Stock Gumshoe

This one comes to us from Stansberry & Associates, as so many of them do, and is an ad for The Oil Report from Matt Badiali ($99 a year, last time I checked).

He’s got a great opening, as usual:

“Hidden 1,000 feet beneath the surface of the Rocky Mountains lies the largest untapped oil reserve in the world — more than 2 TRILLION barrels. On August 8, 2005 President Bush mandated its extraction. Three companies have been chosen to lead the way. Test drilling has already begun…”

Man, who wouldn’t want to buy into that?

He’s even got a quote from Orrin Hatch, ““The amounts of oil are staggering. Who would have guessed that in just Colorado and Utah, there is more recoverable oil than in the Middle East?”

So according to S&A, we’re on the cusp of a new Western Oil Boom in the U.S. — only this time, it’s Oil Shale we’re talking about.

And specifically, it’s the Green River Formation of Oil Shale, most of which is under government owned land in Colorado, Utah and Wyoming.

The part that’s in Colorado is called the “Piceance Basin” — and that’s where the real core of this investment idea takes hold.

There were six original finalist companies that were considered for these licenses, or were testing extraction technology, and Badiali believes that …

“From the remaining three … only one company’s drilling technology will meet the government’s strict shale development standards – and go on to develop oil shale on a commercial level. This company would be responsible for launching America’s first commercial oil shale operation and production”

There are a few comparisons to Alberta’s oil sands in the ad, just to remind us that we’re talking about real potential and buckets of money maybe being made. There is apparently more oil in the green river shale basin than there is in the Canadian oil sands, and in greater concentration (that doesn’t necessarily mean it’s easier to extract).

So what’s this favorite company of Badiali’s?

There are a few hints:

They have a patented extraction procedure, which involves heating the shale and extracting the liquefied oil.

They’ve invested more than a billion dollars in shale, not including an investment of $150 million in similar formations in China.

They think they can extract more than one billion barrels of oil per shale acre.

So what is this company that Stansberry & Associates thinks is the way to “stake your claim to $2 trillion of oil?”

Well, we’ve got to tighten the screws on the comprehensivationizer a little for this one … hmmm, maybe a bit more …

Aha!

This is

Shell Frontier Oil, owned by Royal Dutch Shell (RDS.A or B on the NYSE)

Shell has been working in this area for a while, and does indeed have agreements to work on both US and Chinese oil shale — last fall, they were awarded leases to try three different techniques on 160 acres of US land in the green river basin.

Their basic technology is kind of interesting — baldly simplified, doing what they call “in situ conversion,” they freeze the ground around the shale, then heat up the shale to release the oil, then pump out the oil. The freezing apparently keeps the oil that they heat from just leaching back into the ground or spreading around before they can pump it out. Do NOT assume that I really know what I’m talking about with this, but that’s my understanding.

It sounds at the same time to be beguilingly simple and ridiculously hard to do, but hey, there ain’t that much easy oil left to extract in the world. Essentially, they drill a bunch of holes and insert refrigeration … stuff … into them, then drill a bunch more and put in … some kind of heating thingamabob … and then watch the oil and gas evaporate out of the formation and fall into their wallets. Or something like that.

They believe this will remain a profitable venture with oil over $30, and I’d be inclined to say that oil is never again going back down to those levels (though “never again” is probably the dumbest thing an investor can say to himself). At least, it doesn’t sound any harder than drilling under a couple miles of water, which is nearly commonplace now.

I don’t know whether or not the government will allow large scale extraction, but it’s certainly true that they’re allowing Shell and a limited few others to experiment and see what might work, and how expensive it will be. There’s certainly potential, to the mind of a guy like me who knows nothing about geology — but I’d say that there are also risks, including both market risks (if oil does drop in price substantially) and political risk, since this is likely to be an environmental hot potato if it causes anything like the kind of degradation that many oil sands mining operations cause. I have no idea whether or not Badiali is correct in predicting that Shell’s method will be better than their competitors’, but it sounds like it’s at least easier on the mountain scenery than a strip mine.

It is also important to note, I think, that this is anything but new — and for that reason, Shell is moving pretty cautiously here. This has been a potential oil boom area before, with an accompanying bust that certainly shattered a few companies following the last energy crisis of the 1970s.

There’s an interesting column from the Rocky Mountain News about this project — and you’ll note, it’s from 2005 … Shell has been working on this for decades, and it’s been known that they’ve figured out a pretty good technology for a long time. It may be that this will move the stock or be a big winner for you, and if this is really going to be the next huge oil production site Shell may indeed be in on the ground floor with these first government leases … but I have no idea how much potential that has for Shell’s share price in the near term.

This seems to me to be a perfectly decent investing idea if you’re looking for a megacap oil company, it’s not that expensive at a single digit PE and a nice yield, but we’re still looking at a multi-hundred-billion dollar company … not particularly likely to double by the end of the year, as so many other newsletter-touted stocks promise. Then again, I would urge you not to listen to my uninformed opinion — there’s plenty of reading to do on this company if you’re interested, so go forth and researchify … and share with your fellow sleuths.

