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239: Should You Invest in Oil and Gas?

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Buck: Welcome back to the show everyone. Today my guest on Wealth Formula Podcast is Thomas J. Powell, founder of Resolute Capital. Now Tom was actually on the show earlier in the year talking about oil and gas and what had happened at that time, we’ll get back to that in a second, but you know he has had an impressive career just in general with over 30 years of really outstanding work in entrepreneurship and investing including founding and running a multi-billion dollar mortgage banking company. He’s a leading financier with extensive experience in private equity commercial banking, investment banking, alternative asset management, and corporate finance and governance. He’s also an authority as I said on the oil and gas markets as he leads his team at Resolute Capital in multiple energy-based ventures Tom, welcome back to Wealth Formula Podcast.

Tom: Well thank you for having me back it is absolutely my pleasure and the only thing I can say about that intro is it now makes me start thinking that I’m as old as my father.

Buck: Well it’s better than the alternative right, so it is what it is but congratulations on your success. But you know the last time we spoke Tom you know oil prices and we’d been talking about oil and gas obviously oil prices had plummeted because at that point there was a really unusual confluence of well obviously we have this strange thing with the global shutdown that had happened with covid which we’re still running at short of capacity for sure and then there were all sorts of geopolitical conflicts between Saudi Arabia and Russia. So you know it’s been now you know probably about eight months since we talked about it, so what’s going on now? Tell us what’s the latest in the news in terms of you know oil and any geopolitical issues.

Tom: So Buck I’m going to give you some anecdotal stuff things that I’ve been noticing as we’ve been traveling around the world. We’re back to traveling as well as what I’m seeing from the numbers and the forecasts that are coming through. So anecdotally although California is back into another shutdown in New York as well and they’re talking about schools and things, the world has seemed to found a new normal and that new normal is about how do we go on with some semblance of normal life so what that means is the airplane that I flew on yesterday was full. They didn’t have this middle seat closing off anymore and after I landed at DFW and we were leaving I looked up and there were eight planes on approach that were visible at that point. So that to me anecdotally as the statistics are always lagging behind says that we’re in a good v-shaped recovery. There’s lots of reasons to believe that. The prices had dropped. We’re a perfect econ 101 supply and demand. So you had two big players that decided to go to war on prices and flood the market at the exact same time as you had the market pulling back on demand. And so it created this massive oversupply hitting in mid-June the country had the largest oversupply of oil we’ve ever had and that what is interesting is as of October 30th this year, we were back on par with our six-year trending average. So all of that oversupply has been burned off which was what caused the negative oil prices because of potential storage. So where we’re headed now? We’ve got about 200 rigs that are out in the field in across the united states and it takes about 400 plus to keep us on par with inventories, which means inventories are going to go continue to drop even if we’ve got a pullback and that means prices will likely rise.

Buck: If I could interrupt you there real quick Tom, just for people who are not following energy prices, why don’t you talk a little bit about what’s happened with the prices of oil.

Tom: Absolutely. And you know we went actually from what was forecasted for 2020 by Goldman Sachs was a 65 average spot price and we didn’t get anywhere near that because covet started in the Saudi Russia scenario happened first quarter so we actually went for a day into negative territory down you know below 30 dollars a barrel. Nobody really sold at that price except for traders. What ended up being the spot price for that month was 20 and that’s what the average was in roughly 20 for the month. Where we are today is we’re right around 41 and moving up and down slightly having good days bad days as they say so what we forecast is if the demand even tapers off but the supply can’t keep up with it, you’ll see prices move from forty dollars upwards to fifty to sixty dollars potentially, which is interesting because that leads us into election questions right.

Buck: Right and that’s exactly what the next question to me is, does the Biden presidency have an impact on those prices? You know obviously, we see oil prices recovering a little bit here and then over the next year or two if all the things were the same and we didn’t have any significant legislature changes, etc it’d probably be easier to project, but talk a little bit about the election if you would.

