Episode #205: Derren Geiger, “E&P Companies Are Doing Whatever They Can To Achieve Cash Flow Neutrality”

Episode #205: Derren Geiger, “E&P Companies Are Doing Whatever They Can To Achieve Cash Flow Neutrality”

 

 

 

 

 

Guest: Derren Geiger joined the Cornerstone Acquisition and Management team in 2005. As CEO and Portfolio Manager, he is responsible for the day-to-day operations of the Caritas Funds, including risk management and asset valuation. He also analyzes all private oil and natural gas royalty transactions for potential acquisition and heads up the Investment Committee.

Date Recorded: 01/22/2020

Run-Time: 42:44

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Summary: In episode 205, Meb talks with Cornerstone Acquisition and Management CEO and Portfolio Manager, Derren Geiger. Meb and Derren cover Caritas Funds’ process for investing in onshore US oil & gas mineral rights and royalty interests.

They get into sourcing opportunities, some detail on the royalty model, the role hedging plays in managing risk, and the balance of commodity exposure in the portfolio.

As the conversation winds down, the pair walk through an actual example of how an acquisition played out, as well as Derren’s thoughts on the energy market.

All this and more in episode 205, including Derren’s most memorable investment.

 Links from the Episode:

  • 0:40 – Introduction
  • 1:30 – Welcome Derren Geiger and a look at his firm, Cornerstone Acquisition and Management
  • 2:37 – Portfolio implementation
  • 5:56 – Sourcing properties
  • 8:49 – How often E&P companies are doing partnerships or selling royalties
  • 9:43 – How the portfolio’s investments are impacted by commodity prices and hedges against it
  • 14:01 – The opportunity set for 2020
  • 15:30 – Difference between the Caritas Funds and a traditional MLP
  • 17:36 – Operational risks of building a portfolio
  • 21:16 – Natural resource allocation in the portfolio
  • 22:38 – An example of an investment
  • 26:28 – Biggest concerns
  • 28:59 – Global outlook
  • 33:59 – How does the future look?
  • 38:17 – How do investors slot this into their allocation
  • 39:24 – Most memorable investment
  • 40:19 – Resources to understand the royalty space
  • 41:57 – Connect with Derren: cornerstoneamc.com

 

Transcript of Episode 205:

Welcome Message: Welcome to “The Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.

Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.

Meb: Hey, podcast listeners, we got a fun show for you today. Our guest joined the cornerstone acquisition and management team in 2005. As CEO and portfolio manager, he’s responsible for the day-to-day operations of the Caritas Funds, including risk management and asset valuation. He also analyzes all private oil and natural gas royalty transactions for potential acquisition and heads up the investment committee. In today’s episode we discuss natural resource investing. We cover Caritas Funds process for investing in onshore oil and gas mineral rights and other royalty interests. We get into sourcing opportunities, some detail on the royalty model, the role hedging plays in managing risk, and the balance of commodity exposure in the portfolio. We walk through an actual example of how an acquisition played out as well as our guest’s thoughts on the energy market. Please enjoy this episode with Derren Geiger. Derren Geiger, welcome to the show.

Derren: Thank you. Thanks for having me.

Meb: So you’re just down the road from us today. And we’re going to be talking about natural resources, energy complex, all things investing in that world. Talk to me a little bit about your company, Cornerstone Acquisition and Management. Who are you guys? What do you do?

Derren: Sure. Cornerstone is the investment manager of funds. We manage, the Caritas royalty fund. Our cornerstones and RIA, we launched in 2004. Our funds have generated a net annualized return since inception of approximately 14%. We offer separately managed accounts as well. But what we do at Cornerstone, and again, launching in 2004, we are somewhat of a pioneer in the space, is we created an investment vehicle that offers investors what we think is a more conservative and an intelligent way to gain private oil and gas exposure. And how we do that is we focus on a mineral’s royalty strategy as optimal underlying asset, somewhat of an alternative credit type of strategy with a fast set of energy coal optionality.

Meb: So expand on that a little bit for the newbies out there what that might mean, talk a little bit about what that means as an actual process, an actual implementation, what are investors getting? How does the whole process work?

