Would you ask your broker where to drill?
13 April 2009
Sean Russo
AFTER years of attending various gold and base metals conferences and Diggers and Dealers I attended my first oil and gas conference last week. There were a few familiar faces in the crowd that had made the switch from mining, but otherwise it was a new crowd to me.
Many of the names of the companies were familiar to me as a reader of the business pages and stockbrokers tip sheets. Interestingly, despite many being named after Australian regions, reflecting their origins a couple of cycles ago I guess, they seemed largely to be exploring and/or producing offshore.
As the presentations rolled on over the two days, a couple of clear themes emerged – most hauntingly familiar, one a little different.
The familiar themes were:
- We’re cheap. Everyone was trading at a price that didn’t even go close to representing the value of the underlying assets.
- The product is even cheaper. Many CEOs felt the need to spend valuable presentation time convincing the audience of the underlying fundamentals for their product rather than differentiating their company from the pack.
- The worst is behind us. Some even wanted to offer predictions that the worst the world economy would experience was clearly in the rear vision mirror.
- They were fully exposed to the upside. With a couple of exceptions that had some hedging the clear message from most companies was we have no hedging and won’t be moving away from that position because of the three previous points.
So no surprises to someone who regularly watches CEOs of junior/mid-tier miners tout their wares.
We’re Cheap
Everyone’s always going to be cheap in this part of the cycle, that’s a given. Almost everyone produced a graphic of their share price which I noted at the top of the cycle many miners stopped doing because it looked like such a compelling sell.
The Product is Even Cheaper
This one really gets on my nerves and I feel like screaming out, “we paid to come to an oil and gas/nickel/gold conference, we believe! Get on with it and tell us why we should believe in you!” Note to CEOs: if you have nothing worthwhile to say don’t spend shareholders money to buy a speaking spot. If you talk about the product many in the audience tune out, start sending emails, etc. They simply figure you are padding. Worse, they may come to the conclusion you are dangerous because you actually believe you do know where the product price is going.
The Worst is Behind Us
Argh! (See above).
They Were Fully Exposed to the Upside
They all saw this as virtuous because there is no downside (see above). I feel sure that they said the same thing last year; had they not, they would have had some handsome hedging positions. Management and boards must take responsibility for this lazy approach to risk management, but I am now increasingly convinced that brokers must carry an increasing level of blame for this phenomenon for reasons set out below.
The unfamiliar theme that emerged for me was the way oil and gas companies talk about exploration.
It’s all about managing risk. What struck me with the oil and gas people was in relation to exploration everything was discussed in terms of probabilities and risk/return profiles. Exploration plays were described as a certain cost with a range of probable returns. Too much risk, sell down the interest, share the risk around.
It was very refreshing to a mug punter like me who is basically looking to believe in management’s ability to outperform their peers and tap into that elusive value gap. It was also very refreshing to see CEOs so openly acknowledge, measure and value risk rather than trying to diminish it or explain it away with “overwhelming fundamentals”.
It may simply reflect my ignorance but it always seems to me that at mining conferences exploration is about drilling holes, lots of them. “Here’s a target and we’re going to pepper it with holes and report back”. Or when they are a bit more advanced: “We drilled them, here’s a fly-through, what we do now is drive the blue decline down and pull out the red stuff.” Too easy!
I don’t recall seeing mining companies talking publicly in terms of a risk measured approach or probability based returns for exploration outlay. I know it does happen and that in both sectors there are highly trained professionals who go to enormous lengths to increase the probability of success (reduce the risk) of every exploration dollar spent. (With a success rate usually inversely proportional to market cap, but I digress!)
I am going to put the difference down to nuances in exploration technologies and techniques. What interested me was given that these oil and gas CEOs were so obviously switched on to measured risk and probabilities of success I would have thought that they would be far more likely to embrace risk management on commodity pricing as part of a sound strategy.
Hedging is just like exploration. No-one should be expected to get every decision right. Hedging decisions are made based on the assessed risk of the impact of activities or events which are not certain. You don’t punt the company on one or two holes, so why punt the company on a price forecast.
Why did these CEOs feel the need to leave their companies totally exposed to oil and/or gas prices in a manner that seemed to me to be totally in conflict with their approach to the other tasks associated with their professional disciplines?
Then it dawned on me. They use the same brokers that junior miners do and those brokers sell them to the same narrow group of fund managers who are investing other people’s money into both sectors. Their brokers/advisors have told them if you show hedging tendencies you will be punished by the market. Despite clear evidence to the contrary in recent times that theme persists and leading brokers are recommending share issuance over debt and hedging at a time when equity is considered by many managers to be ridiculously undervalued.
Note to CEOs: whether you are producing/exploring for nickel, gold, zinc, oil or gas, you don’t let fund managers or brokers tell you where to drill, how to drill or how deep to drill. Please don’t let them tell you how to run your business. Risk management doesn’t end when you find the mother lode, but only when you have finally exhausted it.