This is an edited transcript of our podcast episode with Josh Young, published 8 April 2022. Josh Young is the Chief Investment Officer and Founder of Bison Interests – an investment firm that focuses on the publicly traded oil and gas sector. He has over 15 years of experience in investment management, 10 of which were focused on publicly-traded oil and gas securities. Josh became Chairman of the Board of RMP Energy in 2017. After refreshing the board and management team and rebranding the company (Iron Bridge Resources), it was bought out at a 78% premium in 2018. In the podcast, we discuss the cost of drilling, the impact of ESG on the energy sector, and much more. While we have tried to make the transcript as accurate as possible, if you do notice any errors, let me know by email.
Bilal Hafeez (00:00:00):
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Now onto this episode’s guest, Josh Young. Josh is the chief investment officer and founder of Bison Interests. An investment firm that focuses on the publicly traded oil and gas sector. He has over 15 years of experience in investment management, 10 of which were focused on publicly traded oil and gas securities. Josh became the chairman of the board of RMP Energy in 2017, after refreshing the board and management team and rebranding the company to Iron Bridge Resources, it was bought out at a 78% premium in 2018. Before this, Josh was a management consultant to fortune 500 companies and private equity firms, and then investment analyst at a private equity fund. Josh also worked as an investment analyst for a multi-billion dollar single family office. Now, onto our conversation.
Welcome Josh. It’s great to have you on podcast. I’ve been looking forward to having you on for a while now.
Josh Young (00:03:41):
Thank you for having me on.
Bilal Hafeez (00:03:43):
Now, before we go into the meat of our conversation, I always like to ask my guests something about their origin story. Where did you go to university or school? What did you study? Was it inevitable you’d end up in commodities and energy? And what’s your journey until now?
Josh Young (00:03:56):
I’m from Los Angeles, the LA area. The logical path there is to go into real estate or in entertainment. And I like real estate, but I felt like by the time I was coming out of school, the real estate bubble and real estate prices had been elevated for some time. And they’ve gone up since then, but I figured that wasn’t so interesting. So I went to University of Chicago and studied economics. And did a series of the normal progression, I guess it’s considered from econ or finance background. I did management consulting and then private equity, and then worked for a multi-billion dollar asset manager, single family office. And then did a combination of, I launched a small sub-scale hedge fund that didn’t work out and did a number of one off, event driven or opportunistic energy investments, which I had done at that family office.
And I had done previously just personally. And in 2015, after the oil price crash, I set up a fund with a partner and we figured we’d make a fund out of this set of one off investments. It turns out if you do one off investments and you do four, right and they’re great. And then the fifth one, isn’t so great, people don’t want to do the sixth one with you anymore. Even though on average, your record’s great. So the solution was, “Hey, let’s have 10 or 20 positions on at a time.” And in this much more volatile environment, after the big commodity run up there was a lot more opportunity and it made sense to have a basket instead of just one or two things. And so that’s what I do and how I got to what I do.
Bilal Hafeez (00:05:29):
Great. And the company you founded is Bison Interests. Why Bison? That’s an interesting name.
Josh Young (00:05:37):
Yeah. The Bison, it’s an iconic, western symbol and it’s iconic for different reasons. One reason that really resonated with us and that I think it’s working particularly well now that oil prices have started to rise and the strategy is working overtime and has worked actually since inception now, which is pretty cool. The Bison’s the only four-legged animal that when there’s a storm, it faces into the storm and it gets through it safer and faster. The other animals, when there’s a storm coming, they turn and they run away. And so, the other energy investors that were doing what we were doing and many that were doing different things, mostly closed up. And so over the last seven years, since we launched our fund. And the competitive space has really dwindled. It actually, I guess, was prophetic or a prediction about what would happen. And here we are, and things are working really well. I think there’s a lot of benefit to, it seems stubborn and sometimes foolish in the midst of a storm to be facing into it. But that’s where our name came from. And it’s turned out to be a pretty good name.
Bilal Hafeez (00:06:48):
No, that’s great. I had no idea that was the case with Bison’s. That was a great story. And you talked about making a basket of investments. When you say investments, what types of investments we talking about?
Josh Young (00:06:58):
We only invest in publicly traded companies. And we focus on upstream producers of oil, natural gas, and natural gas liquids. And then occasionally we’ll buy stock in either midstream, infrastructure sort of companies generally related to the oil and gas industry or services companies. So, companies essentially on the value chain that help get oil out of the ground or natural gas out of the ground or processed, or sort of. There’s a giant industry ecosystem around that, that I think is very poorly understood. And actually, recently we’ve been doing a lot more of that because it’s so poorly understood. And because there are some advantages from what we’ve been focusing on in terms of knowing kind of who’s winning next as this commodity cycle unfolds.
Understanding the energy sector: upstream/midstream/downstream
Bilal Hafeez (00:07:47):
And so when you talk about upstream, midstream and now presumably downstream, can you just elaborate a bit of what the key types of things that happen at each part of the stream, just for the benefit of our listeners and also myself as well in case I’ve missed something here?
Josh Young (00:07:59):
Yeah, for sure. We actually really don’t do much refining, which is downstream and we will on occasion, but it’s really not been a focus so far for the fund. Upstream is basically the company that owns, that acquires the mineral rights to the land, the rights to extract minerals from land, whether it’s through government or through a private land owner or a mineral right owner. They essentially lease or acquire the rights to the petroleum with some royalty or some other sort of terms. Upstream is the company that owns it and pays for it, or owns the lease to it and pays to get it developed and then generates the cash flow from the sale of the commodity. That’s the upstream company. A midstream company is a company that gathers that commodity and processes it. In some cases, the pipe up to the well, or the pipe up to the field is not owned by the producer, it’s owned by the midstream company.