Derren: Sure. So the underlying asset within the fund are onshore continental U.S. oil and gas mineral rights and royalty interest. So essentially what are royalty and why do we like them? They’re legal right to a certain percentage of production weighted cash flow. It’s generated and operated by an E&P company. They provide consistent yield generation combined with a dynamic underlying portfolio. While we focused on them back in ’04 is, again, it offers a very conservative strategy and that royalties are non-cost bearing. We don’t operate wells. We don’t service wells in any way. We’re simply collecting our prorata share of production related cash flow from the top line of E&P companies.

A little bit unique about oil and gas royalties is that they’re perpetual. So when you compare them to other types of royalties that you’ve probably heard of in terms of perhaps music, royalties, or pharmaceutical royalties, oil and gas are unique in that they run into perpetuity or until the well is fully deplete which can span decades. Here in the U.S., it’s a little unique in that surface rights to mineral rights can be levered and owned separately. So you’re getting exposure to world-class oil and gas space that you really can’t find anywhere else outside of North America.

Our facet of our industry that is a little bit unknown, as well as there’s a very robust secondary market for royalties. They are private. But, again, it takes no longer than, say, 30 days to sell any size royalty package in that their cash flow yielding assets and they’re very tractable. They offer certain tax advantages as well, similar to a real estate. But we’re often asked, “That all sounds great, but what’s the downside?” With owning the royalties, the only thing that really is a negative if you’re not controlling the drilling program, so we can’t tell Exxon Chevron that we want 30 wells drilled on our acreage over the next 12 months. So that’s where Cornerstone’s due diligence really comes into play. And acquiring these portfolios of minerals and royalties where we’re, again, doing the research on the underlying companies making sure that the assets that we’re acquiring are in areas that these large, financially stable E&P deem as core operations so that when commodity prices fall from 60 or oil prices from 60 to 50 to 40, that regular want to be shut down in certain location, but not where we hold our assets.

So the strategy in general tend to resonate with those that are seeking exposure to one of the following. Whether its energy, real asset, yield generation, just generally needs strategies, and alternative credit. Caritas offers semi-annual liquidity was six-month notice. We really try to match the underlying assets that we manage to the liquidity of the funds. We didn’t feel the need to lock up capital for years. I believe these assets are best managed privately as opposed to publicly.

Meb: It’s interesting that you say that as far as the liquidity of these properties is so active. Is there any sort of marketplace for these properties? Is it old school, got to pick up the phone call handful of brokers? How’s the actual sourcing of these properties work? Because that’s surprising me. I feel like they would be almost buying some big buildings a little more illiquid. But it doesn’t seem that’s the case.

Derren: No, it’s not the case. Really the evolution of the energy space. Back when we launched royalties were kind of the boring, semi-attractively yielding type of energy strategy whereby most were kind of going more towards the operation side where you can earn, say, 30% type of IRRs. But again, you have that operational risk. We’ve really gone full circle over the past, say, 10 to 15 years where royalties now I would say that the shining star of the energy sector. But to answer your question, there’s basically three ways in which we source opportunity. There’s a very active oil and gas auction site that we continuously monitor, quite competitive with groups such as ours, private equity groups, even some of the publicly-traded companies that focus exclusively on minerals and royalties and bid on assets there. So, again, quite competitive but an ongoing process.

Secondly, are our brokers. As you stated, there’s 20 to 30 high quality brokers that if I’m, say, shale and there’s an asset of ours that we deem is non-poor, I really don’t want to mess with hosting a data room, sending files to a number of potential bidders. So I’m going to hire one of these brokers to basically host a data room on my behalf and then solicit bids. Again, generally the timeline is somewhere in the neighborhood of 30 days. So, again, we foster very strong industry relationships over our 15 years that we’re continuously calling publicly-traded E&P companies, private E&P companies that have accumulated these type of assets over time. And in this day and age where E&Ps have to live within cash flow, they’re doing everything they can to try to do that. And part of that equation is monetizing assets.

Oftentimes the royalty and minerals that they hold, they’re not operating. So they’re somewhat passive, almost disregarded. But in this type of market, they can monetize those type of assets for the sizable material money that they can use to fund their development program. On the drilling side, they can pay down debt, they could buy, you know, downside commodity price protection. So it really depends on what kind of situation they’re in. But again, that’s where we focus our effort. And again, it’s a little less competitive. We have cash on hand. We can evaluate the assets quickly, efficiently, and provide a fair offer in short order.