Tom: Buck this is one of those times that you know history will likely repeat itself. President-elect Biden, assuming that he does take office, has stated that he will move towards his renewables and will move away from fossil fuels and his partner in the past President Obama led the first real green movement as a president saying this is where we’re going to move. During President Obama’s time, these are some great stats that are out there from the international energy agency during that time the united states for the first time since carter actually became energy independent. We doubled production in the united states underneath president Obama and we had one of the highest prices of oil as well as one of the lowest prices of oil during president Obama and so if that follows suit given those policies such as anti-fracking and not opening up pipelines you’re going to create a constraint on demand and for those companies like ours that already owns a number of properties that makes those properties more valuable both on the revenue as well as on the overall exit value.

Buck: You know so that’s you know that that that’s got the political implications they’re baked in obviously but it seems to me that that the Biden presidency as you mentioned you know probably result in acceleration of alternative energy sources. In the big picture in the long term as an investor in oil and gas, I guess the question that comes to mind to me is what seems to be well there seems to be an inevitability of alternatives becoming the primary energy source of the world eventually after all you know I even heard something recently that the cost of alternatives is now approximating that of carbon source fuels so how do you navigate that as you move into the future? I mean how do you hedge that? How do you time it? Because those are the issues that seem to come to mind. I have a friend and he, I mean he’s basically out of oil now, not because he thinks it’s coming to an end tomorrow but in the next you know decade or two that’s not where he wants to be. So he just cashed out and he’s out on his own. Tell me how you’re thinking about it right now.

Tom:  Buck there’s a number of different questions in there but let me start with the timeline. Our funds are generally three to seven years because I can feel reasonably confident that oil and gas will not be replaced in three to seven years and likely it’s not going to be replaced in the next two and a half to three decades. So growing up in the 70s, I recall a time when we had these long gas lines inflated prices and they swore we would not have enough oil in the year 2000. Now we’re 2020 and we have more proven oil than we’ve ever had. So forecasting the future is generally one way to make sure you get everything wrong so you know I look at that and say okay so where are we going to be three to seven years I can feel pretty comfortable on that and who the buyers are when you talk about the renewables, first of all I’m a citizen of the planet I love that we have alternative energy sources and we continue to get better at all of those things and we want to see that grow. Most of those even though the costs have come down are still created with a large output of hydrocarbons meaning the manufacturing of those blades require hydrocarbons to actually do manufacturing and transportation. So it’s not going away anytime soon and by any time soon I mean in the next two to three decades. Now that doesn’t mean that we won’t continue to get more efficient but it also means that there’s more opportunity for the people that are already in place.

Buck: Yeah sure, sure that makes sense, I mean certainly you know that’s kind of what I was getting at when you talk about a three to seven year approach it seems to me that you give yourselves you know ample opportunity to be able to you know take into consideration, what’s going on and you know exit accordingly. Moving on again a little bit on the same note you know just when Resolute Capital looks at things. As an investment thesis you know Resolute Capital has chosen more of a sort of almost of a real estate approach to oil and gas from the way I have seen it in the sense that they’re really you know what you’re really trying to do is position yourself to sell assets upon development almost like value-add real estate in that regard. Is that accurate and you know if you can talk a little bit about kind of the approaches that you guys in the big picture like to make and why that would be helpful.

