Smart fraudsters do not commit fraud. There are many ways in which scumbags can legally deceive (or lie to) investors. Given all the legal methods available, I’m surprised that some people choose to do illegal things.
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oil and gas
Spotting inflated oil and gas reserves
There are two main approaches:
- Look at management’s integrity.
- Look at the technical data and/or perform proper due diligence.
Microcap stocks and G&A
Thankfully, it seems like many people (including even some institutional investors) don’t get it. With microcap stocks, it’s very important to examine the company’s general and administrative spending. The companies with excessive G&A spending are typically doing one or all of the following:
- Lining insiders’ pockets or supporting their lavish lifestyles (e.g. private jets, unusually expensive meals, etc.).
- Paying for stock promotion.
- Operating inefficiently.
All of these behaviours are bad for shareholders. Excessive G&A is a sign that at least one of these value-destroying activities is happening. Examining G&A will help you avoid stock promotions and really awful management teams.
My approach to shorting oil and gas
When oil and gas companies sell assets to each other in private transactions, they will often open a data room where the acquirer’s team of engineers can look at the data and perform their due diligence. I find it strange that supposedly sophisticated institutional investors are comfortable with oil and gas stocks without being able to perform this level of due diligence.
Maybe I’m crazy but I think that institutional investors are making huge mistakes in the oil and gas sector.
Either they’re wrong or I’m wrong. Time will tell.
I believe that there are currently very high levels of deceptive stock promotion and many opportunities for short selling. The nice thing about the current situation is that institutional investors are involved and are lending out their shares.
Oil trap or value trap?
The website “Oil On My Shoes” contains a short and excellent introduction to petroleum geology. In particular, it explains how economic oil and gas reservoirs are often found in either structural or stratigraphic traps. What I took away from the website is that petroleum geology is quite complex. There are many factors that affect the exploration potential for a piece of land and therefore how much that land is worth. Just because two parcels of land are close to each other (what I would call “closeology”) doesn’t necessarily mean that wells drilled on both parcels will have similar economics.
Many publicly traded companies avoid disclosing information about geology and would like investors to focus on closeology. They want to trick investors into valuing acreage on the sale price of nearby land rather than the geologic potential of the land (or lack thereof). Without knowing the geological details, it’s hard to say if closeology is a reasonable shortcut in valuing acreage. At the end of the day, I think that it is a red flag whenever an oil/gas company tries to steer investors towards closeology. Usually it is an attempt to mislead.
Magnum Hunter (MHR) short thesis
In the independent oil and gas space, I will happily bet against the high-cost operators. I would argue that Magnum Hunter overpays insiders, wastes money on corporate aircraft, and has excessive G&A as a percentage of revenue. This has contributed to Magnum Hunter’s track record of GAAP losses since current management took over in May 2009.
Market cap: $1.42B
% of float short: 18.2%
Cost of borrow: ~0.6%
The put options are somewhat liquid.
Access Midstream Partners: Are their distributions sustainable?
I think that ACMP’s cash flows will decline due to:
- Less gas being carried on their gathering pipelines. Throughput will decline as shale gas wells naturally decline. Throughput on ACMP’s existing assets cannot grow unless more shale gas wells are drilled.
- Cash flows from minimum volume commitments ending.
*Disclosure: I am short ACMP common. This is not one of my better short ideas and I may cover this position in the future.