Meb: What percentage of the time and I’m not that familiar with the sector are these E&P companies actually doing partnerships or selling off some of the royalties? Is it like a quarter of them? Is it like 90% of them? Is it a very just traditional thing that all of them do? What’s the kind of lay of the land there?

Derren: It used to be the case where, again, when we launched that it was few and far between. But now, as you’ve seen since basically 2014 is the downturn of crude prices and currently with nat gas prices, E&P companies are doing whatever they can to achieve that cash flow neutrality. So you are seeing more opportunities coming to market or those that were able to somewhat convince the E&P companies that it may make sense to monetize these assets as an option in terms of trying to achieve, again, living within your cash flow.

Meb: Talk to me about a question I imagine most listeners have is that you’ve lived through the cycle. So compliments. I think the past decade has probably been pretty tough for a lot of people in the energy space. But the royalty model for someone listening would probably say, “Look, if oil was 60 bucks and it went up to 120, you probably doubled your yield and profitability. But on the flip side, if it goes down from 120 to 60, the converse is the case.” Walk through a little bit about how much of a role that prices have on your portfolio, how to think about them, do you to think about them at all, and any approaches to hedging, etc.

Derren: Sure. So, yeah. I mean it anytime you’re acquiring these type of assets, you obviously depending on how the portfolio is weighted in terms of production, you have commodity price exposure right out of the gate. Whether it’s skewed towards oil, skewed towards natural gas, that’s what you’re being paid on a monthly basis. So the way we’ve been able to mitigate that over time, or at least help negate that is on the hedging side, we’re very aggressive hedgers. We target somewhere in the neighborhood of 8% to 12% net to our investors on an annualized basis. If we can achieve that return profile by essentially locking in a certain percentage of our production on price going forward, we tend to do that. So, again, hedging plays a large role in our success over time. And again, a lot of royalty managers are coming to the sense that they should be potentially hedging too if you’re seeing kind of the curve acting quite volatile.

But what we try to do is, again, just decipher where we are in the commodity cycle and act accordingly. So in perceived peaks, we’re hedging that production forward. We’re selling it forward up to three to four years and/or potentially divesting assets above what we think is fair market value. And conversely, if perceived drops, we’re looking to aggressively acquire assets at value. And so we take what the market gives us in the SIBO, we take what the market gives us on the futures curve and we just try to prudently manage the assets accordingly. If you look at our timeline from launch, again, soon after our second acquisition of $63 million in 2005, Hurricane Katrina and Hurricane Rita hit the Gulf Coast pushing natural gas prices to double digits. So we locked in four years of double digit nat gas prices.

Fast forward to 2008, we’re really kind of priced out of the acquisition market as crude prices rose to 130 plus. So we took a step back, locked in that for the next four years. 2014, just noticed a lot of headwinds both on the macro and the micro side. On the macro, again, strengthening dollar backwardated futures curve, softening sanctions on Iran by the prior U.S. administration and so supplies coming online pretty fast globally. But more importantly, on the micro side, a lot of the assets that we acquired were up to a decade prior. So whenever we’re looking to acquire a portfolio, there’s two facets to that. There’s a production piece, which is simply how many wells are currently online producing oil and gas we’re receiving revenue from. And then an upside piece, how much more drilling can come in on our mineral acreage going forward so that for every one, two, three wells that are producing and depleting, there’s four, or five, six new wells drilled on our acreage to offset that.

So that upside piece was becoming rather limited over time. And so we took a step back in ’14 and said, “Look, why don’t we in a very robust royalty market try to monetize the portfolio, utilize the cash flow to redeploy with higher growth opportunity without taking a step up the risk spectrum?” So that’s what we did. We sourced a private equity-backed group and we sold 95% of our portfolio for about $153 million in 2014. And since then, we’ve been patiently and opportunistically redeploying that capital what we think is that value and then, again, opportunistically trying to head out exposure.

