Chit Chat Stocks - International Petroleum (IPCO) with Jim Gillies

Episode Date: October 21, 2021

International Petroleum is an oil and gas exploration and production company. With many subsidiaries, International Petroleum mainly operates out of Canada, Malaysia, and France. The oil industry can be quite complicated, however, Jim brings his expert knowledge of International Petroleum for a great discussion regarding the history and future of the company. Enjoy the show! Our Thursday Deep Dives are sponsored by Quartr, the new way of doing company research. Access conference calls, presentations, transcripts, and more for FREE on your mobile device. Download Quartr on the App Store here: https://apps.apple.com/us/app/quartr-investor-relations/id1552412128  Download Quartr on the Google Play Store here: https://play.google.com/store/apps/details?id=se.quartr.android  Subscribe to 7investing with the code "CCM": https://7investing.com/subscribe/aff/4/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Interested in more of Jim's work? Follow him on Twitter: https://twitter.com/JimPGillies?s=20 Rather watch us on video? Subscribe to our YouTube channel: https://www.youtube.com/channel/UCG5Ni-SI-jyrEsoNUhqftNQ  Contact us: [e-mail]  Timestamps International Petroleum | (2:53) Energy Demand & more | (33:39) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. Today, we have an interview with our friend of the show. I think it's third time guest, Jim Gillies, and we talk about international petroleum. He gives sort of a high level view of the oil markets in general. This was really kind of a veggies session. We got to learn a lot about the entire industry since we're kind of naive to it. Yes. If you don't know much about energy, if you don't know much about oil, this will be a great overview of what inputs and outputs go into it. Jim himself said that, Hey, do not, he almost said, do not listen to me here. He's not, he's no expert on the subject. He said, there's a lot of uncertainty. He's not an expert, but he sounded like he sounded, he knew a lot. Yeah, for sure. Uh, and I learned a lot

from this episode about the industry. I still feel like I'm in over my head, but maybe we inched a little bit long, uh, further along and making some progress here. Definitely. Now, before we get to the interview. We've got a word from our sponsor, Corder. So they gave us some new talking points. There's an update coming out. It's really interesting. There's a new segment that I kind of like. First of all, they used to have companies for 12 markets. It's gone to 15 markets now. Plus they're going to add more over time. It's totally free. And I guess for anyone that doesn't know, I'm using Corder. It's earning season. You have to. It's an investor relations app. It's basically friction-free. You can listen to conference calls, look at investor

presentations, transcripts, and the longer the quarter's out there, the better it gets because it gets all the more conference calls. You can listen to it on a drive. I'm more of a walk and listen kind of guy, but everyone's got their own preference. Oh, new update. Users can now leave reactions while listening to the conference calls to make their voice heard. I haven't gotten the update yet, so I don't know what exactly that entails. But it sounds good. Sounds cool. Sounds fun. I'm going to go ahead and check that out once I get the chance. So just go ahead.

You can download it. It's quarter, Q-U-A-R-T-R, no E at the end. You can also follow them on Twitter. I think it's quarter underscore app. So go ahead and check that out. Without further ado, let's get to our interview. Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff

on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guest is not formal advice or recommendation. Now please enjoy this episode. today we are welcomed by jim gillies and we're talking international petroleum we just had

basically an hour catch-up session an hour catch-up session so i'm not gonna start in with an intro why don't we just get right to international petroleum you want to describe what it is sure hey guys um international i mean i can i uh i'm gonna preface this by i'm going to set expectations low, and then hopefully I don't underperform, but I'll set expectations low. The number of times that value investors have had, and I count myself in their ranks, the number of times that value investors have had their faces ripped off by calling the end of the present oil and gas and commodity cycle, which has stretched on for a while in the doldrums um is not zero and uh it has felt a little bit like waiting for godot

if you enjoy your your playwrights i will say godot never comes spoiler uh so um with that caveat out of the gate international petroleum is oddly enough uh international oil and gas play uh headquartered in sweden slash canada traded in stockholm and on the toronto stock exchange for your listeners uh or viewers i don't know if you're recording video god i hope not audio only don't worry perfect i have a face made for radio um the the ticker symbol on the toronto stock Exchange is IPCO. It's the very aptly, very Swedishly named international petroleum because they do oil and they're international. They are an E&P company, exploration and production. I generally loathe E&P companies. Naturally, I'm going to talk about one here.

um and uh i don't know if you want me to say why i loathe emp companies but um can you give like can you give a little bit of background about what emp the emp players actually do like how their operations work sure i mean they they they they supposedly explore for and produce recover hydrocarbons uh for energy purposes so your your oil and gas play. My basic mental model on this, and I'm sorry, we're not recording anyway, so the fact that I'm reading off my notes on the other screen doesn't matter. In good times, the mental model that I have for these companies traditionally, and it's served me well, is when times are good, when oil prices are high, when gas prices are high,

