First off, the U.S. market has changed a hell of a lot over the last 10 years. American shale producers really upended the traditional market by upping production in the face of lower prices. The method that unlocked all of this, as I'm sure everybody knows, is fracking, the method which involves drilling horizontally into shale formations -- shooting gas and liquid solutions into the rock at high pressure creates fractures, and the unlocked gas and oil is forced to the surface. We all know that this influx led to a crash in oil markets in 2014. Global oil and gas companies have cut expenditures about 40%. They cut almost 500,000 workers. It transformed the shape of the oil industry globally.
Crowe: Still is.
Priestley: Yes. So it's transformed. Why do you think the U.S. market is particularly ripe for investment?
Crowe: It's not just shale. This has been something about the United States market that has existed for decades. But one of the reasons you see the United States market take off with so many smaller companies, independent companies, something you don't see as much in Europe, Africa, and Asia, it has a lot to do with the regulatory framework we have here in the United States.
Let's start, obviously, with oil and gas. A great example is land rights. So in the United States of America, if you own a plot of land -- let's say I'm a farmer in Texas and I own 100 acres, maybe even more. And with oil and gas land rights, I own all the mineral rights that exist below my land. And so an oil company can come to me with a contract that says, "We will pay you X amount of dollars for us to be able to extract oil off of your land." Now, that isn't necessarily the case in a lot of other countries, especially in Europe, where mineral rights are not individual landowners' property. It's actually a negotiation between the state and the company itself.
So with that, you have the tendency, when something wants to happen like drilling in a particular area, there's a few more stakeholders that are involved that have a say in what happens, versus here in the United States, where that oil company can walk right up to that farmer, he signs the thing, and you can start drilling the next day if you really wanted to. So you have that speed that makes it a little bit easier. It facilitates growth in that sort of way.
Another thing you could also look at is the natural gas market by itself. Before we had oil coming from fracking, we had natural gas. And one of the reasons that was actually possible is that natural gas in the United States is actually traded as a commodity completely separate from oil, whereas, if you look at many other places around the world, it's linked in some sort of indexing relative to the price of oil. Typically, it's done on the energy equivalent, which, if I remember my math right, it's about six units of natural gas, which is 1,000 cubic feet of natural gas, is equivalent to one barrel of oil on a British thermal unit, or BTU, basis. On an energy equivalent, that's normally a multiplier that is given to natural gas, and that's how they set oil prices.
If you look at that, even today with oil at $50 a barrel, with that indexing in place, you're looking at $6.57 per thousand cubic feet of natural gas, compared to what the price is today. I haven't checked it this morning, my apologies, but it's somewhere from the $2.50-$3 range. So you can see right there, there's a massive arbitrage opportunity, in that when you have cheap natural gas, it makes people want to use it, and then obviously, more people are going to go drill for it.
Priestley: I think a lot of people don't consider those factors. The other thing you mentioned is, just, physically more, the number of opportunities. I think the entire market, correct me if I'm wrong, is heading toward more specialized, people with more expertise in different, subsea drilling or whatever it may be, and they're connecting up to form some kind of supply chain.
Crowe: Absolutely, especially when you look at something like shale drilling in the United States. Basically, a lot of the independent oil and gas producers that you have in the United States are going to be either land-based specialists or offshore specialists. A great example would be somebody like ConocoPhillips, or those larger independent oil and gas companies that we have. For years, they were diversified across several different production portfolios, where they had conventional, they had deepwater, they had shale. Most of them, in some way or another, have tried to orient themselves toward a specialty. EOG Resources is the best example of that, where they shed almost all of their offshore production capacity and went to a pure shale producer.
And the smaller you get, obviously, it's going to be harder and harder and harder to own multiple platforms of drilling, have multiple levels of expertise. So the smaller you get, you're obviously going to get your specialists. That also applies when you come to your oil-services companies, where you're going to get fracking specialists; they're going to get deepwater specialists. When you get that level of specificity, you're obviously going to get a much more diverse investment opportunity.
Priestley: Absolutely. We're going to talk a little bit about the complexity of investing in overseas energy companies. You've already touched on it, but we have some more points. The U.S. market looks solid. As we've discussed, there are some regulatory reasons, though it's hypercompetitive. But some of our listeners may not be in the U.S., as we talked about, and there may be some American investors looking for foreign opportunities in this segment. But what are some of the challenges in investing in overseas oil and gas?
Crowe: Well, obviously, aside from the market-based things of having to buy something over the counter on ADR or something like that, it depends on the markets. But one of the most obvious things that you see when it comes to investing in overseas opportunities is that a lot of times, a highly regulated industry such as oil and gas has a tendency to be much more closely tied with what the government wants it to do.
