The future is unknowable. We have good intentions, but all of our projections and estimates will be wrong, and could be materially wrong. Wildcat exploration is expensive, speculative and potentially dangerous. An offshore spill or explosion would be enormously expensive. We have insurance but it may not be enough. You could lose your entire investment. Don’t be lazy—read our ten-Q’s, ten-K’s and press releases, and if you lose your money—please no tears.
This icebreaker comes courtesy Contango Oil & Gas (NYSEMKT:MCF), under the header of Lawyer Stuff at the outset of an investor presentation. It’s followed by this taunt of the timid: “Don’t forget about risk-free T-bills in your portfolio...After inflation and taxes you’ll likely only lose 5% to 10% of your investment.”
These guys have a sense of humor, obviously. They also seem to have a winning formula for adding value to the riskiest—and therefore most lucrative—aspect of gas drilling: the financing of exploration for new wells.
As an unhedged, low-cost producer, Contango is notably leveraged to the eventual recovery in natural gas prices (whenever that might be, and for the record the CEO doesn’t expect that any time soon.) It also benefits mightily from the high oil prices that determine the price of its condensate, which amounts to roughly a quarter of the output, but accounted for 59% of the revenue in the most recent quarter.
Contango also benefits inordinately from the business sense and shareholder-friendly philosophy of its founder and CEO, Kenneth R. Peak, whose stated objective for Contango “is not to do ‘more with less,’ it’s in fact just to do less,” getting involved only where Contango has a clear competitive advantage.
As a consequence, the $1 billion company has only eight full-time employees, outsourcing everything up to and including prospecting (though the people it contracts for that task seem to be quite good.) Contango proudly notes that it doesn’t have debt, hedges, a big pool of dilutive stock options, or the accounting gimmicks drillers typically use to pump up earnings.
It has 12 offshore wells in the Gulf of Mexico and is prospecting for more, but doesn’t like to overpay for either rigs or leases. The company is also starting to invest in onshore shale plays.
Most of all, it prides itself on the return of capital to shareholders via share buybacks and its long-term success in boosting gas reserves per share. The share price has risen 30-fold during the company’s 12-year history. Peak owns 13% of the company, and his compensation incentives are closely aligned with those of his fellow shareholders.
Contango’s lean operating model presents risks, of course—starting with the fact that this is essentially a one-man show, highly dependent on Peak’s continuing involvement. The company’s modest size and upfront accounting also expose earnings to considerable short-term fluctuations, and could decline if Contango drills a bunch of dry wells or conversely finds enough gas to warrant additional investment.
But shareholders who’ve stuck around through thick and thin have been amply rewarded. If you’re looking for a leveraged play on costlier energy without excessive executive compensation, reserve shenanigans, or overly aggressive accounting, it’s hard to do better than this.