Dana Petroleum: The Goose That Lays The Golden Eggs

24th Jul '10 by Cuthbert C

38 comments 13365 reads

Imagine you find a goose (or possibly a goosander?) that lays golden eggs. It usually produces 1 or 2 eggs every year usually on its birthday - known as the Annual Goose Month (AGM). Occasionally it has a bad year and lays no eggs. It is obvious that it will only continue to lay eggs if it is looked after really well by somebody that knows what they are doing so you have to be really careful how you feed it and how it is housed and watered and so on. Years go by and you become an expert in looking after this unusual and precious goose. Sometimes you even sing it a lullaby to help it get off to sleep at night.

You decide that in the short and medium term you will not sell any of the eggs in case that upsets the goose and the laying stops. Your cunning plan is to wait until the goose has laid all the golden eggs that you think it is capable of and then sell them all. Years pass and the goose's nest gradually fills up until it is half full of golden eggs. You think you are perhaps half way to the time when it will make sense to sell all the the eggs. But one day a wandering Korean sage knocks on your door, tells you he covets your goose and offers to buy it. What he wants is all the eggs that are in the nest AND the goose that has produced them. What he offers you is the market value for the existing eggs but nothing for those to come later this year, or next year or the year after.....

Why on earth would you sell? You have only to wait and eventually you will have a nest full of eggs worth twice the offer being made. If you take the money you will find it very difficult to find another goose that can lay golden eggs. Why not just keep on accumulating the eggs as you have done for the past 10 years? If you really want to sell the eggs why sell the goose as well? Especially when the price you've been offered includes next to nothing for the bird itself. Isn't the goose actually worth more than the eggs in the nest? Shouldn't an egg producing paragon (that's different from a…

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EdmondJ

26th Jul '10

The rate/scope of crude oil price rise 'proportionately as a multiple, in the next decade' is surely far less an issue relative to whether the current price range offers attractive economics for exploration and development. Then it becomes a case of which companies can demonstrate a spread of attractive projects, i.e. compelling risk/reward.

A further big oil price rise would hamper economic growth hence demand, so isn't exactly in shareholders' interests, it's a compromise.

sirlurkalot

"The rate/scope of crude oil price rise 'proportionately as a multiple, in the next decade' is surely far less an issue relative to whether the current price range offers attractive economics for exploration and development."

Not sure I agree with that. Consider the price of a farming field, which has permission for housing, on the edge of a town. When deciding at which price to sell to developers, of course the farmer owning it will bear in mind the likely sale value of the total of the houses, and will price the bare field at a price which yields the developer after costs a respectable return on capital whilst the farmer benefits from all the value up to that developer slice. The licence terms of any new oil acreage available now will be financially set up to keep for the host government all the revenue up to a slice representing a reasonable profit for the E&P company. The host govt is in the role of the farmer, and the E&P in the role of the housing developer. It's when the crude price increases (a lot) above what was anticipated by the licence terms that the E&P makes superprofits, as has happened in the last decade to make Dana such a value-creator. I argue that the likelihood of similar superprofits (over and above what were anticipated by the licence terms) are less likely in the next decade than they have been in the last decade.

extrader

Hi sirl,

It seems to me that you're likening oilies to house-buiders, and suggesting that the growth of both in the good times has been as much through rising underlying ( land/oil prospects) as through anything else. With the follow on that any failure to source cheap land/prospect acreage will lead to a concomitant reduction in future prospects.....

But the market has NEVER valued 'future prospects" in the oil sector (beyond 6/12/perhaps 18 months) ! Which is a point I believe you yourself have made repeatedly in the past, hence your stated preference (which I respect but lack skills to emulate) in focussing on the short term and picking the 'low-hanging' fruit.......

This is a conundrum I am yet to resolve.........

All advice welcome !

"the growth of both in the good times has been as much through rising underlying ( land/oil prospects) as through anything else"
Yes, though other factors are important (perhaps more so) as well of course.

"But the market has NEVER valued 'future prospects" in the oil sector "
It's true that the secondary mkt hasn't usually traded the shares as highly as those who want to attribute value for distant drilling would like. But from Dana's operational PoV, the price at which the shares trade in the secondary mkt is almost irrelevant, as they haven't used the primary mkt much/at all(?) Operationally, profits and cash flows have gone thundering up due to the superprofits from crude being priced higher than anticipated in licence terms, and of course if this operational value creation is happening then sooner or later it'll be reflected in the SP.

Put another way, let's suppose the shares only trade at 70% of what some analysts think they "should" trade at. If at the end of a decade, profits and cash flows have gone up tenfold due to crude prices rising, then that'll still be a great golden-egg laying period even if the shares at the end of the decade still only trade at 70% of what they "should" trade at.

thegreatgeraldo

Hi SirL,

Dana have made use of the primary market - a placing last year & a convertible the year before(?) - but have relied far more on debt financing. The placing last year, IIRC, was due to the banks trying to be a bit precious over terms

On the OP, it will not rise eight fold over the next decade.

tgg, You're quite right that Dana have used the primary mkt - I haven't been paying attention recently. Apologies.

macroeconomix

On the OP, it will not rise eight fold over the next decade.