These companies, of course, are massive revenue. And these guys are basically looking to acquire more assets. So exploration that they might buy from other companies. And that's not free, but they're in accumulation mode during good times. And the problem that historically a lot of these companies do, like I could give you a long list of Canadian mid-range E&P companies, where the spending on such things tends to be about $1.20, $1.25 for every dollar in cash flow they produce. And you can probably see the problem with that, right? So when times are good, E&P companies tend to run cash flow negative. But because times are good, a lot of these companies also pay out dividends, maybe rising dividends. So they're already burning more than they're

bringing in. And then they want to share the largesse with their shareholders, they pay out a dividend. So that's a further draining cash. But don't worry, the investment banks are always going to be there to help you raise equity, help you raise debt, right? You can always raise more capital. And so that, you know, it's assumed that high commodity prices will be there forever. It's assumed that financial markets, generosity will be there in perpetuity. And then someone like me comes along and says um this is upside down this isn't good uh you know i'm invariably told uh they can run like this because of the value of their reserves they cannot you know they've got the reserves in the ground um and that's great that's great and all and uh the problem is you your value

of your company and again this is just my mental model for emp so this is not what we're not specifically to uh to international petroleum here but uh you know historically this has certainly in the uh the mid and small even the large players in canada this has been kind of what's happened uh these things hemorrhage money by the time you account for all of the sources and uses here and then oil prices turned down gas prices turned down because we have no the single the single biggest uh determinant of firm value is the commodity prices which are of course inherently unknowable and beyond your ability if you're an executive of the company it's beyond your ability to really control, right? Like if Russia and Saudi Arabia decide to jack production by 30%,

guess what? You have no control. Oil prices are going down. Your stock's going to get hurt. So this is kind of a crummy place to be, frankly. And so when the cycle rolls over and oil prices go down, you start bleeding more cash. What ends up generally happening is the companies, They try to stanch the bleeding for a while. They even continue to take on debt, maybe sell some equity at a much lower price. Ultimately, they probably have to kill the dividend, which your shareholder base has been a bunch of people who have invested for the dividend. They tend to sell you without warning or sell you without regard.

They're reasonably ticked off. And so you wake up, say, in 2020, in the middle of a pandemic, the last time that oil touched 100 a barrel was uh was 2014 the most emps are down 80 plus percent dividends have been slashed uh 75 plus in some cases 200 and the entire industry is in ruins and no one wants to talk about investing in oil and gas so it sounds like a fun place to go yeah the uh i think hitting down more on international petroleum um yep can you explain what countries it actually operates in and what types of resources it is producing so basically in uh the lion's share is in canada a country the country of my domicile my birth

uh hopefully not for a while my death um is about 83 percent in canada uh it's basically oil and gas you know uh 17 i think i'm gonna get the number roughly wrong i think it's about eight or nine percent or sorry nine or ten percent comes out of malaysia and eight or nine percent comes out of france but the you know the old like seven eighths of the production is coming out of Canada. So funny thing about Canada, very stable markets, very stable operations, adjacent to some other country, you know, right beside us, you guys seem to like to buy energy from unstable environments. We do sometimes wonder why you don't buy more from us, but whatever. But it is, you light and heavier, various grades of petroleum, gas is a byproduct. I think it's about 48%

Canadian oil, about 35% Canadian gas. And then like I said, the rest of it's just oil and gas out of Malaysia and France of all places. Okay. This might be demonstrating my naivete for the whole oil industry, but do they basically just go around, search for land and then stick a straw on the earth and see what's coming out or is it like there's more tech there's a little more tech than that uh way of knowing what's basically well now you're getting into another favorite company of mine uh you can use seismic data to uh to look at the subsurface this is not what we're going to talk about but you know i'll give you a freebie um uh use a lot of seismic data to look uh subsurface wise so you don't have to just randomly stick straws or you know monitoring

and extraction wells and whatever in places. You use seismic data and the number one player in Canada in seismic data is a company called Pulse Seismic, PSD on the Toronto Stock Exchange, tiny little company, I think it's sub 100 million, trading at about nine times last quarter's cash flow, not last year's, last quarter's. And by the way, during the seven-year downturn in the Canadian oil and gas while the worldwide oil and gas market hit Canada, Pulse Seismic used to be be the second largest player in the space. Two years ago, they became the largest player in the space when they bought the previous largest player in the space because it was an offshoot of Sightel US. It was called Sightel Canada. Sightel had some debt coming due. And so they basically sold