And then processes it and then delivers it to a refinery or delivers it, if it’s gas to a gas… I guess they might own the gas processing plant too and maybe delivers it to an interstate pipeline. The midstream company might also own that interstate pipeline and then deliver that gas either to industrial users, or power plants, or to utilities that then distribute it out. There’s natural gas. And then there’s various other sort of midstream related to natural gas liquids, and then services are companies that own drilling rigs, or own drill bits, or provide technical services to companies to help them figure out where to drill or to help manage the drilling or to manage pressure pumping, fracking. There’s a whole set of different services that go into development. And it’s one of the things I think people don’t really understand so much about oil and gas is the producers.
Congress just called a bunch of producers to testify about gasoline prices. Ironically, they called companies that don’t produce gasoline to talk about gasoline prices, which was one aspect that was interesting. But a bigger aspect is they don’t really seem to understand if you go to a well site or you go to where people are drilling or where they’re fracking and you look around at the people who are there, almost none of them are employed. If it’s an Exxon well site, almost none of them are employed by Exxon. They’re employed by a drilling company and then oil services company. There might be people from that drilling contractor, there might be people from Halliburton or Schlumberger or Baker Hughes or Weatherford, kind of helping supervise the drilling process and providing specialty services.
There might be American Energy Services or one of these other chemical companies with people there delivering drilling chemicals, or fracking chemicals, and mud, and other stuff. There might be sand companies. The sand company people there either facilitating delivery. Anyway, I’m kind of rambling, but there’s this whole set of people who are there and there might be like two people from Exxon or… Exxon, I don’t know, they tend to overstaff their stuff, but from a X, Y, Z upstream producer, you might only have two people if there’s 200 people at the site or 100 people at the site, you might only have a few from the actual company that owns it.
And the rest are people that are contractors and either employed by service companies or contractors to service employees. Kind of like you own a house, you’re getting it built, but you might show up or you might hire someone on your behalf to show up. And then you have all these contractors and subcontractors and whatever that are there to build your house.
Bilal Hafeez (00:11:32):
And so you say, people don’t understand this as much. I can understand politicians not understanding this and the general public, but surely investors in this sector would understand this, but is that not the case?
Josh Young (00:11:43):
There aren’t many professional investors that focus on oil and gas as specialists anymore in business or employment. What they understand, I don’t know because there’s not many left. I think as a generalist investor looking at something like this, it’s quite challenging because there’s a lot of different dynamics at play. And I think there’s some understanding of drilling rigs in terms of you buy onshore, offshore rig for X, and it costs two X to replace it. It’s interesting as a value proposition, as a value investor, where you buy a pressure pumping company, which they’re a little more expensive on replacement costs, but they’re generating cash flow. You buy it for three times cash flow and you think it’s worth five. There’s a little bit of that, but I think there’s a lot of missing, understanding of the steps that are required as well as which aspects are less well supplied and which ones are more well supplied.
There’s really not much. There used to be this whole kind of set of research providers that would help you figure out who’s doing what, when? And a lot of those people, a lot of those businesses are either not in business anymore, they’ve been folded into larger companies and those services have kind of diminished. And for example, there’s been this thesis for a while, that pressure pumping, so the fracking providers that’s been under supplied and that drilling rigs were widely available. And it’s turned out, it was the opposite. The pressure pumpers that they got better margins early, but there’s actually much more of a shortage of staffed, functional drilling rigs than there is of pressure pumpers. And so we’re seeing this crazy move right now of drilling rig companies way outperforming the pressure pumping companies from a share price perspective from this thing that you could see.
We put out a white paper in January, we were late. People were talking about this two or three months before. We were talking about it, we just hadn’t published our research. That’s what I mean. There’s things that you could tell if you were paying attention and it’s just the whole research space and the whole investment space has been eviscerated. And so you can be so early that it almost looks like you’re wrong because the stocks, the fundamentals are there. It just takes six months sometimes for the stock to actually reflect what you’re seeing on the ground.
The impact of ESG on the energy sector
Bilal Hafeez (00:13:56):
And you were saying the research and all of that’s been eviscerated is that because of the bear market in oil that we had in 2015, that sort of period? Or is it to do with the ESG and this whole move against fossil fuels?
Josh Young (00:14:07):
Bilal Hafeez (00:14:07):
Yeah. And do you find on the ESG side that there’s been a change over the last, say six, seven months around investors coming back into the energy space, given the elevated prices of oil and this recognition that there is a transition phase where you will need fossil fuels?
Josh Young (00:14:24):
I think it depends on who you’re looking at. I think there’s a lot of institutional inertia on the institutional investor side, and there’s a lot of doubling down and commitment bias and sunk loss psychology where many places have decided to not invest out of quasi-religious, philosophical motivations, whether they’re afraid of their students coming and protesting in front of their endowment offices or whether they’re virtue signalling, because they run a smaller pension fund or they want to run a bigger one. There’s actually been additional divestments from oil and gas in the last month or so. Even in the midst of after Russia invaded Ukraine, there are shortages of energy in Europe. And I think it was, was it ING? There was some big Dutch insurance company along with, I think they do some other financial services.
And they said they were done in oil and gas. They would no longer provide insurance. And they were withdrawing their investments as well. This is happening still today. And it’s really, there’s two aspects. One is moral. There’s a moral aspect where there’s people in emerging markets and frontier markets who really need this stuff. And if you’re replacing burning dung or burning wood inside with burning propane or natural gas, your life is dramatically improving. Your lifespan is improving. And even if you are very worried about climate change, you’re bringing forward a lot of good where if you’re worried about climate change 80 years from now hurting these people, well, you can double their lifespan now by not burning dung indoors in a hut. And if you burn propane indoors instead of dung, you’re literally, you might increase their lifespan by two X.
