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  • Chris Mayer

Oil, Competition, Fallout & More

“It is only when you can stand alone with a fresh but unshaky hypothesis, for which there is as yet very little statistical confirmation, that you can push big blocks of money into the right sectors and find no competition because no one dares to share the insight with you.”


– Martin Sosnoff, Silent Investor, Silent Loser

I love Sosnoff’s books. I like his style. I don’t remember when I first discovered them, but they were influential when I was a younger investor. While he’s a different sort of investor than I am, I still learned a lot from him. In particular, his emphasis on owner-operators and incentives had a big impact. But I also soaked up general wisdom about the limits of knowledge and the power of conceptual thinking.

(Sosnoff, in case you don’t know, managed money for a long time starting in the 1960s and retired in 2016).

Another favorite topic was this idea that sometimes the best investments are ones where the appeal is not yet detectable in the numbers. He was often skeptical of “easy analytical decisions that extrapolate numbers.” In his experience, it was the hard decisions “for which there is no ready arithmetic that make the big money.”

Which brings me to the topic of the day… Below are a few ideas where the numbers are far from validating any thesis. But they are intuitions about how things may go.

I hope you enjoy reading them.

The Great Oil of Shortage of 20XX…

One of my favorite Buffett quotes is also one of his simplest: “You pay a high price for a cheer consensus.”

The flip side is also true: you pay a low price for a lousy consensus.

Well, you can hardly find more despair than what's in the oil markets. People seem to be trying to outdo each for other for bearishness. One analyst said oil could hit negative $100 per barrel. Maybe it will.

Let us remember, there was no oil glut before the pandemic. WTI crude, for example, averaged $56.98 last year. It closed at $66.24.

Then came the pandemic and lockdowns. Oil prices tumbled. And there is suddenly too much of the stuff around.

But I have a hunch, which is growing into more than a hunch, that all of this will set up the mother of all oil spikes at some point in the future.

The thing about oil wells is they are not like water faucets. You can’t just turn them on and off easily and quickly. When you shut them off, it can take months to get them back online. If ever:

“In offshore, we don’t shut in fields, we shutter them. You begin the process of leaving them forever,” said Tim Duncan, chief executive of offshore producer Talos Energy Inc. (Link)

Offshore oil accounted for 15% of US oil production. How much of that is gone for good?

I suspect the removal of a good chunk of oil production worldwide will lead to a surging oil price once the global economy recovers and we burn through the excess supply in storage. Restarting production will lag the recovery by quite a bit. And the sector may find it hard to raise fresh capital initially.

I admit there is no urgency here. I recognize I am very early. It may take a year or two before oil markets tighten up again. But the stock prices of energy names will react well before then.

Until that time, I am happy to allocate some capital to Texas Pacific Land Trust. Its oil sits safely in the prolific Permian Basin West Texas. It does not drill for oil itself, but owns perpetual royalties on oil produced from its land. It also has an attractive water business and generates significant business from the sale of easements. These capital-light businesses allow it to generate rich profit margins and lots of free cash flow. Texas Pacific has no debt and a pile of cash. It is also converting from a trust to a C corp, which will bring greater transparency and modern corporate governance.

I like it. We will see how it pans out over the next few years. My guess is that investors will be pleased with the results.

Disappearing Competition

High priced offshore oil production is not the only thing that will be shut and shut for good because of the mandated lockdowns. How many restaurants and bars have closed only to never re-open?

Here is one view:

“You can’t even count how many restaurants said they’re closing and are just never reopening, some of which have been there for decades,” said chef Marc Forgione, who owns Restaurant Marc Forgione and Peasant, and is a partner in Khe-Yo.

While larger restaurant chains and well-funded restaurant groups will likely be able to recover, many independent restaurants — which account for two-thirds of American restaurants — may not.” (Link)

This is true overseas as well. I’ve seen estimates that one out of four restaurants in the UK may never reopen.