for a song to Pulse. Pulse did it all, debt finance, no equity. So shareholders haven't lost anything. And now it's a large. So if you want seismic data in Canada, your choice is to go go shoot it yourself which can be expensive and problematic or if if pulse has got uh coverage in that area go license it from pulse uh but that's a plug that's a you know uh you know that's that's an interesting one um pulse has been another waiting for godot stock but if if if i can go to my macro thesis which is that i think this and again a lot of people have been laid waste by this, right? This time is different. I mean, you should, you know, to your listeners, they should probably run screaming the second I say this time might be different. If this time

is different, there's a lot of companies in this space that even though a lot of them are doubled this year, including international petroleum, they're just getting started. If this is after 7-years of what I'm going to call nuclear winter for the Canadian oil patch. If this really is the end, and I think there's reason to suggest it might be, then there is some opportunity in these spaces. I think International Petroleum is a pretty good horse to be riding. I think Pulse Seismic, it's a provider of services to the industry. It's a pretty good horse to be riding. They go out, they acquire land, they acquire land interests. Whether they're just sticking the straw in or whether they have reasons to um understand what might be more uh a lot of cases

they're buying proven areas as well like they've already been proved where you know there's oil and gas in this area uh i think it was called granite uh was the company that uh international petroleum bought a couple years ago i might be fading on my memory here but like that was a proven company or a proven area um you know like we know oil and gas roughly where it is in the western canadian oil patch like in this space like it's it's fairly well known uh geological area or or you know if you sink a straw in my backyard you're not going to find anything but you go out to my friend's place and you know outside just outside of calgary you're probably in a reasonable reasonable place to have a hit so but there's i you know i again

beware people saying this time is different this time might be different okay so go ahead ryan i was going to say what are some of the factors uh driving that belief for you like basically what is your thesis behind uh sustainable rising yeah well yeah i mean well at least it look oil will rise and then eventually it'll peak and then it'll roll over again okay like like i'm not i'm not calling for an era of uh perennially high commodity prices um but i'm just going to do a real quick stalling tactic while i pull up uh yeah so oil as we speak is is now over 80 a barrel and it's been sitting there for the last few days weeks or whatever um there is a tremendous a tremendous amount of operating leverage in these spaces. Different places have different

costs of production. The cost to produce a barrel of oil of sweet Saudi crude is slightly less than it is to produce a barrel of bitumen out of the Canadian oil sands. The Saudis will make money at $35 a barrel oil and the Canadian producers will starve. Okay. Just because the cost to extract that barrel is different. But the, these companies you can kind of plot on an operating leverage and look at like, and I'm trying to keep this very simple and high level because this thesis is simple and high level. And I don't feel the need to, to make it any more complicated unnecessarily than i have to because i like simple um but the for starters we are coming out of the pandemic there's greater energy demand and if i can i'm going to back up a little bit

here like and i don't know if you guys know my background i actually am an environmental engineer i was a professional engineer for 10 years before walking away um i have a reasonable history of uh environmentally themed projects whatever i am a fairly green kind of guy myself at least i fashion myself so um drive an electric car have electric i have solar panels on my roof like yada yada yada um i'm trying to you know deflect some of the ire of the uh the esg crowd when i say um do you guys have any idea how it might be quiz time here uh do you have any idea how much energy use the world uses what the world's energy use is and like a terawatts or something like a terawatt let's go let's go with terawatt hours sure oh my god i i'm gonna throw

it's gonna be a number between oh gosh i have no idea i'm gonna say 80 uh the world energy demand is about 170 000 terawatt hours annually okay um yeah you like your tip your typical american or canadian home typically uses about 10 to 11 000 kilowatt hours and a terawatt is a billion kilowatt so basically worldwide energy use is about 16 and a half billion than average North American homes, if that kind of puts it into context. We have a small addiction to the stuff. Okay. Now, if I'm doing quiz time with Jim here, I suppose I'll make it even worse. You guys, you're closer to school than I am. You're like, oh, God, like, you know, we've done our time in school, man, go away. Do you guys have any idea what percentage,

and by the way, worldwide energy use is rising at about 1.9% annually for the past three decades. So, part of my thesis is that's probably going to continue, right? Where energy use is rising at 2% annualized for the past three decades, that's probably going to keep going at about 2% a year for the next few decades. Okay. So, the big three fossil fuels, coal, gas, oil. What percentage of global energy demand is currently being filled by those, the three big the the three big bads when it comes to climate change and greenhouse gases and whatever

combined or separate combined combined all right this one's a little i think we can be a little easier i'm gonna say 70 i was gonna say 70 okay you're you're underestimating it's actually closer to 80 in 20 in 2019 it was 78.9 okay that's the most recent year i have 2019 2009 what was it I'm going to say like really close, like 82, 83, 85. It was also, it was also just shy of 80%. Oh, geez. We'll keep going. In 1999, what was it?

