Author Topic: Oil Companies - From talking to a company man  (Read 3203 times)

TheOldestYoungMan

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Oil Companies - From talking to a company man
« on: February 18, 2015, 09:53:40 AM »
You probably don't know anything about oil companies and how they make their money.

A close family member of mine was a corporate accountant for what was, at the time, the largest oil company in the world.  He started in the accounting department in the 70's and retired in mid 2000's.  I've had thousands of hours of conversations with him.  He has great stories, he was literally the first accountant in the company to be given a personal computer.  Old people right?  Despite all that talking to him, I really don't know all that much about how an oil company is going to perform.  I do know that it's probably the lowest risk of going out of business that I've ever found.

One interesting thing about oil companies to consider is that they don't actually know what is going to happen in the future.  They own the well, employ the guys running the thing, own the transportation network, the refining, and the distribution.  They have a pretty good idea of how things are going to work, on average.  But until the stuff comes out of the ground, they don't know how much of it there will be or for how long they'll get that much.  They also have a huge failure rate.  If wal-mart had a store fail as often as these guys have a well turn up useless muck, we'd all still be paying too much for q-tips.

They spend alot of money getting the best data they can, but sometimes the well runs dry.  Probably the most sophisticated risk management practices in place in the world today are those employed by oil companies to make sure they never hear a huge sucking sound from either end of that refinery.  Literally every hour of every day, billions of dollars in computers take in billions of inputs from around the world and provide traders with the feedback they need to make the best business decision based on what was decided, at the corporate level, was acceptable risk.

When you look at the field of oil companies, the current set, you're seeing the winners.  After a century or more, it starts to get hard to claim that they don't know what they're doing, but really, you're seeing the top investors.  They absorb the ones that tried to time the market and failed.  Those companies are gone.  The start-up cost to oil production, refining, or distribution is so high that new players seldom enter the field.  Those one-off folks who do dig their own well end up with so much money that they usually just sell out and go live a life of fabulous riches.  A handful go spend that money digging other wells, and a handful of those manage to find more oil, and then still get bought out by the top guys.  It's money out of the ground.  You aren't participating in this part of it.  This is where the money is.

So if you want to know how to make money, as an investor, the safe bet is to buy stock in these companies.  Maybe not all, and I think you can time it to some extent, by waiting for a disaster to "buy the devil" so to speak.  These companies understand the market better than you could ever understand it.  As a corporate organism, they understand it better than any single human ever could.  There is a ton of risk inherent to the oil business.  So internally, their tolerance for commodity price risk is damn near zero.  They don't bet on oil prices.  They take whatever the oil price is, and they make money off of it no matter what.

Another thing to understand, is that a huge part of the oil company's efforts revolve around pricing the end products based on the cost of the commodity.  The cost of the commodity includes the opportunity cost of using vs. selling it.  So another way of putting that is, the actual cost of the oil that became the gasoline you bought, in terms of the effort to get it out of the ground and turn it into gasoline, does not vary based on the price of the commodity.

But the company has to make a choice to turn it into gasoline or sell it to someone else for whatever they want to use it for.  The reason why these companies will always make money is that they have the ultimate hedge in place.  No matter what, they can sell you gasoline at a price that more than covers the cost of their operations..

We could all start using alot less gasoline, but the long bet the oil companies have made is that we won't make that change quickly.  They'll be able to see the trend and adjust based on rates of consumption.  They don't have to get all that close to being right to make money at this.

When the price of the commodity goes up, then they can justify raising the price of gasoline to cover the opportunity cost they lost by not just selling the barrel.  Everything else is smoke and mirrors.  The entire oil industry is set up to make the margins seem a helluva lot tighter than they actually are.

The other consideration, is that for the most part domestic producers of oil can "stockpile" the oil in the ground.  So right now, U.S. oil company A has a huge amount of oil on hand.  It's still in the ground, but they know how to get it and can get it at any time.  They only need to pull out enough to cover the overhead of the field in low-production mode, which is surprisingly little.  They will pull out what they need to, but the rest they will save for when it will sell for more.

