I have a conversation with Paula Harris, a woman who through the course of her career just absolutely upended expectations.
You can listen for free on the Texas Public Radio website. But also, as they say, you can and should subscribe on Apple podcasts or Spotify or wherever.
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The fourth installment of my collaboration with Texas Public Radio’s Paul Flahive, tracking the massive SHAKEOUT implications of the current pandemic. This interview includes insights from Gary Sernovitz, who I previously interviewed and who’s book, The Green And The Black – on the fracking revolution – is very good.
You can listen to the fourth episode HERE!
Please see related posts:
The Shakeout episode two – Universal Basic Income
The Shakeout episode three – Travel Industry
Book review: The Green and The Black, by Gary Sernovitz.
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Editor’s note: Yeah Yeah Yeah I have the worst timing of all time. Still, the idea that this vehicle exists is important!
One of the regrets of my last ten years as a Northeasterner-turned-Texan is that I’ve only fulfilled some of the stereotypes.
To be fair to me, I’ve accomplished important ones. I wear Lucchese boots. I wear bespoke guayaberas – shout-out Dos Carolinas! I am not yet, however, an investor in oil and gas. I say this with some wistful regret. I want to fit in as a real Texan.
I have recently discovered a possible way to correct this – the subject of the rest of this column – but I should start with a few reasons why I haven’t yet invested in oil and gas. The most obvious reason is that I don’t have enough money to be invited into large-scale opportunities. Next, I have no particular expertise that would assist me in oil and gas investing. Prudence suggests – and I always suggest – doing the simplest, low-cost investing thing that requires the least amount of knowledge.
Oil and gas investments are famously opaque and high-cost opportunities – meaning if you buy into some heavily-promoted deal, it’s hard to avoid just funding a dry hole while paying many layers of fees to the operator or promoter, who makes money whether they are successful or not. The proverbial “heads you win, tails I lose,” kind of situation.
Having laid out some caveats – which hold true no matter what – I am intrigued by a Houston-based online platform called Energy Funders designed for the little guy (like me) to invest in oil and gas opportunities.
When you create an investor account on Energy Funders (as I did this month) you can access specific oil and gas exploration opportunities, with a minimum as small as $5,000. Garrett Corley, the VP of investor relations who called to vet me as an investor, says they average about one opportunity per month on their platform, with 34 deals closed to date.
CEO Casey Minshew says over the last five years they have been “Beta Testing” their thesis: That they can disrupt the closed, highly capital-intensive, and high fee world of oil & gas exploration, by giving access to smaller investors while reducing fees.
Minshew shared with me the results so far – involving 34 deals closed to date – as well as the direction he intends Energy Funders to go in the future.
Of 34 deals, 11 have been dry holes. Sixteen have produced appreciable oil and gas to date. Six of the deals, he considers, will be significant wins for investors. I did not independently verify his reported results, but those feel like results one should expect from high-risk investing, and therefore strike me as credible.
Minshew says that for this type of investment, small-dollar participants should split their money between a variety of projects, to lower their risk of failure on any one investment.
Unlike the past five years, however, Minshew explained that the next few years will look a little different in terms of project style. Until now, Energy Funders has mostly backed so-called “wildcat”-style drilling, in which funders inevitably drill dry holes, but hope to have enough big winners to compensate for losses.
Future capital raises on their Energy Funders will focus on lower-risk investing, through two methods. One is to create a portfolio approach to projects, allowing investors access to multiple drilling projects, for diversification purposes.
Their second risk-reducing plan is to open up access to “unconventional,” or horizontal drilling projects.
For those familiar with oil and gas extraction lingo, you’ll know what that means. For the rest of us, conventional means drilling a traditional, vertical, hole in the ground.
The way you lose money in conventional is if your vertical hole is dry, with insufficient oil or gas available for extraction.