I'm going to say 80%. You're learning. Yeah, it's about 77.1%. So slightly lower. And 1989, so 30 years ago, what was it? I'm going to go, I'm going to say nuclear was higher. so maybe like 74 73 it was just shy of 80 78.6 percent yeah my guessing's been bad well but my point is okay you know try having a point jim it'll make it so much more interesting for the

listener the point is even with the rise of renewables okay with hydropower and solar and and wind all this up even with the rise of renewables over the past three decades even with nuclear the percentage provided by the big three fossil fuels is largely unchanged okay and by the way we are not going to be switching to a 100 renewable economy tomorrow we can't and so you've got and all of this data by the way can comes from that you can go to check it out yourself uh folks it's called our world and data.org uh but you know that so basically you've got you know energy use running you know growing annually at you know 1.9 almost two percent over the past 30 years and the fossil fuels maintaining basically their market share air

quotes uh coal is actually down so oil and gas have gained share within the big three fossil fuels, but they've retained a remarkably static market share during the last three decades. Okay. So what does that mean now? Well, the thesis on the stock is you wouldn't know that if you read the newspaper or read the headlines on your favorite investing site, or you look at the tweets it's all you have is you know esg esg uh you've got esg funds and pressures don't own don't own these companies don't own these dirty companies okay and again i i am down if you want to eliminate greenhouse gases from your life as much as possible i am down with that i have i i like to hope i have led as well by example or at least lived up to that myself again electric car

you know paid to put solar on the house but i'm just dealing here i like to say you have to separate your personal ethics brain from your investing brain and the investing brain says we're probably going to still be using these things for a while and yet now you've got a bunch of social pressure saying do not own these things not dissimilar to the social pressure from the 80s and 90s on the tobacco companies don't own these things and you know if you go back and look at philip morris which of course is now altria and spun off philip morris international and had a bunch of other spinoffs along the way and uh i think it's what i mean i think it's north of i think it's almost a 20 annualized return going back 50 plus years right so only that total

return, at least. Yeah, for sure. Yeah. Total return. Yeah. Yeah. Assuming reinvestment of dividends and whatever. And so I look at these things. OK, so now energy use is probably going to continue going up. Energy use is probably going to continue to be funded by fossil fuels and increasingly by the cleaner gas versus coal and oil stays where it stays. Renewables still love to see them want to see more of them renewables remain a rounding error because you know just because i'm about about 80 percent um you know again nuclear is in there okay and we're not building a lot of new nuke plants either with even though they're they're greenhouse gas free and yes i know there's waste from those things but you know if climate change is the

bigger issue then we should be you know getting rid of coal plants and putting in nukes but that's another hobby horse that's another hill to die on i'm not going to do it right now um so what do you do to meet global energy use increase especially in a world where esg pressure says don't own these things well i say you own these things because they are going to in the the other interesting thing that's kind of developed. So in the last six, seven years, since the last time oil was reliably over $100 a barrel, which was 2014, what has happened is CapEx in the space has been dramatically underinvested in. Boy, I hate that I'm doing all this in macro. I'm sorry. but uh so there hasn't been a lot of investment in the space there hasn't been um there's no

excitement for the space and yet a lot of these companies have kind of quietly got their house in order now whether they'll keep their house in order if oil and gas do rise back up and you get oil at 150 a barrel for a year or two or whatever um because that sort of seems like how we're going right now with the you know we're at 80 bucks at the start of the year people you know kind of scoffed at people who said oil is going to hit 70 this year well now we're kind of reliably over 80 and you know the other thing is too is that uh when the last oil bust happened uh bethany mcclain who is the author or co-author of a book that you guys and i were talking about beforehand uh called smartest guys in the room which is about uh about the fall of

Enron, she's written a number of other books or even many books. And one of the books she wrote was called Saudi America. And that is about the U.S. shale space and the rise of U.S. shale. And, you know, if you've spent any time looking at Chesapeake Energy or the former, in every sense of the word, CEO of Chesapeake Energy, Aubrey McClendon, that, you know, kind of from our perspective out here now, versus when they were in it in the go-go periods of time as they were building out shale, the US shale industry was net cash consumptive. It burned, I believe, I'm going to misquote the number, but I believe from that book, Saudi America by

Bethany McLean, I believe it was on the order of $70 billion that the industry raised and basically to set fire to it. And, you know, like, so you've got bankers unwilling to throw a lot of capital at this space right now. You've got a lot of companies that are gone, a lot of companies that are chastened. It's interesting. You start seeing a lot of companies as well that cut the dividends, like I said, because they previously paid this large-ass dividend. A lot of those dividends are gone. A lot of companies are having to learn to live within their means. That's a beautiful thing if you are an investor coming in today. A lot of companies have got religion they were free cash flow that's what we're running the business for it's free cash flow

we'll see if they keep their religion during the time next time times are good but for now that's what they're talking about but come back to international petroleum okay international petroleum has an interesting backstory it's it's was originally it comes out of a i don't know if guys have ever heard of london oil l-u-n-d-i-n no uh it was uh london it was a mining and energy a family business out of scandinavia in the early 80s founded by adolf london now he's passed away since then but there are london family members and london former executives all over this company but basically the original so the original um i might be a little sketchy here at my details but The original International Petroleum, which came out of London Energy, was merged with Sands Petroleum to form London Oil in about the late 90s, I think 97.

