In this week's episode of Industry Focus: Energy, Sean O'Reilly, Taylor Muckerman, and Tyler Crowe share what they know so far about the BHP Billiton (NYSE:BHP) and Vale (NYSE:VALE) dam break in Brazil, and how it will and won't affect the companies involved. Also, the team looks at lackluster earnings from Royal Dutch Shell (NYSE:RDS-A) (NYSE:RDS-B), why Tesla Motors (NASDAQ:TSLA) has decided to dramatically ramp up its production schedule, and how incredibly far we've come in the past 10 years in terms of self-driving cars. Plus, the hosts dip into the listener mailbag and discuss whether Spectra Energy (NYSE:SE) or Kinder Morgan (NYSE:KMI) is a better buy.
A full transcript follows the video.
This podcast was recorded on May 5, 2016.
Sean O'Reilly: It's not every day that a $44 billion lawsuit gets lobbed at a mining company. All that and more on this energy and materials edition of Industry Focus.
Greetings, Fools. Sean O'Reilly here at Fool headquarters in Alexandria, Virginia. It is Thursday, May 5, 2016, and joining me in the studio as always are Tyler Crowe and Taylor Muckerman. What's the good word, guys?
Taylor Muckerman: The bird.
O'Reilly: The bird? The bird is the word?
O'Reilly: That's probably one of the top five Family Guy episodes for me. We're really letting the audience know that we're millennials right now, but...
Muckerman: Not only millennials watch Family Guy. It's a far-reaching audience.
O'Reilly: Yeah, that's a good point. It's broad --
Tyler Crowe: It's old enough now to where it's been around long enough that somebody's had some exposure to it at some time.
O'Reilly: Actually, on that note, did you guys hear that Fox ordered from Seth MacFarlane -- it's going to come out in a year or two -- a live-action comedy space exploration show.
Muckerman: Why not?
O'Reilly: Why not indeed.
Muckerman: A live action comedy space --
O'Reilly: It's going to be a comedic Star Trek or something, I don't know.
Muckerman: With real people.
O'Reilly: Yeah, he's going to star in it, too, Seth MacFarlane is going to star in it.
Muckerman: Good for him. He's more than just a voice.
O'Reilly: Yeah. Hopefully, he'll sing, too. Obviously, the big news of, I think it was last week, was the Halliburton and Baker Hughes merger breakup that everybody saw coming. Taylor, you did a heck of a job covering that on MarketFoolery, though.
Muckerman: Thank you.
O'Reilly: We won't talk about it too much here today, but I think the best way to sum it up is, everybody saw it coming, and somebody wrote a huge check. If you're interested to learn more about Taylor's thoughts, check out that episode of MarketFoolery -- when did it air?
Muckerman: It was Monday, this Monday.
O'Reilly: This Monday, yeah.
Muckerman: The second, May 2.
Muckerman: Yeah. Was that your bold prediction for 2016?
Crowe: Yeah, it was. Yeah.
Muckerman: Good for you, Tyler.
O'Reilly: It wasn't that bold, though.
Muckerman: Bold enough. It took four more months before they announced that it was on the table.
O'Reilly: That is very true, yeah.
Crowe: That, man!
O'Reilly: How long did that -- start to finish -- how long did that get dragged out?
Muckerman: A year and six months.
Crowe: A year and a half, at least.
O'Reilly: Yeah. Eighteen months popped in my mind, so yeah.
Muckerman: Because it was November 2014 when they announced it.
Crowe: It was right just about when OPEC decided they were going to halt production, when everybody was like, "They're going to cut, they're going to cut."
Crowe: And just before that Halliburton and Baker Hughes were like, "We're going to get together, we're going to manage this just fine."
O'Reilly: Yeah. Unbelievable. Earnings season is upon us and Royal Dutch Shell just reported earnings, profits fell unsurprisingly 83%. They vowed to cut costs more, though.
Crowe: Every single time in this downturn, companies have been saying they've been looking to cut costs. This is the very first time we got to see Shell, Royal Dutch Shell, as the combined entity with BG Group, which it acquired last year, and now has finally actually brought into the fold. We got to see the whole new, brand-new Shell, all the fancy new things that they're doing.
O'Reilly: With all the bells and whistles.
Crowe: But not surprisingly, though, is that with that release, new look, same pretty meh results. Obviously, they're going to have a really hard time when it comes to generating profits from its upstream side of the business. One of the interesting things when you go through the actual press release and go through the figures that they released, they started breaking things out a little bit more comprehensively and it gives you a better look at the numbers. One thing that I did find surprising was in the upstream numbers, is they broke out integrated gas, which is everything related to LNG, and we were looking at upstream earnings for these companies being pretty weak. When you actually pull out the LNG component of its upstream earnings, the rest of its production portfolio looks even worse.
