COMMODITY INCOME
Figure 9: Black Gold– Reserves & Coverage Ratio
50,000 100,000 150,000 200,000 250,000 300,000 350,000
0 2012 Reserves (bbl) 2013 2014 Production (bbl) Source: Insch Capital Management
Figure 10: Black Gold – Return vs Risk (per annum) 15%
10% WTI Index Black Gold 5% DJCBP Index 0% 2015 2016 Coverage (RHS)) In a world that runs on oil
price will become the ultimate rationing agent
Shares are “callable” after 24 months at a 10% premium and if called, give a 2 year total return of 29%. By comparison, the current annual yield on AAA US corporate bonds with a 5 year maturity is 0.84% and on BBB bonds it is 5.82%. At the same time, the BG shares retain their
SPX Index -5% Annual Standard Deviation Source: Insch Capital Management
properties are fully enforceable under Canadian law. The reason for selecting Canada is simple: Rule of
Law. In a bond-like investment, the return of capital is an indispensable requirement, not a negotiable luxury. Estimated asset coverage is between 8 to 12 times with the investor having ‘straight- through’ security over the oil producing properties. By contrast, most recently issued bonds are effectively unsecured. Interest payments are only possible from corporate cash-flow. In the real world, coverage on
Footnotes
1 International Energy Agency, Oil Market Report, February 2013. 2 The “peak oil” theory is a logistic model first enunciated by Shell geologist Marion King Hubbert which states that any finite resource will at some point reach a level of maximum output, followed by an unrestable decline.
3 James D. Hamilton, University of California, San Diego, “Historical Oil Shocks”, Prepared for the Handbook of Major Events in Economic History.
4 According to S.D. Levitt and S.J. Dubner, “Super Freakonomics”, the discovery of petroleum may even have saved whales from extinction.
5 Kurtosis: a measure of the “peakedness” of a probability distribution. 6 Wall Street Journal, “Money Magic: Bonds Act Like Stocks”. 7 ISIN number VGG473431275 – Bloomberg Ticker BLCKGLD VI.
62 March 2013
initial purchase price and so their volatility is zero. As previously seen, this is very far from the case with bonds. These features – security over real assets, short duration, high cash distributions and no volatility – are features that will (sooner or later) be of immense value to both equity and bond investors. It may be that there are other, similar
structures available but the point is this: investors would do well to consider alternatives to both equities and bonds while they can.
These types of investments will be of substantial interest to investors who have previously only considered stocks and bonds
The fact is, oil (and other commodities) can be used
to produce high income, low/zero volatility investments that are truly backed by the underlying asset. This can be done without leverage and without the sleight-of- hand so often seen in derivative markets. These types of investments will be of substantial
interest to investors who have previously only considered stocks and bonds. •
Insch Capital Management SA (“Insch”) is a
privately owned alternative investment manager headquartered in Lugano, Switzerland.
www.inschinvest.com
10.5 11 11.5 12
9.5 10
8.5 9
8
small non-financial services companies A-rated bonds is only approximately 6.5 times. What this means is that in the event of a precipitous drop in oil or some other unforeseen disaster, the assets can be sold at ‘fire sale’ prices and the investor still made whole. Compare this to a bond default where bondholders often receive around 10 cents on the dollar. Distributions of 2.375% are made quarterly
providing an annualised return of not less than 9.5%. The income stream is comfortably covered as long as oil does not fall below approximately $66 for a protracted period.
Annual Return
Reserves
5%
10%
15%
20%
25%
30%
35%
40% Coverage Ratio
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