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First, let's liquidate all the cash cow oil companies
04/06/2010 8:30 am EST
ConocoPhillips (COP) is going to simply close up shop liquidate its assets, and distribute them to shareholders.
I wish. It would be cheery to see a CEO admit that the purpose of the public company he or she temporary runs is to create wealth for shareholders. And not to perpetuate either the CEO's job or itself.
While I’m waiting for that unlikely event, I’m going to take what cheer I can from ConocoPhillips CEO Jim Mulva saying that, in the short-term, the best way for this oil company to create value for shareholders isn’t to chase high cost opportunities to look for oil but to pay off debt, buy back shares, and raise the dividend so that the company puts cash in the hands of its shareholders.
Dear Reader, this is the way it’s supposed to work.
Mulva’s decision to pass out cash to the debtors and owners of ConocoPhillips isn’t likely to sweep the oil industry. But, hey, this is the reason that stocks aren’t simply lottery tickets or some kind of Ponzi scheme. The distribution of cash to shareholders, however delayed, is the reason that stocks are worth anything at all.
So I say hats off to Jim Mulva. And I hope he holds on to his job.
Some refrains occur over and over again in my e-mail, no matter what the year. And the one that’s peskiest to answer is “Why are stocks worth anything at all?”
It’s not that I don’t know the conventional textbook answer; it’s just that most people don’t find it very convincing for the simple reason that it runs against everything they know about the way the stock market works.
Buying a share of a company, the conventional explanation goes, makes you a part owner of the company. If you buy a share of IBM (IBM), for example, for your $130 or so you become the proud owner of 1/1.3 billionth of the company.
Of course, you don’t get any real power for that $130. Career managers run the company for you—in theory. But it’s just about impossible for any of us individual investors to get management to change its mind about anything. Not totally impossible. Just almost. I can tell you from personal experience trying to get an electric utility where I owned one share not to flood a valley in the Virginia mountains exactly how hard it is. And management at American Electric Power (AEP) pretty much played fair, well pretty much. They let the opposition speak. They didn’t call meetings for the middle nowhere far away from where their shareholders actually lived. They didn’t walk out when shareholders who opposed their decision began to speak.
But it still took, now don’t quote me on this count of years, six years, a campaign to reach out to institutional shareholders, a law suit, hearings before regulatory bodies at the state and national levels—and more hours than I can even now imagine contributed by people more stubborn than I was--to change the decision.
If most investors are convinced that they don’t have any real say in how the public companies they theoretically own are run, nothing in my own experience convinces me that they’re wrong.
And the antipathy to giving shareholders any say in how their company is run extends way beyond hostility to the individual shareholder with 100 or 200 or 1,000 shares. Consider, for example, the radical change that the financial reform bill that Senator Chris Dodd (D-CT) is sheparding toward a Senate vote. It would require companies to hold a vote on pay and other compensation for a company’s top executives. Of course, this vote wouldn’t be binding on management and the company’s board of directors in compensation decisions. It would be advisory only.
Now don’t you feel better?
But if individual investors don’t get much say in how the company they own a piece of are run, they do still own a piece of something real, right?
Yes, for all the good that it does us. You can always sell that right of ownership on the stock market to another investor, but good luck if you walk in a company’s offices and say “I’d like my $130 in real tangible assets so I’ll take this desk.”
If the company pays a dividend, a shareholder gets that piece of the company’s cash flow as a consequence of share ownership. But most companies pay a dividend yield way below that you’d get from the bond market and many pay no dividend at all.
You can’t vote on running the company, you can’t get a tangible asset and frequently you don’t get paid a dividend, so why is that share worth anything?
There’s the Ponzi scheme answer of course. That share of IBM is worth $130, that share of Microsoft (MSFT) is worth $30, that share of Google (GOOG) is worth $563 because other investors say it is, and you buy it because you’re hoping that some greater fool—I mean fundamentally rigorous investor—will pay more for it in the future.
And then there’s the future distribution answer. IBM is worth $130 because at some point in the future it will distribute its assets to shareholders and the value of that future distribution (plus any growth and adjusted for the time until distribution) comes to $130 a share.
Problem is, as anyone who’s been around the block once or twice realizes, very few companies ever actually liquidate themselves and distribute all their value to shareholders.
In bankruptcy, yes. But then there’s usually nothing to distribute to shareholders.
In the ordinary course of things, however, management rarely decides to distribute the company’s assets (or the value thereof) but instead to continue investing in other “opportunities,” even if at lower and lower rates of return or to buy another business even if the return on that deal doesn’t measure up either. (For more on the way that acquisitions can destroy shareholder value see my post http://jubakpicks.com/2010/02/26/can-ceos-destroy-shareholder-value-in-an-acquisition-just-watch-them/ )
Which is why what CEO Mulva told Wall Street at the ConocoPhillips’s analyst day was so surprising—and to me at least welcome.