I'm willing to bet it will :)

But only because the dollar will, in that time, be pretty much worthless!

Cuthbert C

sorry to be incommunicado - yomping across fells in cumbria this week - mostly out of reach of a signal - so v difficult to read here and damn near impossible to write

SirL said

Chapeau to you if you really thought a decade ago that crude would rise as much as it has. Personally on principle I wouldn't base an investment portfolio around that sort of macro call anyway, even if I thought it, but maybe people differ on that. Do you think crude will rise, proportionately as a multiple, in the next decade as much as it has in the last?

A decade ago I thought it was certain that:-

1) the oil price would rise very significantly - (TBH I am surprised it has not risen much more than it has and I expect it to rise substantially from here - wrt magnitude and timing of rise - who knows but why not $500/bbl by 2020? or more? or sooner? My view is that I don;t need to be able to predict magnitude and timing all I have to do is get the direction right.)

2) the E&P sector would be revalued - (I don't think that has happened yet. I think it is taking much longer than I expected - perhaps we will see that process start now/soon)

3) Dana would be revalued relative to the E&P sector - (there again I don't think that has happened yet. My own opinion is that the current value being attributed is very myopic - as is the case with other E&P's too. )

4) the approach to valuation of E&P's would change from myopic to long sighted, both wrt oil pricing and organic growth and explo and developt not to mention switching to a replacement cost philosophy

5) there would be a wave of consolidation in the E&P sector - (again I don;t think that has happened yet)

Fact is that my investment strategy is not predicated on my possessing second sight and being able to forecast the oil price. It is predicated on several simple facts

A) invest in what you understand - I spent most of my career in the oil industry - I have a better understanding of this than any other sector

B) get to know the companies you invest in - I do that - I've been to most Dana AGM's since the mid-late 90's and I've been talking to management since then - the fact that I understand the industry is undoubtedly a help in establishing and maintaining communication - in much the same way that your own background must help you get to talk to people in various other sectors

C) run a concentrated portfolio

D) watch it like a hawk

E) take a long term view

I've been doing the above for some 10 years now and it has worked for me. I dropped a clanger in 2007 or 8 (forget which) when I got over-confident, made some very poor decisions and capped it off by being offline for three weeks - which turned out to be exactly the wrong three weeks..... but apart from that period I have followed the approach above and have no complaints about the results..

why not $500/bbl by 2020?

Unless the dollar does collapse, that would mean ITRO 25% of global GDP being spent on oil. Add in coal, gas & nuclear (& windmills if there are any tofu knitters around) & you'd have energy making up the thick end of half of global GDP..Never say never etc, but it strikes me that such price levels would wreck the world economy/

kenobi

Never say never etc, but it strikes me that such price levels would wreck the world economy

causing a collapse in demand, followed by a collapse in price, and suddenly all alternatives,
wind, solar etc would appear cheap, thus further reducing demand and re balancing the worlds energy system,
be careful what you wish for !

cheers K

29th Jul '10

why not $500/bbl by 2020?

Unless the dollar does collapse, that would mean ITRO 25% of global GDP being spent on oil

not at all dear chap

(increased population) + (increased per capita oil consumption in developing countries ) + (big price rise) + (improved fuel efficiency in developed countries) + (big rise in global GDP)

Back of the fag packet, current global GDP is around $60/65 trillion, current oil consumption 86mmbblsd, so at $500/bbl, that would come in at $15 trillion. If the world economy were to chug along at 4% growth pa, in 10 years time that would take it to around $95 trillion. Depends how much oil we were using in 10 years time, but probably a fair bit more than currently if the global economy were to grow by 50%?

nigelpm

Depends how much oil we were using in 10 years time, but probably a fair bit more than currently if the global economy were to grow by 50%?

I think people (and in particular the oil bulls) are going to be surprised how quickly the usage of oil is going to drop over the next five years let alone ten.

I think people (and in particular the oil bulls) are going to be surprised how quickly the usage of oil is going to drop over the next five years let alone ten.

I can buy into a relative drop in oil usage, not sure about an absolute decline. The other side of the coin, obviously, is how much more oil can be sustainably produced going forward

Hi Nigel

I used to do a lot of business with the Australian Wheat Board (AWB),

They export most of their production, unlike most other wheat producers, so they were always keen on market research, esp against the 'competition' - rice.

They said that a country wasn;t worth serious marketing spend until its income per capita was about US$ 600, at which point , they started their campaigns.