Oh … and the other two companies still in the running for this? They’re Chevron (CVX), and EGL Resources (which appears to be a private, closely held partnership).

This one on the so-called American Oil Pension (A.O.P) has been making the rounds quite a bit lately, with lots of different variations over the past couple weeks — it’s from Stansberry & Associates and advertises their “Oil Report,” which is yet another subscription newsletter.

It also gave me a headache for a while, but that’s neither here nor there.

Quite a bit of space in the ad is committed to extolling the virtue of the A.O.P., and explaining how many people got terribly wealthy from this investment, with hundreds of thousands of dollars in annual payouts to some lucky investors.

And the big tease is that on May 15, the biggest payout from the AOP’s yet will make everybody rich (or everyone who subscribes, at least).

The special report you get when you subscribe is entitled: “A.O.P. Will Pay for Your Retirement – No Matter What the Price of Oil”

Their acronym, AOP, means “American Oil Pension,” and it doesn’t mean anything to those of us who don’t work for Stansberry. It’s just a made up term to make it seem more mysterious and exciting.

Lots of stuff about this makes these seem like secretive, or well-hidden companies:

Goldman Sachs, the Wall Street Journal, and MSN Money are all quoted as saying this is an undiscovered or under-appreciated investment.

And more officious sounding stuff follows, including:

“Thanks to Sections 851-855 of the U.S. Internal Revenue Code of 1986, A.O.P. businesses pay no corporate taxes on the Federal level.”

(which makes them about as unique and mysterious as Business Development Companies, Partnerships, or Real Estate Investment Trusts — woohoo!)

The other big sell for these companies is that they make money “regardless of where the market goes.” Sounds good, eh?

Well, what they’re really talking about are MLPs — Master Limited Partnerships. And they really have been around for 25+ years, without getting much attention, at least until the last three or four years. They tend to be in boring businesses that are asset-heavy and have lots of depreciation, and most of them are involved with distribution of oil, natural gas, or refined petroleum products. The most well known ones own oil and natural gas pipelines, but there are some that distribute propane, or actually do some oil exploration, etc.

And while the payouts might be a bit larger than usual these days because the price of oil is high and the infrastructure that these MLPs own is being heavily used, as far as I know there’s nothing magic about May 15 or any other artificial deadlines you’ve seen broadcast in these emails. That’s probably just the ex-dividend day for the quarterly dividend of one or several of them. Most of these MLPs have a pretty strong record of consistent increases in their payouts, of not absolutely every year than at least quite frequently.

And most of the teased companies have an average or below-average yield for this sector, along the lines of 5-6% … so if you want a several-hundred-thousand-dollar payout on May 15, you’d better be prepared to put in several million dollars first. Or start compounding your interest on a smaller investment and wait for May 15, 2070. The “huge payouts” language in the ad is a bit misleading, I think.

MLP’s in general have had 17% annualized returns over the past ten years or so … which is great, but a fair amount of that has been capital appreciation, which means in part that the yields are not nearly as high as they were when I first looked into these companies four or five years ago. Back then, I recall seeing a lot of 8-9% yields … today, it’s more like 5-6%, (this might also be a problem with my memory). This is not unlike the yield deterioration we’ve seen from most REITs.

So all the people who held these partnership shares for years are indeed now getting garbanzo payouts relative to their initial investments … you? Not so much. Wait a couple decades.

But, they did say that they had picked out the best four “AOPs” to invest in … so of the fifty or so that exist, can the Gumshoe figger out which four are Stansberry’s favorites?

Let’s see.

In the ad’s words: “What I found is that there are FOUR A.O.P. businesses that stand head and shoulders above the rest—they regularly send out the biggest paychecks… and have superior streams of revenue.”

He calls them A.O.P. companies 1-4, so here are the basics about each one, and the solution to the puzzles:

• “A.O.P.” Company #1: An Oaklahoma based business that transports, stores, and distributes refined petroleum products through 8,500 miles of pipeline.”

This one looked to have two potential candidates on first glance — Enbridge Energy Partners or Magellan Midstream Partners, but I’m sure it’s Magellan.

Enbridge is a little squirrely, since the parent company is based in Oklahoma but the MLP — which is what has the big yield — is technically headquartered in Houston. They do have about 8,500 miles of pipeline, but it’s not primarily for refined products (more crude oil and natural gas). You can look into it and see if you prefer Enbridge Energy Partners LP (EEP) or Enbridge Energy Management (EEM), or the lower-yield management company (that also has other interests), Enbridge, Inc. (ENB). Here’s a diagram and explanation of the management structure if you’re interested.

So this first favorite “AOP” is really Magellan Midstream Partners (MMP) – it has had performance that closely matches the clues given here, and it did IPO back in 2001 so that date makes sense. The distribution dates also match what are likely to be the dividend dates for the next quarter, though I haven’t seen those officially announced (those dates are exactly three months from this quarter’s announced dates).

