Idea Brunch #2 with Josh Young of Bison Interests
Josh shares his views on oil and gas investing and his top ideas
Welcome back to Sunday’s Idea Brunch, your weekly interview series with underfollowed investors and emerging managers. We are very excited to interview Josh Young!
Josh is the founder and Chief Investment Officer of Bison Interests, a Houston-based investment firm focused on publicly traded oil and gas companies. He was previously Chairman of the Board of Iron Bridge Resources, a publicly-traded Canadian E&P, which he took control of, sold off non-core assets, and sold for a premium. Prior to founding Bison, Josh was an energy investor at a hedge fund and a multi-billion-dollar family office, an investment analyst at a private equity fund, and a management consultant. Bison Interests was up 349% net of fees in 2021 and up another 79% net this year through the end of May.
Josh, it’s great to have you back! In your first Idea Brunch interview back in December, you had a bullish outlook for oil and gas despite lackluster sentiment. Now, oil is at multi-year highs and the sector is as hot as ever. Can you tell new readers a little about your background and your outlook for the oil and gas sector from here?
I’m a University of Chicago econ major from Los Angeles, a passionate value investor who found the oil and gas space years ago and realized the potential advantage of focusing on it from a value perspective. Years ago, I identified structural under-investment in the sector, and I positioned to benefit from it with a long-biased, concentrated, value-focused strategy.
One of the noteworthy aspects of the oil and gas sector is its volatility. They’re not called cyclicals for nothing! In the short time since you asked me this, the price of oil fell rapidly and inexplicably. And oil and gas stocks have fallen even more, in some cases down 50% from their recent highs in a month.
After years of the oil industry burning through its inventory of developed and delineated reserves and spare production capacity, undersupply is kicking in, sending prices and related equities higher. And there is much more to come, as it will take years to rebuild the world’s oil and gas production capacity.
In April, you wrote that we were in “The Golden Age of Oil and Gas Producers” and highlighted that “growth at any cost has shifted to investor-friendly debt paydown, share repurchases, and dividend increases.” Why is today a more attractive time to invest in oil and gas stocks than past periods with high prices (e.g., 2007-2008 or 2011-2014)?
ESG-driven divestment and a prolonged down-cycle have reduced the production capacity of the oil and gas industry. Unlike the prior up-cycle from 1998 to 2014, which saw a buildup of activity and investment as the price of oil rose from a low of $11 up to a range of $80-120 that lasted for years, investment in oil services capacity in the current cycle is low. Services capacity needs to be expanded before production can sustainably grow to meet growing demand. It will take years to expand oil services capacity, and then years to deploy it to grow sufficient production to eventually stabilize prices. This process has barely started and may require much higher prices to incentivize producers and services companies to invest, given regulatory headwinds and capital scarcity.
Concurrently, valuations of producers and services companies are very low, as compared to prior cycles at similar oil and gas prices. Investment bank estimates of larger capitalization oil and gas producers imply $65 oil and $4 natural gas, and that shares of more heavily discounted smaller cap producers imply $50 oil and $3 natural gas. This is despite companies having become fundamentally better businesses since the last bull market, with reduced structural costs and improved capital efficiency. This means that potential returns from producers at current share prices could be substantial even if oil and gas prices were to fall. And it means there is enormous upside as the cycle continues and producers eventually benefit from expanded margins and valuation multiples.
In response to low valuations and poor shareholder returns, the industry has shifted to return of capital mode. Companies are rapidly paying off debt, and as they accomplish this, they are buying back shares and paying increasingly large dividends. This shift to a shareholder return focus combined with very low multiples may yield substantial returns even without multiple expansion, with further upside if funds eventually flow into the sector. Ironically, many oil and gas businesses have gotten cheaper through the early stages of this new bull market, as fundamental improvements have outpaced share price appreciation. Therefore, if E&P multiples were to trade in line with historical averages, that could require another step-change in share prices.
And finally, OPEC+ production misses are not yet widely understood but may shock the market and lead to a period of higher prices. OPEC+ countries have been unwinding their production limitations since early 2021, but less rapidly than they agreed to. This is unusual in OPEC’s history, as “cheating” had always been to the upside vs quota levels, especially in periods where market prices were higher, implying that spare capacity may have been overstated. In the history of the oil market, spare production capacity held by groups like OPEC has limited price volatility. The absence of spare oil production capacity increases the odds of significantly higher prices, as well as higher price volatility. Many have cited Russia’s invasion of Ukraine as a factor in higher recent oil prices, but prices may have much further to go from this more pressing and potentially enduring oil market factor, particularly as the economic cycle progresses and recession fears eventually diminish.
In your original Idea Brunch, you mentioned that good management teams are essential for success in the oil and gas public markets. Who are some of the oil and gas management teams you admire most today?
I particularly admire Alex Verge, CEO of Journey Energy (TSX: JOY — CAD$237 million). He had success at multiple prior companies to the point where he was financially independent. And then, when a pension fund asked him to help them with a challenging portfolio of oil and gas assets, he took the reins, rolled a large portion of his net worth into the company, and aggressively repositioned it through one of the most severe industry downturns in history. Alex preserved equity value with herculean efforts: executing on dozens of small acquisitions and divestitures, financing and re-financing debt, and at one point re-purchasing 25% of the company from a foreign owner. Others might have given up, and some of Alex’s peers did, but he stuck with it and has emerged with a more valuable and financially stable company with promising prospects.