London Oil was then acquired by the Canadian energy Talsman Energy, which was itself acquired by a Spanish company called Repsol in 2001. I think 2001. um sorry talisman bought london oil and then reps all bought in 2001 and then reps all bought talisman i think in 2005 or something um but following the sale so here's the london family they got lots of money they launched a new new venture because they can't sit still and discount their money they form london petroleum which is now london energy again in 2002 um and from there they spun off the international assets into International Petroleum in 2017. That's the company today. And London Energy is still out there. It's got a market cap and it's got an

enterprise value, sorry, of about $14 billion. But the international thing is much smaller. International Petroleum is only about $1.1 billion enterprise value today. um but like i said the management suite is absolutely full of ex-london people uh so the chairman of is uh is uh is um london energy's founding ceo uh international petroleum ceo is the former ceo of london energy their cfo came from london five of the seven directors have got ties to london uh i believe their ceo is actually a member of the london family which did he earn his job is it nepotism tomato tomato but you know i mean what are you going to do when you have that that kind of historical family tracing there it's going to happen um but they ipo'd during the

middle of the canadian oil bust so they ipo'd in 2017 never had a dividend to cut they never had you know this history of burning cash so they've always been run for cash flow i mean always been run companies have been public less than four years um but they've all they've kind of i think come into the space and if you also look at the broader history of london energy and and whatever uh they have a history of cash flow and managing for upside return so if a lot the peers of International Petroleum, E&P peers have this jaded history where these oil and gas companies forgot they were in the business of actually making money rather than wildcatting for oil and gas. These guys don't have that history. I think that's important because then

the other thing, and I realize this is horribly long-winded, I apologize to each and every one of the listeners. The other thing is these guys are really tied operating leverage-wise to the price of oil. It's an oil and gas company. When oil was in the $40 a barrel range, which it was through most of 2020, they were free cash flow positive, but just barely. I think they made $9 million or something. But when oil goes up, when oil is significantly higher, say $55, $65 a barrel, now they're doing close to $100 million a year or more. I believe in 2018, oil averaged – by the way, they used the Brent crude, International Petroleum's benchmark oil prices, Brent, as opposed to WTI

or WCS. I think they made just slightly over $200 million on an average oil price of, I believe, just shy of 72. So hey, what's the oil price again, guys? Right now? 80. 80. Yeah. Oh, funny that. So they made $200M when oil averaged, 200M of free cash flow. They made $200M in free cash flow when oil averaged 72. Through the first half of this year, I'm just going to pull up my numbers here if I can find them, which of course are, yeah when i need them of course i can't see them um i think i'm gonna make it up um i believe oil prices for them realized this year is somewhere in the 65 60 to 65 dollar range for

the first half of the year okay um oh there i just found it yeah i mean in the first quarter uh first quarter of 2021 they averaged 61 a barrel average price for that realized in second quarter, the average price was $69 a barrel. So let's saw it off in the middle and call it 65. On that, they have made just shy of $100M in the first half of the year in free cash flow, which is interesting because, as I mentioned earlier, on an enterprise value basis, and again, this is traded in Canada, so you got to convert it back to US dollars for apples and and Apples. But they have about a $1.1 billion enterprise value, market cap plus debt. And they've made $100 million so far in the first half of the year. So real simple again,

average it out to $200 million. Go back to 2018 where they made $200 million. This is a company that can make $200 million in a year trading at $1.1 billion. So you're paying five and a half times, six times cash flow. That's pretty good. Yeah, that's a great overview. Art, sorry, did you have anything else there? Well, I was saying then the next question is, what do they do with that money? Yeah, that's the big question. I think we'll have that on the concerns on the second half.

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Okay, welcome back in. I have a question kind of on the top of my mind, which is we talked a lot about demand staying where it is, at least for oil or the three main. Yeah, I look at it as energy. Energy demand. Yeah, because I don't particularly, energy is fungible, sort of. I have no idea what oil is going to do, or I have no idea what gas or anything like that, but I'm reasonably certain, A, we're going to maintain how much our energy demand is, and B, it's going to grow. Right. Now, if that happens, if we get

whatever higher and higher prices, I think the saying in commodities is that higher prices are the cure for higher prices. Correct. which would what happens on the supply side wouldn't that get more producers and then the price comes back down and then well the government's kind of there's been some government some of the thesis right i don't want to step in your toes is the governments have been restricting right some of the supply or am i getting that wrong yeah there there is a lot of pressure there is a lot of pressure from governments from large investor groups from um uh citizen social groups, if you will, there is a lot of pressure to get serious about climate change.

