Kerry Stokes moves into oil

The billionaire and his lieutenant – former Woodside CEO Don Voelte – are taking some big bets on oil. Why now?

Summary: Kerry Stokes and his lieutenant, Seven Group chief executive Don Voelte, have invested around $250 million in a series of oil-linked deals despite the price of oil falling and tipped to slide even further. These deals include the $100 million purchase of Woodside Petroleum shares and two other more complex acquisitions in the failed ASX-listed Nexus Energy and oil exploration tenements in Texas.
Key take-out: Behind Seven’s deals must lie the belief that the oil price won’t collapse. Its oil investment strategy has multiple risks, but there are also reasons to believe it could work given the yield from Woodside shares, the potential for currency gain, and the creation of new opportunities if the oil price doesn’t fall too far in the current cycle.
Key beneficiaries: General investors. Category: Commodities.

The price of oil has fallen by 15% in three months and is tipped to go lower, which makes it hard to understand why the Kerry Stokes-led Seven Group (SVW) has recently invested close to $250 million in a series of oil-linked deals.

But, as anyone who has watched this billionaire in action over recent decades will tell you, underestimate Kerry Stokes at your peril.

One of those deals, the $100 million purchase of shares in Woodside Petroleum, is easy to explain. It’s at the very least a yield play by the private equity fund run by Seven which is best known for its media and industrial equipment assets.

Two other oil deals are more complex and involve the attempt to acquire, for a reported $80 million, the failed ASX-listed Nexus Energy, and the disputed acquisition for $68 million of oil exploration tenements in Texas.

Because two of the deals are incomplete it’s hard to put a precise figure on Seven’s oil plunge, but as at today they represent an outlay of $248 million, which probably makes it one of the biggest private oil punts anywhere in the world at the moment.

The man driving Seven into oil is its relatively new chief executive, Don Voelte. A former managing director of Woodside, he was appointed chief executive of Seven in July last year.

One of Voelte’s briefs from Stokes, Seven’s biggest shareholder with a 67.9% stake in the stock, appears to be the development of a “third leg” for the group which lists its interests as “industrial services, media and investments” with the ‘investments’ fast becoming a diversified resources division.


Graph for Kerry Stokes moves into oil

With the privately-run investments division at Seven estimated to own $900 million in listed and unlisted assets it has the firepower to continue building on its oil exposure, but if it does there will be much closer scrutiny from investment analysts, with some expressing concern about the move into oil at a time of falling prices.

JP Morgan in its latest report on Seven said its analysts were uncertain about the push into the energy sector. Deutsche Bank said it could see potential upside.

The challenge for everyone outside the Seven boardroom is in trying to understand why the move into oil is being made at a time of falling prices and why it is being made in a series of seemingly disconnected and, in two cases, complex transactions.

The only answer to those questions is that Voelte and Stokes must believe they can unlock value in Nexus and in the Texas tenements, and that they’re confident that the oil price will not fall much further from its current level of $US93 a barrel in the US and $US99/bbl in Europe.

It is also possible that the move into oil is a massive currency play by Seven because of a view that the Australian dollar is overdue for a major correction and exposure to oil represents exposure to the US dollar.

While the currency hedge available from oil exposure has some appeal for an Australian investor there is the risk that a lower oil price could wipe out any currency gain.

Before looking at what might happen to the price of oil it’s worth taking a closer look at the Seven/Stokes/Voelte deals, as revealed so far.


Graph for Kerry Stokes moves into oil

The first, and simplest, was the purchase of a small interest in Woodside from Royal Dutch Shell when the global oil major offloaded an 18.5% stake in Australia’s biggest pure-play oil stock.

For $100 million Seven got a tiny (0.28%) stake in Woodside, an interest which is obviously not threatening to the big oil and gas producer and is best explained by the 5.5% dividend yield, and possible future capital gain.

The Nexus deal is far more complex and is an attempt to seize control, at a bargain-basement price, of a company which has hit problems at a number of assets, including the 100%-owned Longtom gas project off the coast of Victoria and the 15%-owned Crux gasfield off WA’s Kimberley coast – with Shell the majority (82%) owner and natural outright owner of Crux.

In time, Seven is likely to emerge with control of Nexus thanks to the small company’s creditors agreeing to an orderly restructure via a deed of composition, though a hold-out group of Nexus shareholders are threatening a legal fight which could block the deal.

The Texas investment also seems to be heading for a legal showdown with another interested buyer disputing the sale of the exploration ground to Seven by an American company called NextEra Energy.

Apache Corporation, which is in the process of quitting its extensive Australian assets to focus on its North American interests, alleges that it had the right to make an offer for the Bivins Ranch in west Texas and has started a legal challenge against Seven and NextEra.

Behind all of Seven’s deals must lie a belief that the oil price will not collapse under the weight of an oil market approaching glut conditions not seen for at least 20 years.

The oil surplus is so large thanks to the return of the US as one of the world’s leading producers that there are reports of old tankers being used to store the excess offshore.

The Wall Street Journal newspaper reported on Monday that up to 50 million barrels of oil are being held in floating storage around the Atlantic with the London-based consulting, Energy Aspects, describing the surplus as the biggest since 2008-09.

It’s the glut which is driving down the oil price, but as the price falls it is likely that oil producers will cut production, and while that is always the case whenever there is an oversupply of any commodity, the oil cuts this time could come quickly thanks to the US shale-oil revolution.

Unlike earlier periods of oil glut, when Middle East and Russian production proved hard to brake because governments in those regions needed the cash from oil, this time the “swing producer” able to turn production off relatively easily is the U.S.

Tim Cutt, the chief executive of BHP Billiton Petroleum, touched on the new factor in world oil in a paper delivered in New York last week when he referred to the “manufacturing” nature of oil and gas in shale and other unconventional petroleum deposits.

“The repetitive, manufacturing nature of shale is ideally suited to our productivity agenda,” Cutt told delegates to the Barclays Energy-Power conference.

What he means by manufacturing is that shale oil production from hundreds of wells can be more easily controlled than conventional oil reservoirs which tend to boom in their early years and then taper off. In contrast, shale oil starts slowly and actually starts to accelerate later.

Potentially, that means the latest fall in the oil price could be shortlived with profit-focussed US production being turned off much more quickly than Middle East production, potentially creating a prolonged period of oil-price stability, even if at a lower price than enjoyed in previous booms.

For Seven, it’s billionaire leader and the veteran oilman at the centre of the action, there are multiple risks in its oil investment strategy but there are also reasons to believe it could work given the yield on its Woodside shares, the potential for a currency gain, and the possibility of the oil price not falling too far in the current cycle … creating new opportunities in a new era.