They also do transport specifically refined products through their 8,500 mile pipeline system. They used to be called Williams Energy Partners, by the way, but changed their name back in 2003. The yield is on the small side because they’re really growth-focused, but you still get a bit over 5% … not bad, though historically pretty low for the sector and lower than a couple of the others here.

• “A.O.P.” Company #2: Transports and stores refined products crude oil in 12 states through 5,522 miles of refined and crude oil pipelines. This business has issued 15 distribution increases over the past five years and has watched its stock rise by 228% during that time. In 2006, they paid out over $145 million in distribution checks, which is more than twice the amount they paid out in the previous year.”

My first guess as to the best fit for this was Colonial Pipeline Co., which owns the Gulf-to-East Coast pipeline that sat idle and after Katrina and kept my home market of D.C. thirsting for gas.

But it’s not publicly traded … so there must be something else. If you’re interested, Colonial actually reports that they have 5,519 miles of pipeline across those 12 states, and they do transport both refined product and crude oil through the pipeline (in batches, which I didn’t know they could do without mechanical separators, but apparently they can).

But they’re owned by a group of other private companies and partnerships and don’t have any MLP connections that I’m aware of. So … bummer. This one stuck in my craw and took some time.

Because the next company to come up in the thinkolator 4000 was El Paso (EP), which is a pipeline company but not a MLP-structured one, mostly because they paid out exactly $145 million in dividends last year … but they’re not a match either. Arg.

Thankfully a reader came in to help break my logjam on this one — he suggested that it’s Sunoco Logistics Partners (SXL), and, thankfully, he’s right: The 5,522 is the sum of their western and eastern pipelines, at 3,635 and 1,747 miles, respectively. And they do “transport, terminal, and store refined products and crude oil in 12 states.”

So onward and upward!

• “A.O.P.” Company #3: Owns the U.S. portion of the world’s longest liquid petroleum pipeline that transports oil from Alberta’s oil sands to key U.S. refinery markets.”

This one is Enbridge Energy Partners (EEP), which I noted some of the specifics of above for the Magellan one. They do indeed own that US portion of the “longest liquid petroleum pipeline” from Western Canada to the US.

And last, but not least …

• “A.O.P. Company #4: One of the largest independent refined petroleum products pipeline systems in the U.S. in terms of volumes delivered, with approximately 5,400 miles of pipeline. Owns and operates one of the largest independent refined petroleum pipeline systems in the U.S. in terms of volume. They recently issued their 80th quarterly cash distribution increase and should continue to pay out 99% of its profits for at least the next 10 years.”

This one is Buckeye Partners (BPL) — the “approximately 5,400″ and the “One of the largest independent bla bla bla” quotes are direct from their homepage.

All of these are based on very skimpy clues, but since they match the exact numbers given (like the pipeline mileage) and exact quotes from company websites, I’m pretty confident in all of them. As noted with Colonial, there is another company that has exactly 5,219 miles of pipeline … but I doubt that there’s another one out there that has exactly 5,522 (especially when we’re talking about a limited universe of only about 50 companies).

So are any of those good investments?

Oops, I’ve run out of space!

Just kidding. I actually have no idea whether this is a good space to buy right now.

I owned some shares of the various Kinder Morgan partnerships years ago, and they are a nice piece to have in some portfolios. It’s true that the business is remarkably steady if the pipeline is situated to feed the right areas — they don’t care how much the oil costs, they just get a tariff on the volume that uses their pipes, so they shouldn’t suffer if oil prices fall (at least, not too badly).

My primary concern on all of these has been that they can be a pain in the butt, tax-wise (different forms), and that they are very much yield-focused so they compete primarily with bonds and high dividend stocks like REITs … all of which seem crazily priced to me at the moment. My personal sense, and it has not made me any money in the last couple years as I sold my REITs too early, is that the prices will have to come down to make the yields more attractive.

And if you’ve got the inclination to sift through complex corporate relationships, they all have tight and important relationships with other companies — some public, some not — that actually manage the pipeline, or handle corporate responsibilities, or are the major customer of the pipeline, so in most cases there are complicated webs of inter-ownership between at least two related firms. Many, like Enbridge, have even two different partnerships that are essentially two different ways of owning the same thing … just like Kinder Morgan had two partnerships, one that got cash dividends and one that got share dividends. Probably it all works out fine in the end, but I’m always nervous when I need a diagram to understand the company structure.

That’s just me, of course. And as I said, my understanding of this business hasn’t made me any money for years … and it might just be plain wrong. I didn’t see any particular red flags for these companies, or any reason to think they’re particularly stronger than the other 40+ MLPs out there, but if you have something to share on these or found a chink in the Gumshoe’s reasoning, please go right ahead and share it.

And just a quick FYI — I think the best place to look for info on income securities like these is QuantumOnline.com, they have some great compilations of data on preferrred stocks, MLPs, REITs, all that good stuff. You have to register, but it’s free.

Happy investing.

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