil and gas for valuing properties, but there are some rules that are applied there. They're normally done by an independent ratings agency or an evaluation company that looks at their properties and says, "This is economical at such and such a price." At their most recent 10-K, it said that the price that they were going on was $50 a barrel, which was the trailing 12 months of 2015, which is standard SEC protocol, so we can't really knock them for not going at SEC protocol.
It doesn't seem like they're really doing any trickery, based on the current accounting. They brought on some new reserves that they actually, because of cost cutting and better economics, they were actually able to add some stuff that was what they would call technically recoverable, but now it's economically recoverable, that helped to replace the existing reserves. When you add all those things together, it doesn't look like they're really hiding things in comparison to some other people, and also, let's take into account, over the past two years, they have written down a billion dollars' worth of their asset properties. Maybe they just didn't do it this particular quarter.
O'Reilly: Got it, cool. All right, well, have a good one, guys. Thanks always for your thoughts.
Crowe: Thank you.
O'Reilly: If you're a loyal listener and have questions or comments, we would love to hear from you. Just email us at firstname.lastname@example.org.
Crowe: Be like Carl.
Muckerman: That's right.
O'Reilly: Be like Carl.
Muckerman: Be like Carl.
O'Reilly: Again, that is email@example.com. As always, people on this program may have interests in the stocks that 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.
Taylor Muckerman owns shares of Ensco and SolarCity. Tyler Crowe owns shares of Berkshire Hathaway, ExxonMobil, and SolarCity. The Motley Fool owns shares of and recommends Berkshire Hathaway and SolarCity. The Motley Fool owns shares of Devon Energy and ExxonMobil. The Motley Fool recommends Total (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.