Tom: Absolutely you’re spot on. When we first approached Homebound or they approached us to do capital raising we said for one thing the sponsor Homebound will have to be aligned with us and our investors. So you don’t make money unless the investors make money. And that’s a different approach because for most small investments in oil and gas there’s usually what’s called promote and it’s where someone has found a potential project and then they sell it to the people that are actually going to put the money in at three to five times value before they ever do anything. So think of land speculation we said we’re not going to do that we’re actually going to take it through development. So our investment thesis has really four parts the first primary every investment we look at is tax consequences. So the nice thing about oil and gas is it actually gives tax benefits that really no other investment does. So that’s our first part the second part is we want income and cash flow we don’t want to just be debt servicing this while it’s being built and so we’re looking at short-term assets as well as medium-term assets that bring in cash flow. So when you think about that real estate development it’s why you scale the development and you’re putting in the little retailers the Mcdonald’s the Burger Kings to start cash flowing as you’re doing the rest of the development it’s not waiting till everything’s finished to get done. So that’s the second part of that. The third part is doing development so actually having that value. So again similar to real estate you assemble the parcels you develop them you put the tenants in there and then you turn around and you flip them or exit. And that’s the last part is in a three to seven-year time frame we’re building everything for the exit.

Buck: And I think that’s one of the things that struck me is really different is that you know most of the oil and gas stuff out there that I have seen really it’s sort of one of those situations where it’s like you know heads I win tales you lose type of situations from the speculator side right so and this is not you know in some regards with these drilling new holes and stuff, this is not where you’re gonna come out with an asset for sure, this could end up being something where you end up losing all your money so from the operator’s side one of the things I’ve never liked in for most of the funds I’ve seen is that there just is this sense that okay you’re gonna drill and I’m gonna pay you no matter what and if we do really well then I’m gonna get paid and you’re gonna get paid even more but either way you’re going to make money and I’m I may or may not. That to me I’ve never really liked especially in a space like oil and gas. Not only do you but one of the things that you mentioned I think is important to also distinguish is you’ve also got a lot of skin in the game. Usually, you’re investing a lot of money in the things you’re doing but you’ve also maybe you talk a little bit about that as well but also kind of explain sort of the again the parallels of the vision. It’s not really you know we’re going to hold on to this for 20 years and just cash flow right I mean there is a parallel there with real estate and being able to sort of flip it.

Tom: Absolutely as in fact just to give you how similar oil and gas is and Buck I know you know this but for many of your listeners, oil and gas is so similar to real estate that actually with 1031s you can take a brick and mortar and 1031 into oil and gas and vice versa it’s real property it has cash flow streams and you get a deed so it’s a very similar model for being able to build that. As to our philosophy again we’re the private equity firm so we come in and we we really look for value add opportunities so we want to come in and bring expertise and money to a growing organization and then look towards an exit, so pretty simple business models it’s a simple business model it’s not an easy business model right so that’s what we looked at with both Homebound on this as our sponsor so it’s someone that had aligned interests with us, they don’t make their money their big payoffs unless investors and ourselves make big payoffs and it’s in a waterfall that gives the investors back generally the capital before anybody’s taking any profits off, which is the way that we wish to do all of our investments.

Buck: And can you give me a sense of like in any typical opera you know any venture, what percentage of money, you know again I’m not talking about anything specific here but do you have like a general thing where you know Resolute’s gonna provide so much capital if you know and then in you know any limited partners in any capacity may add that because we’re talking about significant dollars here, it’s not you’re going to put in 100 bucks. 

Tom: Yeah so right a fund can be upwards of 100 million and you know in many cases we’ll have a 25 position.

Buck: Right so basically you’ve got a lot of skin in the game which again I think is pretty unusual for these kinds of funds and again if it’s something really speculative you really want to make sure that the big investor is you know really has something to gain there. You mentioned briefly about the oil and gas consequence of investing and this is one thing that for our group is particularly important Tom, we could just kind of remind everyone I think you and I obviously know this but there’s especially with bonus depreciation right now, there’s some really phenomenal opportunities in terms of tax advantages. You want to address that? 