The oil company is timing the market.

Sometimes they time it successfully, sometimes they do not.  The reason why it doesn't make sense to you is that you aren't actually participating in this market.  You are participating in a 4th removed derivative market.  There is literally no single input that will be relevant to your analysis.  Cast your chicken bones and place your bets.

So living in Houston, where we're getting "Hammered by the oil drop" I can tell you what I see.  Oil rigs are in from the gulf, getting serviced and refit.  They were probably overdue for it.  And yea, the workers on those rigs are "laid off."  Not to be insensitive, but those were never permanent jobs.  The apparent stability of the last few years was the irregular part.  Those guys will get work on other rigs in other locations.  Any mustachians on those rigs are fine, the high wage coupled with the time off to develop skills and side jobs help them be their own emergency fund.  Sucks to lose a job though.  Some out of work welders and machinists just got hired to fix up the rig though.  The offshore fleet will go through a rotation, but the price of oil would have to stay low for a really, really long time for this to have a huge negative effect.  The independent refinery is still filling orders from awhile ago.  They may see a dropoff in future orders, but it isn't a problem until the future is now.  And it still probably isn't a problem, because it is their material cost that has gone way down.  It'd be like a bakery having trouble making money because suddenly sugar was free.  They feel the pinch a little because the gas they make suddenly doesn't sell for as much, but it is still selling for a profit.

Because they had to have the product, they placed an order for it months ago, and now are paying twice what it is currently valued at, but that doesn't hurt them that much, because so is everyone else.  Some people will have made a better bet, by having empty tanks that they can now top off on the cheap, while others are still drawing down $118/barrels.

Put it another way, if the economy gets bad enough, a farmer will sell you onions at a loss.  As in, it will have actually cost him more to produce that onion than he is selling it to you for.

You are always paying the oil company a profit to buy that gas, always.  Or plastic or fertilizer or whatever else you are paying for.  It's just they've gotten really good at displaying their data such that a profit of less than what they were expecting somehow constitutes a loss.

The arms dealers have a saying:  War is good for business.  Peace is good for business.
For oil companies:  When oil is up, times are good.  When oil is down, times are good.

The only time the oil companies will have trouble is when a govt imposes price controls.  They figured out how to deal with that too, they just take their oil and leave.  Individual companies also sometimes run into trouble when their boats run into things or their wells/refineries blow up.  I've passed on a number of opportunities to buy an oil company low after such a disaster because, well, timing the market is a sucker's bet.

I don't know if that will help anyone.  It's perhaps one of the most complicated industries in the world, and it touches on everything.  I can't think of any industry that doesn't buy from or sell to the oil industry.  The scale of the whole thing boggles the mind.  When I meet anyone who attaches any kind of special significance to the price of oil, I just mentally check the box in their profile for "doesn't understand the industry."

ValueIsWhatYouGet

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Re: Oil Companies - From talking to a company man
« Reply #1 on: February 18, 2015, 12:48:06 PM »
Very interesting read, and I tend to agree. Most people think "solar" or "electric cars" and think investing in oil companies is a dead end. They're really just printing money, for a long time to come. The barriers to entry are mind-boggling astronomical (global infrastructure, bullet proof balance sheets, huge tax breaks, government relationships/lobbying, technical knowledge, patents, etc), and the long term prospects for these companies are incredible. If I were to bet on alternative energy, I'd still put my money in Exxon or BP to figure it out.

Check2400

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Re: Oil Companies - From talking to a company man
« Reply #2 on: February 18, 2015, 01:00:31 PM »
I really enjoyed the book "The Big Rich."  If you like oil, it is a great read.  If you want to know how Texas became TEXAS, it is a great read.  If you want to see what happens when you live life leveraged with no money set aside, it is a great read. 

Basically, the first wildcatters were all huge gamblers that cared more about winning than earning, and none of that changed when they had more money than every reader on this forum combined.  They just gambled more, and more often than not, they didn't end up winning. 