So if you can do that for a billion people versus worrying about very long dated potential risks, that seems very moral, but then it’s also just very non-responsive to economic signals. We saw huge equity fund flows last year into the broader market and we’re not really seeing those fund flows in oil and gas. I don’t know, it’s been very interesting and we’ve done extraordinarily well and institutions were divesting from Bison and they’re not calling. It’s like, “Okay, well, if you’re not calling us…” And you may see our competitors and it’s just not happening.
And it’s very, again, it’s unfortunate, it’s tragic for a giant number of people who really could use this stuff. And the more expensive it is, the worse it is from just overall, the world is worse off because of it. And many poor people are worse off, but it’s also just very strange. I don’t think I understand. Or I’m maybe becoming more cynical about the mandates for these institutional investors because it doesn’t seem to be, to make humanity better and it doesn’t seem to be to maximise profits. So if it’s not either of those, what are they doing?
Why oil output isn’t higher
Bilal Hafeez (00:17:15):
Yeah. And it seems like they’re falling back into having to fire up coal stations and things like that to meet short term demands. There’s all contradictions that going on here. Now, one question I did have around recent events is that many politicians, for example, and again, lay people have just said, “Why can’t we just crank up the output? The US has lots of inventory and capacity. Why don’t the Shell guys come back up and ramp up production? Why don’t the Middle East do the same, the Saudis and the Emiratis and so on and the Gulf countries. What’s stopping this increase in production?”
Josh Young (00:17:49):
There was a politician, I think it was a Congresswoman who was interviewed on CNBC recently. And she was talking about how oil companies are earning excess profits and how this is wrong. She also was on a group that tried to ban fracking in the US last year and has been recently commenting about how she is anti-fracking and doesn’t want oil companies to drill more in the US. And so the CNBC host correctly asked her, “Hey, how can you be in favour of more oil production, but anti fracking?” And she said, “Oh no, no, you don’t understand.” Essentially, I’m paraphrasing. “You don’t understand, these companies can produce more. I don’t want them to frack. I just want them to produce more.” And so the level of ignorance that production is coming from drilling more wells and hydraulic fracture, stimulating those wells and bringing them onto production.
Again, that’s on the extreme end of either ignorance or intentional disinformation, but in the context to that thing, you pick Congresswoman, right. You either want your constituents to pay $20 a gallon for gasoline, or you want there to be more jobs in the US through drilling and completing wells. And you need to have drilling and fracking. It’s an either or, and I think there’s just not…
I can say this a thousand times and they’ll still say it, right. It doesn’t matter. My take is, okay. I say what I can. I make more money from them being dumb and implementing bad policies. But I don’t want to, I’d rather make an appropriate amount of money and do well through investing in high quality companies at low valuations and have good energy policy. I say what I think is right and good from a policy perspective while understanding that the inertia and trajectory is towards worse and worse policy, which means my stuff will do even better than it would if there was rational laws.
The structural supply issues for the energy sector
Bilal Hafeez (00:19:47):
Yeah. A couple of things I wanted to ask there. So given that there’s been this anti fracking and just anti energy company policy towards many companies in the US and of course, Europe and elsewhere, is there a case that the regulatory environment is just so uncertain, that energy companies that can hang on, why should we necessarily increase production? Because we could start to, and then suddenly the tables could turn and it could be a problem for us. How much of this regulatory uncertainty in this flip flopping that’s been going on is a problem for our NG companies.
Josh Young (00:20:25):
It’s a huge problem. They’re all thinking about it. I talk to companies all the time. I hosted a Twitter space. It was kind of funny, because there was all this nonsense going on. There was even a Dallas fed survey where they published something. I think they were very careful about the questions they asked. As an economist, you get trained in ignoring surveys and observing behaviour. You want to care about purchase behaviour and not what people say. And one of the problems with looking at what people say, especially in responses to surveys is that you can construct a survey with certain questions and you can literally get the opposite result depending on how you structure the questions. And people won the Nobel Prize in Economics for this. A lot of behavioural economics, they observe kind of, if you frame something one way versus framing it the other way you get opposite results.
Many people have been citing this Dallas fed survey, which again, from what I can tell is totally wrong. It was just misrepresentative and many people will show this chart and say, “Oh, well on the left side of the chart, there’s the big bar that says that it’s people saying they want to return cash to shareholders. And the small bar is that they’re worried about policy.” The reality is that they’re all worried about policy. And that it’s really hard because even if you weren’t worried about policy, which they are, every executive that I’ve talked to is concerned about additional negative policy, which is real. The regulators are ramping up. Like the SEC is now increasing their disclosure requirements, which may then be used, that information may be used to pursue these companies in court and tax them more and other stuff.
The regulatory burden is jumping higher right now. It’s in review right now by the SEC, it’s in review period. It’s about to get implemented. It’s getting way worse right now. They’re worried about it. Even if they weren’t, the negative rhetoric by politicians in the media against the oil and gas industry is making recruiting talent extremely difficult. If you’re a young person leaving university and the president of the United States says, “This industry is going away,” why on earth would you choose to enter that industry? The problem is, it’s kind of like that congresswoman’s misunderstanding.
If you say it’s terrible, but then you say, why aren’t you doing more well? There’s people, capital and equipment that it costs money. You have to have the stuff and you have to have the people. If you’re telling the people not to go do it, and then you’re preventing the capital directly or indirectly from doing it. And you’re regulating the application of the capital, such that you’re raising the cost of that capital significantly, of course you’re going to have less of it. That’s econ 101. You raise the cost of something, you reduce the provision of the thing, that’s it?
