Episode Transcript
The Finance Ghost: Welcome to episode 263 of Magic Markets. It's been quite the weekend of news out there, with everything happening in Iran. So there's lots for us to talk about. And of course, oil is the asset class on everyone's lips (except mine, really, because I don't really buy oil). I'll tell you what I did buy - but I'll do that after saying hello to Moe.
So, Moe, welcome to the show. Have you been feverishly trading oil stocks all day?
Mohammed Nalla: [Laughs]. I'm laughing. It's like that denial laugh. It's been such a hectic weekend; the news flow being dominated by this war in Iran. Correctly so, I guess.
So I guess, am I out there feverishly trading oil stocks? No, because you may recall, and listeners may recall from probably around Q3 of last year, I was bullish oil - with a little bit of a geopolitical risk premium view coming through there, as well as a seasonality view coming through.
I was wrong for about a quarter, and then I was patient. So at the start of this year, I just kind of sat through that. So I'm currently long a couple of oil names, that's across the value chain. We can talk a little bit about that.
And I've been happy with that because some of those names are up 50% from when I bought them. Some of those names are up maybe a little bit more, some of them up around 25%. And again, we can unpack which names are up where; which parts of the value chain actually come through.
My actual worry right now: is this now the catalyst and the culmination of the trade that I had on the whole time? And once this war passes, if it passes quickly, does that just mean that this premium that we're seeing in oil prices right now, just erodes very quickly?
So again, for context for our listeners, we are actually recording this quite early on in the week. It's on a Monday, so it's just literally the day after the news broke (about) the war in Iran.
By the time you get this podcast, which will be later on in the week, we'll see how some of that resolves. We'll see if this is actually a short, quick war, or if it's dragged out.
But my worry is that a lot of that's already being reflected in the price - not just of oil, but possibly of some of the safe havens like gold. US treasuries as well.
The Finance Ghost: Yeah, these geopolitical asset classes can be quite scary things. So you may not have been feverishly trading oil stocks today, Moe, but I'll tell you who was - everyone in South Africa. Because Sasol's volumes - I'm looking now - (is) two and a half times their average today.
The stock had a really strong start to the day, and then it basically ended up roughly flat for the day. It's ever so slightly up at the time of recording. It's pretty much at its 52-week high. So that shows you how well this trade has actually worked out. And year-to-date, you're talking a return of almost 37%.
So ever-suffering Sasol bulls have made some money, but today was not the day to make some money. And it's actually quite funny because this morning, EasyEquitie crashed; it just wasn't working. And I wondered if it was everyone trying to get on and buy Sasol! Pretty sure it was.
Mohammed Nalla: There's a saying in the market, right? You’ve gotta buy the insurance before you need it. So if you had a bearish view on things in the Middle-East - that was a painful view. I've had this view for a while, and it was a painful view to wear through two quarters.
Just last week, I was concerned about it, and probably around the middle of last week, the latter part of last week, I went and bought some hedges using VIX Volatility. And it wasn't a large position, but it was just saying, “I'm nervous about what possibly could happen, and I need some insurance”. You've got to buy that before the event happens. Now that the event has happened, it's probably too late.
And that's again that - I wouldn't say it's gatekeeping - but the system's crashing. I mean if you look at US oil-exposed names today, that we've just opened at the time of this recording, it's very much the same story as you're seeing on Sasol. It had this initial spike and now it's actually kind of flattish on the day.
So I think the market's going to wait and see, let it digest - is this long and drawn out? Isn’t it?
And again, that's why what I want to discuss on the show today is oil, generally speaking. We don't want to cover the geopolitics, because you're seeing all and sundry out there on X at the moment commenting on this. And some names are authoritative, others are just using AI slop. So we're not going to go down that route.
What we are going to discuss, though, is: “What is the oil trade?” For me, oil is not just one trade; it's actually a value chain. So when I consider oil, I consider oil names, I look at the cycles, I look at it through the cycle. And that's some of what I want to unpack here.
Because we've done that on gold. We've said, do you buy the underlying metal or do you buy the gold producers? You get elements of cyclicality coming through. You get elements of operational and financial leverage coming through.
