Wednesday, August 4, 2010

Ontario Teachers' Bets on Gulf Spill Driller

Karen Mazurkewich of the National Post reports, Teachers bets on Gulf spill driller:

Ontario Teachers’ Pension Fund has shown it is not squeamish when it comes to risky investing.

The pension fund has purchased a significant chunk of Transocean Ltd. the oil rig contractor involved in the explosion that led to the massive oil spill in the Gulf of Mexico, considered one of the worst environmental disasters in the history of the U.S.

Transocean’s shares have collapsed more than 40% from its US$92.3 high prior to the April 20 accident, and although the well has now been capped and its shares rose 6.3% Wednesday, the company is facing an uncertain future as it winds its way through numerous lawsuits and new restrictions on offshore drilling.

The negative outlook has not deterred the pension fund, which obviously sees blue skies in the future for the company stock. Sometime during the last quarter, Teachers bought 5.56 million shares of Transocean stock, giving it a 1.7% equity stake in the now notorious oil rig firm. At Wednesday’s closing price, Teachers equity stake in the company is estimated to be worth worth US$280-million.

Consensus among industry players is that Teachers concluded that while the Transocean will accrue hefty legal fees over the next few years, the company will be well insured for liabilities, according to Halifax-based Maritime law expert Wylie Spicer of McInnes Cooper.

As for the investment opportunity, “it’s an interesting buy,” said Andrew Parkinson, portfolio manager at Van Arbor Asset Management Ltd. in Vancouver. But a buy that comes with a “cloud hanging over it,” he adds.

If Teachers wanted to get into the oil services sector, which is currently down about 33%, then Transocean, which is down even more, is a cheap buy. But there is a catch. “It’s cheap because there is some potential for serious liabilities there,” said Mr. Parkinson.

At the best of times, this is a volatile sector within the energy sector. In making the purchase Teachers must believe that oil is a good buy at US$80 a barrel, and that the market will go up. In addition to betting on rising oil prices, the pension plan has probably calculated that Transocean is big enough to weather the storm, and dodge some of the liabilities, said Mr. Parkinson.

His view is echoed by John Tasdemir, energy analyst with Canaccord Genuity in Houston, who said many people now think that BP will assume the lion’s share of responsibility [for the oil spill], and there will be some contract protection for service providers.

Even if Teachers bet goes sour, the buy is “not too big” if you look at the overall assets-under-management the pension plan currently handles, added Mr. Parkinson. Teachers has already shown that it has a hefty appetite for offshore oil plays. In 2007, Teachers backed Brazil-based iron ore magnate Eike Batista in his bid to become the second-largest oil and gas company in Brazil, by fronting roughly $425-million in Batista’s company OGX Petroleo e Gas Participacoes SA, which won the right at auction to develop 21 offshore oil areas.

They are long-term holders so they can wait for the market to swing back, said Mr. Parkinson. “It may work out very well for them,” he added.

Teachers would not comment on the Transocean deal.

With a fleet of 139 mobile offshore drilling units and three ultra-deepwater units under construction, Transocean, Ltd. is the world’s largest offshore drilling contractor . The company’s market cap is US$17-billion, and its share price rallied 8% Wednesday on the news that BP has announced that it made a “significant milestone” in efforts to plug the leaking well.

Transocean also announced its second quarter results and reported a net income of US$715-million on revenues of US$2.5-billion, compared with US$806-million in income on revenues of US$2.9-billion for the quarter ending June 30, 2009. The quarter saw increased expenses associated with the oil spill of $82-million for the quarter due to increased insurance, legal costs, and investigation costs.

It's funny because today I commented on Zero Hedge that big hedge funds are also scooping up shares of Transocean (RIG). I was looking at the holdings of Tudor Investment on Tickerspy and noticed they hold Transocean shares (click image to enlarge):


So what? Who cares if some big hedge fund owns Transocean? Well, this isn't just any big hedge fund -- Tudor Investment Corp., run by legendary investor Paul Tudor Jones, is one of the best hedge funds in the world and if they're betting on Transocean shares, I can guarantee you they did their homework.

Looking at the chart of Transocean (RIG), you see a double-bottom recently formed and the price of shares has started moving back up over the 50-day moving average (click on image to enlarge):

And while Q2 profit came in lower than expected on Wednesday, the WSJ reports that its contract with oil giant BP PLC for use of the Deepwater Horizon drilling rig leaves it largely protected from lawsuits and claims for damage stemming from a deadly April explosion.

Does this mean Teachers made the right bet? Only time will tell, but what it shows me is that Teachers isn't scared of taking a significant opportunistic bet on a company that most US public pension funds wouldn't dare go overweight on, fearing "PR risk".

That's the problem with pension funds run by consultants or politicians with no money management experience (very common in the US). In order to make money in these markets, you have to be sharp, opportunistic and not be afraid of "PR risk". Your job is to make money taking calculated risks, not to worry about what the press will write about you for investing in a company involved with the Gulf oil disaster.

Sure there are risks, but Teachers and Tudor Investment aren't stupid. They figured that the reward outweighs the risk and decided to make the call. And Teachers can sit and wait out any short-term volatility. I predict they're going to make a killing on this investment.

***Feedback***

A senior pension officer shared this with me:

"A few years ago OTPP bought $1 billion of contracts which paid out if oil was above $100 in ten years time.The news is how these things work out, not just placing a bet. The follow through in the media is non-existent. It's not brave or clever to make a bet, it's the job."

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