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During this Solution Session, we speak with Michael Danov, President & CIO of SBP Management to hear insights on current challenges and opportunities, the impacts of ESG, and advice for firms looking to start investing in the oil & gas industry.  
Elana Margulies-Snyderman:
Hello and welcome to an outlook on investing in oil and gas. I’m your host Elana Margulies-Snyderman, a director at EisnerAmper. And honored to have with me today, Michael Danov, president and CIO of SBP Management, a family office that focuses on alternative investments, co-investments, private companies, and small and midcap publicly traded companies. Oil and gas has been under the limelight to the rapid increase in energy prices since Russia’s attack on Ukraine, fostering lower supply and increased competition from buyers. However, despite the fact that investing in oil and gas remains below pre-COVID-19 levels, it’s been on an upward trajectory.
During this discussion, Michael will share his outlook on investing in oil and gas, including SBPs journey into the space, what components or types of oil and gas he focuses on, and why, the greatest opportunities he sees in the space, challenges faced, how the move to ESG is impacting oil and gas investing and advice for firms to start investing in oil and gas. Hi, Michael. Thank you so much for being with me today.
Michael Danov:
Hi, Elana. Thank you for having me as well. It’s a pleasure as always.
Elana Margulies-Snyderman:
Absolutely. So, to kick off the conversation, tell us a little about SBP and your journey of how the firm started investing in the oil and gas industry.
Michael Danov:
Sure, sure. I’m happy to share. So, we’re a single family office based in New York. I work with our family members. I’ve been covering the natural resource space for the last 13 years, starting the sell side, by side, predominantly metals and mining. We got more active investing in oil and gas, I would say in 2019, 2020. Traditionally focused on the midstream, low stream, and as well as on the oil field services. And I’ll dive in a little bit more on some of the companies we invested, what we look for and when do we see always an entry point within that space.
Elana Margulies-Snyderman:
Great. And more specifically, Michael, what types of oil and gas do you invest in and why?
Michael Danov:
Yeah. So, back in 2020 when the markets were shifting in oil and gas, and as it’s tradition, people know oil and gas markets have been frothy. We have seen recessions in that space every three, four years and the market’s always been challenging to invest. But what we saw in 2020, as during the last administration and the current administration, we seen fossil fuels industries have been changing the US markets. The drill rigs becoming coming off, the demand supply was not matching what it was needed for. So, in 2020, we saw the amount of drill rigs coming off in US and more international buying was coming in. And we saw an arbitrage, and few of the industries, and few of the companies in oil and gas space, where we took advantage and started investing in those particular companies.
When the markets was at the bottom in 2020, we were the only ones, I think, and our peers investing in the space, while the industry was looking more focused in ESG. As the war erupted and prior to that, we saw the zombie disrupted that well could hit above 100 barrels per barrel, $100 a barrel. And that showed us that the markets was not meeting where they were. Essentially, demand supply was not coming into the side, and we realized that every major producer with the Chevron, ExxonMobil’s of the world, we’re going to have an uptake, and we saw that tremendous last three years.
Commodity markets are never easier to time it, so you’ll always have to find an entry point where it’s comfortable for you to invest in that space. We also saw a lot of the oil field services are coming as well. So, the industry’s been out of flavor for the last few years and finally erupted to the opportunity. And today, we’re seeing our portfolio companies growing double-digit growth on the revenue side, Chevron’s of the world, buying their shared price back. So, everything we’ve seen, it paid off our thesis. And we are not just only investing in US. I’ll touch base on other part of the world that we’re looking as well in the oil and gas space.
Elana Margulies-Snyderman:
Michael, I’m happy to hear about your family office’s success in this space. Given that, love to hear more specific opportunities that you see in this sector and why.
Michael Danov:
Yeah. So, I spend a lot of time in the Middle East. I was just in Dubai recently on business trips. When you look at the Middle East and when you see oil production comes in at average 6 to $8 per barrel, oil costs around 18. Even if they produce at $80 or $90 a barrel, let’s say that’s where their margin is, there’s still going to be opportunities. So, for example, we are looking at countries like Iraq right now in oil and gas field service across everything. Baghdad specifically has been building out tremendous opportunities in that space. To recently you could see Total and Qatar made strategic investments in them.
