manual of ideas q&a - 2015-11-13

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Value-oriented Equity Investment Ideas for Sophisticated Investors

© 2008-2015 by BeyondProxy LLC. All rights reserved. JOIN TODAY! www.manualofideas.com November 2015 – 2 of 114

The Reality of Renewable Energy

EXCLUSIVE Q&A WITH BRYAN R. LAWRENCE, A MEMBER

OF YORKTOWN PARTNERS LLC, AND THE FOUNDER OF

OAKCLIFF PARTNERS LLC

This Q&A was conducted on October 30, 2015.

WE READ ABOUT FALLING COSTS FOR WIND AND SOLAR. WHAT IS

YOUR VIEW OF THE PROSPECTS FOR THOSE

FORMS OF ENERGY?

The falling cost of solar panels has

made it possible for companies like

First Solar to build utility-scale solar

plants in sunny places like Nevada that

deliver electricity at a price of 4 cents /

kWh, which is competitive with natural

gas-fired electricity. The 4 cent costreflects a 30% upfront tax credit from

the government, but stripping this

subsidy out would still leave solar-fired

electricity at 6-7 cents, compared to 4-5

cents from a modern combined-cycle

gas turbine (CCGT) burning natural gas.

In the sunny parts of India, that 6-7 cent unsubsidized

price is a bargain compared with diesel-fired electricity at

25 cents, even if it is available only when it is sunny.

Solar penetration is expanding rapidly in developing

countries because they do not have access to the

developed world’s transmission grid and utility-scale

generating facilities, and instead rely on expensive diesel

generators. It’s a cruel fact that a wealthy American’s

electricity is cheaper than a poor Indian’s because India

has not made the investment to build a modern and

efficient power grid. Bill Gates makes the point that the

most effective way to improve the lives of the world’s 2

billion poorest people would be to give them cheap

energy like we have in the US.

The cost of wind power has also dropped due to

improvements in turbine design. With a production tax

credit from the government of 2.3 cents / kWh, wind power developers are able to deliver electricity from new

utility-scale wind plants at 4-5 cents, indicating that

unsubsidized costs have fallen as low as 6-7 cents.

However, wind and solar remain small contributors to

electricity production in the US, with shares in 2014 of

4% and 1%, respectively. The Obama administration has

called for a 32% reduction in electric utility emissions of

CO2 by 2030 relative to 2005, which boils down to a

requirement that 30% of electricity be generated from

renewable sources by 2030. About half of this goal has

already been achieved by the introduction of low-cost

natural gas from US shale, which has displaced coal. But

getting the rest of the way there is a big engineering

challenge.

When the sun is not shining and the wind is not blowing,

the system will need backup power. Current storage

technologies like batteries and pumped storage are not

cheap. We calculate that Tesla’s Powerwall battery will

cost a household 35 cents / kWh to store

electricity, in addition to the cost of the

electricity generated by a solar panel.

That would triple the cost of electricity

for the household relative to natural gas-

fueled power available from the grid,

which seems unlikely to make consumers

happy.

The places where it is sunny and windyalso are not always the places where

people live and work. Building

transmission lines from solar panels in the

desert and wind farms in the ocean or

middle-American states seems likely to

double the cost of the electricity produced.

The German Energiewende has seen the construction of

wind and solar capacity that is capable of producing all of

the electricity needed by German homes and businesses.

On some windy and sunny days, no power is drawn from

German gas, coal and nuclear plants. But wind and solarare intermittent, and the Germans generated just 15% of

their electricity from wind and solar in 2014. To keep the

lights on, they use gas plants and old coal plants for the

non-windy and non-sunny days (they are closing their

nuclear plants down in the wake of Fukushima), and are

spending large sums to build transmission lines to bring

power from North Sea wind farms south into their

industrial areas.

The result of paying for two generation systems – one

renewable and one backup – is high electricity prices. In

2014, German residential and industrial electricity prices

per kWh were 40 cents and 27 cents, respectively,

compared to 13 cents and 7 cents in the US. A US home

uses about 11,000 kWh per year, so German prices would

cost US households an additional $3,000 per year. An

electric arc steel furnace uses 460 kWh of electricity to

make a ton of steel, so German prices would add $92/ton

to the cost of American steel, compared to a market price

today of $170/ton. Just about everything we consume is

made using electricity, and so our living costs would

increase.