Unconventional refers to horizontal drilling techniques and deep underground rock-formation smashing, known colloquially as fracking. The way you lose money in unconventional drilling is if the high cost of fracking exceeds the value of the oil and gas extracted – particularly if there’s too much gas and not enough oil. Success or failure is mostly a function of costs rather than dry holes. As an extremely general rule right now, gas is not profitable and oil is profitable, although markets obviously vary and will change in the future.
The project up on the site that I reviewed this week is one of their unconventional offerings, which has already been pumping oil and gas. The structure of that deal, as a result, offers less risk and less reward. But Minshew believes that’s increasingly what investors on their platform want.
I don’t mean to endorse Energy Funders as an investment vehicle in particular because, again, I know nothing about oil and gas investing. But the theory seems plausible to me that a larger market exists for lower-risk, lower-return investments in oil and gas, especially among the smaller-size investors that Energy Funder’s online portal will appeal to.
Since at least 2014, margins in oil and gas exploration have been thin. But like any good entrepreneur, Minshew finds a silver lining in tough market conditions for drillers. As he says,
“It is a capital-starved environment right now. [Oil and gas operators] are now willing to play ball with us. Which is to remove fees and reduce prices.” In addition to drilling risk, fees are largely what has hurt small investors. But Minshew believes “The more and more capital starved the industry, the more valuable we will be.”
In other words, he believes drillers will value the money Energy Funders can raise that much more, and that they can negotiate relatively strong terms for participants. That strikes me as a plausible theory.
I’ve written about and invested in, music royalties in the spirit of democratizing access to previously closed markets.
I’ve also written about, but not invested in, customer loyalty-based funding at Houston-based NextSeed which offers little-guy investing opportunities in startups like bars and restaurants. Energy Funders investments are also a kind of democratizing platform, but from a regulatory standpoint is only offered to accredited investors, who must meet a relatively high income or net worth threshold. While their investment minimums are very small – $5,000 – you do have to have some income or wealth to burn in order to participate.
Final note. I understand that to many readers the idea of investing in oil and gas – in the age of climate change – is akin to investing in cancer. I disagree, but ok.
A version of this ran in the San Antonio Express-News and Houston Chronicle.
Please see related posts
My latest favorite investing idea – Music Royalties!
Crowd-Sourcing Restaurant and Bar businesses (to be posted shortly. SA-EN version here)
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The world’s most profitable company listed its first public shares in the first week of December – in the largest IPO of all time – and you didn’t get your chance to buy? Don’t worry, be happy. May I offer you a much better idea?
The Saudi Aramco pre-IPO price guidance tells us at least one of three things. Either:
If we check out the S&P 500 Energy Index (ticker symbol SPN) , made up of the 28 largest US-listed companies, they make a nice comparison with the Aramco listing. I’ll start with the math comparison, and later move on to comparing governance.
Aramco sold 1.5% of itself and priced at the IPO in December as initially worth $1.7 trillion.1 The 28 US-based companies in the SPN are currently valued by public markets, if you add them all up, at 1.1 trillion. In other words, they are valued at 35% less than where Aramco launched.
Aramco produced annual profits of just over $111 billion in 2018. Meanwhile, the SPN companies produce annual profits, if you add them all up, of $291 billion. In other words 262% more in annual profit for US energy companies than Aramco. I don’t know. 2.62 times the annual profit at 65% of the price? That’s my dumb, but also pretty good way, to look at it.
I suppose you could get into proven oil and gas reserves and more complicated analysis here on the future profitability of exploration and production companies, but I like simple, so thanks for indulging me on my simple analysis.
What other way can we understand the relative performance and value of US energy stocks? Here’s one. While the US S&P 500 Index representing all 500 of the largest US-based stocks soared 178% between 2009 and 2018, the S&P E&P Index representing the largest oil and gas companies shrunk 2% overall.
Also, the US energy sector market value, as a percentage of the S&P 500, has hit an all-time low in 2019. So investors are merely modestly valuing US-based energy companies, and valuing them relatively less than they ever have. Just interesting to note.