O'Reilly: Wow! I was surprised because I assumed that they were bare-bones in terms of cost-cutting already, so I don't know what else they're going to do.
Crowe: The idea is there is a lot of overlap between some of the positions that it has with BG Group in places like Brazil, Australia, and other various places where they can consolidate some of the probably administrative work, a lot of costs related to that end of things. Aside from the typical cost deflation that you get from service contracts and things like that, they believe that there is still some cost to be wrangled out of it. Which we're not going to see yet. The merger officially only happened a couple of weeks ago, and for a company that size it's going to take a few quarters to work the kinks out of it.
O'Reilly: Right, to really integrate it.
Crowe: We'll see. It's one of those things where you have to wait and see what happens.
Muckerman: They did say they feel like they're further in advance in the merger than they originally had planned on being at this point, in terms of synergies probably going to be brought forward a little bit sooner, so we'll see. They put the pressure on themselves to another degree, I guess. Not a huge degree, but they did say, "Expect synergy sooner than we thought."
Crowe: Which is kind of refreshing for Royal Dutch Shell. It's never been -- of the big oil companies -- it's never been the one when people think about the really disciplined capital spender and the really trying to be the most profitable and cost-conscious possible. That reputation has always pretty much gone to ExxonMobil. Shell has always been the technology-driven, growth through production, trying to do the things that are really, really beyond the horizon.
Crowe: Alaska, going into the Arctic, and things like that. It's kind of refreshing to see them take this approach now where it's, we're actually going to focus more on actually being a profitable company.
O'Reilly: How difficult do you think that will be for them to even break even right now?
Crowe: Not easy. In some ways it's a lot of the positions that it has taken over the years, have been in what we consider more expensive oil projects. You look at LNG, you look at deepwater, it looks at doing the big up-front expensive things, and when you have that, once they become a legacy production, you have something that's been online for five to 10 years, those per-barrel production costs go down, but bringing it on initially, it can be quite expensive.
Muckerman: You mentioned LNG, and it looks like their liquefied natural gas sales are up 25% year over year. Good to see an area of focus for them actually doing well, especially an expensive area like LNG has been for them.
O'Reilly: Yeah. Moving on to another earnings story that's actually probably more surprising. Tesla just reported: They're going to ramp up production to 500,000 cars a year, two years early.
Muckerman: Don't you raise your eyebrow when you say that? It's crazy, do you think? Yeah.
O'Reilly: Yeah, no. My favorite line in it was they were not specific at all; it was just this one sentence, and I'm paraphrasing here, but they were like, "Yeah, this is going to require more capital." I'm like, "You think?" Does that imply a share issuance at some point again, or maybe Elon Musk will just write another check?
Muckerman: Keep in mind that 500,000 is 10 times what they produced this year.
O'Reilly: Right, yeah.
Muckerman: This is a huge deal, and like you said, they're bringing it forward by two years. Not only are they bringing it forward by two years, but then those two years that lopped off at the end, 2019 and 2020, they expect to maybe, what was it, maybe double from 500,000 to a million?
Muckerman: 500,000 to a million, is that what they said?
Crowe: Yeah, I believe that's actually total cars produced, not an annual production.
Muckerman: Produced, OK, OK, OK.
Crowe: By 2018 they're going to have produced 500,000 total cars, and they are going to be mostly the Model 3. The big push they want to do here is pushing the Model 3 forward and really getting it to market, because we're starting to see some of the larger Detroit automakers like General Motors come out with the Chevy Volt, and they're going to make a big push on that. I guess the best way to explain it is to say that Tesla didn't want to get left behind, and Tesla has not exactly been the most timely company. Over the years everything has seen some production delays, ramping up has been slower than expected. Now that its competitors are taking it more seriously on the electric end, the pressure is on now for them to deliver on that.
O'Reilly: I was really surprised with this release and how essentially aggressive it was, because I don't know if you guys caught this, but they just had two very high-level executives leave.
Crowe: Coincidentally, on the exact same day that they decided they're going to move production up by two years.
O'Reilly: What a coincidence! So odd.
Muckerman: One of them was the chief of production or something.
Crowe: Both of them were production people.
Muckerman: Yeah, yeah, yeah.
