Energy, Oil, Natural Gas, Pipelines, Refining, Coal and Timber
One of the ways I manage my life is to sit in a room several times a year, staring off into the distance, and trying to imagine 5, 10, 15, 20, 30+ years in the future. I ask myself what things I wish I had done when I was younger, what things I would have wanted to avoid, what risks I would have wanted to take, and what experiences I would have wanted to have.
A topic that has come up several times during these exercises is the concept of energy assets. A portfolio of energy assets is fundamentally different in nature than almost any other security, business, or holding. The economic characteristics are often detached from what is happening on Wall Street (look at the boom cycles in finance and those in oil – they do not always line up nicely; it’s entirely possible while stock brokers are jumping out of metaphorical windows, Texas wildcatters are building new ranches and buying new planes). I like the balance that such a collection of holdings could bring to the estate.
If I do nothing differently than I have been, there is little doubt that I will reach old age with a wonderful collection of operating companies and a portfolio of blue chip stocks stuffed with high quality securities churning out dividends. What is missing is a robust portfolio of energy assets. It’s time they got my attention.
To begin putting a foundation in place, a couple of weeks ago, I established a custody account at the bank where I maintain my household CCDA. The broker is instructed to settle any trades, dividends, or other transactions against the CCDA itself, while holding the shares for me. That means it never has a cash balance, nor cash reserves in it; just fully paid securities held in custody by the bank’s broker-dealer division. That way, when a dividend or distribution is collected, it is automatically deposited into the CCDA, just like most people would receive a paycheck.
This particular portfolio of securities – for the sake of convenience, I’m going to call it the Kennon-Green Family Energy Portfolio, or the KGEP Plan – is designed to segregate non-retirement energy, oil, natural gas, pipeline, refining, coal, timber, or other investments from the rest of the holdings, treating them as a stand-alone, isolated portfolio that will be managed as if it were the only thing my family owned. The income from the energy investments will not be automatically reinvested – again, it automatically settles against the CCDA as a deposit – but, rather, I will make purchases from time to time, years apart, when I think something is attractive as a long-term holding. In the future, I hope to slowly build a collection of stocks, royalty unit trusts, and master limited partnerships during market dips, while I study more direct holdings, such as mineral rights. My objective over the next 25+ years is to have the energy assets by themselves be sufficient to keep my family independently wealthy for generations if we had no other investments. By diverting part of our regular cash flow, this should not be hard to accomplish given the time horizon.
I began with one of my favorite stocks from the KRIP plan, Royal Dutch Shell, placing orders last week and this week. For every $66.50 I spend, I get oil and natural gas dividends of $3.44 this year. With raises that only keep pace with inflation, over the next 25 years, every share I buy today should collect cumulative dividend income of $140.00 and $170.00 in cash, plus be worth substantially more in the future. If, as in the past, the earnings exceed the inflation rate, providing real purchasing power growth, the results will be even more impressive.
I would love to add some master limited partnerships, but the problem is that not only are energy profits very lucrative right now, the high yield bubble has driven prices up, meaning that partnership units are yielding 8% when they should be yielding a minimum of 12% to compensate for the volatile nature of the underlying distributions, inflation, and risk. There are some that I think should be in the 15% range but people keep buying them, driving the price further into the irrational territory.
That’s what I mean when I say it is going to be an opportunistic portfolio. I may go years without adding a single penny to the account, then I may go on a massive buying spree, radically increasing our overall level of ownership. It is going to be determined entirely by the value I can get on the acquisition date. In the meanwhile, whatever assets are in custody will provide a stream of capital for me to use for other purposes. If the energy markets tank, I have the luxury of not needing the income, so they can sit there, biding time until the sector recovers.
This is one of those things that is a non-event now, but that I imagine will become a major part of my overall story by the time I’m a much older man. That seems to be how everything begins in my life. It’s the tiny acorns that become great oaks, and, given my personality and temperament, I have the feeling that I just planted the equivalent of a Redwood.
Update I: I wrote a long-form essay detailing the long-term mechanics and experiences of investors in the oil majors that I hope has some educational value to those of you who enjoy the financial theory behind capital markets.
Update II: On 05/27/2019, I released this post from the private archives, where it had been placed several years ago, as part of a special project, which you can track here. This project, which arose because of people telling me how much the old posts on the site meant to them, seeks to restore articles and essays that I feel offer some value, be it academic, educational, philosophical, or historical. It allows you to gain a better understanding into what I was thinking at the time. Nothing more. Nothing less.
Enormous changes have occurred in my life and career in the years since this was published. My husband, Aaron, and I sold our operating businesses and relocated to Newport Beach, California in order to have children through gestational surrogacy. During this same period, we emerged from our semi-retirement and launched a fiduciary global asset management firm called Kennon-Green & Co.®, through which we manage money for other wealthy individuals and families. That means we now are financial advisors (or, rather asset managers operating under a investment advisory model as we are the ones making the capital allocation decisions rather than outsourcing those to fund managers or third-parties), which was not the case at the time this was written.
Accordingly, let me reiterate that this post and the comments were not intended to be, and should not be construed as, investment advice; something that is true of every page, post, and comment on this blog. It reflected our thinking and intentions as private investors at the time it was written, not necessarily our present thinking. As a result of the aforementioned changes, we have fundamentally overhauled our family investment portfolio and desegregated any remaining energy holdings to better accommodate our current needs and plans. Stated plainly, the segregated portfolio, as described and structured in this post, no longer exists. In addition, any companies mentioned in this post were solely for illustrative purposes. Energy investments can be notoriously volatile. They may lose money, go bankrupt, or result in otherwise catastrophic losses. You should talk to your own qualified, professional advisors about what is right for your unique circumstances, goals, objectives, and risk tolerance. Be aware that Aaron and/or I, as well as our asset management firm, may buy, sell, trade, or otherwise enter into transactions involving energy companies and securities related to energy, including through the use of derivatives, and have no obligation of updating these historical writings on my personal blog. They are what they are and made available solely as a courtesy to the long-term community.