Bilal Hafeez (00:23:01):
Yeah. And how much has the pandemic impacted the supply side of energy? Because that’s the other thing that often comes up.
Josh Young (00:23:09):
We were getting into an energy shortage period in January of 2020. And so it made the pandemic much more psychologically challenging for me and for other oil and gas investors and executives. And I think it’s actually part of why there’s so little capital available still. And part of why the industry got so eviscerated. People had held on for years and, there were way fewer people in oil and gas in early 2020 than there were in 2014, but there was a set of funds, a set of companies. The industry could have rebounded pretty significantly. And would’ve. With the pandemic you ended up with shockingly low oil prices. You even had a negative oil print for a day, which gets talked about a lot, but oil was like $20 a barrel for months. And that really has a dampening effect.
Many funds closed down, or they shifted. So many oil and gas private equity funds became energy transition funds or whatever. And you can’t walk that back. You go tell all your limited partners, “Hey, I’m raising a billion dollars to go do this other thing.” You can’t use that billion dollars to go drill oil and gas. And once you’ve rebranded to this other thing, it’s really hard to go back to raising money for traditional oil and gas development. You had a huge shift further during the pandemic in a period where there was already going to be under supply. Demand shocked down in a period where you had this multi-year, under investment kicking in.
And so it looked like for a little while that the industry was going to reset lower and instead, and prices were going to reset lower. But the reality was that this long term underinvestment kicked in way sooner than people thought, especially because of the underinvestment during the pandemic. And so I guess it was just like long term trend plus a shock ending up with something that we were essentially betting on, but got very lonely. And I think people went from thinking we were contrarian to thinking we were absolutely crazy. And here we are.
The investment needs to maintain supply
Bilal Hafeez (00:25:12):
Yeah. I guess the Bison mentality helped, I guess, in the end. And in terms of global supply chain issues, are there problems in securing equipment and parts and so on in the oil and gas sector?
Josh Young (00:25:25):
Yeah. But it’s less related to the general supply chain, post COVID thing and more related to the whole value chain in oil and gas getting eviscerated over the last eight years. And so it’s less of a, “Hey, there’s not enough trucks or not enough boats or whatever to ship this stuff.” And a lot more of, “Hey, the companies that used to be able to make more drill bits can’t. They’ve repurposed those factories or they closed them. The companies that could make more drilling pipe or more X, Y, Z other stuff, they don’t have that capacity because they rationalised it over a long down cycle.” And so this is why you have long up cycles after long down cycles, because it takes a really long time. You have to essentially either build new factories or retool old ones. You have to acquire the talent, which again is increasingly difficult.
You have to find the capital and there’s almost no capital for any of this. For all of that to happen, you need much higher prices and you need it not to be temporary. You need it to be for a long time. This is something I fight a lot in terms of sentiment. There are many people that say, “Oh, well, oil’s high now it’s going to crash.” And it’s like, “Well, wait a second. If you look at the history of oil and gas and you look at what’s happened after long down cycles, you’ve almost never seen a long down cycle lead to a short up, and then everything goes away. You much more often see that long down cycles lead to long up cycles, almost like the biblical seven years of famine, seven years of feast. And it’s not just a psychological thing.
It’s actually, there are lots of physical impediments, but the psychological fallacy of fighting the last war is so hard for people to overcome. And so they really go from, okay you saw this with just general market after the financial crisis. In 2009, I was at a family office. Everyone was pitching us these short only funds, “Hey, there was this rebound, but everything’s going to crash.” And it sounded really sexy. It’s really compelling. Then in 2010 sounded really sexy. So leave the family office, still like seeing all this stuff. Oh yeah. This thing is going to crash and that thing. And that continued, there are still people who have been bearish since 2009. And most of them are out to business, but some of them are still around. I think that’s happening with oil and gas, where you have people who were bearish and wrong in 2020 after the worst of the pandemic.
And then they’ve been wrong in 2021 and now they’re wrong. And I think there’s just this momentum and sure, there could be an economic crisis. Things could trade down temporarily from a commodity price and equity price perspective. But I think there is this long trend up and a lot of it’s driven by the supply chain, but it’s really, it’s not the COVID supply chain that’s the issue. It’s that the value chain was eviscerated. And it’s still not, we’re still not seeing investment. You need this investment. You need to get funded and start, and then it takes multiple years and then you have more capacity. And we’re not even seeing that start.
Whether the Middle East step up supply
Bilal Hafeez (00:28:33):
And outside of the US, are there other places where you are seeing investments? In the Middle East, is there investment going on there? Could they meaningfully increase their capacity? People talk about Iran coming back online. Venezuela, perhaps. I’m just trying to understand where there’s potential positives on the supply side.
Josh Young (00:28:49):
Yeah. You can, I’m not a peak oil person. I’m more of a peak cheap oil person. There’s plenty of oil for a long time. And there’s plenty of natural gas. There’s even more natural gas for a long time, from a world perspective. And there’s enough to be able… And that’s like, what really gets me, there’s enough for the quality of life of the poorest people in the world, the poorest two billion people in the world to improve dramatically, if we adequately supplied them. And we need the regulatory certainty and we need to be rewarded instead of punished for doing it. But really, there is this plenty, it’s just expensive. And it needs to be in courage and not discouraged. When you look around the world, the rig counts are still really low and the service capacity has been eviscerated worldwide.
It’s not just eviscerated in US and Canada. I don’t know. You have Saudi Arabia saying they’re going to raise their spare capacity by a million barrels a day. There’s no evidence that they have the spare capacity that they claim right now. In fact, there’s a lot of evidence that they don’t. What exactly do they mean by raising that capacity? They are drilling more natural gas wells, and they burn a lot of their oil for power. It’s possible that they replace some of the oil they’ve been burning for power with natural gas and then export more oil.