At about US$ 700, from memory, sales took off, as Mr Chan decided he wanted - and could afford ! - noodles today, pls, instead of rice....

I have an image of 50-100 million Mr Lee's , tired of cycling, who decide to buy a motorbike - and, what;s more, they can afford it ! - whilst another 10 million Mr Wongs decide it's time to get their first car.....

To cut to the chase : I think you're plain wrong to think hydrocarbon consumption is going to fall materially any time in the next decade.....

Equally, I think in the next 20 years, there's likely to be a game-changing move to sustainables/renewables.....

I've got my uranium sourced (;>). Can anyone point me towards the solar and wind-power 'winners' ?

TIA

gibson330

I think people (and in particular the oil bulls) are going to be surprised how quickly the usage of oil is going to drop over the next five years let alone ten.

Agreed Western economies are forecast to reduce oil demand faster than GDP contraction.

But look at China and India – between them they account for some 37% of world population with the USA at just 4.5%. (Source: http://en.wikipedia.org/wiki/List_of_countries_by_population). Forecast per capita consumption for China ranges are difficult to model but current 'official' estimates are seen to be way too low.

Further out, China and India’s forecast population growth far outstrips that of any Western country as does their projected GDP growth.

Last month China became the largest consumer of energy on the planet. Its important to understand also the rate at which their energy demand has accelerated in recent years and continues to grow.
Source: http://www.thefirstpost.co.uk/66094,business,china-overtakes-usa-united-states-as-number-one-energy-user

I just don’t see the evidence to support any material fall back in demand in the time scale that you quote.

30th Jul '10

To cut to the chase : I think you're plain wrong to think hydrocarbon consumption is going to fall materially any time in the next decade.....

I just don’t see the evidence to support any material fall back in demand in the time scale that you quote.

It's simple to me. Look around you.

People are starting to behave differently - energy efficiency, wind farms, solar panels. electric cars. It's happening slowly relatively but it IS happening.

The problem however is as tgg has pointed out that oil is getting harder and harder to discover and costlier to produce.

It's going to be an interesting balance over the next 10/20/30 years.

People are starting to behave differently - energy efficiency, wind farms, solar panels. electric cars. It's happening slowly relatively but it IS happening.

Looking across the pond, demand is starting to recover, currently around 5% off its previous high. I'd say the drop is primarily down to the recession rather than windmills & meedja types buying electric cars

marben100

Hi extrader,

I have an image of 50-100 million Mr Lee's , tired of cycling, who decide to buy a motorbike - and, what;s more, they can afford it ! - whilst another 10 million Mr Wongs decide it's time to get their first car.....

ISTM that we're past the motorbike stage already: http://economictimes.indiatimes.com/news/international-business/China-auto-sales-hit-record-high-in-March/articleshow/5777709.cms

SHANGHAI: China's auto sales jumped 55.8 percent year-on-year in March to 1.74 million units, setting a new monthly record, according to figures released by an industry group Friday.

Vehicle sales in the first quarter rose 71.8 percent from the same period last year to 4.61 million

Seems likely that more than 10m Mr Wongs will have bought that first car, by the end of this year alone. Car sales in China surpassed those in the US earlier this year.

Nevertheless, there clearly is a limit to how far the POO can rise, before consumers are forced to slash their consumption. Moreover, as soon as businesses are convinced that a floor of, say, $100/bbl appears to be in place under the oil price, a whole series of technologies not economically viable (or only marginally viable) at current prices become attractive for liquid fuel production, e.g. tar sands development, GTL/CTL, algae(!) etc etc. Clearly these will take some time to implement on a meaningful scale but consumer demand will, eventually, be surpressed by an unaffrodable fuel price, until new fuel sources do become available.

Cheers,

Mark

I don't think crude can rise much above $100-150 for long because that's the level at which alternatives become economically viable. Of course it takes time, measured in years, for alternatives to get going, so there could easily be price spikes above that level for a year or three at a time, but IMO the price can't sustain above that. So IMO what would happen would be the crude price sticks at that level (with occasional year-long periods above or below that), crude consumption sticks at whatever can be produced, and in the longer term alternatives provide the balance of whatever other energy demand there is.

As far as corporate share prices, M&A and all that is concerned, I don't think share prices of eg E&P companies like Dana, would ever sustainably reflect spot crude prices above $100-150 because the mkt would assume those spot crude prices are short-lived. Remember the way that when crude went to $150 or so, it wasn't reflected in SPs. I suspect that if crude went to say $200, which it might well do for many months/a couple of years at some point, E&P SPs would stick at those implied by $100, journalists would write about a new paradigm, bulls would write in a frustrated way on bulletin boards for many months, before crude settled down and prices regained contact with each other. Of course there would be money to be made in that scenario, but essentially it would be an unsustainable phenomenon.

Dana Petroleum: The goose that lays the golden eggs

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Cuthbert C

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