O'Reilly: There's a piece over on Bloomberg about two Tesla production chiefs leaving ahead of the Model 3 ramp-up. It was Greg Reichow, R-E-I-C-H-O-W, I'm totally butchering that, Tesla's vice president of production, and John Ensign, vice president of manufacturing, will leave the company. Then a person familiar with the situation, who isn't authorized to speak about the matter, said the executive changes are linked to delays, glitches, and a recall that has bedeviled the Tesla Model X. Wasn't it in the release that just came out, they said that Model X production was finally ramping up or something like that?
O'Reilly: I don't know. What a coincidence, though, those two guys are gone and then...
Muckerman: We'll see if it's a coincidence moving forward.
Muckerman: If it was actually their fault and they were actually separating the wheat from the chaff.
O'Reilly: I have to think that these were smart guys, and if they were having a hard time, is Tesla reaching a little bit here with its goals?
Muckerman: Did it specify if they left or if they were forced out?
O'Reilly: Nobody ever says. One of the reasons for, I think it was John Ensign, was personal reasons.
Muckerman: Yeah. He could have been doing an all right job, just wasn't comfortable with the stress factor of moving this forward two years.
O'Reilly: Which also wouldn't be surprising, given what we've heard.
Muckerman: As you've seen, tech companies, you see folks jump from company to company. I'm imagining that these two folks aren't going to be hard up for work, now that they've announced their freedom from Tesla.
O'Reilly: They're going to go work on the Apple car.
Muckerman: Apple car, they could go work for any number of car companies that are trying to go electric or autonomous or both. Yeah, I think they'll be all right.
O'Reilly: I caught this just before we went on air. GM and Lyft are -- you remember, of course, GM invested $500 million in Lyft a couple of months ago -- they're going to be test-driving self-driving electric taxis in a soon-to-be-named city.
O'Reilly: Would you ride one?
Muckerman: Absolutely. Probably not the first.
Crowe: I'll wait till maybe the third or fourth before I jump in.
O'Reilly: The third or fourth city or the third or fourth car?
Crowe: The third or fourth car.
Muckerman: The third or fourth car, yeah. I want to have a buffer zone between me... we get like a presidential motorcade going.
O'Reilly: I'm really curious what this will cost to go a couple of miles or something, because you're not paying a human driver.
Muckerman: It's interesting, because I've seen and read other places being, you have to basically 3D-map the entire city and people think that we're a decade away from that being done on a major scale, so I imagine it's going to be a small city. It's not going to be a metropolis; it's going to be a rural small capital from a smaller state or something like that. Google just signed a deal with Fiat, I think, to produce some autonomous-driving vans, delivery vans, so there's going to be some of those rolling around somewhere.
Crowe: It is almost fascinating to think of how rapidly this is progressing.
Muckerman: Yeah, the cars have the technology. It's just if the streets do is the big deal.
Crowe: But if we were to take a leap back to 2008...
O'Reilly: Never would have dreamed any of this.
Crowe: If you had said in 2008, Tesla Motors is going to by 2018 have produced 500,000 cars.
O'Reilly: It will be worth $14 billion.
Muckerman: This is the same time when they were struggling to produce the Roadster and Elon Musk was forcing more liquidity into the company at multiple times in 2008.
Crowe: 2008, you go, "Tesla Motors is going to build 500,000 cars, they're going to have family friendly-esque-like sedans in the $35,000 entry-level luxury price range."
O'Reilly: Don't forget the falcon wings. Don't forget those.
Crowe: An SUV, and everyone in Detroit is going to try to chase and catch up with them, or in some ways might be ahead of them with certain offerings, and at the same time, "Oh, on top of that, you're not going to drive your car anymore. We're just going to let a robot do it." The advancement in the past four or five years in the automotive industry is staggering. Like you say, it's kind of removing the wheat from the chaff here; this is going to be one of those times where somebody is going to step up to the plate big-time and make a lot of money. It doesn't mean that everyone in the space today is going to be --
O'Reilly: If this driverless car thing really catches on, I have to think that that's immeasurably bad for the big three automakers.
Muckerman: I saw something from the CEO of Ford, he's saying that, "Yes, we might produce less cars, but these cars are going to be used much more than they are today."
O'Reilly: They'll make more on service revenues?
Muckerman: The vehicle miles driven will probably amplify.
O'Reilly: That's a really good point.
Muckerman: These vehicles will be running to the higher mileage counts much sooner. Yeah, they're thinking that service might save the day if production numbers drop, because right now your vehicle sits idle while you're at work, while you're at home. In a perfect world for these EVs and autonomous cars, they're never going to park unless there's nobody that wants to do anything.