The problem is that their natural gas is incredibly expensive. I know many people that have been hired from the Shell gas industry here in the US to go to Saudi Arabia, to drill Shell gas wells there, it’s hard. And it takes a lot of water, which you need fresh water for it. And Saudi Arabia doesn’t have an abundance of fresh water. And fracking a well there I don’t know, there’s activity in Oman too. A well that would cost, let’s say six million dollars in the US might cost $30 or $40 million in Oman or Saudi Arabia.
Bilal Hafeez (00:30:35):
Wow. Okay. So it’s multiples higher?
Josh Young (00:30:37):
Yeah. Yeah. Really, I think, yeah, they have the capacity, they have the rock, but just because you have that doesn’t mean that it’s getting developed. And again, we’re actually seeing, we’re still burning the furniture. There’s still so little development that you’re actually reducing your capacity still at current levels right now, April, 2022. So you actually need to build more stuff to be able to ramp up just to supply the world for demand today. Then you need to build more in order to supply the world for demand in 2025 or 2030. And you’re just not, that construction isn’t happening yet. You have drilling companies that half of book value and still costs are higher and there’s not the factories to be able to build the stuff. Yeah, I think it’s quite challenging and we’re not even starting.
And then the one other thing on that is exploration. You need to find the stuff that you’re going to delineate and then develop. You need to find the fields. And in many cases there is not been, I think from a global perspective, we’re producing 10 times as much oil as we’re discovering on an annual basis. And that’s been happening. I mean the real big exploration push slowed down in 2012. And so we’ve been under investing in exploration for a long time. That means that all the other activity, other than exploration is to some extent burning the furniture. From a value chain perspective, we’re working through the working capital and that looks good. And Congress might say, “Oh you’re over-earning,” but we’re under earning. And we’re under earning because what you want to see for a healthy market to balance is you want to see exploration sufficient to discover more than 100% of your consumption, not 12% of your consumption.
And we’re just not seeing that activity ramp up. Again, it’s like, I know I keep saying we’re not seeing it, but the early stages of a recovery from a supply perspective require investment and activity that’s not happening. And so all the other stuff it’s noise and we’re just not solving, we’re not starting to solve the problem. And I think from a government perspective, the idea is, “Hey, we have these alternative energy policies. We have all this other stuff we’re going to… We don’t need that by the time that becomes an issue, it’s not going to be necessary.
And I guess my pushback is, “Hey, let’s look at France and Germany and other countries that made the investment that the US and others are starting to talk about making. And they’re not in a position where they can move off of these hydrocarbons. They’re actually more dependent on them than people thought.” I think it’s a policy error and it’s leading to a potential. It seems likely at this point that we’re in a, multi-year bull market for oil and gas. And at the same time the sentiment is, “Oh, it’s topped, it’s done. Commodities are over.” And it’s like, “Okay, well this is the shortest commodity cycle in history, if that’s true and very, very unlikely.”
Whether the oil bull market is still early
Bilal Hafeez (00:33:30):
In terms of the oil price, say WTI or Brent, do you think we could get, say 200 or so? Is that a reasonable level that we could reach if not higher?
Josh Young (00:33:40):
I think we have to. We’re just not seeing… We saw oil at, I think WTI got to what? 125, almost 130 recently when there was concern that Russia was going to get shut off completely. And then, it bounced around there. It spiked a couple times and now it’s back down below 100. The problem is you just look at the activity at $100 oil. And we’re now we’ve been at 100 or above now for a few months. And it looks like we’re probably going to be in that range for a little while here. It’s hard to predict the future, but we’re in this range. What we’re seeing in this range is not enough of this base level activity that you need to rebuild the industry’s supply capacity. I think you need much higher prices, whatever price you start seeing exploration wells drilled much more frequently and rig building factories, retooled to actually build rigs, and pressure pumping oriented fabricators or whatever.
I’m using factories as a general, where there’s specific of terms for these, but just the manufacturing capacity to make these things. When you start seeing that, that maybe is an indicator that you’re getting closer to an oil price, that makes sense. But even then you need them to be built. You need the fabrication and manufacturing built and then you need more of it built and then you need it to run for a while, to replace all the stuff that broke and then you need more stuff.
And so again, just from a very pure widget perspective, you need the widgets that make the widgets and we’re not making those first ones and we’re not even fixing the factories that make those first widgets to make the second widgets to get third widgets. It’s a classic economic cycle problem and we’re still this… Measured in that perspective, we’re maybe second ending where the prices are starting to rise because we’re in a problem and we’re just not getting that investment to make those widgets.
Bilal Hafeez (00:35:34):
No, that’s a really good point. What you’re saying there is that the looking at the price alone is deceptive about whether we’re at a high or not. You have to look at the online fundamentals and whether there’s the investment and the production and everything coming online, to be able to generate that additional supply. Because if there isn’t then the fundamentals aren’t there for this peak oil price to occur.
Josh Young (00:35:52):
Yeah. Yeah. Exactly. I’m glad. This is actually one of the reasons I wanted to talk to you. I’ve seen some of your interviews and I think you do a good job of distilling some of the macro. There’s all this noise and lots of things that people toss around and I think you do a good job of distilling. And I think that was a really good observation. It’s really is just like, it’s not just about price, it’s about activity and there’s a lot of different inputs to get to an output, which seems desired, which is lower oil prices and that may require much higher prices for some meaningful amount of time.
Will Russia change the outlook on oil supply?