You don't have to look very far to see examples of this. You have Saudi Aramco in Saudi Arabia, you have Petrobras in Brazil, PEMEX in Mexico. These are companies that are these hybrids of publicly traded investments and state-owned companies, where they kind of have to be servants of two masters.
From a public investment side, you have to develop a rate of return. You actually have to make it worthwhile for shareholders to want to be involved with it. That normally means efficiency, low cost, things like that, whereas, on the state side, sometimes the objective may be a little different. It may be employment, things like that, or it may be producing more at a lower price just to make sure that the citizens of the country have adequate oil supply, when it may not necessarily be in the best interest of the business.
So when a company -- for example, Petrobras, or the upcoming Saudi Aramco IPO that's supposed to be happening -- we've been talking about it for several months, but now all of a sudden it's gotten very quiet, so it's hard to tell when that's going to happen. When those investments happen, you really have to wonder, what is management's true objective? And if it's not 100% aligned with shareholders, it's a little bit more difficult to have the confidence that, when they're making capital allocation decisions that it's going to be in your best interest as an investor.
That said, if you are looking to internationally diversify, you don't necessarily have to invest in companies that are outside the United States, because there are a lot of companies that are U.S.-based companies that are making their investments in the international markets. I think a great example of that is Cheniere Energy. They are the first company in the United States that's going to export liquefied natural gas from the United States. And even though they're looking to use that cheap natural gas from the United States as the opportunity, all of their growth and customer demand is coming from international markets. So their play is more on the growing demand for hydrocarbons and energy outside of the United States.
And there's a wide range of companies that you can look at, where you may be investing in an American market, but your clear objective is on an international customer base.
Priestley: Yeah, absolutely. You touched on the Saudi Aramco IPO, which possibly is going to be delayed until 2019 now. Just to give listeners an idea of this, they're selling a 5% stake. That's what they're floating. We don't know if it's going to be on the London Stock Exchange or New York Stock Exchange in addition to their domestic market.
Crowe: Yeah. The two exchanges seem to be doing this nice little waltz of "What can you give us to put us on your exchange?"
Priestley: Yeah. So they're hoping to raise $100 billion for 5%, which is just astronomical. The record at the minute has been for Alibaba, which was $25 billion. So we're talking about huge valuations here, primarily because of the issues that you raised, with the fact that it's a state-run organization, and they're looking to add to their income. So it's not necessarily geared toward what a traditional company model is that we expect. You mentioned companies that people can get into in the U.S. that gives them some exposure internationally. If you were to peg two or three of these, what would you give?
Crowe: I have three. I think one of them, some people will say I'm cheating because it's Canadian and not non-American. And they're even traded on the American exchange. But three companies that actually look pretty interesting to me that are non-U.S. companies working in the energy markets are Brookfield Renewable Partners (NYSE: BEP) -- they are a Canadian company that is a subsidiary of the larger Brookfield Asset Management (NYSE: BAM). They're one of the largest asset and hard asset managers in the world. This is a company that specifically works with renewable assets. Most of that today is hydroelectric power, with a little bit of wind power sprinkled in there as well. They're a very interesting company.
Instead, of a lot of these companies as of late that have been these renewable power holding companies, it's one of those things where everybody's looking at those to grow at double-digit clips quarter after quarter after quarter, and everything can be forgiven as long as you're growing really fast.
Brookfield has taken a very contrarian approach to this, where they basically look for distressed opportunities and try to invest when the market for a certain asset looks absolutely miserable. A great example of that was, I believe it was earlier this year or late last year, they purchased TerraForm Power and TerraForm Global, which were yieldco companies from the now-bankrupt SunEdison. They were two assets that were mostly utility-scale power generating facilities using solar power.
TerraForm Global has a much larger footprint internationally. They have a decent-sized footprint in India and China, whereas TerraForm Power is mostly United States-based. The idea here was, even though it was a relatively complex transaction, which, something a company only as large as Brookfield Asset Management and its subsidiaries could actually handle, it was an extremely distressed asset compared to the market rates that a lot of solar panel facilities are selling for today.
So you have examples like that. They were one of the ones that really jumped in on hydropower a few years ago when assets were selling for extremely cheap. By taking this distressed asset approach, they've been able to keep a much better balance sheet because their cost for acquisition is much lower than for other people, keeping an investment grade. And when you're getting a 5% dividend yield on something like that, it looks pretty attractive.