So, our idea is to find public equities that have exposure to specific regions or countries, like LatAm and Middle East, and come in at lower valuations before they take off. The key in the oil and gas space, become a free cashflow companies, use lower leverage, use that opportunity, trace it back. Some of the investments that we made have turned out really well for us. Chevron, ExxonMobil, just on the bigger names that we’ve done really well. Those smaller names that also benefited from this side. I think for the next five years, we think oil and gas will stick around between 100, 150.
There’s no new production in US. When US government goes to your Federal Reserve to replace the supply with their own reserves, that just shows the production, whereas it’s not even close to meet the demand. So, no matter how many imports, the war obviously put a lot of situation, a lot of countries had to diversify from traditional energy, but we don’t think that’s still going to come to an end until traditional energy will replace it. So, for us in the oil and gas space, we still continue to invest in that space.
We’re continuing finding opportunities. There’s always going to be mispricing. Obviously, everything turns in to the cost of barrel. Obviously, the ETFs are a big chunk of that that could drive the equities down. I think some of the hedging that we’re looking into right now, that could offset these downturns. But the way we market our investments, we invest in public companies as private investors, like a private equity model. And we hold it for three to five years and hopefully they’ll pan out. And then if they get bought out, M&A is picking up, we’re going to hold that share position the next company to offset, and needed taxes, and continue rolling it out from that perspective.
Elana Margulies-Snyderman:
Great. Michael, on the other hand, I’d love for you to address some of the challenges when it comes to investing in oil and gas. I’m sure there are a handful that you could elaborate on.
Michael Danov:
Absolutely. I think that the number one is the management. When I was on the sell side, we used to advise public equity companies, whether it’s metals, mining, oil and gas, finding the management is the key component of this business. Unfortunately, a lot of the management over leverage, overgrow, and sudden become free cashflow businesses. It’s the key component to finding an asset class and how do you become a free cash flow asset company within two, three years, not taking too much leverage. Obviously, once you get into free cash flow, would the number one mistake happens all the time, which is businesses, they start going for M&A or growth, or making irrational decision how they grow their businesses. Today, to find those management is very hard. Also for us, it’s also the C levels that own position that companies, what’s their investment in the business.
We typically look for management that own anywhere between 10 to 30% of the equity of the company, which is the key, because then they have skin in the game and incentivize to be involved. And that’s also very hard to find. So, to find a successful management or a management that’s going to prove the street that this is why it’s worth investing in the company, I think that’s the key component. Two, it’s the execution. And of our business comes through its challenges. From drilling holes to find those opportunistic oil and gas companies that actually know what they’re doing, from that perspective is also challenging. I think operations could be a key component. We’re seeing logistics costs rising, so we’re seeing some of this in our LatAm companies that are having issues on the logistics side. And of course, the employers, who’s willing to roll up the sleeves and grow the company with the management together and with their investor base.
So, for us, that’s key always. We also look at the specific board members in the business that operate, as by end of the day we bet on the jockey, not the horse. So, the management’s always going to be the key for us. Some other the challenges we look at is the logistics or from a jurisdiction. So, when we look at businesses in LatAm, like Argentina, Brazil, Mexico, Columbia, there’s great oil and gas companies there. But obviously, those are the challenges you have to hedge yourself with the currency, political risk and so on. And the question is from that, do you get a better value investing US companies or Middle East or LatAm? So, you have to figure it as internally, where’s your best return of investment? What we also like, and some companies, we also like to invest in state-owned companies. There’s few that we have invested. And usually, state-owned companies have performed very well over the time and they will never go out of business because they’re always going to be backed by the government.
Elana Margulies-Snyderman:
Michael, to shift gears a little bit, ESG is obviously top of mind for the general investing industry. And wanted to see how this factors into oil and gas investing and how ESG has, if at all, changed the landscape for oil and gas investing.
Michael Danov:
Yeah, unfortunately today, ESG has been a bull promotional market for the last 15 years. And it’s definitely diverted traditional equity investors today. The problem we have with ESG is that there’s good free cashflow companies, oil and gas, but today allocators unfortunately cannot buy traditional oil and gas companies or fossil fuels and have to steer focus on ESG. I personally don’t think that’s a way to look at it. Again, this is my opinion. I’m pro-ESG, the globe is getting warmer. Obviously, I think every oil and gas company will become utilities at some point in the future. But to replace oil and gas supply with traditionally ESG products, it’s not economic friendly to users today. What I mean by users, customers, and to investor base.