Bilal Hafeez (00:36:24):
Yeah, absolutely. And what’s your take on Russia then in terms of it’s oil supply? So obviously Europe hasn’t imposed sanctions on energy yet, it may well do soon. They’ve done some sanctions on coal, but obviously there’s an aversion to touching Russian entity. There’s something going on there. How do you view something like that? It’s such an unusual event, but Russia’s one of the biggest producers in the world. And for them to come under this new regime, how do you interpret that for your sector?
Josh Young (00:36:54):
I’ve been just underwriting continued production from Russia, uninterrupted. And I understand that’s probably wrong. There’s probably some amount of oil production capacity and oil export disruption from Russia. All of that from my perspective is just upside to price and upside in terms of drained inventories elsewhere in the world. There’s so much bad news and news flow and so much incorrect information out there on a variety of fronts right now that I feel a little bit like I’m operating as a pilot on instruments instead of a pilot able to look out the window. And so when you’re operating in that cloud of uncertainty, one of the ways to address it is to try to block out what you see in the window. Because you might see something, but just because you see it doesn’t mean that it’s as real as it’s represented.
And this infuriates people, I think more than people are upset about being bullish early in a commodity cycle after a move, but again, relative to what we were talked about still very early, they hate even more taking information. I’ll acknowledge it. Maybe I’ll tweet it or something, but it’s not the core of the thesis. Maybe Russian disruption happens, maybe it doesn’t. Maybe Iranian production comes online, maybe it doesn’t. Maybe Venezuelan production starts to rebound. And again, both Iran and Venezuela are very complicated.
They would take many years to bring on production and frankly I wish them well. I hope that they come on and I hope that their economies boom, and in my analysis, especially with Venezuela, I see the potential. And actually, Iran is pretty close. I see the potential for such a substantial economic boom in those places to the extent that they move towards a free market, that they may actually end up consuming more oil incrementally than they incrementally produce at least for a number of years.
And so I don’t think, you look at the, what is it? Tens or hundreds of millions of people in Iran and Venezuela and you look at the former state of their economy and how oil intensive it was. I don’t see that as a threat to the oil market. And I also see it as a very potential positive just to all of those millions of people who live in those places. Anyway, that’s a digression. The main point is I think it’s really hard to tell obviously if Russian oil production comes off, it’s going to be very hard for it to come back on. The reservoirs there are very complicated, service companies have been moving out. They’re not totally out. And announcements are somewhat deceptive. They’re still providing services in some capacity. There’s still some activity in development in Russia.
Our view had been already previously starting middle year, last year. And we started sharing this, that OPEC Plus had been running out of spare capacity. And Russia was one of the few places that had a little bit of extra capacity left. Maybe they have less and maybe that starts to get degraded, maybe not. That part again is unclear. That’s the tree and the forest is this global underinvestment for a decade plus in exploration, global under investment in production for the last five years plus and demand rising on a 1% plus annual basis as a long term, multi decade check.
How has China influenced the energy market?
Bilal Hafeez (00:40:13):
And they’re all really, really good points and the support on to kind mind people of the structural story here. Because I think again, as you said, it’s easy for people to dismiss these things as temporary spikes in oil, when Russia eases up, then somehow there’ll be correction, but you rightly point out there’s something deeper going on here. Now I did want to ask about China and China’s role in the energy sector. Are they providing equipment and services in the oil sector because they may have different goals or they’ve talked a lot about climate change themselves and maybe they’re scaling back themselves. But how’s China influenced the energy market? because obviously they’re probably one of the biggest consumers in the world.
Josh Young (00:40:46):
There’s two questions with China. One is their demand and then one is their ability to provide services worldwide in the oil and gas sector. On the demand, it’s even worse than global demand. Imagine your instruments are unreliable, because there’s some electrical issue and you can’t see out the window. So TBD, right? I think the Chinese regime has a lot of incentive for people’s quality of life in China to improve incrementally over time. That’s how they stay in power. The deal with a totalitarian state is that you, on one hand have all the political power. On the other hand, you need to have a large majority of the people with their lives improved in some capacity on an annual basis or else they have a violent revolution. Or some other sort of thing, the long history of these sorts of states.
And so generally that’s productive, not necessarily for iron or not necessarily for various other commodities, but oil and natural gas are very much necessary and uranium and certain other commodities very necessary for that progression for them to stay in power. And they are laser focused on staying in power. And so I think there’s alignment and there’s lots of mess and noise and various things that they’re doing to stay in power. But the biggest thing they’re doing is slowly improving their GDP per capita, which is highly oil intensive based on where they’re at from a development state. In terms of their ability to deliver effective oil services worldwide, I’ll just politely say that’s the bull case is, you replace the Halliburtons with X, Y, Z Chinese services company in Russia for example, that makes me more bullish on oil not less. I’ve seen a few of these projects.
There’s a movie I cite sometimes, Syriana, where they show a Chinese firm coming in. And you look at the number of people applied to a project and then you look at the development of that project. And I guess I have to caveat, this isn’t something that I’m not saying that Chinese people are not capable, obviously. All people are capable. It’s a function of corporate culture. It’s a function of government intervention in the management of companies.
It’s a question of innovation cultures within companies. And then the reality of increasingly difficult to find and extract oil resulting in the need for innovative companies, with new technology, with highly motivated and aligned people and Chinese corporate culture today, from what I can tell as well as observing projects that Chinese services companies have been highly involved with, it doesn’t seem like there’s a good, it’s a kind of square peg round hole sort of thing.
The best way to play the energy sector
Bilal Hafeez (00:43:30):
Yeah, it makes sense. They don’t really have their own large oil and gas sector for them to build up the expertise either unlike say the US or Russia. I did want to ask about, the types of investments that you are making in this bull market scenario. A basic question, and this I’m speaking as a non specialist is, why not just buy oil? Oil futures? Is that simply the best way playing this? Why look at oil fuel service and all of these other sorts of things, because isn’t it just a play on oil price itself.