Another one I've looked at is Danish Company Vestas Wind Systems. Not on the American exchanges, with no ADR or anything like that. So if you're willing to go on to the Pink Sheets and go look for something as an American, Vestas is pretty interesting. Over the last three or four years, the company has done a rather remarkable turnaround. Previously, very low margins, wasn't doing that great. But at the same time, three or four years ago, wind power hadn't quite come into itself like it has over the past couple of years. Wind today is actually the lowest-cost option for power globally on a per-kilowatt-hour basis, based on research by a bank, Lazard, who does a study on this for the past few years.
And now that they are the lowest, you've seen an incredible growth for Vestas, not just in orders, revenue, but operating margins have grown to into the double-digit range. They're growing about $1.5 billion of free cash flow annually, and about 20% of their market cap in cash with a relatively low debt balance. So if you're looking for somebody in a high-growth industry that hasn't levered themselves to the hilt, I really like Vestas.
Last one. Anybody who heard me a couple of years ago, when I used to do this podcast pretty regularly, I recommended Total (NYSE: TOT) a lot, and I have no problem saying that again.
Priestley: Nope, I agree with you.
Crowe: They're one of the big five when it comes to integrated oil and gas companies. As of late, they went through this very opportunistic timing thing, where 2014-2016 was a period where they were bringing a lot of their new projects online, so their capital commitments were going down just as the market was starting to tank. So they weren't stuck trying to pay for all these projects, in comparison to somebody like Chevron, with their major Australian projects and things like that. So they were able to reduce capital expenditures without sacrificing a lot of growth. They've been able to grow oil production at a 5% to 9% clip over the past two years, while at the same time actually doing it profitably, which is something that's amazing over the past couple of years. It has become the highest rates of return on equity in the integrated oil and gas space as of late.
Sprinkle on that their investments in renewable energy. They own two-thirds of American solar-panel manufacturer SunPower. If you're looking for somebody in the oil and gas space to finally make that transition to other energy sources, I think Total looks like the best bet.
Priestley: Yeah, I agree with you. They've been in the press recently because they bought Maersk. Am I pronouncing that correctly?
Crowe: I've never figured that one out myself.
Priestley: I worked briefly in North Sea oil, and I know there was a mass exodus from the area, but Maersk actually has 80% of its production in North Sea. Now, obviously, they're realizing that they can extract profitably from the region. So it's interesting to see them double down on the region without hesitation -- $7.45 billion in that deal, including debt. And as you said, I completely agree, I think they can withstand lower oil and gas prices for a longer period of time, and that's really been their strategy, and they've delivered on that.
Crowe: Yeah. It's interesting to see them making these big acquisitions now, because there was always this talk, let's say 2015, when oil prices were starting to decline, where analysts and Wall Street, people were always saying, "Why aren't the big integrated oil and gas companies going out and spending money? Why aren't they making those acquisitions, the consolidation in the market that so many were expecting?" And if you looked at Total, they were like, "We're just going to keep things quiet for a little while. We're going to not take on too much debt. We want to basically get what we have done."
And now that they're in a position that the oil price has steadied right around $50, they have been able to generate a decent return and get in a relatively comfortable debt range, now they're like, "OK, let's open up the checkbook while the asset prices around the world are still relatively low." It's a great opportunistic buy that, if anybody has been watching the oil market over the past several years, it's like, yeah, it's a really good time to be buying.
Priestley: Yeah, absolutely. Interesting, what you were talking about earlier, about the regulatory issues and tax issues in Europe and other parts of the world not being as favorable. I know that the refining, which they've pared back recently, is actually one of the least profitable areas of the market for them compared to their peers, when conversely, their upstream is one of the best, as you said. They also hold 19% interest in Russian oil company Novatek, if anybody is interested in more international exposure.
So, that's wonderful. Thank you very much. I love your recommendations. Brookfield, I think, is a great company. One thing to consider with them is that 90% of their portfolio has an average contract time of 17 years left. So people complain about their payout ratio being high, but...
Crowe: When your revenue is contracted that far out, why not?
Priestley: Exactly. There's not many companies that can boast that. So thank you so much, Taylor. Anything else left to add?
Crowe: No, I think I'm good. Taylor is on the show so often --
Priestley: I know, I'm so sorry.
Crowe: -- I think when Sean was hosting the program, I think he confused us at least once a month. So this isn't the first time.
Priestley: I'm on par. [laughs] Well, thank you very much, Tyler. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. To get in touch, please feel free to email us at industryfocus@fool.com or tweet us at @MFIndustryFocus. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear.For Tyler, I'm Sarah Priestley. Thanks for listening, and Fool on!
Sarah Priestley has no position in any of the stocks mentioned. Tyler Crowe owns shares of Brookfield Asset Management and Total. The Motley Fool recommends Chevron and Total. The Motley Fool has a disclosure policy.