I think markets are rarely wrong in the long run, so what explains this US energy sector versus Aramco anomaly? In the case of Aramco at least, it’s worth remembering the stock market did not actually drived the IPO price here.
ARAMCO History
Let’s briefly recap the history of the Saudi Aramco IPO. This is Saudi Arabia’s state-owned oil company, formed after the Kingdom nationalized holdings from oil giants Exxon, Texaco and Mobile between 1973 and 1976. Aramco has been sovereign-owned since then. The current leadership of the country, Crown Prince Mohammad Bin Salman al Saud (known as ‘MbS’ to the kool kids) believes that:
1. They have the world’s single most profitable company, and
2. MbS has long thought that they could sell some of the world’s most profitable company on the global stock market, they could use the proceeds to diversify into other industries and technologies.
This makes perfect logical economic development sense for the long term prospects of the Saudi Kingdom.
The problem for the past few months, however, is that MbS wanted a $2 trillion valuation for Aramco, while large global investors gave pre-IPO feedback to Aramco’s bankers that they would value the company around $1.2 to 1.5 trillion.
Saudi Aramco’s backup plan, therefore, was to reject the international feedback, and to instead sell shares to mostly Saudi investors on the Saudi stock exchange, at a valuation of $1.7 trillion. Since they planned to sell only 1.5 percent of the company, that would – simple math tells me – raise around $25 billion.
The great thing about selling only to Saudi investors is that MbS as recently as October 2017 locked many of them and their relatives in the Ritz Carlton hotel, Riyadh for up to three months, essentially as hostages, until they coughed up money to the Kingdom, reportedly netting around $106 billion. This was described by MbS’s government as an anti-corruption campaign at the time (and who’s to say, maybe some of them are corrupt?) but there’s only the subtlest distinction between what actually happened and what a mafia shakedown would look like, if conducted entirely at the Ritz Carlton, Riyadh. MbS is also widely believed to have ordered the murder and dismemberment of Washington Post columnist Jamal Khasshogi and other dissidents, a point also surely not lost on local wealthy investors.So we’re not exactly getting, let’s say, efficient market pricing feedback from local Saudi investors here.
This listing on the Saudi exchange highlights Aramco two biggest problems – vulnerability to shocks, and governance.
US-Based Advantages
The US-based market for energy companies has the advantage of being highly competitive and diversified. This makes it flexible to respond if bad things happen.
What do I mean by “flexible,” and “bad things?”
For example, drone attacks lobbed in by Yemeni (Iranian-backed) forces shut down for some time half of the productive capacity of Saudi Aramco back in September.
It is hard to imagine a few drone attacks stopping or slowing the productive capacity of 28 different companies that make up the entire S&P500 Energy sector.2
Another huge advantage of the US-based energy sector is governance. Not to put too fine a point on it, but the CEOs of Exxon and Chevron don’t typically gather up all the wealthy folks in the world and lock them in a hotel like hostages until they pledge to do the company’s bidding. Say what you will about them, but the US energy sector corporate leadership is considerably less stabby than MbS. For that reason alone, US energy companies should be valued by investors well above Saudi’s Aramco.
To keep local Saudi investors in line and prevent them from doing the rational thing – like selling Aramco shares and buying much more attractive alternatives like US energy companies – the local Saudi investors’ shares will be ‘locked up’ for a year after the IPO, restricted from selling.
Capitalism is really great, except when it combines with command-economy authoritarian tactics that lock up investor’s money – or investors themselves – for long periods of time.
A version of this post ran in the San Antonio Express News and Houston Chronicle (a bit before the December IPO.)
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Gary Sernovitz, the author of The Green and the Black, brings the perfect profile for diametrically opposed thoughts about the fracking boom, which is probably what we need to explore the oil and gas revolution of the past decade. He’s a self-described New York liberal, who works as a managing director of a private equity firm focused on oil and gas.
He’s deeply immersed in industry research, and he’s a good writer with a sly sense of humor.