Josh Young (00:44:01):
It’s a great question. And there are great macro investors who are just long dated oil futures or options. And I’m not saying that won’t do well, but it does appear that there are better returns available through owning equities that are very levered to improvements in oil prices. And so you might think you have a lot of leverage through futures or through options on futures. And options on futures are very highly levered, but you also have a lot of timing risk and you also have… You’re essentially betting on prices on the forward curve today. If you look at what’s priced into a lot of the oil equities on the producers side, it’s easier to explain on the producers. The services are more complicated, which again is I think partly why they’re not attract acting as much capital.
I won’t try to explain that. I’ll just focus on the producer. The average producer right now is pricing in per various different investment bank reports, pricing in about $60 WTI oil in the US and in Canada and pricing in about, let’s say 250 to maybe 275 per MCF natural gas. And so you look at the forward curve and you try to make a bet that’s equivalent to a levered producer that earns that, where their cash flow increases very disproportionate to an increase in the commodity price. And on the natural gas side, it’s even more egregious because there’s contango instead of backwardation. So the forward price for gas is actually higher, whereas the forward price for oil is lower. But you look at how much money these guys make at different prices and then you look at historic valuations. And one, you have a catch up on historic valuations.
The producers are trading at lower multiples than they did historically, despite higher margins than they had historically. You have this nice setup relative to just spot pricing and relative to the forward curve. As the forward curve improves, their cash flows improve dramatically. And then when you look at where the capital is going, so dividends are complicated, because they’re just giving the money back to investors, but companies that are paying down debt, improve their cost of capital because they become intrinsically less risky.
Those companies that are most actively using their extra cash flow from oil being at 95 or 100 or whatever today to pay down debt are increasing their likely multiple in the future because the market assigns a risk. Generally it’s about every dollar spent on debt pay down gets you $2 or so in market cap over time. Just again, the risk associated with the market cap, diminishes substantially as you have less and less debt, when you go from over levered to under levered, the transformation in market value, which is a lot of where I’ve seen success is dramatic.
Secondarily, if are at a very cheap valuation on a cashflow basis and you use your cashflow to repurchase stock aggressively, you can compound money very rapidly by doing that. And again, that’s been very underappreciated. Certain value investors are focused on that. Charlie Munger has talked about it a lot, but it’s not something that’s well appreciated, partly because corporate buybacks have such bad reputations for different reasons. And so if you’re early in a commodity cycle is partly why it’s important to be able to understand what’s happening from a multi-year perspective. If you’re early on, people pressure you a lot to not actually buy back shares. They pressure you to pay dividends. I’m citing T. Boone Pickens or certain other people that that was their strong preference in a different world at the end of a commodity cycle instead of the beginning.
And then they pressure you to pay down debt, which again is good. But if you can really get in a position where you’re retiring a large number of your shares in a rising commodity price environment, while you’re keeping your production relatively flat within cashflow, you can end up compounding a lot. You look at that setup compared to owning the futures, if the forward curve just stays where it’s at, you could potentially earn a five times or 10 times return owning a average or slightly cheaper than average oil producer equity or oil and gas producer equity versus losing all your money, owning the future because you buy the option on the future and the option expires worthless.
So you really need the price to go up a lot. In the case where it goes up a lot that base return for a producer increases dramatically, especially for the ones that are paying off debt, buying back stock or compounding through production growth.
Bilal Hafeez (00:48:39):
And do you neutralise the equity beta when you make these holdings? Because obviously these whatever stock you buy will have a beater to the S&P or whichever sort of index you look at. And so if overall stocks go down, then you’ll be hit by that.
Josh Young (00:48:55):
No, and there’s reasons for that. Partly I found that, and this is partly from looking at returns before going into professional investment management, as well as at a multi-billion dollar family office, where I was involved in allocating money out to other managers, as well as doing principal investments. Long short managers tend to do quite poorly on their long investments relative to long only managers.
It’s, Buffet’s secret to some extent. It’s basically float plus not really messing around too much with market timing. And he does a little bit and tries to make sure he is not buying at the end of cycles or whatever, and is very valuation sensitive. But you look at where Buffet focused, where various other phenomenal value investors focused, and it’s much less on market beta and much more on being right about particular opportunities. That being said, market beta could actually play out very favourably to extent that commodity prices do well over time.
And the market stays under supplied because if you’re a producer at, let’s say three times free cash flow right now on an enterprise value basis. And you’re taking 30% of your free cash flow and buying back stock. Essentially you’re retiring a little more than 10%. Let’s say you’re just retiring 10% of your stock every year. Well, if your commodity price falls a little, your stock falls a lot, for a year. Let’s say it’s down 50%, which is not unreasonable, a lot of these stocks are very vulnerable.
If you can retire your stock at half the price, let’s say you retire 20% of your shares in a year instead of 10%, your snowball builds way faster. And so there is volatility as an investor in this space. If we’re named Bison, they sent into the storm, we put out a white paper in December called Embracing Volatility, explaining why we bought stock in November, even though there had been a run, because there was a big pullback as people got scared.
I think you have to, in order to earn exceptional returns, it’s necessary to accept an amount of volatility that is considered impolite as an institutional, long short manager. And again, I think that’s part of where this has been less of a fit and part of what’s pulled public equity capital away. Ironically, a lot of that capital has gone into tech VC or tech growth funds or the entire globals of the world, which have imploded because the reality was that a volatility was always there. It was just hidden based on mark to model instead of mark to market. And so ironically, a lot of the funds that were seeking quiet and were seeking steady compounded returns that didn’t exist, it was fake. And now we’re seeing those allocators facing the consequences of pursuing stability. I just embraced the volatility.