“ It ’ s a cruel fact that a

wealthy American’ selectricity is cheaper

than a poor Indian’ s

because India has not

made the investment tobuild a modern and

efficient power grid.”

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And German electricity costs seem likely to grow as they

push towards their goal of 80% of electricity from wind

and solar by 2050, compared to 15% in 2014. Such a goal,

without a breakthrough in storage technology, would

require a massive number of wind and solar farms that

would be used a fraction of the time, and a hydrocarbon-

based backup system as large as today’s for non-sunny,non-windy days.

Three hundred years ago, our energy came from wood

and muscle power, animal and human (some of which

came in the form of slave labor). The

standard of living of a European or

American was essentially unchanged

from that of a Roman, except that the

Romans had flush toilets and we did not.

Burning coal radically lowered the cost

of energy, and made much more of it

available. This enabled the IndustrialRevolution, and a massive expansion of

wealth and innovation. Then the

discovery of oil gave us a new fuel that

was more useful, cheaper and power-

dense – the Titanic launched in 1911 with

coal-fired boilers that required sailors

with shovels, but the super-dreadnoughts

that fought at Jutland in 1916 were

powered by oil, which made them faster,

larger and able to steam further. Cheap oil and electricity

are the foundations of Western prosperity.

Society is now engaged in a third energy transition, from

oil to renewables. Unlike the prior two, it is not driven by

lower cost, but rather by concern about the environment.

Like the prior two, it is likely to take decades to

accomplish. A century after Churchill’s decision to power

warships with oil, more than a third of US electricity –

and almost half of Germany’s electricity – is still

generated with coal.

We will be using hydrocarbons for decades to come. As

one example of this, the horizontal drilling that has

unlocked so much oil and gas in the US is extracting only

5-10% of the resources in many places. Technology islikely to increase that, and our management teams are

working to make it happen.

HOW ARE YOU APPROACHING INVESTING IN RENEWABLE ENERGY?

Building out renewable energy and making the power grid

more efficient is the biggest engineering project ever to be

undertaken by our civilization, and it will create profitable

opportunities.

So far, the utility-scale solar and wind plants being built

in the US and abroad are not attractive projects. Even

with government subsidies, many renewable energy

companies are unprofitable, and First Solar itself has just

a 6% return on equity. At Yorktown, we aim to have each

partnership go up 3x, which has driven a 25%

compounded return over more than three decades ofinvesting. It’s hard to deliver 25% returns investing in

companies returning 6%.

But we have found a smart grid investment for Oakcliff,

which now owns 5% of Energy Assets,

a publicly-traded UK company that

installs smart gas and electric meters for

industrial facilities. The UK government

has mandated that all 1.5 million

industrial gas meters be smart by 2020,

which means able to send information

on gas usage every 30 minutes via textmessage or email. This information will

enable UK businesses to use gas more

efficiently – imagine a Tesco store able

to turn its thermostat down and then

back up at night to use as little gas as

possible while having the store warm

enough at opening in the morning. Each

meter costs £850 to install, and Energy

Assets earns an annual lease payment of

£120, for an unlevered return of 14%. The £120 lease

payment is 1% of the £10,000 fuel bill for a typical

customer, and so churn is well under 1% per year. This

makes it possible to finance meter installation with debt,

increasing return on equity to more than 20%. Energy

Assets is the leading installer of these meters in the UK,

and is a great example of an attractive business that will

add a lot of value as the UK makes its power grid more

efficient.

We are looking for similarly attractive businesses at

Yorktown, including smart grid and storage companies,

but would be interested in private companies and a larger

ownership position.