Meb: And so if you look at the lay of the land today and as far as if I had to guess, coming into this, I would say there’s probably some competing forces. There’s the forces of the energies general sector struggling in prices over the past number of years. But on the flip side, the interest rates where they are with your sort of strategy being particularly interesting to a lot of people as well as the vast amount of money in private equity that’s sloshing around. What are those forces doing to kind of come together and produce as far as the opportunity set in 2020? Are you finding a lot of super cheap, awesome deals, or are you finding the opposite is true or somewhere in between?

Derren: I think it’s somewhere in between. Again, we’re really focused on that negotiated type of transaction. If you’re focused strictly on the auctions or the brokerage side, you tend to be paying more retail or elevated prices. So, again, with the full evolution of the energy space over the past decade or so, you are seeing a lot more competition in our space. We launched…it used to be the Canadian royalty trust were kind of the yield play, but then the tax environment changed. Then with here in the U.S. upstream MLP were kind of the flavor of the energy sector, which again, blew up after 2014.

Meb: Could you make a little distinction for the listeners the difference between what you guys do in a traditional MLP?

Derren: Sure. Oftentimes, we own the same assets, although an upstream MLP might own some minerals and royalties, but they might also delve into operated interests and so forth. So it really depends on the MLP. But really, what we didn’t like about that model was that in order to keep those distribution steady arising, they were on the hamster wheel of continuously having to acquire assets no matter where we were in the commodity cycle. So whether you’re at a perceived peaks or a trough, you’re just continuously acquiring. Because, again, depletion is inherently somewhat limited that distribution, as you’re adding assets, that distribution can stay steady. Again, they could be depending on the MLP, a little bit over levered and so forth.

So again, as prices declined in 2014 and beyond, those distributions were massively cut or eliminated. As a publicly-traded vehicle, as soon as that happens, investors just head for the exits in mass. And now you have that, you have contagion risk, another MLP cut their distribution yet you haven’t, investors are going to start eyeing your firm as to whether or not your distribution is going to be cut too. So it’s somewhat of a domino effect. And, again, a number of those MLPs filed bankruptcy haven’t been back. And so now you’re seeing more of the C Corp focus in terms of minerals and royalties in private equity. Most large energy-focused private equity firms have now a dedicated mineral and royalty team.

Meb: And so is that tends to be who the biggest competition for purchasing properties? Is it private equity? Is it family offices and other firms like yourself?

Derren: I think it’s primarily private equity. Now, given our size, we try to fly a little bit under the radar of the larger private equity groups. I mean, we’re targeting portfolios averaging somewhere in the neighborhood of 20 to 50 million per transaction. Whereas to move the needle for some of the larger private equity firm, you need something well in excess of that.

Meb: Thinking about risks and thinking about someone who, say, has a family office individual that’s interested in allocating to your firm or someone like it, there’s the obvious macro risk of prices, but what are the actual operational risks as far as building a portfolio? So you mentioned, of course, valuation to not overpaying for properties and being selective about the properties. But once you actually allocate to a property, you just sit back and collect checks like the monopoly man for the next decade or is there any involvement in the company or what end up being any sort of operational issues that you’ve come across over the past 15 years? Is it fraud? Is it just the wells run dry quicker than expected? Is it the haymaker hurricane? What’s the main concerns?

Derren: You’ve labeled a few there. I would say, again, as a mineral royalty focus strategy, you are definitely more passive in terms of your interest being non cost bearing. So your exposure to the operating expense side is only through the operator and the pain that they’re feeling from rising costs and so forth. So the largest risk that I’ve come across over I’d say especially over the past 10 years is again when commodity prices move to take down significantly such as 2014 and we’ve been fluctuating a little bit better between, call it, 40 to 50 cents, really E&P companies are really pouring down their operations. So it used to be that they were rewarded on how many locations they had exposure to throughout the U.S. or globe.

But now it’s really like, “Okay, what are the three to five most economic plays for us where we can generate our best return?” And that’s where they’re heading. And they’re either shelving the rest for potentially monetizing it through sales. But again, what you want to do as a royalty owner is understand what operators are invest in certain geographic areas, what areas do they be poor so that when prices start climbing, they’re still going to be committed to the area where you own your assets. That’s the biggest risk. But again, as you pointed out, acquisition risk is there in terms of not overpaying for assets, being patient, letting the market come to you, and then again, not being overly greedy. These prices spike. You’ve got to be nimble and you’ve got to take advantage of that on the futures curve.