O'Reilly: Right. I had an Uber driver, this was a couple of months ago. Very nice gentleman. He had one of those new Priuses, the futuristic internal looking ones. I said, "That's a nice car; how many miles are on it?" or whatever. He says... OK, I'm going to give you a little bit of background first before I have you guys guess. Not only does he drive this full-time to make money on Uber and everything, but his two brothers do.
Muckerman: They've got the night shift, the morning shift, yeah.
O'Reilly: You have three men using the car full-time to make a living. Guess how many? It was just over a year old. Guess how many miles were on this Prius.
Muckerman: That's good. I'm going to say, I'll go 95,000.
O'Reilly: 280,000 miles.
Muckerman: Holy cow!
Crowe: That was just in a year, so that's a perfect example of what an autonomous taxi cab is capable of.
O'Reilly: You were right, the car never had any downtime. One of them worked from like 8:00 a.m.... Isn't that crazy?
Muckerman: That's full utilization.
O'Reilly: I was like, "You're destroying this car."
Muckerman: They're getting their money's worth.
Crowe: That's for sure.
O'Reilly: They definitely are, so yeah, I don't know. Other big story, and I have to confess I wasn't aware that the story was as big as it was, but BHP Billiton and Vale might be facing a Deepwater Horizon-type event, you know, what happened with BP a few years ago. A huge dam broke in Brazil and I didn't know it was that big, but $44 billion has now been... the bill's been sent to them.
Crowe: This is a story that probably has been a little underreported.
O'Reilly: The American media didn't report on them.
Muckerman: That, and that they have the Canadian wildfires now that are going on and wreaking havoc in the energy industry.
O'Reilly: Way to plug Canada!
Muckerman: Hey, Stock Advisor Canada, got to look out for my people.
O'Reilly: Good job.
Crowe: But back in November, getting back to the Vale/BHP thing. There was a mine, Samarco mine in Brazil, they had a mine tailings dam, basically it's when you have an iron ore mine or any type of mine, you're going to have some sort of place where you have mine tailings, all the reject and waste that's related to the mine. That mine, or the dam holding back tailings and all of the liquids...
O'Reilly: This is wastewater, this is not good stuff, yeah.
Crowe: Wastewater, nasty stuff, really nasty stuff. It broke, and for 400 miles of a river in this southern part of Brazil, that's called Minas Gerais, it basically ravaged 400 miles of the river.
O'Reilly: Nineteen people died. They're talking about, it took a month or whatever for it to finally ooze out into the ocean.
Muckerman: They say dilution is the solution, but not to this degree.
O'Reilly: Not here.
Crowe: When you put it in context, there was this weird pause for BHP and Vale in the sense of, this is bad, we don't know how bad it's going to be, but it's probably going to be pretty bad. About last month they got a bill from... it was more like a cleanup-cost sort of thing, not a civil litigation suit. It was looking like it was going to be manageable, something like $1 billion, $1.5 billion, something that companies the size of BHP Billiton and Vale could handle relatively easy. However, with this potential litigation, as much as $44 billion, that is one of those giant killer kind of litigation things, and something that is always a major risk when you're investing in anything that involves the exploitation of natural resources.
We saw it with BP in 2010. I don't think anybody could have necessarily quantified in the moment how much this was going to be. You knew it was going to be bad, but I think on BP's most recent quarterly they said, "We have spent $56 billion," and that's going to be the total bill that they think it's going to cost for the 2010 Deepwater Horizon spill. When you put that into perspective, that sort of incident could be a giant-killer for Vale or BHP.
O'Reilly: The share prices, I was checking out Vale at least before we came down here and it was at $4 then, and it's at $4 now.
Crowe: Some of it may be priced in. Vale does have some ties to the Brazilian government, very similar to how Petrobras does, so it's hard to say...
O'Reilly: They might not want to kill it, is what you're insinuating?
Crowe: Exactly. It's the same thing when it came with BP, when it comes to these penalties, you want to get the money, so you don't want to break the company that you're doing it with; it can really cripple it in terms of payments, but you don't want some sort of litigation or anything like that that is going to completely bankrupt the company, full stop, right in that moment, because you want to get paid. You want to keep employed.
Look at Volkswagen. Right now the amount of money that they're putting aside is probably not going to be all the amount of money that they're going to spend on it, but over time as they still generate earnings, they're going to be able to pay it off. That's been the same thing with BP. They didn't put $56 billion away immediately; it was over time.
O'Reilly: Man! We've got a mailbag question that was actually tweeted to us on April 27.