He covers the environmental impact, financial impact, and the geopolitical impact of the shale revolution. He also clearly appreciates the capitalists at the core of the story, although often humorously for their mistakes and faults as much as for their tremendous success.
Environmental Impact
Since any conversation about fracking inevitably leads to an environmental fight, its worth noting Sernovitz quickly distances himself from a hardcore industry perspective.
“I believe the scientific consensus that climate change is happening now because of fossil fuels. The evidence for yet more changes is overwhelming. Climate change is a serious threat to human life. While I am more hopeful than most environmentalists that we can address these issues with technology, efficiency gains, and a cleaner energy mix, I believe that continuing to consume energy as we do will have terrifying effects over the coming decades.”
One central point of Sernovitz’ book, however, is that the environmental narrative of the fracking boom isn’t as simple as it’s frequently portrayed. Neither from the opponents’ side, such as was presented in the anti-fracking documentary Gasland, nor from proponents’ side, from industry.
It’s safe to say that each side of that debate considers the other side to be morons, which is never a great place to begin a discussion. Sernovitz is neither a moron nor an ideologue. Rather, he is someone who, while profiting from the oil and gas business and fracking in particular, has spent a tremendous amount of time thinking about opponents’ views.
To Sernovitz’ credit, he dedicates 49 pages to what he calls “The Local Perspective,” by which he means what an economist might call the environmental externalities of fracking. The open frack-water ponds, the worries about local drinking water, the possibility of leakage, the earthquakes.[2] Gasland, he argues, presented a simplified, non-scientific and non-representative propaganda piece about dangers to the drinking water, which is probably not the real big local environmental impact of fracking anyway.
He also dedicates 34 pages to what he calls “The Global Perspective” on fracking, which he short-hands as the “the Al Gore” worry, that the boom in cheap non-renewable hydrocarbons dooms us to a warmed planet and apocalyptic results. To his credit – and in line with my own fears about the biggest environmental impact of fracking – Sernovitz allows that he worries about this too. Our short-term pleasure at being able to drive huge SUVs at affordable pump-prices will be punished by the long-term irreversible damage we do to all living things by not switching to renewable, non-polluting energy sources, and possibly quite soon.
Sernovitz’ articulated environmental hope, and one senses that he’s explored this angle deeply with concerned liberal foundation boards who want to invest with his company but also prefer not to wreck the planet, is that the ‘clean gas’ boom will be an intermediate weaning step away from dirty coal and onto the energy renewables in the future.
But he’s not such an ideologue that he’s sure:
He concludes that we just don’t know enough yet about the methane problem to measure it against other alternatives. Meanwhile he holds out hope that gas isn’t all bad, when compared to its current alternative, coal.
Capitalist fun
Sernovitz clearly enjoys the story of capitalism working – innovation, mistakes, risk-taking, salesmanship, fortunes lost, fortunes won, and surprising global changes wrought, where they were least expected. He admires the pioneering spirit and grit that the early frackers showed. Elements of fracking techniques, including horizontal drilling and using liquids to open up closed shale rock, had existed for decades. But as Sernovitz explains, the right combination of techniques required much trial and error.
One story of The Green and the Black is how this combination of innovations and elimination of errors transformed the US from a forgotten has-been producer of expensive oil and gas into a leading supplier and global driver of far-cheaper oil and gas.
Sernovitz does not settle for the convenient anointing of far-seeing geniuses that many business books do. Instead, he acknowledges the role of extraordinary luck, as well as a we-had-no-choice-with-our-backs-up-against-the-wall decision-making of the fracking giants Aubrey McLendon, Mark Papa, Harold Hamm, and George Mitchell – who he anoints the four members of the Mount Rushmore of Fracking.
How financially valuable?