And with the onset of sale, one thing that’s really happening is the compression of the futures curve. So back in ’05 and ’08 when I gave the hedging example, we locked in production three to four years forward. With the onset of shale, that 3 to 4-year curve now is at best 12 to 15 months. When an outlier event happens such as the Saudi infrastructure attacks or Iran firing missiles into Iraq, it[s going to move the curve but only in the front end. And you need to be nimble enough to take advantage of that when you can. So on those two attacks, we were able to hedge from late 2019, first quarter 2020 production. But after that, the curve starts to flatten out pretty significantly. So again, with the onset of shale, the compression of the futures curve has made us evolve a little bit on kind of our hedging approach as well.

Meb: You traditionally do that with futures, options?

Derren: We typically do it with total return swaps. So we utilize strong counterparty, historically BP shale cargo in order to hedge that exposure out.

Meb: Talk to me a little bit about is there much any lots correlation benefit of Nat gas and oil? Is that something that is a 50/50 split and at any point you consider diversifying into even other natural resource sort of royalties? I know you mentioned music, but I guess you guys aren’t buying Taylor Swift’s catalog anytime soon.

Derren: No, no, not yet. But we may get that way depending on what energy does over the next 12 months. No. So we tend to like to manage a fairly balanced portfolio in terms of commodity waiting. It’s not 50/50. It’s definitely more oil skewed. I would say 65/35 currently. And given kind of the relatively near term outlook for both parties, we’re definitely more bullish on crude than nat gas right here. More positive on both commodities going forward. But again, we’re sitting on four-year lows on nat gas prices in the teeth of winter. And so it’s going to be a bit of a struggle there with the supply overhang. In terms of kind of delving into other types of royalties, no, we really haven’t considered that heavily. Although one subject matter that comes up more and more is just kind of the ESG impact of everything. That’s going to have a material impact on the oil and gas industry over the next 10 years. It is quite material. And so we want to be prepared for that accordingly as well.

Meb: Is there any sort of example you could give? And I don’t know how helpful this was, but I like to kind of visually try to understand this little property or something you acquired and how it played out. So you’d be like, “Hey, we bought this property in Louisiana. We agree that it’s a 10-year term,” or is it just last indefinite forever? Just give a little more color on how an actual transaction may play out of one of the properties you guys would acquire.

Derren: Yeah, let me give you a couple. Back in 2016, early 2016, when crude prices fell down into the low 20s or mid-20s, I expect a lot of owners of these assets were overlap, hadn’t hedged and really in their somewhat being pressured by their energy lenders to do something. And so on one occasion, we were introduced to a stressed seller by our shared energy lender who simply introduced the parties and walked away. Again, very diverse portfolio, held interest in over 15,000 wells spread throughout 17 states, a little bit more oily, skewed. So a real shallow decline, production decline. So everything that somewhat ticks our boxes in terms of what we’re looking for, and then again, having somewhat of a stress seller doesn’t hurt either in terms of trying to acquire these assets that are given kind of the price backdrops or mono-price backdrop.

So that’s one instance where, again, it was somewhat of a negotiated transaction introduced to us by our shared energy lender that came to a conclusion where we acquired a portfolio. We’re a little over 19 million. So the end of 2014, we acquired a rather small concentrated Colorado condition whereby the assets were all located in one county, operated by one publicly-traded E&P company, but generated very attractive yield, good growth outlook. So everything we generally look for, although it’s concentrated as it blended into the large characterize portfolio, it provides a good mix. And so as we held it, it kept producing as expected, but in 2017, the end of 2017 entering into 2018, we were just getting very cagey about the political environment in Colorado. And it was becoming somewhat very similar to where we live in California in that a lot of anti-drilling initiatives were finding their way on the ballot. And we just didn’t want that exposure.