For what it's worth, I agree with that. You need to get serious about climate change. But I believe they are stamping it down the wrong way. They're doing it by stamping down development of oil and gas reserves. They're doing it by preventing certain projects from coming to fruition or being allowed to proceed. I don't think that's not addressing what the problem is, which the problem is worldwide energy demand north of 170,000 terawatt hours per year growing at 2%. This is the world you live in. How are you going to choose to meet that? It's 80% or 79% ballpark being fed by the big three fossil fuels. If you've looked at coal prices recently, the commodity coal pricing, they've skyrocketed along with so many other commodities. Why?

Because you've got various countries in the world very quietly trying to get their coal supply because they realize that the energy, we're going to use energy and we have this energy demand and And we are currently incapable of fulfilling that demand via just the incremental projects to address energy demand are not all going to be renewables and green because it's too small. And forget about supplanting things. But if you've got political pressure, like I said, if you have political pressure weighing on these things to me this looks like tobacco this looks like big tobacco from the 80s and 90s

right no competitors coming online well why why do you now i can see more competitors coming online you know i can see like you know some of these some of these projects if if i'm just going to say something incredibly stupid which you know will uh you know won't be the first time let's say you got $300 barrel oil. Okay. At $300 a barrel, a lot of people are going to give up on their, um, on their deeply held religious beliefs concerning new oil development. Why? Because it's $300 a barrel. As you say, the cure for high prices is high prices, but this is not something like anytime like if you guys like compounders and i know you do um you know nothing in this space is going to be what you're going to call a classic compounder i am not going to buy this

company and hold it for the next 25 years and when i enter my retirement days and decide to calculate my kegger on this thing uh you know look back go well i made 20 annualized over the past 25 years by buying and then sitting on my rear end um that's actually you guys can swear on this show i heard i heard jeff moore on with uh uh with thrive so maybe i should uh i'll get a little more risque work blue um but no like you're you're not gonna you're not gonna like you're not gonna hold this for 25 years as a kegger company this is this is a the environment we're in right now says to me, you want to be buying these things and buying in volume. When the world rolls over or when the cycle rolls over, and it will, you want to be getting out. You don't want to be

sitting there going, oh, and by the way, you're going to miss the top of the cycle. You just are. You'll either sell early or you'll sell late. But I promise you, Except by luck and chance alone, you will miss the precise top. So you can't worry about that. But if you can buy international petroleum, I started looking at this thing in the low fives. It's now in the low sevens, Canadian dollars. If these conditions persist for a couple of years and you get high oil and gas prices for a couple of years, Because the last major cycle in Canadian oil and gas, upcycle in Canadian oil and gas, I think largely went from late 2009, early 2010, until 2014.

Like, you can get multiple years here of an upcycle before things roll over. Someone's going to correct me on those numbers. It's roughly right, people. Roughly right. You can get multi-bags out of these things. And then when everything is wonderful, and everyone thinks they're a genius for investing in, you know, these oil and gas plays, that's actually when we'll start looking to get out. But you know, but in the meantime, you're paying like this company today, like when I first started looking at it was trading at four, like, my cash flow forecast, which I shamelessly am adopting minor tweaks, but largely adopting from the company itself going, hey, look, at $75 barrel average oil price. Okay. At $75 barrel average oil price, for the next four years, we will produce $1.2 billion in free cash flow.

Well, that's pretty interesting when the enterprise value is $1.1 billion, isn't it? Yeah. I saw that number. I was like, okay, if the oil price stays elevated, things are looking pretty good here. And that's the big question, right? How many years do oil prices have to stay at these levels or higher? Your guess is as good as mine. I could speculate, but I think past cycles suggest... I'm always bemused by... I used to teach at a local university a few years ago. and i would say last time i taught the course i think was 08 or 09 and um in that course i used

to ask my students when was the last time oil was below 10 a barrel and so this is 09 right let's say it's 09 um was last time oil was below 10 a barrel and they're like oh like 1950 1930 you guys want to take a stab at it oh okay ten dollars a barrel guys it's not gonna be oh man i don't know my history i don't know the numbers on the history of like the oil crisis in the 70s i'm gonna i have no clue i was reading uh history of the standard oil company last week so good i'm going to go earlier than that or i'm going to go like 1915 would you believe it was 1999 oh wow yeah but but but that's the point ryan everyone is always wildly off because they can't you know oil prices rise farther than anyone thinks they can when they go up okay and i point