Sernovitz tries some back-of-the-envelope calculations of the income and wealth effects of the US fracking boom. Between 2007 and 2014, he estimates, the oil and gas industry netted $150 billion in additional income due to the shale revolution. More substantially, however, is the future wealth effect of making shale deposits a viable source of oil and gas. Between usable and estimated reserves, plus ancillary investments in pipelines, gathering systems, and export terminals, the wealth effect of the fracking boom probably adds up to $2 Trillion, according to Sernovitz. Which is quite a lot.
Other facts about the fracking boom also offer a sense of scale, such as the weird one that the size of the Bakken shale in North Dakota would give – at $60 per barrel of oil – a theoretical Nation of North Dakota a per capital oil wealth between four and five times bigger than Saudi Arabia. Whoa.
In my one-time adopted state of New York, where fracking was subject to a moratorium since 2008 and effectively banned since 2015, the technique and subsequent energy boom is a kind of shorthand for capitalist evil.
Where I currently live in South Texas, fracking may not be universally celebrated but even people who did not get rich from the recent boom have a sense that it has meant a huge economic shot in the arm for the region. Criticism tends to be muted, and, politically at least, a non-issue. People don’t need to shout “Drill, Baby, Drill” in South Texas because that’s going to happen anyway and it’s in fact against state law for municipal entities to restrict it. There’s no reason to shout about an activity that the entire political structure supports.
Geopolitcs
Sernovitz would like the layperson to understand not just the financial implications of the shale boom, but also the potential geopolitical changes wrought.
Here Sernovitz strikes a mostly optimistic note. Reduced dependence on frenemies like Saudi Arabia and Bahrain, and independence from more traditional enemies or rivals like Iran and Russia, he argues, makes the shale revolution a geopolitical gamechanger for the United States.
We will have less need to prop up kleptocracies or become partisans in places like South Sudan or Libya if we’ve got options, at a reasonable price, under our own land. This won’t stop the sea from rising and swamping our coastal cities, of course, but it is one less thing to disrupt the world.
Absence of traditional blame narrative
Have you ever had a conversation with a sub-prime mortgage CDO structurer about what he thought he was doing before 2007, creating a weapon of mass financial destruction? No? If you did, you’d understand the story is a bit more complex than the journalistic narrative. The products were not designed to be as toxic as they seemed, in retrospect. For reals, and I’m not being smirky as I write this, the underlying products were designed so that people with an imperfect credit history could buy a house. That was the real product, which we seem to forget. People in the sub-prime mortgage CDO production chain all had their own narrow self-interested job to do, but the underlying idea was not evil at all.
In that spirit, I appreciate Sernovitz’s frustration:
“It sometimes seems as if environmentalists believe that the oil industry’s business is to make carbon dioxide. Our business is to make fuel. Carbon dioxide is the by-product, the vast majority of which is emitted when people consume our products – in ‘your’ wheels, not ‘ours.’”
And then he continues,
“Yes, I believe that there is a moral difference between making money by producing oil and spending money by consuming it. I do not dispute that climate change is more on my conscience that on others.’ But that moral difference is subtle, subjective…”
I also appreciate Sernovitz’ position as a New Yorker surrounded by people who casually hate his industry. He does not have the luxury of unreflective one-sidedness. On the contrary, he is an expert ambassador for the industry living deep in enemy territory.
One of the problems with forming unbiased opinions on complex business topics is that true experts tend to come from within their own industry. And in that sense, may be discounted by critics as self-interested in defending the industry. But if you don’t listen to experts from the industry, you’re probably not listening to the most important experts on the situation.
Of course, at the end, I’m jealous of Sernovitz too.
He writes humorously and from a position of deep knowledge about an important finance topic. He writes about the big picture, as well as the minutia of his industry. He continues to make money with his expertise. Did I mention he’s funny as well?
Basically, I hate him.
Maybe I’ll get up the guts to ask him to do a podcast here.
Please see related posts:
All Bankers Anonymous Book Reviews In One Place
[1] Is that why I’m still a Catholic despite the ridiculous medieval bent to the Church’s teachings?
[2] Since I finished the book a week ago, earthquakes in Oklahoma have put the “seismic activity” problem of frack-water disposal back on the front burner. Ugh.