And so, again, after a three-year holding period, considering what we acquired that, what we received in terms of cash flow over its life held, and then what we sold it for, we were able to double our money over a 36-month holding period. So we’ll take that any day and move on. We don’t want exposure to some of the non-friendly energy states such as obviously New York State. California is pretty precarious to get things done here. The Colorado is moving that way and depending on the presidential election in 2020, if it is a Sanders or Warren type of win where they want institute a fracking ban, a lot of acreage in New Mexico is federal land. So that would impact New Mexico, which is a very significant oil and gas producing state. So you really have to be on your toes in terms of not only commodity prices, futures curve, but the politics. Generally they’re controlled by the state. But again, if you have presidential candidates threatening fracking bans, you need to pay attention.

Meb: Of those kind of concepts and ideas, what keeps you up at night, as far as the portfolio? Politics is an interesting one because it’s unpredictable. Are there any other areas that make you nervous or at least it’s something that you think quite a bit about?

Derren: I would say, again, kind of the ESG impact plus politics, they somewhat go hand in hand. So, I mean, if you’re looking at ESG institutional capital kind of coming into the space will likely be strained going forward. Energy right now is about historic lows of less than 5% of the S&P. So really the nonrenewable energy sector has been painted with a broad brush is harmful and will be shunned regardless of its relative cheapness. How we view it is this is significant in that it’s almost a built in governor on domestic production, which again, is highly priced supportive. How we manage assets as we’re environmentally agnostic and so much as we look at things from a practical perspective, not an ideological perspective. This gives us the flexibility to again look at energy in a more holistic sense rather than deeming any space is necessarily good or bad. Whereas today, the entire spectrum is largely viewed as bad. But through this negative prism, there’s going to be excellent opportunities available to investors. So I think keeping me up at night is more of the politics because I’m going to have to consider…you almost have polar opposite type of potential candidates in November to choose from.

Meb: You just hedge the portfolio by buying some Bernie Sanders and Elizabeth Warren futures on one of these offshore bookies. Problem is, of course, that the offshore bookie may just disappear into the Caribbean ether. But what are they trading? At last I saw, I think it was like plus 500 for those two. Somewhere in there. Trump was down to minus 140, which has moved quite a bit in the last month or two. That’s according to Odds Shark. So who knows? I joke with our listeners that the number one determinant of who wins the presidential election historically has been, of course, the stock market, which has something like an 82% success rate because if the market is up…I forget if it’s just up in the 10 months or 12 months leading to the election that the current party stays in power. So last election, we were tweeting a bunch. We said Hillary needs to start buying some futures because the outcome was favoring Trump and lo and behold.

Let’s put on your prognosticator hat and with the full understanding that some of the forecasting and ideas here could fall into the category of gossip. But maybe talk to me a little bit about, it was fun to read through your letters because it talks quite a bit about geopolitics, not just in the U.S., like you mentioned, Colorado and federal, but also around the world. Because as we know, energy prices and commodities everywhere are often a global phenomenon. So talk to us a little bit about what does the world look like and the outlook you have for what you guys think about prices and what the future may entail?

Derren: Yeah. I mean, that’s what’s so interesting about the energy market is it’s constantly changing. There’s always something pushing and pulling at the price aspect of it. So I think I’d start with obviously where most of the production occurs in the Middle East. So OPEC Plus, which includes Russia, again, agreed to a 1.7 million barrels per day production cut. What’s a little unique about this is Saudi Arabia is trying to keep everybody in line in terms of adherence. It’s very common that most of these OPEC countries cheat on their quotas. But again, Saudi Arabia has the power to keep them in line and that they can flood the market at any point in order to crater prices. I think one thing that perpetual is Middle East strife.

And so whether it’s the Saudi infrastructure remaining vulnerable to Iranian led attacks. You’re seeing the same for act now, again, a few weeks ago. Know Iraq is OPEC number two largest producer, so it’s significant. And then you’re just seeing a Mediterranean Iraqi political unrest creeping towards the only area citizens think they have any leverage which our oil facility. When they have something to say whether, you know, we saw this kind of with the Arab Spring a few years back, that they’re going to congregate in mass and start attacking the oil facilities in order to get their voices heard. And so we’re seeing much more of that. And what you’re seeing at the same time is the U.S. trying to disengage from the Middle East with the onset of U.S. shale. We’re not as reliant, especially with President Trump. He doesn’t want to pay for it. He thinks other countries that are importing wealth from the Middle East should be footing that bill.