the 140 barrel oil we got or roughly that in 08 okay and i think again it was like 120 it was certainly well over 100 in in 2014 and then everyone you know the downside when when oil fell below 30 forget that minus 38 thing from the futures contract nonsense from the middle of pandemic because that was you know as someone forgot to close a contract okay we got that night But I think it was 2018 when oil was hovering around $30 a barrel, $30, $35. And what were the major houses doing? What was Goldman Sachs predicting? Oh, oil is going to go to below $20. When you get these extremes, oil, for whatever reason, tends to overshoot on the extremes. It goes up farther than you think it's going to and then falls farther than you think it's going

to. And so right now, I think we're outperforming. And you start looking around at the world. What's the world saying? The world's talking about inflation. The world's talking about commodities. The world's talking about reopening. The world's talking about how oil and gas and fossil fuels bad. And so we can't own them. You've got the major oil companies, and I'm using that term very deliberately you know total out of france total total um you know bp british petroleum they don't want to be called british petroleum anymore because they're energy companies now right we're energy companies they're trying to step away from what brought them to the dance and yet you know and you've got other companies i'm trying to remember who it was who's like

exited the canadian oil sands or whatever like these are all good and wonderful things and i am a fan but i'm just sitting here going no one wants to own these things there is a reasonable path to this company earning its entire enterprise value in under four years if that starts happening and by the way uh international petroleum has generated about $100 million, like I said, in the first half of this fiscal year. They're calling for slightly less than that in the second half of this year, because they amped up their CapEx budget. I said earlier, all these companies have underinvested their CapEx. So, you know, that's probably necessary, but also possibly worrisome, because, you know, you don't want them spending all their

money on CapEx, which, again, has been the seeds of problems in the industry as a whole, historically but again london energy and these guys spun out of london have a good track record by some accounts some of the earliest money invested in the energy space has apparently 60x since i think the beginning of this century i have not independently verified that but that's what i've seen from some of the writings from this company not like the broader london energy london oil not international petroleum obviously but like these these guys know how to make money in this space and you know if you're wrong if i'm wrong then you know an oil prices retreat to say 45 a barrel this thing probably tumbles along makes 10 15 million dollars a year free

cash flow the rest of the industry is also going to suffer and and that's just the way it is um But I look at a world of pandemic reopening, inexorable slow growth, but still growth of worldwide energy use, and not insignificant societal pressure against new fossil fuel, new oil and gas. And I say, this is kind of, in my kind of contrarian investing style, this is very interesting to me. Right. So the price of oil is hugely important here. If someone's looking at international petroleum, what are some other metrics, if they were a potential investor, that they should be looking at and that you're looking at to see whether things are going well or things are going poorly? It's going to be a little flippant here. Cash flow, cash flow, cash flow. Because again, the sins of this industry have been in the cash flow space, as in these companies burn a lot of it. We can point to the value of reserves, the 2p reserves proven and probable, and the net asset. This is the calculation that all oil and gas companies are supposed

to do, and International Petroleum does, and I think their NAV, which is again tied to the proven and probable reserves that they have, I think their NAV is somewhere about, let's look it up here, $8.40 US. So call that $10.50 Canadian, the stock price is about $7.25 as we speak. That's lovely. That and two bucks will buy you coffee down the street. I don't really put a lot of stock in NAVs. I mean, it's nice to have, but there's no, there's nothing that says the market has to value this company at precisely at NAV or higher and NAV is just an estimate. So, so I don't watch NAV too much, but I do watch how much cash a company is generating. And I do this for any company. It's not just, you know, oil and gas, but I want to see what's the company doing, you know,

what's its cash dynamics how much cash does it generate and you know and then what does it do with it so i've already mentioned one thing that these guys don't do dividends yet i've mentioned another thing these guys are doing which is their capex budget they've taken i think they started this year at 37 million i think they jacked to 73 million so yeah and that is going to impact their free cash flow forecast for the rest of the year was for an incremental, I believe, $35 million to $95 million. Remember, they generated just shy of $100 million in the first half of the year.

Incremental $35 million to $95 million because they have this higher CapEx. Now, CapEx can be good, or maybe they're just starting to fritter away like some of their brethren. But I will point out as well that that incremental cash flow for the rest of the year is based between $55 a barrel average price at the low end and $75 a barrel average price at the high end. And we are above that $75 price right now. So there is a pathway where they end up doing another $100 million in the back half of the year.

And what do they do with it? Well, what they did with the cash on the first half of the year, the near $100 million they generated, I think it's $99.2 or something like that, what they did with that is they paid down their debt. They got some cash filled up with balance sheet, but the vast majority of it went under the credit line. And so I suspect what the company will continue to do is they will continue to pay down the credit line because it's real hard for companies with no debt to run into trouble. It's not impossible, but financial trouble, it's damn near impossible if you've got no debt. I think they're going to take out their debt.