Tom: Absolutely and this is one of those things that I think will go away to a slight extent so let me explain the way it is today and the way it has been in the past even through democrat or republican administrations. Exploration of oil and gas is an ongoing need and the government does subsidize that by allowing investors to write off their investment regardless if it’s successful or if it fails so even if it’s successful you still get to write off a hundred percent of your investment and that’s against the year’s income, highest taxed income in the year you made the investment or you can, and or you can carry it forward for up to three years. So right now doing tax planning and we’re in 2020 and if you think that there may be a push for higher taxes, you can lock in a tax benefit for 2021, 22 and 23 because it can’t change from what you put in today because these are the tax flaws that stand today. Now again the government being itself it can always do anything it wants to but that would be very difficult to pass. So what that means is 250000 investment 250000 off your top line income. There’s no alternative minimum tax, it doesn’t get captured back in that way so it’s a very structured deal we have a white paper because I can’t give specific tax advice sure we have a white paper that has all the internal revenue codes that actually walks through that. Generally, CPAs are surprised in tax preparers when they read it because they didn’t realize how much the tax benefit there is.

Buck: Yeah by the way if your CPA folks don’t do not have an idea you need a new CPA because that’s if there’s one thing that this show is all about it’s about tax-efficient investments. But what I will do is Tom if you would get me that white paper and I’ll make sure to send it out to people as an attachment. You’re talking about specifically you know the use right now of bonus depreciation as well bonus depreciation obviously is one of those things in real estate that we’ve really benefited by as well. What happens if in 2021 or 2022 for example because I think in 2022, 100 bonus depreciation is supposed to sort of go away anyway just because it was you know as opposed to sunset anyway. But what happens after that? I mean it then is it you know like you know 70 or 80 percent or what typically happens?

Tom: So there’s there’s two categories that as you make an investment in oil and gas that they fall into like real estate. One’s called an intangible drilling cost IDC’s and one’s called the tangible drilling costs TDCs and historically the TDCs make up about 30 percent of the total costs and the intangible costs make up about 70 percent. So if you think of it this way the nodding donkeys you see down in Southern California or the derricks that you see out when you’re in Santa Barbara those are tangible so the building of those would be amortized on a standard tangible depreciation schedule still get to write them off 100 against income. So that it is different than a lot of times your depreciation in real estate but it takes a longer period of time oftentimes upwards of seven years. But that 70 percent is written off still in the first year and that’s the intangible drilling cost and that again has been through time through presidencies stayed in place because it incentivized the money to go into these deals.

Buck: And just one more thing I’d like to point out it is one oil and gas again just as from an educational standpoint, this is one of the very few things that can actually be written off against W2 income as well any kind of income it doesn’t have to be just passive income is that right?

Tom: That is correct. Again, check the white paper out but when you look at it I was first introduced to oil and gas because of the tax benefits back in the late 80s and have continued to see that that tax benefit is the reason to have it as part of a portfolio.

Buck: Got it. Tom anything else we need to know about oil and gas before we go?

Tom: You know Buck the resounding message I’ve had for this year is that I have not seen an investment opportunity like this in my lifetime in a space. So I’ve seen great investment opportunities but in the space right now there’s it’s got all the you know contributing factors of uncertainty lack of cash flow that’s running into it, great companies that are teetering on the edge, not because they don’t have good projects but because they’ve got too much debt. So it allows us to buy up a number of great projects that we wouldn’t normally be able to get at prices that are depressed and if you have any thought that the United States and the world is going to recover from this covid and we’re going to get back to some level of normalcy at some point then this is a strong play it’s what it looks like buying low and selling high.

Buck: As most of you probably know from listening to our show, we can’t talk specifically about any of Tom or result capital’s funds but it is something that if you are an accredited investor and you’re part of Investor Club or you join Investor Club you can get exposure too and I will be sending out an additional email as a reminder of some of those things that Tom’s talking about to our you know Reg D group next week if you’re on that, if you’re an accredited investor, just another reason to join our group. Tom, I want to thank you once again for being on Wealth Formula Podcast as always it was very educational.

Tom: Buck it is my pleasure and thanks for inviting me on. Have a great end of the year.

Buck: You too. We’ll be right back.