Game Change In The Middle East? Here's A Great Way To Profit

Aug.22.11 | About: Delek Group (DGRLY)

Great news from the Mideast? How is that possible? Of all the US’s foreign policy missteps, blunders, and bear traps since the end of World War II, none have held more catastrophic consequences than those in the Middle East. But geopolitics often turns on small events which, at the time, are not seen as portents of change. Yet that is what is occurring off the coast of Israel right now.

First, a geopolitical reality check. Yes, we want to engage the Arab world because they have a rich cultural history from which our (Arabic) numeral system comes, they once made strides in mathematics and science, etc. And yes, we are all on this planet together so engagement makes sense. That said, why does so much of our foreign policy infrastructure revolve around the Middle East? Why do our State Department, CIA, DIA and other economic and military analysts spend so much time monitoring the health and succession plans of Saudi Arabia’s King and Crown Prince? Why do we care whether the Shiite resurgence we unleashed by our quest to punish Saddam Hussein and free the Iraqi people is benign or malignant? Whether Iran is friend or foe, Libya encumbered or unencumbered by Gaddhafi, Syria run by an Assad or an asylum? In a word:

Oil. Or more accurately, oil and natural gas.

That doesn’t mean U.S. motives are driven solely by our quest to assure oil and gas for transportation, heating, cooling, manufacturing, and chemicals as some conspiracy theorists believe. Emigration, a desire to prevent human rights violations, defense of true allies, and the usual fiddling with power politics that often backfires because we forget Garret Hardin’s dictate that “you can never do merely one thing” are often as important or, at the time, even more important.

But the elephant in the room, no matter the cause du jour, remains oil and gas. And in this crowded and volatile little corner of the world, them what’s got it wield a mighty big carrot. Israel’s neighbors got it, Israel don’t. Or hasn’t. Until now.

Until now, Israel has imported the lion’s share of its natural gas through an underwater pipeline from the Egyptian city of El Arish to the Israeli port of Ashkelon. They are currently in negotiations with Qatar to buy LNG (liquefied natural gas) which would reduce their dependence on Egypt for this gas – particularly since Egypt now wants to double the price that Israelis pay and since Egypt is seen as a now-less-stable provider, what with the various factions there jockeying to show who is tougher on Israel.

But Egypt’s supplies of natural gas are nothing like their wealthier-in-oil neighbors and their population of 80 million souls is the largest in the Arab world – and rapidly growing. It won’t be long before they will need all their gas just to service their own factories and consumers. (In the process, pushing Syria and Jordan, both of whom are served by the same pipeline downstream, to seek relief elsewhere.)

Now what if? What if Israel was the net exporter to Egypt rather than the other way around? What if Israel were the prime exporter to Syria and to Jordan? Might such a trade dependency mellow Egyptian fervor against Israel? Solidify Jordanian acceptance of reasonable conditions? Push Syria to (publicly support but privately) reduce funding to Hamas and reduce the Iranian influence in their own nation? While many think linearly and only see a bad situation getting worse, the wise analyst allows for the unexpected and has ready strategies to unleash if the remote becomes the reality.

But, you say, this is a pipe dream. Moses took a wrong turn and went into the land of Israel, not the land of Saud. And they’ve drilled all over that small beleaguered nation and found bupkus. That's no longer true.

Let me give credit where it is due: the company I suggest for your due diligence came to my attention from my friend and fellow SA contributor, Vivian Lewis, the editor of Global Investing. I asked Vivian if there was a way for US citizens to participate in the future of the Tamar and Leviathan oil and gas fields which are offshore of Israel without having to buy Delek Energy Systems and/or Avner Oil on the TelAviv Stock Exchange. I was disheartened to find there was no direct way, but impressed by the thoroughness of her reply, so I decided to take her suggestion for the best way to play it. Which is:

We are buying Delek Group (OTCPK:DGRLY), an ADR traded OTC in the US. The chairman of Delek Group, Yitzhak Tshuva, has been compared to Warren Buffett and, indeed, he is building a conglomerate using, among other things, the premium and investment income from DGRLY’s insurance subsidiary. (What else would you call Berkshire Hathaway (NYSE:BRK.A) but a conglomerate -- an activist mutual fund?) But Delek is much more than insurance. It also has tentacles in infrastructure, water desalination (like our Hyflux (OTCPK:HYFXY)), real estate, finance, investment management, underwriting and investment banking, auto sales, biochemicals, cable TV and high-speed Internet, and telecommunications. (I like utilities in markets like these and here's a company that's both in energy and telecom utilities and other businesses I think will do well...)