The problem facing ConocoPhillips is one facing all the big Western oil producers. National oil companies have got all the toys and they won’t let the Western majors play.
About 73% of the world’s conventional oil reserves are controlled by national oil companies that don’t allow any equity participation by foreign oil companies, ConocoPhillips told analysts. If the foreigners want to play, they can manage or provide services for a fee, perhaps, but they can’t buy into the asset itself. That means that the foreign companies don’t get much, if any, part of the price appreciation in the oil in the reserve.
Another 20% of conventional oil reserves, ConocoPhillips calculates, are in Russia and other countries with national oil companies but where Western oil companies are allowed to take an equity stake. Frequently, however, that stake turns out to be less valuable than the Western producer had initially thought. At this same analysts meeting ConocoPhillips announced that it was selling half of its 20% stake in Lukoil (LUKOY), Russia’s second largest oil company. The investment just hadn’t panned out, Mulva reported, because the Russian government favored Gazprom and Rosneft, the country’s state-controlled oil companies.
Only around 7% of the world’s conventional oil reserves were in countries that allowed the Western oil majors full access to the oil and full equity ownership.
The problem isn’t one limited to ConocoPhillips. It’s faced by all the Western oil producers.
And they’ve responded to it in different ways.
Some have stepped up their drilling activity in the few countries that allow them full access. That’s already led to a rising rate of dry holes. For example, in 2009 Chevron’s (CVX) drilling failure rate climbed to 35%. More than one-third of exploratory wells came up dry. That compares to a 10% failure rate in 2008. (For more on the rising dry hole rate see my post http://jubakpicks.com/2010/03/09/oil-drilling-failure-rate-plunges-at-the-western-majors/ )
Some have decided to invest heavily in unconventional oil reserves such as Canada’s oil sands. Nobody knows exactly what the costs of production will be in the long term in Alberta or even whether or not environmental problems such as the immense quantity of water used in production and the extra carbon produced in the production, refining, and then burning it will put a limit on how much oil will be produced from these reserves.
Some have opted to invest in natural gas—either unconventional gas from North American gas shales or liquefied natural gas from countries such as Qatar. At the moment a glut of natural gas on the North American market has driven prices below $4 per million BTUs ($3.863 on Friday). At this price nobody is making money on gas. The estimate is that something like 40% to 60% of North American gas is hedged at $6 per million BTUs (British Thermal Units) or better. Nobody’s quite sure who is making money at those prices. (There’s serious controversy among industry analysts about what the real production cost of natural gas is, especially for gas produced by fracturing gas shales.)
So ConocoPhillips has decided that for a while at least it doesn’t pay to throw shareholder money at the problem. The company plans to reduce debt by the sale of assets such as half of its stake in Lukoil and to let production remain flat at 1.7 million barrels a day for three or four years.
After that, if I can read between the lines, ConocoPhillips believes it might have a better read on what investment opportunities are really likely to pay off and begin to invest more in expanding production again. (For example, two or three years down the road the United States might actually have an energy policy and President Barack Obama's proposal to open the Atlantic Coast for drilling might be more than words.)
Who knows? Some of the world’s national oil companies may have run into such tough production problems by then that they’d be more willing to take on equity partners with very deep pockets. (For more on how this could all lead to a return to fears of $200 a barrel oil, see my post http://jubakpicks.com/2010/03/16/the-trends-still-point-to-200-a-barrel-oil-even-if-when-remains-a-bit-unclear/ )
In the next few years, though, ConocoPhillips will spend money on buying back shares—which gives shareholders who don’t sell shares to the company a bigger piece of the pie over time—and in raising the dividend. CEO Mulva told Wall Street that he plans to take the distribution ratio, the percentage of the company’s cash flow after capital spending that will go to dividends, from 24% currently to 40%. ConocoPhillips will begin by raising its dividend by 10%. The stock recently paid a yield of 4.3%.
I don’t expect many oil companies to follow ConocoPhillips’ lead. It’s tough for an oil company to admit that, even for a few years, it can’t grow reserves. Some majors have recently signaled a commit to very different strategies. ExxonMobil (XOM), for example, is investing in North American gas shales and Middle Eastern liquefied natural gas. And Wall Street hasn’t exactly fallen all over itself to praise
ConocoPhillips for protecting shareholder value.
Given all that, I wouldn’t bet on the stock going much of anywhere for a while. This strategy is going up against a deeply engrained bias toward growth—in earnings and in share price. But if you’re looking for pure yield, I think CEO Mulva will take good care of you over the next two to three years.
Full disclosure: I don’t own shares of any company mentioned in this post.
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