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I plan to install a solar array on the roof of my house.
Prior to installation, I asked a local solar expert guy to provide specific architectural plans, for my house. He provided estimates on monthly savings I could expect, based on my past energy usage as well as the specifics of my roof.
I love my spreadsheets (who doesn’t?) so I had fun calculating my ‘return on investment’ for a planned solar panel installation. I’ll mention the financial ‘return on investment’ I expect to receive a little further on in this column.
Having mentioned that I plan to install solar panels, there’s a real grumpy part of me that kind of hates the solar industry. Let me explain.
Solar Subsidies
I don’t know how much sense these industry subsidies make.
I start with an aversion to public subsidies for private gain, especially when the private gain will probably be captured by higher-income homeowners, because they are the ones who can afford to make multi-thousand dollar optional improvements to their home. Solar proponents will reply that the public gains broadly when we move toward sustainable energy and away from non-renewables. Financially, however, private households capture the monetary gain from the public subsidy, so it rubs up against one of my principles of private gain on the public dime.
Maybe even more worryingly, I have a pet theory that all the local and federal subsidies over the decades are actually inhibiting solar innovation. It’s relatively easy to read about all the ‘innovative’ solar technology coming down the pipeline. But I also kind of feel like we’ve been hearing about all this innovation since the Nixon administration, and residential solar still isn’t a good financial choice for households, if we removed all the government subsidies.
Some industries over the past forty years – think of advances in telephony, software, or computing power in that span – relentlessly innovate in a competitive market and produce stunning breakthroughs and extraordinary cost reductions. Solar power was not-quite-competitive with non-renewables in the 1970s and it’s still not-quite-competitive with non-renewables in the 2010s. Why is that? I can’t prove this, but I have a sneaking suspicion that an industry built around government subsidies will attract a different set of talents and mindsets than an industry built around market competition.
Which kind of begs the question: Are all the subsidies – in the long run – helping or hurting a faster shift to renewable energy?
I don’t mean to be overly harsh on solar power. Obviously, I’m installing it at my house. In general, I’m in favor of boosting our mix of renewable energy usage versus non-renewables, because that just makes sense. A billion years of future solar power versus even a few remaining centuries of oil & gas certainly argues for using more of the former and less of the latter.
Sustainable?
I’m a markets guy, however, and when an industry can’t become market-competitive over the years, it tends to just remain a niche player. Solar power is not yet – in a real markets sense – “sustainable.” As a markets guy I want to put on my Inigo Montoya accent to remind solar proponents who talk about solar power as “sustainable” to say “You keep using that word. I do not think it means what you think it means.”
The punchline
Ok, but can I make money installing panels at my house? I estimate that the annual return on my initial investment, after twenty-five years, would reach 6.3 percent. Theoretically, I could earn more than that, if I kept the panels installed for more than twenty-five years. On the other hand, I’ve learned the expected lifespan of the system is about twenty-five years, so it doesn’t make much sense to expect it to last longer than that, in my model.
Is that enough?
What do I think about a 6.3 percent return personally on investment in renewable energy?
It sounds about right, as a private incentive to invest my money. 6.3 percent easily beats what I can earn in a wholly ‘safe’ investment, like a bond or a money market account. It’s also a return on money above what I pay on my mortgage, so that it makes theoretical financial sense to outlay the money for solar panels, rather than just pay down my mortgage principal faster. 6.3 percent is below historical long-term returns from stock investments, but that seems ok too. With any more federal and city subsidy, my “private return on capital” might seem excessive.
Like any model, a large number of assumptions go into calculating a financial return on solar panel installation.
Assumptions
These assumptions include the following:
If all those assumptions hold true – admittedly a pretty large set of ‘ifs’ – I’ll reap a pretty good private return on my capital.
A version of this appeared in the San Antonio Express News
Please see related posts:
Natural Gas Revolution in South Texas
Oil companies – This Makes No Sense
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