For me, you've got to understand the deeper oil ecosystem if you want to contextualise that within your longer-term portfolio. If you don't, yes, it's a beta trade. You've got some war in the Middle-East. Now all of a sudden you want to buy it, you're in, and you're out.
That's a different story. I'm saying, if you're interested in oil longer term, does it make sense? Does it actually make money, and which sectors make money within that value chain?
The Finance Ghost: And I guess a big thing that you need to be careful with when it comes to oil is, because the thing is basically run by a cartel, they are incentivised to keep the price in a window where they can make money, but they are not suffocating volumes.
So you occasionally see these spikes to over $100 a barrel (this is Brent crude I'm talking about). But they tend to be short-lived these days. The last time that it was actually above $100 a barrel for more than just a couple of months - I'm looking at a long-term chart now, you've got to go all the way back to pre-2014. That's when it was above $100 a barrel; it came all the way down, and then it sits in that window.
And so that's the problem, right? If you are just trying to buy oil, the commodity itself, you actually need to buy the businesses that are using the stuff to generate cash flow. Because this is not like gold. This is not gold the commodity. Oil does not behave anything like gold, actually.
Mohammed Nalla: Yeah, that's absolutely spot on. Because listeners will know, in gold, I always say I prefer the underlying commodity. I don't like the operational financial leverage that comes in the miners.
With oil, I have a very different view. And that's because they're fundamentally different assets, right? Remember, gold is a safe haven; a store of value. It doesn't degrade. You can literally put it in your vault, forget about it. And yes, there are security costs and stuff over the longer term.
Oil is a consumed asset, right? It’s a commodity that gets consumed regularly (I don't have to tell you that - that's not rocket science). But it's also (a) very cyclical, and (b) as you mentioned, cartel-like behaviour gives you different dynamics on the back end with OPEC.
I want to push back a little bit with regards to some of the points there on the cartel - like behaviour, because I think the effectiveness of OPEC over the course of the last several years has been diluted. I think if you look at the US as an oil producer, as an energy producer in general, the US is now the largest, biggest, baddest player in the world.
That also moves the needle, because if we go back to those inflection points that you were talking about, historically, oil got to $100, and that incentivised a lot of investment in the US Shale and Permian Basin, and all of that supply came on stream.
I remember a long time ago (this is not an updated number, but a long time ago) I saw a very detailed research report that suggested that for as long as oil stays within a $55 to $75 sweet spot, that's where it's most stable. Right?
And the reason for this is, above those levels, you incentivise people to put more supply on stream, and that eventually gives you that massive cyclicality and eventual choke points - too much supply. Llikewise, anything below that level means that a lot of US shale production is not economically viable. We're not talking about the Saudi Arabias that are economically viable at single-digit oil prices. We're talking about US shale production, a big needle mover in US energy and global energy markets.
And so I've always used that 55 to 75 to try to calibrate my expectations. Who can forget, during the COVID pandemic, when the oil future actually went negative? In order to get that oil future, it went negative over a very short time period because of the storage costs and tankers on the sea. There was no demand going out the door.
So if you want to protect against some of that massive cyclicality, that's where you’ve just got to be very sensitive. Where do you play in the value chain?
And maybe now's the time to unpack some of that, Ghost. If you look at the bigger players - if you're looking at ExxonMobil, Chevron (I would look at those as really well integrated players) they've got production coming through. They've got trading houses that sit within these massive conglomerates. Those trading houses in these kind of markets make a lot of money for some of these players. It helps offset some of the swings that they're getting in the rest of the names. And then they also own some of the midstream and downstream pipelines and the rest, storage.
Those big players are really a product of how strong your balance sheet is. I think when you're looking at a big player like that, you can probably buy them if the balance sheet is strong; they're going to ride through these cycles because that is their sole purpose for existing. And they own enough of the value chain in different parts to give you that blended effect that comes through. And so that's how I would look at some of the big players there.