So again, it just creates somewhat of a hotbed of more volatility, more problems there. If we’re disengaging at the same time you’re seeing somewhat of Iran as a bad actor kind of play the villain in this area. In addition to that, I mean, you have Libyan exports being blocked by political factions in the neighborhood of 800,000 to a million barrels a day. That’ll come on and off. Just depends. Venezuela is the mass. They’re producing a little under 700,000 barrels per day. That’s down from 2.4 million barrels back in 2016. So, I mean, wherever you look, there are supply issues potentially that are price supported. And with that global demand has been really consistent. And I think that’s been under covered.

We’re talking about 1.25, 1.3 million barrels per day demand growth each year, pretty consistent. If you take out a blip of 2008, 2009, primary energy on a global basis increased by almost 3% in ’18, which is the highest in 10 years. So it’s almost just like population bath. It’s like we’re going to have 2 billion people over the next 20 years plus another billion current inhabitants who want access to power. So while you’ll see developed countries demand, just sort of level off, you’re going to see the Chinas, the Asians, the Middle East, and North Africa regions really kind of pick up that slack and keep demand relatively steady.

And then if you’re talking about other kind of macro type of positive, now China did agree to 52.4 billion energy buy over the next 24 months. So we’ll see if that comes to fruition. U.S. recession fears have virtually gone away. And the U.S. dollar’s starting to weaken. So I think you have a lot of positive. I mean, like outside, it’s just it’s going to be more of I think a longer-term supply issue. Again, we’re sitting at four-year lows. You do have a lot of LNG demand coming on, but you have a heck of a lot of supply coming on at the same time. So I think that, from our perspective, a lot of these LNG core facilities just don’t get built over the next five years. And the globe tends to balance eventually. Now prices I don’t think are going to rise in the $5, $6 per MCF range. But, again, something acceptable in the $3 to $4 range say on a seasonal basis is more than adequate. So, again, that’s what we see in the macro geopolitical positives. As I’ve talked about before, those are the negatives as well.

Meb: From someone who’s manage these portfolios for 15 years now, as you look on out past 2020 into the horizon, what do you think looks different? I mean, this seems like in my head a pretty stable sort of business that if managed thoughtfully with an eye towards price and with a big nod towards having insider knowledge, just an understanding of the field and the players and everything else, seems like a great asset class to allocate to. So two parts to this question. One is how does the future look different for your industry meaning the investors in these royalties? And then two, anything you guys think about doing different, launching new types of funds, just continuing to raise assets or anything else? What does the next decade look like for Cornerstone?

Derren: Yeah. I think, look, I’ve said this before, we need to be much more mindful of the political landscape, the ESG landscape. But, again, with that, I think that the press is overly concerned with that as opposed to some of the items I brought up earlier in terms of the positive. We’re not years away from a full transition to renewables or easy electric vehicle. We’re still decades away from that kind of massive transition. I mean, if you look at electric vehicles [inaudibele 00:35:28.387] right now it makes up about 2% of the U.S. auto fleet. And while they’re rising, it’s rising in relatively tepid pace. So next year, we’re not going to surpass the 3%. So it’s going to be multi-deck type of transition I guess is the primary point.

And with that, those that are painting, whether it’s oil and gas, with a broad brush in terms of negative, I think our discount in the opportunities that that type of mindset are going to create industry wide. We always wanted to be kind of at the more conservative end of that spectrum and that we don’t want cost bearing interest impacting our ability to generate return for our investor base. So we actively shied away from that. For us, I think what’s really changing also in the industry is just the number of entrants and participants. Again, private equity is coming in force. You have new publicly-traded corporations forming. So that provides more competition, but it also provides more opportunity.

The opportunity is for potential sales from us to others, like we did in 2014 where we sold virtually all of our assets, and then we somewhat press the reset button and get after it again at value. So we view it kind of double-sided coin in terms of opportunity and competition. Again, given our size, we can be nimble. So I would think that those are the primary kind of outlook of concerns for us. And then in terms of products, we’re increasingly getting more interest from those that perhaps don’t want exposure to the fund but they do like the lure of the underlying asset base, but they want to control it. So they want to control the exit, they want to control potentially the hedging call, whether it’s levered.