That would leave a vacuum for well-funded survivors to step into. Demand would not seem to be a problem for survivors when things open up again. (By the way, it is not so easy to open up again. Restaurants and bars need to time re-stock – fresh food, beer, etc. They couldn’t open tomorrow if they wanted to.)

But there is the wildcard of social distancing. How do the economics of a restaurant change when you can’t pack them in like you used to? Standing six feet apart won’t work in most any bar I’ve been in. Then again, as long as such restrictions last for months (not years), it probably won’t matter much. Long-term earnings power is the key to valuation.

Still, the above is way to think about investing in this crisis: Look at who might benefit from disappearing competition. The surviving restaurants and bars may enjoy an unusual surge in demand. The same might apply to hotels.

More Fallout – Landlords, Vendors, Lenders, Emerging Markets

There is additional fallout to consider: the impact on landlords, vendors, lenders, etc.

I would draw your attention to a well-written letter to the Wall Street Journal from a “silent partner” in two small brewpubs in Michigan. (Link)


I like this letter for two reasons. One, I like how he lays out the costs and challenges of running these small businesses under a lockdown. Second, I really like the way he ends the letter:

“…like most small businesses, they had modest cash reserves, and without a quick infusion of cash, they would be in danger of having to close permanently, with the resulting chain-reaction impact on their employees, vendors, landlord and lenders.

The old nursery rhyme says that for want of a nail, a shoe was lost, for want of a shoe a horse was lost, and so on until a kingdom was lost. Let’s not lose the nail.”

In my more optimistic moods, I think this crisis will make people appreciate businesses more. They will now understand how all the things they enjoy do not come magically into existence. These things require the hard work of a lot of people and capital and someone willing to take a risk to start a business. There is a complex network of businesses involved in even the simplest of things. Maybe people will come to think better of business generally.

Nah!

One more note on fallout: How about all those developing markets overseas? This from the New Yorker:

“The virus is only now beginning to take hold in many developing countries—where masks, ventilators, and even clean water can be desperately scarce—but they are already feeling its economic effects. One is a sudden lack of remittances from nationals working abroad. These account for about a fifth of El Salvador’s GDP and a quarter of Somalia’s. When a waitress or a shopkeeper in Paris or Queens loses income, money stops going to Senegal or Nepal.” (Link)

Think about this before you leap into emerging markets because the stocks seem cheap. They may well get cheaper.

The more one thinks through the consequences of this shutdown, the wider and wider the circle of damage seems to spread…

The Deficiencies of the S&P500 Index

Last point, off theme from the above, but something I thought was interesting….

It’s no secret that most funds have failed to beat the S&P500 in recent years. You could put forth any number of reasons why this is. Most people tend to focus on the deficiency of the managers. Few people look at the deficiencies of the index.

Murray Stahl and Steven Bregman at Horizon Kinetics are among the few who do the latter. I wrote about Murray Stahl’s essays last week. I don’t want to beat a dead horse, as the saying goes. So I will be brief here. I just want to share a slide from Bregman’s presentation on Wednesday (Link):

We live in the bizarro world of investing. We have seen negative interest rates, negative oil prices and even negative sales. (Delta Airlines reported that refunds pushed net sales into negative territory for a time in the most recent quarter.)

Maybe the construction of the S&P500 is not so strange in this context. And I know this is not exactly a new story. But I still find it astonishing that 20% of the S&P500 is in just 5 names. This is for an index everybody seems to think is diversified and a good measure of the broader equity market.

As I write, the S&P500 index is down only 13% - which seems incredible given all that’s going on, unless you consider the construction of the index. The S&P600 – made up of stocks with market caps between $600 million to $2.4 billion – is down 30%. Quite a difference…

For what it’s worth, European indexes are also down 22%-30%. The FTSE is down 22%. The CAC 40, in France, is down 25%. The Italian index is down 30%. A survey like this gives you more perspective on how bad things have been for the equities.

Thanks for reading and enjoy your weekend!

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Published April 24, 2020

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