Something that I've liked for a long time is (and I think certainly South Africans, you don't have this exposure) down in the South African market, you've got Sasol (we'll touch on Sasol shortly). But up in the US, up in global markets, you've actually got players elsewhere in the value chain, and that's for example, Oilfield Services. And here you'd get a company like Halliburton - very famous.
Dick Cheney, former vice president of the US, was on the board of Halliburton. I'm certainly not saying - there are no political views here - but Halliburton makes their money as a service provider to oil companies. So I would say, that's somewhat lower beta, more defensive.
If you want to be in this for a longer than just the initial pump on the price, then further down the value chain, you've got to look at players. They're called midstream players. And these are the players that own pipelines and that own storage facilities. And this for me is kind of the defensive sweet spot. Everyone here knows how I like good cash flows, I like high dividends.
Go and have a look at some of these players here - Enbridge, Kinder Morgan coming through in there - some big names. And if you go and have a look at them, you can see that through-the-cycle, these are the players you want to own. They're boring, but these are the players you want to own for steady cash flows, and high dividends.
And again, even with that defensiveness, if we actually see massive dislocations in terms of volumes and global energy markets, these players might still feel some of that pain as well, Ghost.
The Finance Ghost: I mean you've highlighted ExxonMobil there. So, all-time highs. If you go and Google it right now, you will find that the stock is trading at all-time highs, which is interesting because the oil price is certainly not anywhere near all-time highs.
And actually if you then go and do a chart of ExxonMobil - which as you know, I can never resist the temptation to do - what you find is that the current share price is not quite double where they were in the mid-2000s, just before the crisis, but it's not very far off. And that's when oil ruled the world. That was before we understood anything about big tech. Software-as-a-Service was like a weird thing that Mark Benioff was building, and pretty much no one else.
It was just a very different time in the world. If you look at the top 10 market caps in the world pre-Global Financial Crisis, it was banks, it was oil, and Microsoft. My thesis around Microsoft is that it’s the only one, if you go and have a look from that period in the top 10, that you'll still find in the top 10 today.
ExxonMobil: all-time highs. Unfortunately for them, their market cap of $642 billion or so is pretty small these days, compared to some of the other absolute monsters. I mean for context, I just checked Apple, that's $3.9 trillion. So the oil names, much as they might be doing well because of the steps they've taken since then, (are) still way behind tech.
But the fact that the share price is so much higher, despite the oil price not being where it used to be, tells you a lot about how they've actually gone and found additional ways to extract value out of that value chain, as you say. And that's a very different situation to the gold miners, as you pointed out, which is really just getting the stuff out (of) the ground, managing the operating leverage of mining, managing the jurisdiction risk, depending where they are.
The oil players have had to be a lot spicier than that. They've had to really go and change their businesses over the past two decades.
Mohammed Nalla: Ya, ExxonMobil is at all-time highs. There are a number of players - there's a stock I've owned more recently (certainly since last year) called Suncor Energy, it's a Canadian stock. They're also at all-time-highs. If you look at their performance versus ExxonMobil, they've actually shot the lights out. They've done pretty well.
But I think your point is valid. These oil majors were there during the last cycle. With all the fears around AI and “are we in a tech bubble, an AI bubble”, whatever it might be - at the end of the day, as long as oil remains our baseload of energy (it's the stuff that powers the planes that we fly around the world in and our cars and pretty much a lot of stuff that's out there) - as long as that remains the overarching structure of the global economy, these players can do very well.
Some have done badly, right? I mean, if you look at BP: BP had gone through a tough time. There were rumours that they'd be taken over, I think by ExxonMobil, maybe Chevron. They were looking at actually taking over BP a little while ago, and then they walked away from that deal. So it's not an easy business.
I think anyone who's out there who looks at this industry will know it's actually a very tough business to be in. But the bigger players have done remarkably well because they've diversified their businesses. And remember, it becomes a balance-sheet play. They're just so large they've got the heft to push that through.