One caution we have is the role of regulation, which maychange in ways that are harmful to investors. Much

attention has focused on rooftop solar in California and

other US states. It costs about $12,000 to install panels on

a homeowner ’s roof, or $3 per watt for a 4 kilowatt array,

of which 50-60 cents is the panel and the rest is

installation costs. The $12,000 cost is borne by the

installer, and the homeowner signs a lease paying 13 cents

/ kWh for twenty years, which is attractive relative to the

“Society is now engaged

in a third energy

transition, from oil torenewables. Unlike the

prior two, it is not drivenby lower cost, but rather

by concern about the

environment. Like the

prior two, it is likely totake decades to

accomplish.”







15 cents charged by the local utility for electricity from

the grid.

Assuming typical California sunshine, the watt of panels

will generate power equal to 15% of rated capacity, or 1.3

kWh per year. So the installer receives annual lease

payments on each watt of 17 cents (1.3 kWh times 13

cents / kWh), and has annual costs on each watt of 2

cents, leaving 15 cents of annual cash flow per watt. On

his $3/watt cost, this is a 5% unlevered return, which is

not attractive.

However, the panel installer benefits from a 30% federal

tax credit, which reduces his capital cost to $2.10, and

boosts the unlevered return to 7%. Also, the panel

installer has created a market for “solar bonds”, which

allow other homeowners to buy securitized pools of lease

payments that pay a 5.75% interest rate. The panel

installer locks in a 1.25% spread, and the business grows

rapidly.

The problem is that the 15 cents / kWh charged by the

grid includes the utility’s 5 cent wholesale cost of

electricity (likely produced by a CCGT using natural gas,

but also by a utility-scale solar farm) and the 10 cent fixed

distribution cost of the grid itself. To the extent that more

households put panels on their roofs, and do not pay the

utility for power when it is sunny, the 10 cent fixed cost

of the grid has to be spread across more households. This

seems unfair given that homeowners putting panels on

their roofs (i) tend to be richer than other

homeowners and (ii) remain dependenton the grid when the sun is not shining.

In response to this pressure, policy-

makers in California and Arizona are

debating changes to utility pricing that

would recognize the energy and grid

costs of electricity separately. For

rooftop installers, this would not be

good. Being able to charge lease

payments of just 5 cents / kWh would

lower unlevered returns to 1%, which is

hard to finance with 5.75% debt.

Businesses like this make us suspicious

of regulatory rules that do not reflect

underlying physics and economics. There is too much risk

that policy-makers will change the rules, and leave an

investment thesis in tatters.

It would make us more comfortable if policy-makers had

a mandate from voters to put a price on carbon. With such

a price in place, the engineers who actually make the

system work – including those at our companies – would

figure out how to make changes at lower costs than what

today’s confused set of regulations and executive actions

is likely to bring.

Of course, that would require policy-makers to tell voters

that the new system will cost more than the current

system, which is not a pleasant task for them. While we

are waiting for that to happen, we will work to invest in

low-cost energy – hydrocarbon and renewable – that

makes attractive returns for our investors.

Background: How to Think AboutInvesting in EnergyBASED ON AN EXCLUSIVE I NTERVIEW WITH BRYAN R.

LAWRENCE, A MEMBER OF YORKTOWN PARTNERS LLC,

AND THE FOUNDER OF OAKCLIFF PARTNERS LLC

The interview from which the following quotes are

excerpted was conducted in April 2013. While the outlook

for energy has changed materially since then, we find that

Bryan’ s wisdom and insights possess timeless value.

Access the video and transcript: http://bit.ly/1iqFN3p

Editor ’ s note: Finding a person who is thoughtful on the

topic of energy is no easy feat. Even rarer may be

successful value investors who are also veterans of the

energy business. We consider ourselves

fortunate to have met Bryan Lawrence ofOakcliff Capital. Bryan was introduced

to us through Guy Spier and the

VALUEx Zurich/Klosters annual

gathering, where Bryan is a de facto co-

founder and regular participant. Bryan’s

family has been in the energy business

for decades, providing him with unique

vantage point over the ins and outs of oil,

natural gas, coal, and other energy-

related business operations. More than a

decade ago, Bryan set up Oakcliff

Capital, enabling him to apply his value-

oriented investment philosophy across

industries and geographies.

