Unconventional resources have become conventional. The overall quality and access to some of these “new conventional” energy reserves is declining, increasing costs for producers and we expect to ultimately keep prices elevated. We believe that investors should be long and strong this industry to take advantage of the sustained higher prices. However, selectivity is warranted. Investors should avoid what we believe is the next CLEC-Telco disasters of 2002-03, which is the high yield market financing of many unsustainable business models known as shale/tight oil production. Here we have seen incredible popularity, with deal after deal getting done, regardless of quality, and many done at very low yields, which we feel do not compensate investors for the risk of the lack of cash flow generation and sustainability of some of these businesses.
We also believe that investors should be cautious in Master Limited Partnership (“MLP”) investing. Investors have been enticed by the juicy yields offered, but unfortunately many of them are not generating true distributable cash. Worse yet, “cash available for distribution” is a metric that the company themselves calculate. This is a situation of the fox guarding the hen house. This metric is calculated by breaking up capital expenditures into “maintenance” and “growth.” So the more the company lumps their capital expenditures into the “growth” bucket, the more fictional cash flow they have available. Some of the companies we have looked at state that 80% of their capital expenditures are “growth,” yet they aren’t growing. For investors this then is a return of capital not a return on capital and we believe is unsustainable.
We have seen a recent pull back in the price of oil and believe it creates an opportunity to continue to invest in oil producers. Our take remains that supply from US tight oil/shale is real but temporary and that many of the swing producers will continue to struggle to meet their production targets. As examples, look to Libya, Iraq, Venezuela and Nigeria. We continue to invest up and down the capital structures (loans, bonds and yield equities) of what we view are very sustainable producers to find what we see as the optimal risk/return characteristics.
1 Source: Wikipedia, Athabasca oil sands, http://en.m.wikipedia.org/wiki/Athabasca_oil_sands.
2Source: U.S. Energy Information Administration, data as of January 13, 2014.
This article was written by Doug Holt and Tim Gramatovich with Peritus Asset Management, the sub-advisory firm of the AdvisorShares Peritus High Yield ETF (NYSE Arca: HYLD).