We have seen very little bit of success in the ESG space overall from the product and actually for consumer use. So, until that reflects differently, I think ESG still has a lot of years to prove that this is going to be a game changer. And once it replaces, it’s great. Look, we all pro it, but until then it’s not. We do have one investment in the clean coal tech space, not really oil and gas related. But that product, essentially the compound reduces the emissions and save energy in coal plants. We are actually investing that space as well again, because these companies are free cash flowing.
So, we looked a lot of the ESG tech. I think ESG tech components to make oil and gas company more efficient and sustainable, I’m pro that. But as a commodity replacing, I think we’re so far away from that until the financials actually make sense and become as mentioned, consumer friendly, investor friendly. And actually, these companies could become cashflow positives. Today, it’s very few that could do that, whether it’s solar, whether it’s power plants, whether it is wind farms, that have not been sufficient and they’re very expensive to build out. And the payback period is much longer than it is, and that’s why everybody’s going back to the traditional fossil fuels.
Elana Margulies-Snyderman:
Michael, I wanted to see what advice you have for other family offices, PE firms, hedge fund firms, other investment firms, who want to start their foray into investing in oil and gas.
Michael Danov:
Yeah. I mean it’s important that they have a team member or a partner or a founder that has experienced operational side of the business. It’s always hard to find both. We have background as family operationally and investment. I think the key component is don’t have formal investment when everything’s all time high, you start chasing those opportunities. I think it’s important that as an investor you have to find good management free cashflow assets and how they’re going to grow the business in the next five years. How is this scale going to happen? We are going to see more M&A happen in that space. So, you want to come in and take a look at that. But it’s important as a new investor, you get educated on the space, whatever it takes. You could start with the index funds, I think that’s one way to do it.
And at the same time, I think it’s important for the new investors to really understand how the ecosystem works. And if they don’t, I strongly recommend go to some analyst stores and check out operations, and to really understand that, because there’s so many ways you could invest in the oil and gas space from a different asset class. But until you fully understand operations of the business, I wouldn’t recommend. And it’s very cyclical, so you need to catch the cycles and oil and gas, whichever three years we have up and down, and the markets when companies over leverage. But it’s really tough to find those opportunities.
Elana Margulies-Snyderman:
Michael, we’ve covered a lot of ground today and wanted to see if you have any final thoughts or takeaways that you would like to share with us.
Michael Danov:
Yeah. I think it’s important as an investor, I think for us specific as a family office, we continue finding distress assets. We continue find opportunities. Look, we’re a very patient investor. We typically invest in companies when they trade 5, 10 cents on a dollar, or when they’re out of flavor in the markets. I think going forward in oil and gas, let’s continue that. We don’t think there’s value investing in US companies. I think LatAm, Middle East, Europe, Asia will see better growth and return on capital from that perspective. So, since it’s a very global brand, also the whole petrodollar is going to be interesting to see as China might take over the market share and the currencies might be traded in Yuan instead of dollar. And I think that could hurt the US dollar from that perspective and the petrodollar.
I mean that’s partially where we see the current political war and the bricks are teaming up versus us. So, it’s interesting to see what’s going to happen the next three, four years within the ecosystem. But oil and gas will play a big role, whether it’s the OPEC, whether it’s the Saudis, OPEC+, there’s going to be an interesting shift happening in the next three years and I think we’ll see more opportunities overseas than in US.
Elana Margulies-Snyderman:
Well, Michael, I wanted to thank you so much for sharing your perspective with our listeners.
Michael Danov:
My pleasure. Thank you for having me in, guys, and look forward to the next one.
Elana Margulies-Snyderman:
And thank you for watching. Visit eisneramper.com for more information on this and a host of other topics.
Transcribed by Rev.com
 
Solutions Insight: Video Series
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Elana Margulies-Snyderman
Elana Margulies-Snyderman is an investment industry reporter and writer who develops articles, opinion pieces and original research designed to help illuminate the most challenging issues confronting fund managers and executives.
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“EisnerAmper” is the brand name under which EisnerAmper LLP and Eisner Advisory Group LLC and its subsdiary entities provide professional services. EisnerAmper LLP and Eisner Advisory Group LLC (and its subsidiary entities) practice as an alternative practice structure in accordance with the AICPA Code of Professional Conduct and applicable law, regulations and professional standards. EisnerAmper LLP is a licensed independent CPA firm that provides attest services to its clients, and Eisner Advisory Group LLC and its subsidiary entities provide tax and business consulting services to their clients. Eisner Advisory Group LLC and its subsidiary entities are not licensed CPA firms. © 2023 Eisner Advisory Group LLC. All rights reserved.

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