During our hour-long conversation in 2013, Bryan

provided a tour de force on what really matters in the

energy debate and how to successfully invest in energy.

We are pleased to share the following excerpts.

“ Businesses like thismake us suspicious of

regulatory rules that do

not reflect underlying physics and economics.

There is too much risk

that policy-makers willchange the rules, and

leave an investment

thesis in tatters.”


http://bit.ly/1iqFN3p









Bryan Lawrence (transcript): Maybe the best way to

understand the energy business is that joke about the two

guys in the forest. They are walking along and they see a

bear. One of them leans down and starts lacing up his

sneakers and the other one says to him you can’t outrun a

bear. And he says no, but I can outrun you – that really,

really for me describes how to think about the energy business because you are by definition selling a

commodity. You have no idea what the price is going to

be. It goes up and down.

You have confidence that there’s demand for your

product, but you don’t know what the politicians are

going to do at any given time that may cause mischief.

And by the way, they should try to “cause mischief ”

because putting tons of carbon dioxide into the

atmosphere is not a terrific thing. No one’s advocating

that. I don’t think they have any choice but to keep

coming back to this attempt to make things better whenthey’ve got the laws of physics against

them. You’re going to be exposed to this

set of regulations which are

unpredictable and not numerate. Your

best recourse as an energy investor is to

be in things that are very cheap to

produce relative to the other guy.

The argument for coal is that in some

places in this country there is the ability

to mine coal for $30/ton. Now, at

$30/ton, it makes it quite easy to sell into a wholesale

electricity market of ¢5/kilowatt hour and make a very

attractive return on capital. This is no longer true in some

of the basins of the United States. Some of the basins in

the United States, the Central Appalachian basin which

was one of the great basins on earth — that and the

Newcastle area in England really fueled the industrial

revolution. But the good stuff gets mined early. Central

Appalachian coal has been mined out. Costs there are

$70/ton. That’s “the other guy” from the perspective of

the coal industry. It is increasingly difficult for Central

Appalachian coal to compete. Coal from the Powder

River basin, from the Illinois basin, takes over, and thatdynamic seems like it is going to play out for a little bit

more.

From a natural gas perspective, what has happened with

horizontal drilling and fracking is we’re still seeing the

ramifications of it play out. But it’s as big a revolution in

energy as the OPEC embargo was. No one would’ve

predicted even as short as five years ago the magnitude of

the amount of gas that has come up out of the earth. There

have been questions about the safety of it. As more time

goes by the chance that there’s some systemic problem,

some structural problem with horizontal drilling and

fracking, diminishes. You’re going to have individual

operators who make mistakes, but the practice is actually

quite sound.

It is repeatedly demonstrated in various basins that it is

possible to add gas reserves for maybe $1 or $1.50/Mcf.

And when you can add reserves for $1/Mcf, the rule of

thumb in the energy industry is that you can sell them

profitably for 2.5-3.0x that. That’s why every now and

then you see $2.50 gas. There are producers out there who

make attractive returns with gas in the $2s.

Gas at $3 is very much like coal in the high forties. That

back and forth between gas and coal has caused a shift in

the production of electricity in this country, from coal

which used to be about half of it, and gas which used to

be about 20% of it. Coal has given up roughly, depending

on which statistics you use, about 10 percentage points of share [as of 2013].

That’s likely to continue with the higher-

cost coals unable to compete…

WHO TO “TRUST” AND HOW TO “VERIFY”

Editor ’ s note: How can investors in

energy companies get comfortable with

the people and the numbers behind those

companies?

The energy sector — perhaps not unlike

other sectors — is notorious for the existence of CEOs who put growth and empire-building goals ahead of prudent

capital allocation. Promises of return on capital tomorrow

more often than not override return of capital to

shareholders. Rare exceptions, including Kenneth Peak,

the late founder of Contango Oil & Gas,1 only seem to

prove the rule.

Further complicating an objective assessment of capital

allocation, especially for generalist investors, are the quite

inadequate accounting measures of financial performance

and valuation metrics such as P/E, EV/EBITDA or price

to tangible book value. This is replaced by PV-10s,

proved reserves, and our favorite euphemism for pie-in-

the-sky thinking: contingent resources. The latter find

themselves too often in investor presentations — a good

indicator of the (lack of) conservatism of management.

