Why does Rick sound so happy in this energy market? Interview with Rick Rule, Sprott US Holdings Inc.
Rick Rule is a naturally happy guy, despite being immersed in one of the most depressed parts of the economy right now. I’ve known Rick for almost two decades, and it was his comments as a lender to the energy patch-‘This is the best time in the Market for us’ that spurred my interview with him.
Now a Director of Sprott, Inc., a Toronto-based investment manager with over $7 billion in assets under management, and CEO and President of Sprott US Holdings, Inc., he brought a lot of experience and wisdom to our conversation.
Our one hour interview comes in two parts-look for Part II in the next day or three.
Keith: Rick, in our pre-interview you said this energy market is not getting you down—in fact, just the opposite. Tell me why that is.
Rick: One of the huge advantages to being 62 is that I’ve come to live my life in 5 year cycles. As a professional now I’ve been through eight 5 year cycles and 5 years seems a lot less daunting than it used to.
Rick: Particularly given the scale of the upside I’m looking at. I think if I asked any of your readers if they’d be prepared to live through a 35 or 40% down cycle so they could experience a 5 or 10 fold up cycle, everybody if they thought about it rationally, would say yes.
The problem is people’s perception of the future is set by their experience in the immediate past and the 35% down side seems much more probable then the 5 to 10 fold up side because it’s been so long since we’ve experienced an upside.
Keith: Basically you’re saying that the risk-reward for you is on a time scale that actually gives you a bit of an advantage.
Rick: Absolutley and it’s the time scale everyone will be on whether or not they care to admit it to themselves. People who don’t want to consider the 2 to 5 year timeframe are the natural normal victims of the market.
Keith: Correct. So tell me what you’re doing now and maybe what you’ve been doing for the last two quarters to get ready.
Rick: On the equity side in oil and gas almost nothing. My belief is both Calgary and Houston are in denial. And they are in denial from an intermittent position of strength, meaning that the oil and gas industry got enormously over capitalized in the 2002 to 2012 period.
Cutting through that over capitalization takes some time and so I’ve not been doing very much at all on the equity side. We have been attempting to be active on the lending side. I guess I can explain both of those and should go back to the equity side.
My suspicion is that a lot of the producers are getting notice of impairments with periods to cure from their banks.
And everybody from the banks to the brokers to the shareholders is hoping the market turns around, hope not being a very effective investment strategy. You are beginning to see a real flood to market of companies’ noncore assets; the problem is there are only sellers and no buyers.
Rick: Which means that’s a situation that is not going to work. They aren’t going to be able to sell enough of their noncore assets and that’s the problem. We need, of course, to see 2 or 3 quarterly operating statements to see the impact of $50 oil on a $90 Proforma and in particular, on a revolving credit facility.
Many of your readers may not know what a revolving credit facility is but it’s the dominant form of debt financing in the oil and gas business. They are reserve base loans that occur on an interest only basis and are renewed year to year based on a percentage of the net present value of the companies producing reserves.
Of course, the estimate of a net present value varies dramatically with the price quote. The net present value calculations done by 3rd party evaluators this year were done with price estimates in the out years, the 2nd, 3rd, 4th and 5th years that had fairly aggressive escalating oil and gas prices.
These prices were about 25% in excess of the 3 year strip and futures markets, meaning companies reserve evaluations came through at premiums to what the market was expecting as a consequence of the pricing scenarios used by the evaluators.
If oil and gas markets don’t improve markedly soon, the next set of evaluations that will come out will be substantially lower, which means the impairments will be much more extreme. And they are going to be extreme after a 12 month period where companies have already been forced to cut their budgets. Which means in addition to the fact that the pricing assumptions are going to be reduced, deferring a year’s worth of capital investments means the company’s reserves pictures will be bleaker too.
Suffice it to say, I think the bomb goes off in Calgary and Houston in the 1st, 2nd and 3rd quarters of next year. So we don’t have a whole lot to look forward to on the equity side in the 12 month timeframe.
Keith: What about the lending side?
On the lending side, there is about twice a decade when oil and gas players are forced to come into the high yield part of the lending market. In other words, they are forced to come to Sprott. And we’re coming to just one of those periods.
This article is for information and discussion purposes only and does not form a recommendation
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