Comparing Direct Asset Investment vs Stock Performance for an Oil & Gas Investment

When considering how to add energy exposure to your portfolio, shares of public oil and gas companies are typically the first choice that comes to mind. While this approach is simple, holding shares of specific companies exposes investors to agency risk which can lead to a poor correlation between the price performance of the underlying asset (i.e. energy commodities) and a company's equity performance. History is peppered with examples of energy companies who mismanage debt to the detriment of shareholder value, even though the assets these companies manage are yielding attractive returns. Fractional ownership of energy assets offers a distinct advantage over stock ownership by allowing investors to receive passive monthly cash flows from the underlying asset while simultaneously alleviating concerns about poor management decisions that would negatively impact the stock price.

Energia has undertaken a comprehensive case study to assess and contrast the return characteristics of a direct, non-operated working interest investment with an equivalent investment in stock for two companies: Occidental Petroleum (Oxy) and Southwestern.

Case Study: Occidental Petroleum

Energia conducted a 5-year direct asset investment simulation assuming a $100,000 investment starting in January 2018, focusing on the working interest of  291 unconventional Oxy wells in the Permian basin. Using operating cost assumptions standard for wells in the Permian and NYMEX strip pricing as of January 2018, Energia calculated the value of Oxy's 291 wells at that point in time, and the model was then populated with 5 years of actual production data and realized prices to determine the cash flow generated by this asset during that five-year period.

The $100,000 investment produced cash flow of $211,000 between 2018 and 2023. Furthermore, the residual value of the asset today stands at $73,400, using an effective date of September 2023 and NYMEX pricing from August 28th. Consequently, the total MOIC on the initial $100,000 investment would be 2.85x.

Energia estimated Oxy’s cost of equity in January 2018 using the Capital Asset Pricing Model. With a beta of 1.26, which represents the stock's sensitivity to industry-specific movements in the oil & gas exploration and production sector, using a risk-free rate of 2.46% based on the 10-year U.S. Treasury yield at that time, along with an assumed market rate of return of 8%, Energia derived an estimated cost of equity of approximately 9%. This means that investors would have expected a return of 9% per year to compensate them for the risk associated with investing in Oxy's stock. However, when examining Oxy's actual stock performance over the same five year period, it yielded a total return of 4.51%, inclusive of reinvested dividends.  In other words, the initial $100,000 investment would have only grown to $104,510.

Case Study: Southwestern Energy

Energia conducted a similar 5-year direct asset investment simulation assuming a $100,000 investment in 433 unconventional Southwestern Energy wells in the Appalachian basin. The study applied operating cost assumptions in line with other operators in the Appalachian basin, NYMEX strip pricing as of January 2018, and Energia calculated the value of Southwestern Energy’s 433 wells at that point in time. Then, the model was populated with 5 years of actual production data and realized prices to compute the cash flow generated by this asset during the five year period.

The $100,000 investment in working would have yielded $156,000 in cashflow between 2018 and 2023. Furthermore, the residual value of the asset today remains at $82,600, using an effective date of September 2023 and NYMEX pricing from August 28th. Consequently, the total MOIC on the initial $100,000 investment would have reached 2.39x.

Energia estimated Southwestern’s cost of equity using the Capital Asset Pricing Model. With a beta of 1.26, a risk-free rate of 2.46%, and an assumed market rate of return of 8%, the estimated cost of equity was approximately 9%. Again, this means that investors would have expected a return of 9% per year to compensate them for the risk associated with investing in Southwestern’s stock as well. In reality, Southwestern’s true stock performance over the five year period yielded a total return of 12.69%.  Essentially, an initial $100,000 investment would have grown to $112,690.

Summary

In both scenarios, direct asset investment yielded significantly greater returns when compared to buying the equity of the asset owner. In order to minimize agency risk, investing directly in the asset itself is far more preferable. At Energia, we believe in democratizing energy investing by providing access to offerings with direct asset exposure which have the ability to yield greater returns than otherwise available in the energy sector. 

‍

‍