Four Factors You Need to Know to Crush Market Mayhem

The successive market tumults of the past months have everybody wondering: Is there a single “safe” place in the investment landscape left in which to entrust my funds?

We never want our readers to be mired in a single moment of doubt. When it comes to investments, we don’t follow the maxim “where there’s a will, there’s a way” — especially when our Central Bankers are thinking that!  

It’s knowledge that paves the way and keeps the successful investor from being rocked by all the gyrations. At Outstanding Investments, we have some essential criteria for just this turbulent situation.

Four-Point Checklist for Mayhem-Proof Investment Success

  1. Avoid sectors that are subject to wild market swings, such as the currently volatile housing and housing-related finance arenas.
  2. Look for companies with real assets or skills that are always in demand; we avoid firms that sell the proverbial “vaporware” or operate under business models that revolve around intangible paper assets backed merely by more paper assets.
  3. Consider buying only well-managed, safely run businesses that can operate profitably in good economic times and bad.
  4. Invest for the long haul.

The ONE Business That Makes the Cut

There are few businesses in this world that are more “long haul” and “hard asset” than the oil and natural gas business. Over the life of any given hydrocarbon province, exploration may take many years, if not decades. Development proceeds in stages, with widely varying scales of risk, and again may last for decades. Extraction operations may last for many decades as well, with some oil or gas wells yielding product for a century or more. (For example, there is an old oil well just north of Pittsburgh — called the McClintock No. 1 — that has been in continuous operation since 1861.)

However, virtually all wells eventually deplete the reservoir to the point of no return. And then they must be “plugged and abandoned” (P&A). Plugging a well first requires that the down-hole equipment and casing is pulled out of the ground. Then, the hole is filled and sealed with concrete.

And don’t forget that the many systems associated with oil and gas extraction, such as gathering pipelines, pumps, trunk pipelines and downstream refineries, also have time frames spanning multiple decades.

It stands to reason that the more parts of the business your company can accomplish in spades, the better shot you’ll have at capturing more profits over the long haul. One good client can provide decades worth of business. Take 10 such clients from several nations, and you’ll see a multi-billion dollar empire of energy service.

The Way of All Wells Spells Post-Wellhead Profits

These elements of the oil and gas business constitute highly complex industrial processes. To make it all work, oil and gas companies have to invest large amounts of money to build out and create capital, whether it is the basic geologic prospecting and acquisition of seismic exploration data the process of drilling the wells or installing the massive valve systems and pipes or the pumps to push the product down the lines. And the wells, pipelines, pumps and other systems require constant servicing and maintenance, up through and including the process of P&A.

According to some studies, over the entire life cycle of a typical oil field or larger hydrocarbon province from exploration to eventual P&A, about 70% of the funds that are spent go toward later-stage field development, long-term extraction and enhancements to development wells, plus eventual P&A and the winding up of operations.

Put another way, only about 30% of the total life cycle cost is up front with the relatively high-visibility exploration and discovery, plus appraisal and early development. So the smart investor will be sure to scoop up a stellar P&A player if he wants to grab some high-margin profits.

The Five Factors That a Perfect Oil Patch P&A Play MUST Have

  1. A savvy strategy that allows the company to offer every tool, service and trade necessary during the entire well life cycle. You want a one-stop-shop oil service company. Because bundled services mean greater efficiencies — yielding higher profit margins.
  2. The ability to remain profitable even while growing the business through smart and timely acquisitions. A company that made money when oil prices made all-time lows will deliver HUGE returns when oil is hitting new all time highs.
  3. Access to international markets, onshore and off. We’re talking Europe, North Sea, the Middle East, and West Africa, in addition to the Gulf of Mexico. And if a company has secure inroads to oil-rich Venezuela and Russia — even better!
  4. A company that can profit from the ups and downs of industry cycles: including anomalies like the hurricanes of 2005. Now, two years later, only a fraction of that damage has been repaired, and you want a company who’s down there, taking care of business.
  5. Numbers, numbers, numbers… No matter the business, when you hold this company up to its nearest competitors, does it offer value and good future ROI? Check the P/E, the profit margins, the market cap and the earnings growth. Is the cash already flowing?

As long as you can say “yes” to these five factors, you’ll be weeding out a lot of the risk in any oil investment. So don’t be afraid to dip your toes in the rich offerings of the energy service market, no matter what our markets have in store in the days ahead.

Until we meet again…
Byron W. King

October 4, 2007

The Daily Reckoning