1 Kenneth Peak passed away in April 2013. For many valueinvestors around the world, his legacy lives on through some ofthe most instructive commentaries and presentations of any

business leader in the energy industry. See, for example,Contango’s presentation at the IPAA Oil & Gas InvestmentSymposium on April 17, 2012, http://bit.ly/1PahJ1r

“Your best recourse asan energy investor is to

be in things that are verycheap to produce relative

to the other guy.”


http://files.shareholder.com/downloads/AMDA-1MMZX6/2620011236x0x642812/80ea4d76-d2b0-436f-88c9-b31b724bcd5f/Contango_IPAA2012.pdf




http://bit.ly/1PahJ1r










How to “Trust, But Verify”

Bryan Lawrence (transcript): Sometimes with the use of

state well log data, sometimes with access to information

in materials that are presented publicly. In a private equity

context, you can do it by getting access to non-public

information but you have to get comfortable with the

microeconomics of what is happening.

If it costs you $5 million to drill a well and you add

100,000 barrels of economically recoverable reserves,

that’s $50/barrel. It’s not going to work. How do you

predict the ultimate recoverable 100,000 barrels? There’s

an initial flow rate and it starts to decline so you have to

make some estimate now about where that curve will end

up. Now if you’ve got fifty wells and they’re all following

a rough curve, and you’ve got ten years of history for

those wells, it’s a very easy thing to estimate. When

you’re at a new basin it’s harder.

But again, when the company is

composed of lots of individual projects

and you can get a sense from what the

economics of those projects are, that’s

how you have to assess the cash coming

up off of those projects and then how

attractive it is to keep doing those

projects in the future... You have to

understand that.

And then as Reagan would say, you have

to trust but verify. And a simple way to

verify is to take all of the money that thecompany has spent on capital, whether

it’s capital spending or whether it’s

spending on acquisitions, net of anything

that they’ve sold, net of disposal

proceeds, and take that number over

some period of time, three or five years

and divide it by the amount of production

over that period of time, plus the amount

by which proved developed reserves

increased. That number over that period

of time is the amount of real producing

assets that were added. We’re not talking land and

acreage or whatever. We’re just talking actual producing

cash-flowing assets.

Over a decent period of time, if you divide the amount

that you spent by the amount that you added, and that

number is much in excess of $20/barrel, then you have a

problem [as of 2013]. And by the way, if your discussions

with management show that all the projects should be

$20/barrel but in fact these consolidated numbers are

showing $40/barrel or $50/barrel, then there’s something

wrong and you need to understand what that is. The

business is pretty simple that way. In the end, a certain

amount of cash is spent to punch holes in the ground and

a certain amount of cash comes out of the ground.

Consolidated financials obscure that, but can be pretty

easily mined to get at that answer.

Exemplary Capital Allocators in the Energy Sector

Bryan Lawrence (transcript): I’m still puzzling through

the Exxon results [as of 2013]. I would’ve said before we

did this study that Exxon was one of them, that I had

more respect for Exxon than any other large company.

I’m still puzzling through why that is. Maybe they’ve had

a bad three years but I would still, despite these last three

years, I would put Exxon on that list just because of the

last thirty years.

EOG Resources is an amazing

company. Mark Papa has run that for a

long time. The business has changed a

lot now that horizontal drilling opened

up so much gas. EOG’s historical

advantage was they could add reserves

at about $3/Mcf, and that was amazing.

That was top decile or quintile

performance sustained over decades.

Now people routinely add reserves at

$1/Mcf in some of these basins. The

game has changed. EOG now is under a

lot of pressure to prove that they still arespecial.

In coal, there’s a guy named Joe Craft

who has done an amazing job of seeing

the opportunity in the Illinois basin

earlier than anyone else and building up

a company called Alliance. There’s a

fellow named Chris Cline who has done

much of the same thing. Both of them

are very interesting to watch. Chris has a

company, Natural Resource Partners is

his royalty business, and then there’s Foresight Energy

Partners.