I understand the question. And again, might have maybe I was a long answer to a short question, but I think really there’s a big advantage in being able to say, “Hey, I care about earning a multiple times return over the next five years.” And yeah, it’s going to be painful. Yeah. I hate giving back money in the sense of a down month or down year. But if I can see where I’m getting to, and I see the path and I understand that there’s going to be significant road bumps along the way, instead of trying to guess when those road bumps happen and somehow getting blown up in getting on those guesses, I’d rather just have the exposure, take extra exposure where I can, when a road bump happens. And then potentially get to return capital once I get to where I’m trying to get to.
Bilal Hafeez (00:52:29):
Okay. Yeah. That’s very clear. And what’s your biggest focus this year? Where are your eyes set, say for the next six or 12 months?
Josh Young (00:52:38):
A little bit on Canadian producers, where many of them are producing natural gas. And I think people forget that there’s a little bit of this whip effect where the US gas market is the handle for the whip. It’s the more substantial part. And Canadian natural gas is the tail of the whip. And so the tail really moves a lot when the US market moves. And so you have these US producers up a lot. And the Canadian producer stocks are up, but I think people don’t understand just how big of an impact there is on natural gas and then on natural gas liquids, which then affect the oil market and effect realisations. There’s this happening along with currency effects, where Canada is very poorly managed from a fiscal perspective.
And so the Canadian dollar is doing very poorly, which is amazing if you’re a producer of a non-Canadian dollar denominated product tied into a non-Canadian dollar denominated economy. And you’re an exporter of that product with most of your costs, denominated in Canadian dollars. This is, we’re actually working on a white paper right now on this currency effect. You have this market that people don’t understand along with the currency effect. A lot of focus on that and then a lot of focus on oil services, just catching these inflexions, that it doesn’t seem like many or around even notice or work on.
Bilal Hafeez (00:54:07):
Okay, that’s great. Now I did want to ask a few personal questions as well, because we’ve covered a lot ground on the energy sector, and we could carry on for a while, but I did want to round off with personal questions. The first one was, what’s the best investment advice you’ve ever received?
Josh Young (00:54:20):
That’s a great question. I think the best advice I got was to figure out what you’re going to do and do it and not let the noise distract you. It was from my dad and it was after the oil price crash in 2014. And I think it just… I don’t remember exactly how he worded it, but it was something along those lines. And obviously I took that to heart and it felt really dumb for a while. And I think there’s a lot of truth to, if you can figure out what’s going to happen, you have to have that exposure to win from it. And you just have to set yourself up in a way where you have the longevity to be able to express that and to be able to economically benefit from it.
Bilal Hafeez (00:55:03):
Great. And presumably, you must be overwhelmed with information like we all are. Do you have a system or some productivity hacks you use to just keep on top of things?
Josh Young (00:55:11):
Kind of. We’re constantly gathering good, positive indicators as well as good contrary indicators. Really the best system that I’ve come up with. And there’s lots of different organisational things, but really like heuristic high level, the simplest thing that I can recommend to other people to do that I’ve done, that’s worked well is notice who does well over multiple years. Notice who the best investors you can find are, not from 50 years ago, but who’s doing well now? And who’s done well over the last number of years? And what are they finding interesting? What are they focused on? And trying to notice that and prioritise that over whatever the headlines are, or famous analysts or whatever. And so allocating time and focus and energy to ideas from people that do well.
And some of it’s the Napoleons like find me lucky generals thing. Some of it might be luck, but hey, that’s interesting too and maybe I guess you’d call it a momentum factor or whatever. And then some of it’s going to be just brilliance that might not yet be as well understood and so that’s a… And just because they’re doing something doesn’t mean I’ll do it, but it definitely means that I’ll pay attention to it. And I think other people should do that. And it’s a little frustrating when I see many people get excited about an idea or an analysis or a headline from a source that has a very poor track record. It’s like, “Okay, that’s nice.” I don’t really care and I understand that’s human psychology, but just because someone has a degree, or is on TV, or did well historically, whatever. It doesn’t make that idea necessarily even worth allocating a meaningful amount of time.
Books that influenced Josh
The First Billion Is the Hardest (Pickens) and Fooling Some of the People All of the Time (Einhorn)
Bilal Hafeez (00:56:55):
Yep. I hear you that I think that makes a lot of sense. And I see you have a number of books behind you. Yeah. I always ask guests this, what are some of the books that have really influenced you?
Josh Young (00:57:03):
Yeah. I disagree with T. Boone at least for this part of the cycle on the dividends over buybacks, that later in the cycle, I think he’s right. But I liked The First Billion Is The Hardest, I thought that was really interesting. And I really liked Einhorn’s, Fooling Some Of The People All Of The Time, and his book about Allied Capital and kind of how that happened. And I keep this momentum, a friend sent me this, I have the gas station, the Amran, the gas pump as a reminder of humility. And so I think the Einhorn thing is important. I think the T. Boone’s stories are important and keeping physical things. It’s easy to talk about, it’s hard to really remember, especially actually in the early stages of a recovery where returns are phenomenal and you feel like a genius, a genius does fail and it’s really important to anchor yourself. And so those have been books and stories that have really helped me stay focused on what I’m doing without hopefully blowing up.
Bilal Hafeez (00:58:01):
Great. That’s great. And how can people follow you?
Josh Young (00:58:05):
Bilal Hafeez (00:58:19):
No, that’s great. I’ll keep a note of those links on the show notes as well. With that, thanks a lot. It was super informative to listen to you, you’re very eye opening, especially for non-specialists like myself. Once again, thanks a lot for your excellent conversation.
Josh Young (00:58:32):
Thank you for having me on, I appreciate it.
Bilal Hafeez (00:58:37):
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