Cutting Off The Tail, Part 3

In Case Of Emergency, Break Glass

Having covered insurance, measurement and management of risk tolerance, and other topics in the last two parts of this series (here http://lifeinvestmentseverything.blogspot.com/2013/01/cutting-off-tail-part-1.html and here http://lifeinvestmentseverything.blogspot.com/2013/01/cutting-off-tail-part-2.html), I will now turn to a subject area that I hesitate to cover lest I be considered a kook or nutball survivalist.  However since the topic at hand is hedging the worst outcomes so that you can sail through life in a more carefree manner I think I would be doing my readers a disservice if I did not at least mention ideas on how to mitigate the very worst situations.  Accordingly, I will offer some thoughts on how to cost effectively prepare for natural and other disasters that might disrupt daily life as we know it and possibly put you and your family at risk.

CHK: Out With The Old...

Aubrey McClendon's Exit May Pave The Way For A Sale

After running into a cashflow shortfall and years of ethical failings, Chesapeake Energy attracted the attention of activist investors last year and the problems plaguing the company began to be resolved (see http://lifeinvestmentseverything.blogspot.com/2012/05/chk-little-help-from-your-friends.html among other past posts).  Today after the close of the market the company announced that its founding CEO Aubrey McClendon will be stepping down.  To be fair to Mr. McClendon, he and former partner Tom Ward (now at SandRidge Energy and also attracting activist attention) built a monster exploration and production company out of nothing.  However, the long track record of poor corporate governance and the aggressive manner in which a big oil and gas company came to be run have held back the market valuation of CHK.  Now that the firm has bid adieu to Mr. McClendon it would appear that there is room to change how the company is run and the valuation it receives.

I think there are three plausible outcomes for the company.  First and simplest is a sale to a larger firm.  There are a number of large oil majors which would find CHK's collection of drilling assets to be extremely attractive and they all have the financial wherewithal to complete the deal.  Since the company's balance sheet has been backed away from the proverbial cliff, a sale could presumably be done in a non-distressed manner.

Second, the firm could simply get a new CEO more accustomed to running a firm like this in a more conservative "harvest" strategy and emerge as a credible, long term oil and gas player.  Such a CEO could come from the executive ranks of an oil major and over time allow the firm to attract a higher valuation.  Something similar happened to the firm now known as EOG.  EOG was originally named "Enron Oil & Gas" and for obvious reasons was considerably beaten down by the market.  A change of management and name plus the passage of time and EOG is now viewed as a credible oil and gas play that does not trade at a hefty discount to peers.

The third possibility is that the long-running Board investigation into Mr. McClendon's entanglements with CHK uncovered something particularly bad.  If it is significant enough to affect the firm, the future might not be so bright for CHK investors.  Since there appears to be no such disclosure as of this evening I am inclined to discount this possibility, but it is still possible.  The stock is up some 10% after hours, so others seem to be optimistic.

In any event, it has been entertaining to watch CHK over the years and present times are no exception.  I suspect that anyone who bought shares over the last year will find the outcome of the Aubrey McClendon saga to be profitable.

As always, do your own due diligence, consult your advisors and be careful.  You can lose money on this stuff.  Not intended as investment advice.

Disclosure: I am long CHK equity and call options.

WIW: Another Dollar Selling For 90 Cents

Finding Fixed Income Value In A Closed End Fund

In recent months, it has become increasingly difficult to find reasonably priced buying opportunities, especially in the realm of fixed income.  Even the closed end fund (CEF) world has been bid up as there are very few funds that meet my investing criteria (market cap of at least $500MM, no excessive leverage or management fee, and at least a 10% discount to net asset value).  In fact, more often than not when I screen CEFs there are no funds that meet my hurdles.  However, there appears to be one very attractive bargain still available in fixed income CEFs, the Western Asset/Claymore Inflation-Linked Opportunities & Income Fund (WIW).

You Put Your Peanut Butter In My Chocolate!

In Brief: Chesapeake-Methanex Gas Supply Deal Portends More To Come

Today Chesapeake Energy (CHK) and Methanex (MEOH) announced a long term gas supply deal: http://methanex.mwnewsroom.com/press-releases/methanex-corporation-and-chesapeake-energy-corpora-tsx-mx-201301240848830001  The terms of the deal are that over a period of 10 years CHK will supply enough natural gas to a MEOH plant in Louisiana to produce 1 million tons of methanol annually.  It takes approximately 22 MCF of natural gas to make 1 ton of methanol (http://www.methanol.org/Energy/Resources/Alternative-Fuel/Energy-Tribune-MI-Lynn-July-2009.aspx - 100 CF makes 1 gallon of methanol and there are 333 gallons of methanol in a ton), so this deal equates to about 33 BCF a year.  As CHK has forecast 2013 production of 1,030 to 1,070 BCF of natural gas, this deal accounts for about 3% of 2013 natural gas production.  While that may not seem like much, this deal also has a very attractive form of upside for CHK in that the price it will receive for its gas will be partially based upon the market price for methanol.  Since methanol is priced at the margin based on its energy content as a substitute for oil and refined products, CHK is effectively capturing some of the price premium oil commands above natural gas of equivalent energy content.  Financial details have not been released (and they are unlikely to ever become public), but if this allows CHK to sell natural gas at a 1/15th or 1/20th multiple of the price of oil instead of the current 1/27th multiple ($3.50 natural gas/$95 oil) the company gains substantial upside to the current depressed level of natural gas prices.  MEOH benefits from this agreement because its feedstock costs for methanol are based on the price it receives for the finished product and so has a substantial amount of protection for its margins even if methanol prices move a long way up or down from their present level (methanol prices are volatile).

This appears to be a win-win deal for both companies.  Given the current glut of natural gas in the US, I expect to see more deals structured between gas producers and large end-users that improve the long term economics of both parties' businesses.  An additional benefit for the natural gas producers is that if enough of these deals are consummated (especially for new natural gas-using plant capacity), the excess supply depressing natural gas prices at present should gradually decline to yield a tighter market with more attractive spot prices for gas.  If this model is attractive enough, it could even be an indication that we might see a major end user (chemical company, utility, etc.) buy a natural gas producer.

As always, the above is not intended as investment advice.  Consult your advisors, do your own due diligence, and be careful.  You can lose money on this stuff.

Disclosure: I have long equity positions in CHK and MEOH and I am long calls on CHK.