So, there are some ways to see what they’ve done. The

list is short in the industry, but then again it’s short in a lot

of industries.

What Really Matters When Analyzing an Energy Business

Editor ’ s note: When we try to assess an energy E&P

business, the various operational and financial metrics

found in SEC filings and investor presentations can be

“…a simple way to verify

is to take all of themoney that the company

has spent on capital,

whether it’s capital

spending or whether it’s spending on acquisitions,

net of anything that

they’ve sold, and take

that number over some period of time, three or five years and divide it

by the amount of

production over that

period of time, plus theamount by which proved

developed reserves

increased.”







overwhelming. This is often exacerbated by management

teams seeking to dazzle investors with fancy well maps or

gigantic estimates of resources of oil or other fossil fuels.

How often have you seen in presentations by energy

companies a chart similar to the one below?

If, as we do, you tend to grow more suspicious of

management the more such charts you are presented with,

you are probably not a geologist!

So, what should investors focus on whenanalyzing an energy exploration and

production company? Which

fundamental metrics are the most

important ones?

Bryan Lawrence (transcript): It’s a

pretty simple business to understand and

you can add a lot of value to your own

life and that of your investors by doing

your best to cut through what you’re

being told about maps, and well logs, andother things, and just focus on cash.

When you’re selling a commodity, all

that really matters is the cost at which

you’re adding those reserves or buying those tons. Just

look for people who can, on a long-term basis, identify

and produce these resources cheaper than anyone else.

Look for evidence that this is not some sort of accident

and that they can continue to do it.

What you want to do in oil, and it’s hard to do, but you

want to add proved developed reserves at $20/barrel [as

of 2013]. The number of companies doing that is maybe5% of the total, 10% of the total, but if you can add

proved developed reserves — and I’m not talking about

proved undeveloped reserves that maybe over there

behind that hill, maybe when and if we do spend the

money on it. I’m talking about stuff that is actually

hooked up and producing. If you can add those at $20 a

barrel, you’ll make money with $60 oil, and you’ll make a

lot of money at $90 oil. But you need to be prepared for

$60 oil because it is within the realm of possibility.

Natural gas, it continues to evolve given everything that’s

happened with fracking. But you need to be able to add at

$1.25 or $1.50 [per mcf]. Adding at $2 when the end cost

of your commodity is $3.50, it’s not going to work.

You’ll go bankrupt slowly.

In the coal business, you have to be extra-vigilant about

your cost because you have natural gas very cheap and it

is possible that you’ll see a $10/ton or $20/ton price put

on carbon [as of 2013]. It’s not outside the realm of the

possible. Certainly, the sulfur dioxide regime that was put

in place after the Clean Air Act resulted in, no one talks

about acid rain anymore, because the cap-and-trade

system put in place fixed it.

Once the engineers knew that there was a cost on sulfur

emissions, they figured out how to make the sulfur

emissions go down. It’s very possible that they will at

some point come to some sensible

solution where laws of man could be putin place so that the industry with some

confidence could understand they’re

here to stay, and at that point the work

would begin. Should this plant with a

14,000 heat rate be replaced by another

coal-fired plant with a 10,000 heat rate?

And let’s not get rid of all coal plants,

but if you replace a 14,000 heat rate coal

plant with a 10,000 heat rate coal plant

you’ve just reduced your emissions and

lowered your costs for everybody.

In that kind of world, in which a tax is

put on carbon, you had better be the low-

cost producer of coal because coal emits

twice as much carbon per kilowatt hour

produced as natural gas does. So to the extent the society

does actually start pricing carbon, natural gas would get

more expensive, but coal will get more expensive in a

faster rate. But in the end it’s all about cost. Everything

else is details.

How to Pick the Right Investments in the Energy Sector

Bryan Lawrence (transcript): I tend to look for energy

companies where it’s not two or three big decisions that

are driving it. You don’t want to have someone with a

$150 million project floating in 10,000 feet of water and

then 5,000 feet of earth’s crust, in the subsalt off Brazil.

That’s a big chunk of money to write, best done by some

national or partially-national oil company.