And I think they will probably also start buying back some stock. I'm hopeful they will. I don't see a dividend in the near future. I kind of hope they don't. Or if they do, I hope they make it up the special variety because I like companies that can manage their dividends, not that are paying them because they think they have to and go into penury to maintain that dividend come hell or high water. So the priorities for the cash they generate in your mind is debt first, repurchase is second, then hopefully a special dividend. that would that yes interesting all right any more uh questions i don't have i don't have any uh i think we covered any yeah i think it covers it pretty well are there any other risks aside

from oil prices uh well like i said stupid management uh which the oil and gas space has not lacked for over the years um these guys had the pedigree which made me interested in them um but yeah bad management management that uh uh management that allows that allows the company to get into that caricature of the mp company i gave at the very start the you know spend a dollar 20 for every dollar you make we'll make it up in volume look at the value of our reserves here's a dividend um there's a reason that's a cliche it's because it's played out that way for a lot of these companies and they've been bombed out the last seven years because of that uh i would be i would be very um annoyed with and would probably reduce my position in this company

disclosure i own it i don't think that's a shock um but you know feel free to level level charges of talking your book here. I would be very disappointed to see this company go down that road, but it would be the first thing I would be watching for. If they called out a dividend, like we're going to pay $0.10 a quarter or whatever, but look, it's only 50% of our free cash flow. Well, sure, it's 50% of your free cash flow when the average oil price is $75. What are you going to do when it goes to $55? You're going to put on your credit line? I don't like that i'll be gone i see that i will be gone how much do they have uh in debt uh on the most recent let me pull up that part of my spreadsheet uh most recent reported quarter which was ended

for june of uh 2021 so um uh you know we were we're due for the next quarter uh in uh to hang on here in U.S. dollars, because again, it is Canadian dollars, but my numbers here are they had $21.3 million in cash and $262 million in debt. Right. So they're going to need another year of this kind of another 12 months at these current levels to pay down all that debt. If that's where they go. Yeah. If we wake up and Q3 numbers are out and they say, oh, we made $50 million in free cash flow in the quarter, and we bought back $50 million worth of stock, and now we've reduced our, I mean, if they did that, that'd be damn near 5% of the shares. But that's what it would be. But if they say, yeah, we spent that $50 million on

shares because we're comfortable with our leverage, I wouldn't be too upset about that. And I believe, though, one of the issues here, and this is probably more my speculation than anything else, but their credit line requires them to hedge, I believe it's about 40% or 45% of their production. And so they hedged earlier in the year at significantly lower oil prices. uh i i have to imagine that is grading on some some of the insiders who would be like well geez you know we could be like we're we're hedged at 45 50 a barrel oil's hanging at 80 bucks plus for brent um boy it'd be nice to get rid of that debt so we don't have to pull out some of that you know so we don't have to buy by requirement of the credit line hedge uh you know we could then goose our cash flow so i i suspect they will if like again if they make 50 million dollars

this quarter which i think yeah it's reasonable guess um 40 to 50 million um i suspect it will all go on to the credit line but you know i'm open to i'm i if you're listening out there international petroleum i'm open to buybacks as well all right always at a price well not always But yeah, on this company where, like I said, I think there's a reasonable path to see that this company is trading at, you know, five, five and a half, six times what, you know, or I think I've got the upside down. Basically, they can earn their entire enterprise value in five years, five and a half years. That's a reasonable price. you know, you can, if you're a 50 times sales software as a service company and you're buying back your own stock, I think you can get out of here with that nonsense. Yeah. Reduce the flow

by 0.1% a year. All right. I think that that would end it. Ryan, you want to? Yeah, I'll hit the outro, I guess, for any listeners that aren't familiar with you, where can they find it? I am the lead advisor for Hidden Gems Canada, which is from a Motley Fool product here in my fair country, the Great White North, as our friend Chris Hill likes to call it. I also serve as analyst advisor at large for, as does everyone else on Team Canada, for all of the other Canadian products. So you can occasionally find me in Dividend Investor Canada. I occasionally contribute to Stock Advisor Canada. We just launched another service called microcap mission in canada which is oddly enough aimed at microcap investors uh but my my primary

love and where you can find me 80 plus percent of my time is on uh hidden gems canada where i do my best to horribly confuse people every month by picking a weird stock okay well i think that's going to do it we want to remind our listeners that brett and i are not financial advisors Anything we say or discuss here on Chit Chat Money is not formal advice or recommendation. We are, however, general partners at Arch Capital, so clients may have positions in the securities discussed in this podcast. Thank you all for listening. We'll see you next time.