Again, the benefits here, certainly for those that don't like gold (where they say gold is this useless relic and you put it in the cupboard and you forget about it), oil is not that. Oil is something that you actually consume. And for me, the only longer-term risk to this sector (regardless of value chain, regardless of whether it's the producer or the midstream player, whatever it might be) is what happens with clean energy. And I think the biggest boon that the oil industry could have gotten right now is the Trump administration's pushback towards fossil fuels
Because if you think about it, if EVs became as dominant as some people had said they would be (if they were regulated in some geographies - it's been dialled back in North America) - if that actually gathers some traction, that erodes a lot of the use case of oil. And I would see that as the one most critical, fundamental risks to this industry, regardless of where you play in that value chain.
Now, Ghost, I want to actually ask you a direct question. As a South African, we all know when you talk oil, there's just one name in oil on the South African markets, and that's Sasol. And you mentioned how Sasol had spiked, and now it's flat on the day, based on when we were recording this.
But what I want to ask you about Sasol, and just unpacking your view: we've spoken about some very important things. We've spoken about balance sheet, we've spoken about where you play in the value chain. That's why I want to ask these questions around Sasol. I know some of the answers here, but I think it's important for our listeners.
Sasol's not a pure kind of production play on oil because there's a chemicals business and you can unpack that. Sasol doesn't have enough, or any in fact, midstream exposures. You might have some downstream exposures, I remember you had a couple of Sasol forecourts - the retail arm that comes through there as well.
But that's the question on Sasol: what is Sasol? Where does it play in the value chain? And the second question is, when we look at that balance sheet, is Sasol really in the league that we need to be talking about? When you compare to some of the global players?
The Finance Ghost: Yeah. So Sasol is obviously a huge topic in and of itself, but the TL;DR on that thing is that they went into that big deal in the US for chemicals. Like so many South African companies, big offshore deals don't always work out so well.
What's really happened is, Sasol eventually just decoupled from the oil price. The correlation actually became quite poor. It wasn't really the case that if you were buying Sasol, you were buying the oil price and vice-versa. And it wasn't actually just because of the chemicals exposure. It was also just because of the infrastructure issues.
Some real concerns around production in Secunda. There's stuff around emissions and energy and taxes and all sorts of stuff. Plus failing South African infrastructure, and what an issue that's been. So poor SASOL has really been just a sad and sorry tale for many reasons, but they have actually recently started to make some pretty important improvements.
And I think that is why the market is looking at this and saying, “Okay, well, the oil price is up, Sasol can kind of go up with it” - because production volumes at Secunda Operations were actually up recently. They finished a major project, their destoning plant there. So that was pretty much in the nick of time, because last year the average rand price of oil was down pretty sharply, actually.
In the six months to December in Sasol's results, they talked about the average rand price of oil being down 17%. So that's a lot. But their production volumes at Secunda Operations were up 10%, so they actually offset some of that. Now the production improvements should stick, whereas obviously if the rand oil price goes up, then Sasol scores in that situation.
Capital expenditure was actually down dramatically. So that also did great stuff for their free cash flow, which was positive in that period.
And let me tell you, the positive free cash flow at Sasol is something to celebrate. The balance sheet's not too bad. Net debt to adjusted EBITDA is at 1.6x. So debt’s come down a bit.
It's a way to play it. It's not actually the only way. On the JSE, funnily enough, there's a random little company called Efora Energy, but it's suspended from trading, so good luck on that one. So Sasol is definitely the way to play it.
And will it become just cleaner over time and maybe more oil-related? Look, there's been a nice shift in it now and I think Sasol is probably the best example of that old story in the market, of how the price drives the narrative. Because when Sasol is doing well, Sasol bulls are everywhere - and then Sasol has a long period of doing nothing, and then everyone is bearish on Sasol.
For me, it's just in the too-hard bucket. It feels like something where you make money quickly and then you go away, like I did in the pandemic, and like so many other people did when that thing collapsed. Just make your money, and then say cheers. It's not like the big internationals who have built out this beautiful integrated business model. I think that's my overall take on it.
There are many, many Sasol die-hards in the market, and that is the way they die sometimes - quite hard. It's not pretty.
Mohammed Nalla: [Laughing] I shouldn't be laughing. I remember I worked with an analyst and we used to always tell him, you know, “It's Sasol” and he dies on his sword on Sasol. I fully concur with you. I think Sasol definitely behaves as a leveraged cyclical play. I think the chemicals give you a little bit of a slightly different dimension on that.