Muckerman: The millennial mailbag.
O'Reilly: Millennial mailbag, that is right. Drew Morris on Twitter tweeted at us: @MFIndustryFocus, "Question for the energy team -- which is a better buy today, Kinder Morgan or Spectra Energy?" Who wants to go first?
Muckerman: I'm going to just say Spectra Energy. That's the company I own of the two.
O'Reilly: Conservative choice, OK.
Muckerman: Higher dividend. I like the regional focus, and this resource focus of natural gas and the East Coast for the most part. For Spectra, they do have some West Coast operations in Canada, but I like the narrower -- it's not a narrow focus by any means, because it's one of the largest pipeline companies in North America, but it's a more narrow focus than Kinder Morgan is. That's why I personally like it better, and then the dividend yield is much better as well.
Crowe: When you look at the two of them, both are certainly... you couldn't call either of them what you'd call a bad investment. I think this is like debating between two pretty good companies. If you were to pick one or the other, I don't think anyone's going to be completely unsatisfied with their choice in any way. But I'm actually kind of on the same page with Taylor. I tend a little bit more toward the Spectra Energy side of things. One of the reasons, because of it, is in their development, like, their project pipeline and a lot of the existing business they have right now is in what is called the demand pull side of the midstream business, which is rather than being the company that gathers from the field, which is from the well and things like that. That's known as supply push, where you're taking everything from the supply and getting to customers.
Spectra Energy focuses more of its pipeline and distribution on the demand side of things, so they're going to be the ones connecting to power plants and connecting to individual homes through gas distribution networks that they have in Canada. That side of things does have a tendency to be a little less volatile in terms of volumes and things like that. It gives a little bit more of a stable outlook in terms of its earnings-generating capabilities, versus Kinder Morgan does have a little upstream production, a little closer to the wellhead.
Muckerman: The tankers that they have, yeah.
Crowe: Some tankers and storage and things like that. With that sort of business model, and if you look at the way in which Spectra Energy is looking to grow in the next several years, with, I believe, it's another $20 billion in investments.
Muckerman: Yeah, $15 billion have already been spent, and a $35 billion plan from 2014 to 2020, and they're already well on the way.
Crowe: With that much left and most of it dedicated toward that, we're going to serve the customer, the demand end of things, I think it does look a little more promising.
O'Reilly: I like Kinder Morgan better.
Muckerman: Like Tyler said, it's like neither one of them is technically a bad investment.
O'Reilly: It seems to me, Kinder Morgan obviously cut their dividend recently in order to fund their expansion projects because Wall Street definitely is not throwing money at energy companies right now, but I do think the dividend will eventually get reinstated.
Muckerman: They didn't really cut the yield. The yield was never up there with some of the bigger yields in the pipeline space.
O'Reilly: Very true, yeah.
Muckerman: They just trimmed it to represent where their share price was and what their financials really look like, it wasn't that they trimmed it to 0.5% or 1%, yeah.
O'Reilly: Bare-bones or something, yeah. I'm interested to get some criticism if you guys have any. It seems like there's more upside with Kinder Morgan, as opposed to Spectra.
Crowe: How so?
O'Reilly: It used to be, it's the largest energy infrastructure company in the country, actually North America. Used to be at $40; now it's at $17. Spectra I don't think fell more than a third in this whole energy downturn.
Crowe: You mean from a valuation standpoint.
O'Reilly: From a valuation standpoint and stuff.
Crowe: You could certainly make that argument, but if you're looking from a growth pipeline perspective, you could even say that Spectra has more upside simply because their development portfolio has remained robust throughout the entire time, whereas Kinder Morgan over these past couple quarters has actually been trimming their backlog.
Muckerman: Spectra hasn't cut anything, I don't think.
O'Reilly: Cool. All right, thanks for your thoughts, boys. Have a good one!
Muckerman: You, too.
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. Again, that's email@example.com. As always, people on this program may have interest 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 Tyler Crowe and Taylor Muckerman, I am Sean O'Reilly. Thanks for listening, and Fool on!
Taylor Muckerman owns shares of Halliburton and Spectra Energy. Tyler Crowe owns shares of BHP Billiton Limited (ADR) and ExxonMobil. Sean O'Reilly has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Ford, Kinder Morgan, Spectra Energy, and Tesla Motors. The Motley Fool owns shares of Companhia Vale Ads, ExxonMobil, and Halliburton and has the following options: short June 2016 $12 puts on Kinder Morgan. The Motley Fool recommends General Motors. 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.