What you want is companies that are making lots of

decisions. The reason that you want them to be making

“When you’re selling acommodity, all that

really matters is the cost

at which you’re addingthose reserves or buying

those tons. Just look for

people who can, on a

long-term basis, identifyand produce these

resources cheaper thananyone else.”







lots of decisions is that as decisions reveal information,

that can change how they’re making those decisions. If

they are the kind of management that you want to be

partners with, they’ll make those decisions and change

those decisions intelligently.

The other thing that you want is a long track record. You

want a track record of someone who’s made those

decisions intelligently over time, as demonstrated not by

well logs or squiggly lines on a graph or maps showing

what could or could not happen if this well or the other

well was drilled, or a mine was mined. You want to see,

cash went in and cash came out at attractive rates of

return for a long period of time.

Once you have that, you’ve already eliminated many,

many energy companies. There’s an awful lot of

promotion in the sector, lots of maps, and

if this happens that will happen. If you

eliminate that, you can find yourself withopportunities to buy cash flow-producing

assets that are mispriced because people

are more focused on potential regulation

or they’re more focused on gas being at

$2 [per mcf] when it’s pretty clear only

some producers can make gas work at $2

[as of 2013].

You can use the swings of the

commodity price and the swings of

political fortune to find moments when

really good businesses run by peoplewith good track records are mispriced

relative to their likely cash flows.

It’s gotten a little bit harder to identify

natural gas and oil producers simply

because the technology has changed so

dramatically. We’re all waiting to see

what the decline curves really are, what

the economics of these different basins

really are. They’re becoming clearer

now, but it’s very rare to open up an oil and gas

presentation and not see a claim of 50% to 100% IRRs on

all their new wells and yet the returns on equity for the

industry as a whole are nowhere near that, and you could

argue that some significant percentage of the industry is

destroying capital.

We have a study here [as of 2013] that shows that the

finding cost per barrel of Exxon Mobil is north of

$50/barrel over the last three years, which is a stunning

number. Exxon is one of the most respected companies in

the world, probably the most competent large energy

company out there. And that it cost them $50 per barrel

equivalent to add proved developed reserves, it’s very

difficult to make money adding reserves at $50 and

selling for $90. Between the time value of money and thecost of lifting the hydrocarbon up out of the ground,

you’re just not going to make money, and this is Exxon!

The Risk of a Higher Regulatory Burden on Traditional

Energy Sources

Bryan Lawrence (transcript): The risk is high that there

will be a lot of talk about it, and there is a lot of talk about

it. The risk is lower that actually there will be a successful

move of our cost of energy in this

country from ¢5 to ¢10. That would

require a reallocation on a perpetual

basis of 9% of our gross domestic

product. To put that in perspective, this

recent excitement we had over the fiscal

cliff [as of 2013] resulted in $60 billion

of incremental taxes despite all the

leverage the system had because disaster

was going to happen. The net result was

$60 billion of incremental taxes which is

0.4% of GDP. All that Sturm and Drang

at the end of last year.

We’re talking about something thatwould be twenty times as large to move

us from ¢5 to ¢10. Back to the analogy

of the goldfish swimming in the goldfish

bowl, I don’t think that people really

understand what it would mean to absorb

that kind of cost. I do think that some

politicians know this. Some politicians

actually are numerate, most of them are

not.

And so the dynamic continues to be the formulation of

plans followed by the confrontation with the laws of

physics and the pain that they have to inflict. In Europe

[as of 2013], the idea of making carbon cost €30/ton

means electricity has to be more expensive. That’s not a

very politically palatable thing. You just see this pattern

over and over again.

“What you want iscompanies that are

making lots of decisions.

The reason that you wantthem to be making lots of

decisions is that as

decisions reveal

information, that canchange how they’re

making those decisions.

If they are the kind ofmanagement that you

want to be partners with,they’ll make those

decisions and change

those decisions

intelligently.”

Watch a video of our exclusive 2013 interview with Bryan Lawrencein the Manual of Ideas Members Area at http://bit.ly/1iqFN3p






manual of ideas q&a - 2015-11-13

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