RapmasterD

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Re: Oil Companies - From talking to a company man
« Reply #3 on: February 18, 2015, 01:24:55 PM »
Very interesting read, and I tend to agree. Most people think "solar" or "electric cars" and think investing in oil companies is a dead end. They're really just printing money, for a long time to come. The barriers to entry are mind-boggling astronomical (global infrastructure, bullet proof balance sheets, huge tax breaks, government relationships/lobbying, technical knowledge, patents, etc), and the long term prospects for these companies are incredible. If I were to bet on alternative energy, I'd still put my money in Exxon or BP to figure it out.

+1

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Re: Oil Companies - From talking to a company man
« Reply #4 on: February 18, 2015, 04:16:31 PM »
What the OP is talking about is major, vertically integrated oil companies -- the guys that go from taking the oil out of the ground to delivering gasoline into your auto gas tank at one of the company's branded gas stations.

But there are a lot of OTHER types of "oil companies."  There are "upstream" oil producers (outfits that take the oil and natural gas out of the ground), "midstream" oil handlers (outfits that move through pipelines and store the stuff the oil producers bring out of the ground), and "downstream" oil processors (outfits that operate refineries, which could be outputting anything from aviation fuel to specialty lubricants).  And there are also oil service companies that keep oil rigs running and provide other necessary field services.

So... it ain't that simple AND there are a lot of different opportunities and investing options out there -- all under the "oil company" monicker.

KingCoin

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Re: Oil Companies - From talking to a company man
« Reply #5 on: February 18, 2015, 06:42:45 PM »
What the OP is talking about is major, vertically integrated oil companies -- the guys that go from taking the oil out of the ground to delivering gasoline into your auto gas tank at one of the company's branded gas stations.

But there are a lot of OTHER types of "oil companies."  There are "upstream" oil producers (outfits that take the oil and natural gas out of the ground), "midstream" oil handlers (outfits that move through pipelines and store the stuff the oil producers bring out of the ground), and "downstream" oil processors (outfits that operate refineries, which could be outputting anything from aviation fuel to specialty lubricants).  And there are also oil service companies that keep oil rigs running and provide other necessary field services.

So... it ain't that simple AND there are a lot of different opportunities and investing options out there -- all under the "oil company" monicker.

This is correct. Different companies have massively disparate hedges in place, marginal costs of production, and leverage profiles. The fact is, if oil stays at $50, hundreds of these companies will go bankrupt. Many have raised mountains of debt and expended billions on cap-ex predicated on $80+ oil. Yes, Exxon will be pumping til the cows come home, but there are many large "oil companies" who's debt is already trading at less than 50c on the dollar and will need a rebound in oil prices to survive.

gimp

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Re: Oil Companies - From talking to a company man
« Reply #6 on: February 18, 2015, 11:49:34 PM »
Very interesting read, and I tend to agree. Most people think "solar" or "electric cars" and think investing in oil companies is a dead end. They're really just printing money, for a long time to come. The barriers to entry are mind-boggling astronomical (global infrastructure, bullet proof balance sheets, huge tax breaks, government relationships/lobbying, technical knowledge, patents, etc), and the long term prospects for these companies are incredible. If I were to bet on alternative energy, I'd still put my money in Exxon or BP to figure it out.

The big oil guys are oil companies, but more than that, they're energy companies. Oil is profitable as hell, but if it suddenly permanently stopped, they've got the cash on hand to survive an industry change to solar or wind or whatever. They hedge their bets and have teams working on alternate solutions if need be. It'd hammer their stock and profitability, sure, but they'd most likely make it.

With that said, their margins on oil are pretty good. The higher oil prices go, the more incentive people have to look into things that aren't oil. They can have short-term profitability at the expense of possible long-term upheaval. And vice versa, when prices go so low that it starts hurting a bit, they know that things are shiny long-term because more people are buying trucks and SUVs because gas is cheap today. (Slightly exaggerated.) In either case, they've got the money, people, and smarts to figure it out.

I threw about $500 into VDE a month ago as a long-term investment. We'll see how it goes. I figure it won't deviate terribly far from VTI over the long term.