More and more of its cash flow and big profits, however, are coming from energy -- the exploration and production of oil and gas, the retailing of natural gas, the distribution and marketing of various fuels, operating crude oil pipelines and storing various fuels, refining and marketing petroleum and its byproducts, and operating gas stations and convenience stores. From upstream to downstream, Delek is there.

The company has been building on its successes since its founding 60 years ago. It is as well-known in Israel as Berkshire Hathaway is in the USA. All the above by itself was enough to pique my interest in the company, but there is even better news: with its most recent purchases, Delek now owns, via direct and indirect holdings, 89% of Delek Energy (80% direct). You can see how this plays out in the chart below (click to enlarge) but, all told, this gives DGRLY 53% of Noa & Mari-B, the vast natural gas fields off the Israeli coast. The other 47% is owned by the USA’s Noble Energy (NYSE:NBL).

It gives DGRLY a similar percentage of the Tamar fields, which, at 5 trillion cubic feet of natural gas is even bigger, as well as in the biggest of all, the Leviathan -- which was Noble’s biggest discovery in its nearly-80-year history as a company. Not yet fully delineated, the Leviathan looks to be living up to its name, with some 16 trillion cubic feet of natural gas already proven and another 9 trillion as probable. It is expected to show 4 billion barrels of oil, as well.

Click to enlarge

A lot of investors are playing the Leviathan and other eastern Mediterranean discoveries via Houston-based Noble. That makes sense if you are uncomfortable with foreign companies and if you don’t mind owning a pure play whose earnings rise and fall with the success or failure of their discoveries as well as being subjected to the vagaries of the oil markets. It’s a great company we’ve owned before and, at cheaper prices, will own again.

Others are buying some of the other players in the area, like Delek sub Avner Oil Exploration Ltd. Partnership on the Tel Aviv Exchange. It is also a pure play and holds sizeable positions in a number of fields. (Like Noa (23%), Ashkelon (23%), Tamar (15.625%), Dalit (15.625%), Zarah (25%), Zurim (25%), Ohad (50%), Aviyah (50%), Keren (50%), Ruth (25.106%), Alon (26.4705%), Rachel (22.67%), Amit (22.67%), Hanna (22.67%), David (22.67%), and Eran (22.67%).)

But, in times when we already own substantial positions in oil companies, I prefer to participate via a company in which the oil exposure is mitigated by financial services, insurance, and consumer durables – but which is also an even larger stakeholder than Noble Energy in Noble’s most successful find ever. Through its subsidiaries, DGRLY controls 45% of the Leviathan, with Noble and other partners owning the rest. So much for Israel being the odd man out in terms of Middle East oil wealth!

Leviathan and the other eastern Mediterranean discoveries in Israeli waters could be a serious geopolitical game-changer. I believe the nation of Israel recognized this from the start and will do everything it can to maximize the success of these undertakings. For other nations in other regions, oil might be about money. For Israel, it is also about national security, perhaps even about survival. So we have a great company, with a diverse portfolio of businesses (again, think Berkshire Hathaway) in a nation known for well-regulated and transparent corporate governance, with likely strong backing by the government of that nation, and with the largest piece of a leviathan find. I like it.

I’m buying DGRLY for its energy holdings, but I consider the other businesses to be excellent ones, as well. I simply think of them as icing on the cake. Given the current market environment, and my articles from June forward in these pages that the markets would be weak through at least September, we are only taking pilot positions. We have placed limit orders between 15 and 20 and seen a number of those fill at the lower end. DGRLY is thinly-traded in the US so, if you agree with us, place limit orders and only show part of your trade to the market-maker. Fill it over time. Our plan is to make DGRLY one of our Top Ten Holdings, but I believe we’ll have the rest of the summer to do just that…

Disclosure: We, and/or those clients for whom it is appropriate, are long DGRLY.PK. We are adding more on dips.

The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: we do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.

Past performance is no guarantee of future results, rather an obvious statement but clearly too often unheeded judging by the number of investors who buy the current #1 mutual fund only to watch it plummet next month.

We encourage you to do your own research on individual issues we recommend for your analysis to see if they might be of value in your own investing. We take our responsibility to proffer intelligent commentary seriously, but it should not be assumed that investing in any securities we are investing in will always be profitable. We do our best to get it right, and we "eat our own cooking," but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.