On 22
October 2009 Reuters
reported
that Korea National Energy Corporation will purchase Harvest
for C$1.8B or C$10 per unit. On 12 December 2008 I wrote, “For
these reasons Harvest appears to be fairly cheap and a good
opportunity.” This article will examine the anatomy of the trade
and opportunities for redeployment of capital.
PEAK
OIL
One of
the underlying themes for my investment philosophy is Peak Oil.
Many major oil producing countries have already passed their peak oil
production; Germany in 1966, the United States in 1970 and shortly before the
Nixon shock when he unilaterally defaulted on international gold obligations,
Iran in 1974, France in 1988, in 1999 Argentina and the United Kingdom around
the time Gordon brown sold massive amounts of England’s gold,
Mexico in 2004 and Kuwait is expected to peak in 2013, Saudi Arabia in
2014 and Iraq in 2018.
The
prescient oil specialist and investment banker Matt Simmons, author or Twilight In The Desert, thinks OPEC has
almost no spare capacity. The role
of the monetary metals, particularly gold, is to perform mental calculations of
value; pricing. The sooner you begin to calculate value in terms of
real things the sooner you will be able to understand the relationship
between gold, oil and your
stomach. Provident living principles include having excess energy;
a monkey that gets margin called starves to death.
The
United States, consuming 400% more than it produces, needs a reliable source
to feed its addiction and Canada is the perfect candidate.
CANADIAN
ENERGY TRUSTS
The
Canadian energy trusts are generally high-yield going concerns that pay out
distributions based on cash flow. Generally, under Canadian tax law
they receive preferential treatment so long as the pay out ratio is above
50%. This special treatment will change in 2012 but many trusts have
significant tax pools to shield income like Harvest with $3B.
When I
recommended Harvest its price was FRN$8.68 per unit or about 0.33 grams of
gold. The unit price of the Canadian energy trusts were decimated with
the fall in oil and Harvest was no exception. For example, it fell to a
low of $3, or about 0.10 grams of gold, on 9 March 2009.
HEDGE
STRATEGY
The
role Harvest played in my portfolio had to do with passive
income according to provident living principles.
Accordingly I followed my own suggestions I wrote in my article.
Worst
case scenario oil prices continue to fall and the Federal Reserve Note Dollar
continues to strengthen which will weaken Harvest’s extremely
attractive yield from the current approximately 30% (depends on your tax
situation). Long term put options can easily be purchased to preserve
capital investment.
Despite
the volatility in price I maintained significant monthly cash flow, a 30%
cash-on-cash yield will do that, and actually significantly increased my
position by purchasing additional units with the proceeds from the put
options. Consequently, the new problem is to figure out where to deploy
this capital so that the portfolio balance and lifestyle are not disrupted.
PENN
WEST ENERGY
A
comparable company to Harvest is Penn West Energy (PWE)
although they produce over three times as much oil and gas, do not have a
refinery and are not burdened with as much debt. At $17.67 per unit
with a C$.15 per month distribution it currently yields cash-on-cash about
.78% or 9.3% annually.
Like
Harvest it implements a prudent hedging strategy that minimizes the impact of
volatile commodity prices. Even with weak commodity prices in Q2
2009 they achieved $25.64 netback per
barrel of equivalent which included a realized hedging gain of $5.46.
But
Penn West has risen about 35% in the past two months. The goal is to
buy low and sell high. While I think Penn West will make a good dairy
cow for my herd it does seem a little expensive at the current price.
Consequently, the open strategy will need to be a little more complex
than a market order.
SELL
STAGGERED PUTS
For a
time horizon of a few years, which includes the tax pool advantages, Penn West
appears a decent purchase around $16 per unit. It may even be worth
paying a little extra in order to reduce US$ exposure with the cash balance.
A
naked put, also called an uncovered put, is a put option whose writer (the
seller) does not have a position in the underlying stock or other instrument.
This strategy is best used by investors who want to accumulate a
position in the underlying stock but only if the price is low enough.
If the buyer fails to sell the shares then the seller keeps the option premium
for bearing the risk.
Selling
naked put options does entail significant risk. The maximum value at
risk would be the strike price minus the premium received and would
materialize in a bankruptcy that I would consider a black swan. A more
likely risk would be a significant decline in the unit price like what
happened with Harvest in March 2009. This risk has a higher probability
because of the recent run up in price and coming seasonal weakness for energy
commodities.
But I
need a new dairy cow for my herd and am not very fond of my unemployed cash
in this zero interest rate environment where the Federal Reserve will fail
with quantitative easing. Consequently, I think opening
some uncovered put positions on Penn West around the $15 and $12.50 strike
prices for December 2009 and March 2010 will be a good use of the excess
liquidity that has resulted from KNOC’s tender offer.
If
Penn West floats around its current price then the options will not exercise
and I keep the premiums. For the March 2010 $15 puts that amounts to
$65 per contract and depending on the margin requirements will take about
$500-1,200 of excess liquidity for a very flexible stress test. Of
course, raising the bid to $.85 or higher, in a measured and staggered
fashion, will help increase the return. Remember, you make money when you open the position
not when you close it.
Thus,
this strategy will be able to replace the lost passive income from Harvest.
Excess capital can be used to reduce risk and expand one’s wealth
foundation by moving a significant portion of the unused capital into
cash positions holding physical gold, silver or platinum
bullion via GoldMoney.
CONCLUSION
The
world has a very serious problem with its energy sources and consumption
habits. While nations may do incredibly stupid things, like the Nixon
shock or Brown’s blunder, individuals can take calculated risk to
protect, preserve and grow their capital according to provident living
principles.
But
even after acquiring good assets the markets can turn and therefore it is
important to implement a good hedging strategy to preserve capital.
Sometimes against your wishes the market will take your dairy cow to
market and turn it into hamburger in which case it will be time to find a new
dairy cow.
But
there is a wide variety of investments available and sufficient tools to take
measured risk. In this case, Penn West appears to be a slightly
expensive replacement for Harvest and with an uncovered put strategy the
acquisition of units will be at a better value than the current market price.
DISCLOSURES:
Long HTE, physical gold, silver and
platinum with no position in the problematic GLD or SLV ETFs and short put options on Penn
West.
Trace Mayer
RuntoGold.com
Trace Mayer,
J.D., holds a degree in Accounting from Brigham Young University, a law
degree from California Western School of Law and studies the Austrian school
of economics. He works as an entrepreneur, investor, journalist and monetary
scientist. He is a strong advocate of the freedom of speech, a member of the
Society of Professional Journalists and the San Diego County Bar Association.
He has appeared on ABC, NBC, BNN, many radio shows and presented at many
investment conferences throughout the world.
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