And so what we’re seeing is kind of an increase on the separately managed account from. And for us, we managed assets the same way. I mean, the only thing that would differ is if the FMA holder said, “Look, I don’t want this levered at all. I don’t want it hedged. I want to ride the futures curve.” And then, again, that’s their calling. That’s a basis. But in the fund, we’re going to continue to manage as we have in the past 15 years. And I think what’s unique about what we’ve done is that, given the revolution really in energy sector in terms of technological advances, how we’ve gone into leaps and bounds in terms of production, the onset of sale, our strategy really hasn’t changed at all. And so it stood the test of time, very volatile bouts of cyclicality in ’08, ’09, 2014 through to ’16. And so again, while there’s been a lot of change industry wide, there has been very little change here.

Meb: You talked to most your investors, whether it’s family office or individuals, institutions, where do they kind of slot this in? Do they typically sub-out some sort of energy allocation? Do they use it as a bond alternative? Is it rather fit into an Odds’ bucket? How do most people think about it?

Derren: Yeah, it’s across the board really. I think increasingly, it’s looking more as an all credit strategy a potential energy kicker just because of as global interest rates are pressured lower and lower this type of strategy can generate a very attractive yield with relative comfort, albeit in the energy space. So again, the non-cost bearing aspect of royalties really gives our investor a comfort that they can earn attractive or above market yields in a unique strategy. So, again, when we’re reporting our fund performance on a monthly basis, as you know there’s usually a box you need to check in terms of your strategy. So we face the same problem of do we check energy? Do we check out credit? Do we check our niche narrative? So it’s a tough one for us as well.

Meb: As you look back over the years, and this doesn’t apply strictly to energy, it could apply to anything, what’s been your most memorable investment?

Derren: I think it’s been our most memorable divestment. So in 2014, when we sold, I mean, we couldn’t have timed it any better. Again, throughout the middle of 2014, oil prices had surpassed triple digit, very robust market. And again, we had the foresight to say, “Look, let’s monetize this asset base, utilize the proceeds to redeploy growth potential and not taking on any more risk.” And that’s what we’ve done. And so there’s been a promo. That’s the one because again that the amount of or the degree of commodity price downturn in 2014 was so massive that, again, it culminates into a 30% year for us. Whereas most energy funds were decidedly negative.

Meb: If people are looking for more information on the royalty space on kind of what’s going on in your world in general, is there any good resources you can think of, any conferences, any books, any online material, any newsletters? What’s the best way for people to get up to speed?

Derren: Yeah, I think if they’re attending conferences, there’s two NAPE, N-A-P-E, conferences in North American Petroleum Expo in Houston twice per year. One is coming up in February. That’s generally winter [inaudible 00:40:49], very, very widely attended. So whether you’re a group like ours or a publicly-traded E&P company, private, even along the upstream, midstream, downstream. I mean, it’s just it’s a massive Expo that we attend each semi-annual period. There’s a ton of material out there. Again, something a little bit unique in the energy space is on the public side there’s so many industry events and presentation opportunities that these companies put out updated PowerPoints virtually monthly and that you can get really good insight into what they’re looking at going forward, where they’re focusing their operations, the cost per well, the results. So again, that the industry itself and the participants within the industry are a wealth of knowledge in gathering information. There’s obviously oil and gas periodicals, oil and gas investors, very good, well written, very strong articles. I would say that those are the kind of at the top of my list.

Meb: Awesome. Listeners, we’ll add some links to the show notes, medfaber.com/podcast. Derren, where do people go to find out more information about you guys? What you’re up to, follow along, interest in investing, where’s the best place?

Derren: Sure. They can go to obviously our website, cornerstoneamc.com. They can contact us directly. I can supply our contact information whether it’s by phone, by email. So again, that’s how to contact us. Happy to talk on the oil and gas side or on the investment side.

Meb: Very cool. We’ll add those links to the show notes, listeners. Derren, it’s been a lot of fun. Thanks for joining us today.

Derren: Thanks, Meb.

Meb: All right, listeners, shoot us an email or feedback@mebfabershow.com. We love listening to feedback. Give us a review. Subscribe the show on iTunes, Breaker, which in my current favorite. Thanks for listening friends and good investing.