But that's not really where I like to play in the value chain. I like playing in services further midstream. That kind of space, for me, is the sweet spot for my long-term portfolio. I like the compounding, I like the dividends that come through.
For the short-term, for trading, I think players like Sasol - get the high-volatility kind of moves to the market.
Maybe that's where we should wrap the show right now. As we're speaking, lots of uncertainty around the Middle-East. We don't know how that's going to resolve. Pretty much no-one knows how that's going to resolve. Not even the Americans, not even the countries involved in this.
So just be very careful out there. Keep your risk management very, very tight.
If you were to push me on a view here, Ghost - because I know you probably want to, right - I would say the risks are that you get these spikes that come through. Maybe, as we're seeing already today, you get the spikes, and then they fizzle out. If this is a shorter war than anticipated, then yes, that might be true. If this drags out, though, and I think there could be a very long tail to this, that could be counterbalanced by other strong players.
I mean, before this war, lots of talk around a glut in the oil market. So how much production can other players put on stream right now to offset the drag from the Middle-East? That's really what's going to move the needle.
So Ghost, that is my view on the geopolitics. That's my view on the oil markets. And just be careful out there.
But I don't want to end on a downer. I don't want to end on a bad note. I want to end on some good news. And again, there has been some good news, right? I mean, it's something that both you and I share. It's something we discussed on the show. But I'll leave it for you to actually just mention this to our listeners.
What is actually the one silver lining in the markets that you've had over the course of the last two weeks?
The Finance Ghost: Ya, for sure. It's got nothing to do with oil. And it's what I mentioned at the start of the show when I said, well, I've been trading something. Not today, admittedly, but I was happy to note that Netflix has walked away from the Warner Bros. Discovery deal, which means that the Netflix share price has done some beautiful things.
And I'm going to quote here from the very last sentence in our Netflix report in Magic Markets Premium in January. We said, “Ironically, if the deal is blocked by regulators, that might be the best near-term upside catalyst.”
Now, it wasn't the regulators who said no. It was simply because the Ellison family just cannot help themselves but throw money at the problem. And they just kept on bidding it up to the point where Netflix was beaten out by Paramount Skydance.
So Netflix has walked away. Hilariously, analysts are now like, “Oh, look at the discipline at Netflix”. Even though they were very happy to chase that deal until the 11th hour.
What I'm looking forward to (apart from the fact that it's just nice to see that the Netflix position worked out so well) is that it just felt like a good buy, and it has worked. I wanted to own the company, so now I do.
But what I'm quite looking forward to in the transcripts is now you're going to see them get all bearish about the box office again. Because for a quarter, they had to kind of pretend like the box office is great. “That's where we want to be. We want to own the studios.”
Mark my words. Give it a quarter, maybe two. It's going to be back to, “The box office sucks and the release periods, blah, blah, blah, blah, blah”. I mean, it's the age-old story, right? People talk their book. But I'm happy that the trade worked out.
Mohammed Nalla: I'm watching that. I think that's a great point to land on. I also went long Netflix, following our report again, on the catalyst of: maybe the deal doesn't happen. That's a nice upside catalyst. Or even longer-term, if the deal did happen, I think to your point, let's watch that next earnings transcript because yes, people talk their books and now they're going to have to talk it down.
Paramount Skydance, that stock also rallied on the back of this, very temporarily. But let's see. Because they're going to be saddled with this very expensive deal.
Can they make it work? Can they become a really material media player out there? Effectively, they're going to own a lot of big chunky assets in that media space. Maybe that's a topic for another day, Ghost - something else that we can cover in Magic Markets Premium.
But what do you think? As our listeners, as our subscribers, let us know.
Hit us up on social media. It’s @MagicMarketsPod, @FinanceGhost and @MohammedNalla, all on X. Or you can find us on LinkedIn. Pop us a note on there.
We hope you've enjoyed this. Until next week, same time, same place. Thanks and cheers.
The Finance Ghost: Ciao.
