Starting this week, I'm beginning a new project. This post represents the first experimental post that I'll be putting up. 1-2x a week, I'll be reading the 10-K of a company, breaking down the problems they face, and what opportunities exist in the margins. I call this "The 10-K Margins".
Covid-19 has rained economic hardship on most "real" industries, decimating most of what we would have considered as the economic engine of our society. Just 10 years ago, the most valuable companies in the world dealt in physical goods - from big box retailers, to massive oil conglomerates.
This year however, represented the inflection point, moving society away from where we were, to a new future. One major example of this has been the relegation of resource extraction firms in the pecking order of big business. Just 10 years ago, oil companies represented some of the most powerful businesses in the world. Now? They are hardly found in the top ten.
To understand what's going on here, let's look at Murphy Oil, a typical oil company and how they fared over the course of 2019-2020. For background, Murphy is your typical oil company, with most of it's operations in the US and Canada.
It's about as typical as it gets. The business model is quite simple. They primarily make their money selling oil and gas products, which primarily come in the form of either condensate and liquids. They get paid once resellers or brokers take the oil off of them. Overall, the business model is straightforward
But 2020 hit them hard. Coming off the back of extended slowness, the drop in oil prices in 2020 resulted in a massive shock in the business. The price of oil fell off a cliff, and suddenly many investments and equipment purchased at a time where oil prices are higher, suddenly didn't make economic sense. They pared back heavily, closed down a number of thier offices, and adjusted executive compensation. While not in red territory, the company clearly was hit heard.
So what can we glean here? Well, the interesting thing about 10-K's is that often you see the real problems impacting the business. These are letters to the shareholder, and space is limited, so the risks and problems stated here are very likely those high at the priority list of the company
In other words, they represent the opportunity for any entrepreneur to take advantage of them to grow.
In this case, there were three main opportunities for growth.
First, a major risk Murphy put forward was foreign currency price risk. This makes a lot of sense, many of these massive international conglomerates hold their money in multiple different currencies at different times of the year.
There's two ways this can manifest
- Fluctuating currencies can impact the overall value of any foreign cash reserves that are being held.
- Fluctuating currencies can also impact the ROI of any potential projects, given investments in external countries.
One opportunity here could be for entrepreneurs in countries receiving a high amount of external investment to act as arbiters of currency stability in exchange for either a fee or equity (i.e we will peg the currency for you, if we receive X shares), and for access to the market.
A second problem highlighted by Murphy was Commodity price risk. The key here is that all projects are priced with the end goal being the oil price. While there are massive amounts of modelling done in order to forecast pricing, the past few years have shown that wild fluctuations and events can, and will happen.
The key here is that there is a very high degree of uncertainty and risk in the market. For entrepreneurs that are capable of absorbing the risk, there is a huge opportunity to capture value here. One potential is to commoditize price guarantees and contracts for certain resources at certain levels (very similar to futures) but in the every day market.
The idea here is that you can offer to buy oil and gas at certain levels, and after X number of months, years or decades, trade it in. If you are above the level, you can resell on the market. If you are below, you will have to make the difference. Ideally, you bet that the majority of company forecasters know what they are doing.
Finally, there is a component of environmental and political concerns. The main problem is that the environment is a global problem, but worked on in a local level. Countries, states, counties, cities and even different neighbourhoods all have different rules in terms of what the rules are for each area.
Currently this information is only accessibly by paying environmental consultants huge amounts of money. However, there is an opportunity for entrepreneurs here to find a way to offer a mid-way service (i.e not a full report, but rather perhaps an exploratory memo or quick action feasibility) that will provide an answer to most exploratory questions (i.e what are the rules and regulations if we did X).
All in all - the oil industry seems to have entered a period of prolonged stagnation. The world will never stop needing oil, but we are currently attempting to understand what our new relationship with this substance will be. In the meantime, I suspect this to be a volatile industry for the years to come.